Consideration of a Possible Public Private Partnership for a Municipal Fiber Network Utility

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1 TO: FROM: SUBJECT: Kent Studebaker, Mayor Members of the City Council Scott Lazenby, City Manager Consideration of a Possible Public Private Partnership for a Municipal Fiber Network Utility DATE: March 3, 2015 ACTION Provide direction to staff on the future of broadband utility services in Lake Oswego. RECOMMENDATION Staff recommends that the City of Lake Oswego seek an agreement with a private partner to provide last mile fiber to the premises (FTTP) broadband connections to homes and businesses in Lake Oswego. Key elements of this recommendation include: 1. The up front financing, build out, and operation of the fiber network would be done by the private partner, under contract with the city. 2. As with our other municipal utilities, it would be operated as a fee supported selfsustaining enterprise, and branded as a City of Lake Oswego utility. 3. It would be a true open network. At the most basic level, it would provide dark fiber access to homes and businesses, and any content provider (Comcast, Century Link, Frontier, Google, or any other) could market their services (voice over IP, digital video, Internet access) directly to residents and businesses using the city s fiber network. 4. The city would also make available, at cost and at the customer s option, basic Internet access (e.g., 100 megabits per second and gigabit options), but no other digital services. INTRODUCTION/BACKGROUND Resolution 14 33, adopted by the City Council on June 3, 2014, states It is the policy of the City Council of the City of Lake Oswego to support the construction or expansion of state of the art, fiber to the home broadband service within the City of Lake Oswego.

2 Without taking a more pro active approach, Lake Oswego faces two possible futures for fiber broadband service: Page 2 1. Monopoly. In this future, which is the more likely of the two, a single large corporation will emerge as the dominant provider of FTTP broadband utility service in all or parts of the city. Google, Comcast, and Century Link have all talked about building FTTP networks in the city. Frontier (formerly Verizon) already has some FTTP service in place on the west end of the city. It is likely that the first utility to install FTTP infrastructure will be the only one to do so, since the risk and uncertain return for another company to over build the first company s network would not make business sense. This is exactly what has happened with coaxial cable (i.e., cable TV) networks: even though most cities cable franchises are non exclusive, as a practical matter no other cable company invests in a community once an existing coax network has been built. As a result, the first company into a neighborhood will be in a monopoly position; initially with respect to fiber Internet service, and ultimately with respect to any kind of non mobile communication since no other technology can compete with the bandwidth of light in fiber optic strands. There are two major problems with the monopoly future. The first is monopoly pricing. Monopolies simply charge what the market can bear. In economic terms, they will raise the cost of their service until price elasticity reaches one; that is, the point at which a 1% increase in cost will drive away enough customers so that total revenue drops by more than 1%. This graph shows it best:

3 Municipal utilities, on the other hand, set prices equal to the average cost of service, which is typically far below the monopoly price. Monopoly pricing makes people pay more than they should, and it drives away the customers who are most sensitive to prices. Page 3 For some monopolies like electricity, the government (Public Utility Commission) goes through the motions of rate regulation, but it isn t usually effective because the PUC really can t figure out what the true average cost is, and the regulators have a hard time being objective about the people they are supposed to regulate. And due to their political power in the US, the big telecom monopolies have preempted rate regulation for Internet service, including the last mile utility service. The second problem with the monopoly future is control over content. In the long run, the money (profit) will be in content, not just the utility service. It s no accident that Comcast owns NBC. There is talk about national legislation that would force net neutrality and open access on the telecom monopolies, but if you follow the money on political contributions, this will be a token effort at best. The problem with giving a monopoly control over content is that our residents and businesses have limited choices and pay too much for the services they get through the Internet. 2. Oligopoly, or Who s tearing up my street this time? In this future, several companies build independent, redundant fiber networks, with multiple fiber connections to each home or business. There are three main problems with this future. First, it s a waste of money. If there are three overlapping, redundant fiber networks in Lake Oswego, one way or another our residents and businesses will end up paying for three sets of infrastructure when they only need one. This would make no more sense than paying for three completely redundant sets of water pipes to each home, or three sets of local streets to each driveway. Second, it would cause unnecessary disruption to neighborhoods during construction, and fill our rights of way with redundant cables, conduit, vaults and pedestals. Third, while it would appear to offer the advantages of competition, in situations where a small number of companies dominate a market (an oligopoly), it s common to see price fixing even if it is done informally rather than through direct communication as in a cartel. Because of the barrier to entry (the high cost of building a redundant network), it would be impossible to create a truly competitive environment.

4 Page 4 ALTERNATIVES Public Private Partnership The alternative I recommend is to contract with another entity (private or public) to build and operate the network. Until now, this has not been very common. There have been relatively few companies with the necessary capacity and experience. With fiber networks becoming more widespread, there are now a number of construction companies that have gained the expertise to design and build the systems. They often have access to financing that is more than adequate to cover the costs of the networks. Some smaller ISPs, like Hillsboro based FiberSphere, have seen the writing on the wall and are willing to build and manage the systems like a utility. Clackamas County and the Clackamas County Educational Service District use a combination of contracted and directly managed fiber services. PGE operates a fiber network as part of the management of their electric distribution system, owns most of the poles that would be used in the older sections of the city, and could be a potential partner. A contract could work like this: the city would issue a Request for Proposals, inviting companies or other potential partners to propose a fixed monthly cost per connection to build and operate the network. The city would then enter into a long term service contract that would allow the company to amortize its investment. Within this overall framework, there are several options the city could consider: A turnkey approach, where the city manages the agreement and allows the company to market the service under the city s brand, but is otherwise not involved in providing the service. A hybrid where the company builds and operates the network, but the city handles functions such as utility billing, marketing, Internet access contracts, etc. A further hybrid approach where one company finances and builds the network, and the city contracts with another company or organization for operation of the network (this probably offers the lowest cost to residents and businesses of the three options). Standard City Utility Another alternative would be for the city to provide last mile broadband access as a municipal utility. In Oregon, this has been done by Ashland (using older coax technology), Cottage Grove (using a WiFi mesh), and Monmouth, Independence, and Sandy (all using fiber networks). Hillsboro is now considering a municipal fiber utility. Sherwood has operated a broadband utility for over a decade, with a network of approximately 100 miles of fiber optic cable. Clackamas County has built and operates a fiber backbone that serves as a data superhighway between the cities in the county.

5 Page 5 Advantages of a city operated utility: It would offer the lowest cost for residents and businesses, for a variety of reasons (lack of the need to produce a profit for owners, fewer taxes, lower cost of borrowing, and often lower overhead costs) It would provide more control by the community and the City Council. There are some disadvantages, but the primary one is current lack of organizational capacity. We are still in the middle of the Lake Oswego Tigard Water Partnership project, and will soon be embarking on the Boones Ferry project in Lake Grove. Managing and building out a fiber network, while not overly complicated, would consume a fair amount of staff resources that could probably be better spent in other areas. Another disadvantage is the need to finance a city operated utility. For an established utility, this would be no problem, but without a financial track record, it could be difficult to issue revenue bonds. Even though they are separate enterprises with solid customer bases, the outstanding debt in the water and sewer utilities is relatively high due to recent projects and some members of the community feel that the city should limit additional debt. DISCUSSION Some of the pros and cons of taking a more active approach to a community owned FTTP utility: Pros Many of our residents expressed interest in getting access to reliable and very fast Internet service that could have been provided by Google s network; every indication is that our community is highly receptive to the kind of broadband service a fiber network can provide. Such a network can be an outstanding economic development tool, for businesses ranging to the high value added offices in the Kruse Way corridor, to the many professionals who do all or some of their work from home. We have a great deal of staff expertise in this area, and are in a better position than most cities to pursue it. I have had fifteen year experience managing a municipal ISP, including the design and financing of a fiber to the premises network. Chip Larouche is widely regarded as one of the best IT directors in the region, and his staff has built and operates a fiber network for city use. Jordan Wheeler has extensive experience and knowledge in franchise and broadband issues. David Kudna and his colleagues in Engineering (including GIS) worked closely with Google in their exploration of fiber service; much of the information they produced could be useful in a Request for Proposals. We maintain high standards for customer service in the provision of utility services. People may complain about their water and sewer bills, but they would much rather deal with our staff on a billing or service issue than the phone or cable company.

6 Page 6 Cons Even with all the money spent on political campaigns by the telecom monopolies, the federal government is finally admitting that last mile fiber based broadband service really is a utility. A municipal broadband utility could link most of the homes in the LOSD to the district s network, providing future educational opportunities that we probably can t imagine today. We can learn from recent experience from other cities in Oregon and other states, and possibly partner with other cities. The timing is good: while some telecom companies have considered installing a fiber network in Lake Oswego, none have yet committed. Costs for fiber related equipment are at an all time low. For example, the cost of each Optical Network Terminal (the box that needs to be installed in each home to convert the light signal to an electrical signal) was over $1,000 when Monmouth and Independence built their initial systems; the cost is now below $100. To put this in perspective, if all of our homes were served, it represents a savings of over $11 million. The proposal is for a truly open network, where the incumbent telecom providers would be invited to use the network (at no cost except for direct costs such as rack space in the network hub) to offer digital services to Lake Oswego homes and businesses. Nonetheless, they will probably oppose the concept because they would prefer to extract monopoly prices from subscribers, and control subscribers access to content. We have a lot on our plate in other utility projects. A public/private partnership would, however, shift much of the administrative burden to the private partner. Installation of a fiber network will, like other public works projects, be disruptive. But given the advantages of a network that uses the bandwidth of the light spectrum, such a network is inevitable. If done through a contract with the city, the city will have more control over the impact on the community. NEXT STEPS If the City Council is receptive to this concept, the next step would be to draft a Request for Proposals for a private (or possibly public) partner. This will take some work, since the more information we can provide (and the more we can reduce risk and uncertainty), the better the proposals will be. In preparing the RFP, we can get advice from other cities, and from firms currently building fiber networks. The RFP could be a two step process, where we first seek general statements of interest from potential partners, and then seek detailed proposals from a smaller number of firms or organizations. Before issuing an RFP, we will need Council direction on some of the service options, as noted above.

7 Page 7 Our community survey, scheduled for this spring, would give us an opportunity to estimate the take rate for a broadband utility. There would be no commitment from the city until and unless the City Council awards a long term contract with the private partner(s). The RFP process will, however, consume some staff time and possibly incur some costs for outside expert advice.