Internet users can be so demanding. They want blazing fast connections to the Web, and if they don't get it at the right price, they'll switch providers in less time than it takes to download the latest viral video.
That challenge is hitting home in a big way for Verizon Communications (VZ), now under fire from consumer groups and scrutiny by the Federal Communications Commission for certain fees included on Internet customer bills. The flap underscores the challenges facing phone companies as they strive to wring profit from broadband businesses while keeping customers from opting for comparable services provided by cable companies.
Verizon and rivals such as BellSouth (BLS) had an opportunity to reduce phone bills when the government did away with fees charged to phone companies that had been intended to subsidize phone service in rural and other hard-to-serve areas. A year ago, the FCC said it would phase out the "Universal Service Fund" charge for providers of wireline broadband because it hampered the telecom industry's ability to compete with cable providers, which do not pay such subsidies. The government officially stopped assessing the fee, typically passed onto consumer bills, this August.
DIGGING IN. But BellSouth and Verizon customers didn't immediately get the hoped-for relief. Consumer groups complained that the telecommunications giants were unfairly raising fees by refusing to pass on their savings to consumers. Jason Oxman, a spokesman for the Competition Coalition, says that the FCC took away the fee with the expectation that it would allow Verizon and BellSouth to offer more competitive prices, not keep them the same.
BellSouth relented, hoping for smooth regulatory sailing for its planned takeover by AT&T (T) (see BusinessWeek.com, 3/7/06, "Is Verizon Heading South?"). The company dropped a $2.97 monthly fee for high-speed Internet. "Approval of the merger with AT&T is extremely important to us, and we wanted to remove any distraction that this charge might have associated with it," says BellSouth spokesman Joe Chandler.
Verizon dug in. The company says it would have raised prices if it hadn't gotten the regulatory relief, so the elimination of the USF fees lets it keep prices pretty much unchanged. Verizon prices DSL service competitively, hoping to recoup costs with other products, such as phone and TV services, says spokesman Eric Rabe. Verizon profits more from customers who subscribe to two or more of its services because each additional connection only adds marginally to the cost of supplying an original phone line.
SPREADING THE PAIN. The trouble is, many customers are opting for "naked" DSL, or standalone broadband. "The revenue from phone service helps pay for that DSL line," says Rabe. "That revenue goes away when a DSL customer decides that they just want a cell phone (and disconnects their phone service). Now we have all of that cost for that line only offset by the DSL service."
So Verizon opted to spread the added cost of the DSL-only subscribers over the entire Internet customer base by appending a monthly fee of up to $2.70 to all Internet customers' bills, even those who also buy phone or television service through Verizon. "We didn't want to make DSL service for those who don't take phone lines prohibitively expensive," Rabe explains. In other words, Verizon didn't want to lose customers to cable services such as Time Warner's RoadRunner (TWX) by making it extra expensive to subscribe to only to its Internet service.
High-speed Internet is a big and growing business at Verizon—key for a company that's losing phone subscribers in droves to cable operators and competing technologies (see BusinessWeek.com, 8/1/06, "Verizon, Vonage Fight Off Cable's Threat"). The company added 440,000 new broadband connections in the second quarter of 2006, for a total of 6.1 million broadband subscribers. That helped boost revenue from data services 89.8% from a year earlier.
INCREASED DEMANDS. But growth like that comes at a cost, and Verizon is spending billions on a network that will deliver even faster forms of Internet access, as well as TV services. As Internet users have begun to demand more and more data—in the form of streaming video, social networking and messaging, and multimedia downloads—providing Internet service to the same customer base has become more costly, says American Technology Research analyst Albert Lin. "All the service providers are stuck in this conundrum of what do you do to satisfy consumers," Lin says. "Consumers…are expecting to get more for their money over time. But the way consumers are spending time on the Internet demands more from the network."
Despite the increased service demand, however, competition with cable companies, municipal Wi-Fi networks, wireless carriers, and others has kept telecommunications companies from increasing prices, Lin says. And if consumers and the FCC have their way, the elimination of the USF fees will mean price cuts, too.