Searching For An Oracle:

2001 MDU Market Predictions

By Larry Kessler , InteliCable

 

Technology has always reflected and shaped human history. From hunting and gathering cultures, to the development of sailing ships and automobiles, to space flight, to computers and the Internet, history and technology have been integral with one another. The role and function of specific technologies are the subject of man’s never ending quest to achieve more, travel farther and ultimately, to make life more convenient. The rising demand for state-of-the-art digital video and high-speed Internet services in the MDU environment is about accessing technology to achieve these same goals.

 

Logic Dictates

There are essentially two approaches to making predictions about the future. The non-analytical approach is to say no one can possibly determine the future, since in the future everything is happening each time, for the first time, for the only time. The more analytical and logical approach is to say that predictions of the future are simply projections of the present. This approach provides for a more thorough understanding on how to prepare for critical business decisions during 2001. By understanding both the present and very recent past, it becomes an easier task to predict both the obstacles and opportunities presented in the residential multi dwelling unit (MDU), digital video, high-speed data, voice and in general the broadband industries.

 

The Next 30 Days

Navigating through any business environment is a daunting task unless an oracle, a source of knowledge, information and wisdom can be found. Whether you hire a Tibetan sherpa to trek the Himalayan mountains in search of a prophet or turn to careful research and analysis of the current marketplace, consider the next 30 days to be an important time for any telecommunications and technology service provider. It is an important time to assess when and how circumstances will most likely affect critical business decisions for operating in the MDU marketplace during 2001.

 

As there is little logic in discussing the nuances of creating new business plans given the absence of fluid capital investment, attention is instead given to the constant adjustments appearing likely for strengthening a company’s current positions. A specific focus is on the financial and operational requirements of achieving a high level of customer service, superior technical performance, while at the same time achieving both financial and operational efficiency. While earnings will always play the largest part of a lender or investor’s decision to continue making investments into the private operator industry, earnings are simply a by product of customer service and technical performance. Without these, without expending the effort required to make these remarkable, there is no long term earning potential for private system operators in the MDU marketplace. As such, there will be no long term access to operational capital. It is the lack of access to capital that is playing a role in eroding the faith of MDU property owners. Owners are beginning to better understand the correlation between an operator’s current and future levels of access to capital and their performance. Throughout 2001, system operators providing voice, video or data services should expect more in-depth inquiries of financial status by property owners.

 

Here To Stay

Implementing the analysis that predictions of the future are simply projections of the present, it is prudent to consider the multiple factors involved with current issues driving the digital video, broadband Internet, telephony and MDU industries.

Communications technology is integrated into nearly every segment of our daily lives. We awaken to technology each morning. We drive it, call on it from our cars and purchase products with it. Simply stated, technology is everywhere. And research shows that our willingness to adapt to new technologies increases its pace with each new technological development. This is particularly true with communication and entertainment technologies, which today are the television, telephone, computer and the Internet.

To reach 50 million Americans it took 80 years for telephone, 40 years for radio, 20 years for television, 5 years for cellular phone and 2 years for the Internet. These are important facts, as current research repeatedly shows that as a communication and or entertainment technology becomes more widely available, it is more rapidly in demand. This simple fact is driving the current frenzy of demand among property owners to provide their residents with the broadband services of digital video and high-speed Internet access.

 

Digital Video

Classically revisited, this subject has become a virtual clash of the Titans. Once believed to be nothing more than the result of over active imaginations, channels with 24 hour news programs, sports programs, cooking channels, gardening channels and even channels that do nothing but talk about other channels abound with success. Not so long ago, state-of-the-art programming included HBO and 12 additional channels. Today, the choice of programming is overwhelming. And with technology to do what technology does best, continuous evolution, changes in the quality and quantity of video programming continue to sky rocket. By example, many cable channels are broadcasting in digital. In short, they are giving us better pictures and higher sound quality. This fact has set a sequence of events into motion that directly impacts MDU property owners and private system operators.

 

Pressure To Perform

As a part of the 1996 Telecommunications Act, the Federal Communications Commission (FCC) issued an order requiring that all programming broadcasters have until 2006 to deliver their signal to American viewers digitally. Of course, this has set into motion a chain of events that ends with the consumer.

By broadcasters transmitting their product digitally, television manufacturers are working to produce digital ready televisions. But with their price point of still being far out of reach for most consumers, the reality of a high percentage of households owning such a TV is expected to be 5-8 years away. As such, set-top box manufacturers are stepping up to the plate with seemingly endless budgets for product research and development. These two occurrences create pressure for franchise cable operators to upgrade aging cable systems, making them capable of transmitting this new digital product. But at the same time, they are upgrading their systems for two-way, high-speed Internet access for head-to-head competition with the local Bell company. In part, it is the pressure of being able to become "digital" that is driving franchise cable to become a formidable product for MDU residents, making them a more formidable competitor for private system operators. But the pressure to perform for franchise cable is not just prompted by these changes.

 

Enter DBS.

The big players, DirecTV and EchoStar arrived on the scene early to transmit sights and sounds digitally. Like fuel to a fire, the arrival of these companies and their products became the catalyst for a pace of change never before seen within the franchise cable industry. The DBS companies were also the first to begin working with private system operators and MDU property owners for the delivery of a wider programming selection, in digital. At first, they seemed to be the solution both private operators and property owners were looking for when searching for an alternative to the local franchise cable operator. However, it soon became evident that this was oftentimes proven to be more of a cancer than a cure.

 

Sharks or Saviors?

The MDU industry in general now understands that DirecTV was a key force in convincing the FCC that property owners should be forced into allowing residents to install satellite dishes on the property. Violating every premise of the Fifth Amendment to the U.S. Constitution, the DBS giant was successful in accomplishing its goals. And while this has surely resulted in at least a slight increase in the size of DirecTV’s customer base, its efforts have ultimately resulted in property damage and a number of expensive legal battles between property owners and residents, as well as the MDU industry at large with its current legal battle challenging the FCC’s decision. At the time this article went to press, each of the MDU industry trade organizations have jointly filed a lawsuit challenging the FCC’s authority to make such a Ruling.

But what has incensed property owners during the past 24 months is that while attacking MDU owners with one hand, DirecTV is working to gain favor with owners by using small, frequently under trained, under experienced and under funded system operators to bring their product onto MDU properties. Presenting DirecTV’s high profiled marketing materials, perhaps some of the best in the business, many owner’s do not understand that it is not

DirecTV with whom they are doing business, but the often times small company offering to solve the properties video solution problems by simply "installing a single, small dish on each building." Most of these operators understand very little of the financial, technical and human resource commitment to serving MDU residents.

Through their system operator program, DirecTV has allowed so many operators to resell their product that one MDU property can receive multiple proposals for a single project. In most cases, these operators are under experienced and under trained in the MDU marketplace. These system operators are typically not cut of the same cloth as the traditional Private Cable Operators who have been in the trenches with MDU industry for the past several years. The net effect of this approach by DirecTV has been to not only banish a number of these neophyte system operators into financial oblivion, it has created some of the greatest customer service travesties seen to date in the MDU marketplace.

 

The DBS Horizon

In 2001 expect to see the MDU industry respond to DirecTV first, through its current case to overturn the FCC ruling of nearly two years ago. Secondly, expect to see owners working with only a select group of private system operators using DirecTV as their source of video programming. One such company that will continue to gain significant favor among owners, given their current records of performance during 2000 is DirectDigital.

Also in 2001, expect to see WSNet rise in popularity with both MDU property owners and private system operators seeking digital video programming from sources other than DirecTV, EchoStar or the local franchise cable operator. Moving forward with bold initiatives in education, training and product development, WSNet is poised to fill the void DirecTV has never seemed able to fill. Unlike DirecTV, WSNet has been well grounded in the MDU marketplace for several years. However, their approach to using the experience will most likely prove to be the key element in determining their success or failure during 2001.

As a brand name, expect to see WSNet continue growing as it continues to become a fixture with a number of MDU industry events (a key element of gaining entry into this traditionally conservative marketplace). However, expect to see EchoStar (DISH) also continue in its quest to answer the call for private digital video services through companies such as Castle Cable. Castle Cable is one of the leading Private Broadband Operators achieving significant success with the DBS product.

 

High Speed Internet

Even into the fourth quarter of 2000, industry experts embraced the analysis that demand for high-speed Internet access was virtually limitless. However, these same experts now realize that the rush to satisfy the demand has generated a large amount of over capacity in various parts of the system. This has resulted in companies having to dramatically lower their prices in order to gain access to newcomers seeking access as well as to steal away customers from the competition. The end result is lower profit margins met with plummeting stock prices. This leads to layoffs and other cutbacks that ultimately put a severe strain on quality customer service, the one fact of high-speed Internet access that MDU residents do not tolerate well.

In 2001, more MDU residents will seek to benefit from the new Digital Subscriber Lines (DSL) which will cost little more than a telephone line, but act as a high-speed Internet line and a telephone or fax line simultaneously. Most research studies show higher penetration for DSL services rather than cable modem services. However, cable modem service through franchise cable operators is expected to break previous records, every quarter during 2001.

DSL connects users to the Internet at speeds much faster than the fastest PC modems, meaning that download times will be tremendously short. This service will largely be provided by the local Bell companies (Southwestern Bell, Bell South, Verizon, etc.). But DSL is also the principle technology used by companies specializing in providing high-speed Internet access to the MDU marketplace (BroadbandNow, Reflex, Darwin, Velocity).

High-speed access, coupled with faster, smarter PCs will also make video-conferencing finally work during 2001. As such, expect to see the demand for videoconferencing increase during 2001. But providing perhaps more impact on increasing the demand for broadband Internet access is a migration of the computer into the television.

 

TV + PC = ?

During 2000, both consumer electronics and computer industry trade shows abounded with new equipment to watch digital television, surf the Net and check e-mail at the same time. The year represented one of the most significant turning points in Internet history with the introduction of these technologies.

The end result of making the television and computer synonymous with one another is the reappearance of the set-top box (see Private & Wireless Broadband, September, Broadband 101: Digital Television). As it turns out, active adults age 45-60 are logging onto the Net in record numbers. During this past year, a study by the gurus at Media Matrix showed that this age group’s access to the Net grew 18.4%, a faster rate than any age group. Even more surprising is that this group stays online longer than their 18-24 year old counterparts, surfing longer and spending more money online. But given their lack of time, patience or interest (perhaps all three), they are willing to wrestle with learning about the Internet but not computers. Additionally, many parents of younger children are finding that allowing Internet access into the home through the television is a better way to control access. But perhaps the most compelling argument for the migration of the computer into the television through a set-top box is that even the cheapest televisions never crash or lock up, while even the most expensive computers still do.

Throughout 2001 expect to see more MDU residents responding to high profiled consumer marketing for these new services and devices, which of course means increasing the demand for access to greater bandwidth. The challenge for the property owner is who to select as the provider of this access. The challenge for private system operators is how to win this game on the Bell’s or franchise operator’s home turf.

 

The Net Generation

Children born between 1977 and 1999 have grown up with computers and technology and are referred to as the Net Generation. They have also grown up more self-confident, more pampered, more easily distracted, and less amenable to the business and family models of previous generations. They dislike long explanations and discussions and just want to move on. The World Wide Web and wireless technology provide them a perfect environment to pause just long enough to get a few bytes of information and then click onward. For an excellent book on N-Geners, check out Don Tapscott's Growing Up Digital. This is a good read for those who are interested in forecasting broadband service demands in the MDU environment, given the fact that the Net Generation demographic is now and will continue to be an increasing portion of the MDU resident population. As such, their demand for all things digital and broadband is high. Their tolerance for bad customer service low. It is here where the opportunity to achieve success as a private operator both begins and ends.

 

The P Generation

Some researchers have noticed subtle changes in children who are now between 6 and 12. Dubbed the P-Generation – after Pokemon - these children spend all their spare time playing the latest Nintendo games. P-Geners are different in their level of intense concentration on game playing to the exclusion of all outside stimuli. They play for hours and research has started to demonstrate that they maintain the style or personality they adopt in the game in real-life. These are the children of today’s MDU residents.

Both N- and P-Geners are wreaking havoc with the family structure. As doting parents allow their children to have every available technology, the children move into their own Techno-Cocoons and pull away from the family. Less communication, less discipline and simply less family are the consequences. In 2001 expect to see this become more prevalent as not only the children, but also their parents wrap themselves in their own cocoons. But as a matter of business, a very large business, it is the MDU owners and therefore the private operator’s job to provide these cocoons.

 

MDU Broadband Access

In 2001, the MDU industry will continue to see a showing of the big four, Darwin Networks, Reflex, BroadbandNow and CAIS through the first quarter. By the second quarter expect to see one of these companies forced to retreat from what was once considered a market with endless opportunity. Other less known service providers who can be expected to achieve success in the MDU market are companies such as HSI, Partners and Velocity.

 

Jumping Hurdles

As MDU owners are more aggressively approached by companies like AT&T with broadband service agreements encompassing all voice, video and data services, the ability to do business with these properties becomes an impossible task for private high-speed Internet service providers. The economics of providing this service are such that sharing penetration severely erodes the bottom line. Therefore, it is rarely a viable business model.

Additionally, as the Bell companies have become much more savvy to how these providers have managed to entrench themselves into the MDU marketplace, they too are pushing contracts onto property owners for the purpose of locking in exclusive marketing rights for local dial tone, long distance and high-speed Internet service. This is happening despite the fact that most of the Bells have many long roads to travel before they are capable of delivering the promises for high-speed Internet access. However, the fact remains that their latest approach in putting the cart before the horse with these marketing agreements is further tightening the marketplace for Private Broadband Operators.

It is important, however, to keep in perspective that the MDU market is extremely large and very poorly penetrated with digital video and high-speed Internet services, so far.

 

Standing Tall

During 2001, expect to see the private, high-speed Internet access service provider (the Private Broadband Operator) do little more than flinch at the competition. Time, and according to many industry experts, the future is on their side. The increasing demand for high-speed Internet access is now a foregone conclusion, particularly in the MDU environment. Also accepted is the fact that both franchise cable and local Bell companies will not be able to meet all of this demand as they also are not without troubles themselves.

Given the FCC’s Advanced Services Ruling forcing the Bells to open their networks to DSL competition, and what cable can expect in 2001 to be a similar FCC ruling forcing them to open their networks to cable modem competition, these telecom giants are feeling the pressure of Wall Street’s reaction to these regulations and their ailing bottom lines. The capital purse strings will be tight through at least the first and second quarters of 2001, as they were during the third and fourth quarters of 2000. If ever there was a time for Private Broadband Operators to see hope in the MDU market, it is now.

 

Making Repairs

In 2001, expect to see Private Broadband Operators such as Darwin, Reflex and BroadbandNow step back from the typical Real Estate Investment Trust (REIT) model of doing business. While entering into service agreements with REITs has decided advantages, the balance of equity and efficiency are traditionally tipped in favor of the REIT. Unfortunately, this has brought financial hardship to many private operators of all services. The business model of "you pay for everything, install everything, operate everything at your expense and provide me with a lucrative revenue share," has forced a number of operators out of business. The end result of this is angry residents who are receiving poor service for the period leading up to the operators financial collapse. Fortunately, both system operators and property owners are becoming increasingly aware of these issues. The simple fact is that the demand for bandwidth from MDU residents is a very real thing. But the cost of providing this service under current business practices is too high for sustaining a long term, viable return on investment.

During 2001, MDU owners can expect to see more residents making leasing decisions based on the access to high-speed Internet service. As such, Private Broadband Operators not capable of helping the MDU owner meet this demand can expect a swift escort from several potential deals. Expect to see the winners of this game be those who are smart and gorilla warfare like in their approach in determining which markets and which properties to become partners with. These warriors understand well that they are competing with franchise cable, the local Bells and certain national companies who are getting their act together, offering promises of easier access and competitive pricing.

 

For Property Owners

During 2001, property owners should expect to see Private Broadband Operators requiring more financial participation than in the past. The going forward business model for most service providers is going to be various forms of the joint venture with property owners. Without this, they will find it difficult to maintain long term viability. The other financial model that will prove successful for both property owners and system operators is for the property owner to install the wiring infrastructure, leasing this to a high-speed data provider. This will increase the pace with which services can be deployed, as well as provide the owner with a source of income sufficient to schedule a payback of the installation in a relatively short period of time. However, it will be incumbent upon owners to develop contract language and negotiation strategies that will protect their investment, facilitate service to the resident and provide adequate equity for the provider to guarantee their long term presence.

 

This evolution of the high-speed data service model will increasingly require property owners to begin adopting the mindset that high-speed Internet access is as a necessary of an amenity as a laundry center rather than a source of income, at least for now. Most experts agree that the source of ancillary income will come from products and services offered online rather than through revenue sharing from monthly access fees paid by residents. But this should not be expected to take place on a measurable scale for at least 2-5 years.

Owners should continue expecting to see deadlines for the installation of service pass without success, sometimes with a 60-120 day variation. Contributing factors such as regulations, blatant obstruction by local Bell companies, the shortage of a work force and tighter requirements on capital expenditures will continue to be a problem for all providers of broadband services. As such, the best solution for owners still desirous of acquiring these services will need to consider playing a larger role in facilitating broadband Internet access. This approach is helping many owners clear some of the hurdles for getting this service to residents.

 

For System Operators

During 2001, providers of high-speed Internet access should expect to see greater difficulty in either acquiring access to new capital or getting existing capital released by investors or lenders. Slow to understand the market, the money end of this business is finally calling attention to the bottom line of today rather than yesterday, as was once the case. Evaluating the failures and successes of previous private cable operators will aid in better understanding how the MDU marketplace and the business models required to operate in this environment achieve failure or success.

 

Operators should expect to encounter increasing skepticism from MDU owners during 2001, as 2000 left many in the MDU industry talking about failures to deploy on schedule and customer service complaints from residents. In general, this skepticism is the result of many factors. The most blameful of these results from an over selling and under delivering of the product. Either through the efforts of company policy or overzealous salesmanship, many owners during 2000 were led to expect results that are almost impossible to achieve.

 

Operators will be forced to call attention to this issue throughout 2001.

Since the largest and most high profiled MDU companies were aggressively approached with service and easement agreements first, at times with the siren calls of stock options for IPOs that have yet come to fruition, the failed profile of some broadband promises is high. When placed in concert with the fact that a number of MDU property owners see little logic in financially participating in the cost of bringing broadband service to fruition, given that such service will eventually be delivered by the cable, phone, satellite or local ISP industries, the MDU market can be seen as a harder place to do business during 2001. But operators should do little more than respond to these challenges by heading into the locker room and making some game time adjustments (see Private & Wireless Broadband, September, Broadband 101: High Speed

Internet).

 

A Dose of Reality

During 2001, providers of high-speed Internet access can expect to be given a rare second chance to perform. This is an opportunity that their earlier private cable counter parts have typically not received. The reason being, AT&T, WorldCom, Sprint and many others have all but abandoned the residential marketplace in search of the gold mine hidden within the business customer world. Additionally, franchise cable and the Bell companies continue to experience difficulty in widely deploying these services, particularly since their capital flow is slowing as a result of recent stock market performance. This leaves MDU owners faced with what is becoming a minor crisis, the need to provide a connection to the broadband world for residents.

 

Providers should also expect to see an increasing willingness among several owners to consider financially participating in bringing access to residents. This will be particularly true if greater efforts are made on the part of the system operator and equipment manufacturer industry to provide more education on the nuances of what it takes to provide these services and what can truly be expected.

For the traditional, video only Private Cable Operator seeking to become the new breed of Private Broadband Operator, it will be necessary to evaluate which options best suit your business plan. During 2001, the decision on how to provide service will be between purchasing wholesale bandwidth for distribution over existing cable plant, or entering into strategic alliances with those who are already in the process of perfecting the science of providing broadband Internet service in the MDU environment.

 

The Demand

MDU owners are increasingly faced with residents basing rental decisions on whether or not high-speed Internet access is available. This can be expected to become a more critical issues during 2001. As a consumer, the MDU resident is simply reflective of the general trends recently reported.

 

Cahners In-Stat Group is reporting on broadband access trends in a study entitled, "Broadband Consumers - Profiles and Strategies." Their research explores the U.S. broadband Internet access market, providing market forecasts, demographics, online user habits, and strategies for increasing the customer base. It indicates that approximately 9 percent of U.S. household are currently using some form of broadband Internet access service, with DSL and cable being the two most common forms. It also projects that the number of cable modem and DSL subs will increase 77 percent between 1999 and 2004, with service revenues growing from $1 billion last year to $13.3 billion in 2004. The research goes on to specify that 65 percent of broadband consumers are between the ages of 25 to 44 and have a four year degree, 40 percent are single and 50 percent have an annual household income of at least $50K. When paralleled with MDU industry studies on resident demographics, each lender, investor, property owner and service provider can conclude that the ball is rolling down the hill and there is nothing to stop it.

 

The MDU Industry

The United States apartment vacancy rate continues to decrease in professionally managed apartments. The filing of permits for new construction showed slowing during the fourth quarter of 2000, a trend that can be expected to continue in 2001. However, the completion of existing projects started 12-16 months earlier were up at the end of 2000. For private operators, these facts offer the suggestion that the market is still growing, albeit somewhat more slowly. But more importantly, the opportunity for increasing revenues continues to grow as the occupancy rates of apartments are continuing to steadily increase.

For operators looking to target key market areas, the hottest MDU housing market areas for 2001 will continue to be in the Southeast Atlantic states (VA, NC, SC, GA, FL), as well as in the West (NV, AZ, CO, UT). Strong economic growth with an increase in employment opportunities will keep the market strong in these areas for some time. Expect to see both institutional lenders and venture capital firms asking for business plans to represent at least a partial focus in these market areas, preferably in tier two and three markets.

The most sluggish markets for 2001 will be NY, NJ, PA, CT, RI, MT and ND. The economies of these areas will lag behind in these areas, reducing the drive for new construction as well as the creation of new jobs to increase occupancy. Ironically, most of these states are in mandatory access states where attempting to be a private system operator is typically financial suicide anyway.

 

Important Trends

After a full year of attention being drawn to wiring infrastructure and technology issues, many property owners are becoming increasingly aware of the need to make their properties and amenities more tech ready and tech savvy. The 2000 Counselors of Real Estate survey shows that MDU real estate companies are continuing to use technology to differentiate themselves in a very competitive marketplace. In concert with this, property owners now consider technologies and services such as digital video and high-speed Internet access as critical tools when renovating older properties.

Throughout 2001, service providers should expect to see a dramatic increase in the rehabilitation of older properties. This is simply a continuance of a trend that grew rapidly during 2000. And while being involved with a renovation project requires a much higher level of communication with the owner, property manager and residents, the penetration levels achieved are typically higher than average, as is customer satisfaction. Growing a customer portfolio from these projects will prove to be a successful tool in improving the bottom line during 2001.

 

Building Bridges

The gap of knowledge between the average property owner and private system operator is wide. Understanding what is required to successfully deploy digital video and high speed data services is critical from both perspectives. As such, this gap must be bridged, quickly.

Service providers should expect to spend more time educating and working with owners and the MDU industry at la