CNET también está disponible en español.

Ir a español

Don't show this again

Mobile

DSL math doesn't always add up

It doesn't take an advanced degree in mathematics to understand why Covad Communications and other high-speed Internet wholesalers are on the financial ropes.

    It doesn't take an advanced degree in mathematics to understand why Covad Communications and other high-speed Internet wholesalers are on the financial ropes: Selling a service with slim-to-none margins to customers who have trouble paying their bills is a recipe for disaster.

    Just ask Covad or its former rival NorthPoint Communications. In its annual report, Covad was rated a "going concern," meaning the independent auditors who helped prepare the report believe the company does not have enough cash to sustain operations for the next 12 months if it continues to burn through money at its current rate.

    Deadbeat customers helped put Covad in its current predicament.

    According to Avhi Ingle, Covad's vice president of marketing, the company was providing DSL service to more than 90,000 customers served by nonpaying ISPs at year's end. Of those customers, roughly 39,000 continue to receive service while Covad waits for ongoing bankruptcy proceedings to be resolved.

    "We can't touch them right now," Ingle said. "We're paying for them and not getting paid. Let's just say that I can't comment on it any further."

    But that's just the beginning. Covad is struggling to make money from its paying customers as well. Trying to discern just how much of a profit Covad could make on any given DSL line is a complicated equation.

    Covad executives would not provide many details about how much money they make per installed line, calling the information "proprietary."

    But a well-placed employee of now-defunct NorthPoint with knowledge of the company's finances shed some light on the obstacles the independent DSL providers have faced in their quest for profitability. Of course, Covad's finances differed from NorthPoint's, but some telecom-industry prices are regulated, and therefore the two companies likely had similar cost structures.

    The source told CNET News.com that the average cost for a phone line from a local telephone company averaged about $15 a month. There were wide variations by area. For example, a loop in Chicago cost about $5 a month, while the same loop in Boston or Houston cost roughly $25 a month.

    "We were hoping with line sharing that the weighted average would come down to about $9 a month, but that of course turned out to be a pipe dream," the source said. "The damn discounts never showed up on our bills, and we had to involve the (local phone company) relations staff to get ugly and challenge the foot dragging. Finally, discounts started showing up in a very piecemeal fashion months after the fact."

    On top of the phone line costs, the ability to install network equipment in the phone company's facilities--known as co-location "cages"--cost about $1,800 a month. Each cage contains equipment capable of serving roughly 270 DSL connections, resulting in a co-location charge of roughly $6.67 per line each month.

    Finally, there's the cost of transporting the data itself.

    The source said there is an average bandwidth cost per cage of about $1,900 see story: Covad crumbles per month, adding another $11.25 per line to the wholesale cost of providing DSL service.

    Add it all up, and NorthPoint paid roughly $33 per line each month, excluding any additional expenses it incurred from subsidizing the marketing costs for its ISP partners. Those marketing charges, which typically cost between $300 and $400 a month, aren't included in determining wholesale gross margins, but they do find their way to the bottom line.

    Assuming an average retail price of about $39.99 to $49.99 a month for residential DSL service, DSL wholesalers such as Covad and NorthPoint were bucking long odds of quickly achieving profitability.

    NorthPoint's total cost of acquisition per line averaged about $1,400, meaning that even at an average cost to consumers of $65 a month, it took almost two years to recoup the capital and nonrecurring network and marketing expenses on each line, the source said.

    Although DSL service prices have increased in recent months as more competitors have bitten the dust, Covad and NorthPoint were doing most of their growth when DSL prices were considerably lower.

    Frederick Moran, an equity analyst at investment bank Jefferies & Co., said EarthLink, one of Covad's largest bill-paying ISP partners, pays Covad $30 a month per DSL connection.

    If Covad's cost to deliver a line was $33 a month and it's only receiving $30 a month from customers, to say nothing of the customers that didn't and still haven't paid their bills or the marketing expenses it's footing, its easy to understand how the company racked up a net loss of $1.44 billion in fiscal 2000.

    Covad's Ingle wouldn't provide many details about how much the company pays to acquire DSL lines or its gross margins. He did say that line sharing has brought down its average cost for access to the local phone lines to around $5 a line, and that it takes between two and a half and three years for the lines to reach break-even status.