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ADSL

Okay, so maybe it is their favorite acronym, but it's all the same. ADSL is Verizon's secret weapon to destroy all the small up-start ISPs that made them look so bad in the beginnings of the Internet. I am going to tell you why. It is a story that the public doesn't want to hear. The public likes it much better being able to sit around lapping up all the MP3s and vids the speedy new technology has to offer. But like any gift from a Fortune 500 company, there is a price.

Let's start with a basic ISP economics lesson. How much is the going price for 1 megabit of bandwidth these days? The answer is (if you shop well, and are big enough to demand it) around $350 per megabit per month. What is the speed of the base level ADSL connection? 768 Kilobits per second. So how much does a base level ADSL connection cost the ISP? Approx. $260. How much does Verizon charge for their entry level ADSL connection with bandwidth and e-mail? Only $40!

Now I know you are saying, "Hey dude, you must have missed a digit somewhere. They would be losing $220 per customer per month if it works that way. That can't be right!" My reply is that it is exactly that way, if you believe their marketing BS. In reality they don't really allocate that much bandwidth to each customer. They over-subscribe the Internet bandwidth side of the equation. If they actually had to make money (more on why they don't later) they would have to over-subscribe their Internet bandwidth by a factor of over 6 to 1 must to break even.

Your next question of course is "What do you mean, they don't have to make money? Don't their shareholders force them to make money?" Amazingly, you have hit on the exact reason why the ISP part of Verizon doesn't have to make money. Verizon's shareholders don't hold stock in the ISP part because it operates as an wholly-owned un-regulated subsidiary. That means that any losses it takes are covered by the big regulated monopoly portion of Verizon.

Let me illustrate with a short econ lesson about telco monopolies. How much profit is a regulated monopoly allowed to make? In most states regulated monopolies are allowed to make a set profit margin over and above their operating expenses. These operating expenses are the costs of providing telco services to the area in their control. So if, for example, they are allowed to make 5% of their total operating expenses, and running at peak efficiency they only spend $50 million to cover an area, then they are allowed to make $2.5 million. If however, they weren't very efficient, and it cost them $75 million to cover the same area, then they would make $3.75 million. Get the idea? The more it costs them to provide service to an area, the more money they actually make.

Again your perceptive question is "How does this apply to ADSL?" I was waiting for you to ask me that. In fact they do it with a neat little con game called the WHolly-Owned un-REgulated subsidiay (WHORE for short). The WHORE loses money, since they are not regulated, they can lose as much as they want. The regulated monopoly has to cover the losses of the WHORE. The monopoly makes up for most of the loss by over-charging for the physical circuit that connects you to their network. The rest of the losses are just extra costs of doing business, and therefore make the telco even more money, since they get to keep 5% of all their operating expenses.

"You gotta be pulling my leg. I thought the Public Utility Commission (PUC) was there to stop that type of thing!" Well, yes and no. The PUCs real job is to make sure that the public is protected from the chaos that would ensue if a regulated monopoly went out of business, or otherwise failed to provide services. The concept of public protection from big, greedy corporations came much later, and is still mostly just public relations, not reality.

You want proof? Here is an actual example from recent changes in Verizon's pricing structure on ADSL. Verizon used to charge $32.50 for the telco circuit portion of DSL (the wire from them to your house), and then they charged an additional $17.45 for the Internet bandwidth and e-mail. The telco circuit portion goes to the regulated monopoly portion of Verizon, and the $17.45 goes to their unregulated ISP WHORE. When Verizon started to feel the heat from companies like Covad, NorthPoint, and Rhythms, Verizon decided it was time for a price cut.

"How did they structured the price cut?" you ask. They decided to cut their price by about 20% to $40 per month for the telco circuit plus the Internet bandwidth. If you do the math (I know you already have) that would imply that the telco circuit would go to about $26, and the Internet portion would go down to about $14. But in reality they left the telco circuit where it was ($32.50) and cut the un-regulated ISP WHORE price down to $7.45!

"Why would they cut the throat of their own ISP?" you demand. Because, as I explained earlier, it is more profitable to lose money that way. It also has the additional side effect of KILLING all of the local ISP competition to the WHORE. Normal ISPs can't afford to sell a $220 resource for only $7.45, that would be insane. Is this strategy working? Hell yes. Just go look at the recent announcements by Northpoint and Covad. They are being unfairly priced out of the market, and the small ISPs are being forced out right along with them.

"What do you think will happen when all of the competitive providers for ADSL are gone? What will happen when all of the competitive ISPs are gone?" you ask incredulously. The same thing that has always happened in markets with no competition, escalating prices and reduced quality of service. "What about cable modems?" you ask as a last ditch effort to salvage your cheap bit-sucking habit. My outlook there is equally grim, with the FTC and the FCC rolling over to the Time Warner/AOL merger deal with no conditions for open access and competition. They will be just another big out-of-control monopoly, if we are lucky maybe they will crush Verizon just for fun, but that wouldn't be any better for the consumers.

"Jeezus, don't you have anything positive to say?!?" I sympathize with this last question, and I will try to offer up a solution that has been pecking at the back of my brain for years. Take all of the wires in the street, and all of the telco switch facilities and give them back to the people. Make the whole infrastructure of monopoly regulated telcos belong to the people who have paid for them. They are too valuable a resource to allow to remain in the hands of a few unscrupulous companies any longer. These companies were paid a GUARANTEED profit for decades. They actually made more money because they over-built their systems. Since we already paid for it, it is righfully ours.

Once the systems are acknowledged as being returned to their rightful owners, the people of these United States, we can go about making proper public policy decisions on how to manage them, without these big monopolies and their WHOREs getting in the way. I know this solution isn't very positive either, but it puts a big smile on my face. :)

In conclusion, I would like to put in a plug for the small ISP. Yes, they provide services For A Few Dollars More (a great Clint Eastwood movie by the by), but they are worth it. They actually have neat people to talk to when you have problems. Technical support people who can differentiate their posterior from a cavernous underground burrow. In addition, they actually bring money and jobs into your communities rather than shipping them off to Texas, or Minnesota, or wherever then can get the cheapest labor this week. And of course, their biggest advantage, since they are already high priced, they have nowhere to go but down. :)

I say next time Verizon comes knocking on your door trying to give you a fast Internet connection with a ludicrously low price, don't be fooled. Give them a taste of YOUR favorite four-letter word. Ya, right.

<Note: The economic model of telco monopolies is much more complex than the examples contained herein, but you get the general idea. ;) >

Reading this makes me feel good about Verizon. Here I was being annoyed with the quality of their tech support, while they're taking a loss to provide me with cheap ADSL. How wonderful. This is a prime example of capitalism at work. Verizon gains market dominance while I get cheap ADSL. Cooperation to mutual benefit.

I wonder if Verizon is really as stupid as you think they are. That is, I wonder if they really hope to achieve a monopoly in the ADSL market and raise prices to recoup their losses. Raising prices significantly above what it costs to provide the service would give birth to dozens of competitors, immediately working to erode Verizon's market share. Also, technology is steadily advancing, providing alternatives to ADSL which could send it the way of the dinosaur at any moment. Verizon must know that it's taking a gamble on ADSL which, even if it pays off (i.e., ADSL remains the chief way people connect to the Internet for years to come), will result in Verizon losing money.

I bet Verizon doesn't plan to make money from ADSL at all. Rather, their presence in the area is for the purpose of building up their brand. Verizon wants to be a player in the tech industry, and what better way to earn the reputation as a serious player than to become the best ADSL provider. That reputation is more valuable to Verizon in the long run than the entire ADSL market. That's what they're after.

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