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HomeMy WebLinkAbout2004-04-19 City Council (9)City of Palo Alto C ty Manager’s Report TO:HONORABLE CITY COUNCIL 11 FROM:CITY MANAGER DEPARTMENT: UTILITIES DATE:APRIL 19, 2004 CMR:215:04 SUBJECT: UTILITIES ADVISORY COMMISSION RECOMMENDATION RE: FIBER TO THE HOME (FTTH) BUSINESS PLAN PHASE 2, FINAL REPORT RECOMMENDATION At its March 18, 2004 meeting, the Utilities Advisory Commission (UAC) on a vote of 3 to 2, "recommends that the City Council authorize the formation and construction of the fiber to the home project pursuant to the Fiber to the Home (FTTH) Business Plan Phase I, dated May 7, 2003 and Phase II dated March 17, 2004, subject to an advisory vote to be placed on the November 2004 ballot issuing up to $40 million in utility revenue bonds for the construction of a FTTH system, and authorization to lend up to $7 million over four years of Utilities electric enterprise funds for the incremental build out of a FTTH system for operational expenses incurred during this timeframe. The UAC recommends no additional funding for the project until the project is approved by the City Council. Upon approval by the Coungil, the UAC recommends that an expenditure of up to $120,000 be authorized for public relations and legal analysis but not engineering design." DISCUSSION The FTTH Business Plan, Phase 2 Final Report and staff recommendations were presented and discussed at the March 17 and 18, 2004 special UAC meetings. The UAC staff report (attached) summarizes the project and initial staff recommendations. Since discussion with the UAC in March 2004, staff has consulted with additional legal and financial experts. Staff has concluded, based on legal constraints and the need to issue debt that is highly creditworthy (and therefore affordable), a two-thirds voter approval for additional funding is required. There are a variety of financing vehicles that can be used to fund FTTH, but many of the options require a special tax or surcharge during periods in which program revenues are inadequate to meet financial obligations. Other financing options, one of which would not require two-thirds approval, require CMR:215:04 Page 1 of 2 additional research and will be preliminarily discussed during the Study Session with Council on April 19. Given the new information and an anticipated lengthy public hearing on April 19, a second Council meeting to discuss the FTTH proposal has been scheduled for May 24. This will allow the UAC an opportunity to discuss the new information at its regular meeting on May 5. On May 24, the UAC recommendations will be presented and the Council discussion will occur. This will allow staff to make additional recommendations or provide alternatives. Staff continues to recommend that, should the Council determine that pursuit of a fiber utility be of sufficient importance to the City so as to take precedence over other priorities of the General Fund departments involved - City Manager’s Office, City Attorney’s Office, City Clerk’s Office and Administrative Services Department - that Council make this project a Top 5 priority for 2004. ATTACHMENTS A. Minutes from Utility Advisory Commission meetings of March 17-18, 2004 . B. UAC Report: Fiber to the Home (FTTH) Business Plan Phase 2, Final Report C. Staff Summary Regarding FTTH D. Final Phase 2, Uptown Services Report E. Summary Report of Risk Assessment of FTTH F. Financial Pro Formas PREPARED BY: BLAKE HEITZM"A~T (--) #/ Manager Utilities Telecommunicat~ns DEPARTMENT HEAD: CITY MANAGER APPROVAL: EMILY SON Assistant City Manager CMR:215:04 Page 2 of 2 CMR21504 Attachment A UAC SPECIAL MEETING ON FIBER TO THE HOME MARCH 17, 2004 Rosenbaum: Good evening. This is a special meeting of the Utilities Advisory Commission. (Voices overheard from the Council Conference Room) We are working on this problem, there is a meeting next door. Good I think we have solved that problem. So to repeat this is a special meeting of the Utility Advisory Commission of March 17 for the purpose of discussing the Fiber to the Home Business Plan Phase II. Lets have a roll call. John if you would start by announcing your name. John Ulrich, Elizabeth Dahlen, Dick Rosenbaum, George Bechtel. Our fifth member Dexter Dawes will be with us approximately 8:30, he is flying in. Let me take this occasion to introduce and congratulate John Melton who will be our fifth member of the Utility Advisory Commission. John, welcome. Oral Communication Rosenbaum: Our next item is Oral Communication. Is there anybody here who would like to address us on any subject other than Fiber to the Home? Seeing none, we will move on to the main item which is Fiber to the Home Business Plan Phase II of the Final Report. Fiber to the Home Business Plan Beecham: If I could, I’ve called to have someone come out to correct the audio. It may be a few minutes till someone can arrive. Rosenbaum: Can we continue or is the interference too great? Alright then I think we better take a short break until we resolve this problem. (5 Minute Break) Rosenbaum: Good evening once again. We are now on Item III the Fiber to the Home Business Plan Phase II Final Report. Let me make a few preliminary comments. If you are interested in speaking to us we would appreciate it if you would fill out one of these forms and give us your name and address. We also have the final report available for sale and Dee Zichowic who is sitting in the back comer here will be happy to sell anyone who is interested in having their own copy of this report, a copy. Now we have set aside tomorrow if necessary to continue this meeting and what I proposewe do is first we will hear from the staff UAC Minutes Special Meeting FTTH 3/17/04 - Approved 4/7/04 Page 1 of 55 CMR21504 Attachment A and our consultant. Then I would like to set aside a brief period perhaps no more than half hour if there are commission questions of staff and the consultant. This is particularly important to do tonight because our consultant cannot be with us in person tomorrow night but will be available by telephone. So if there are questions I would like to take care of that first. If there are further questions from the commission we will put that aside until we have heard from the public. At the end of the public testimony we will decide whether we think we can finish tonight or continue the meeting for further commission discussion till tomorrow night. So we will play it by ear and see how it goes. John do you want to take over? Ulrich: Yes. I have a presentation Mr. Chairman that will be shown. I hope everybody will be able to see it. It will take a little time. It is broken up into couple of parts so that we have the opportunity for a presentation of our Risk Management. Also the Business Plan from Neil Shaw and some concluding remarks that I’ll make and for those of you that have been following Fiber to the Home for several years, a number of the items here will be redundant but I think it is important because of the complexity and high profile as the project has had that I would like to start at the beginning. And feel free to ask members of the staff some questions. I do have one thing I would like to ask though. First is that you mentioned that we have the documents that can be purchased. We placed two of the Business Plans out on the table with a note that said that they are for review and people are welcome to look at them. One has been moved away from the table and the person that has it could return it so that it can be used by people here at the meeting and then if you would like to have a copy you can see Dee Zichowic at the back who will arrange to get a copy. But it looks like a binder like this and appreciate if that is returned to the back of the room. I would like to just kind of start with a little bit of history. I think most people know that Palo Alto is one of- in fact it is the only city in California - that owns and has basically full service utilities to all its residence and business. They include electric, gas, water, wastewater and a fiber utility. Much of what we are talking about this evening is looking at the foresight of our founders and translating that into whether we should take another giant step and look forward to going into a business in Palo Alto owned by the City and focusing on a business that we believe will be in the interest of our residents and businesses. We started back in 1900 in the electric business and you can imagine the first people that walked around the City of Palo Alto asking its residents ’would you like to have electric service’ and many people would not even vision what all the things you could use electricity for back then and of course today it is indispensable and cannot be replaced easily. I think we are in the sense on a similar threshold in Palo Alto and the purpose of this meeting is to review the combination of all the analysis that we have done and have this as the beginning of UAC Minutes Special Meeting FTTH 3117104- Approved 417/04 Page 2 of 55 CMR21504 Attachment A a forum for residence and businesses to let us know what they think of the business plan. Then ultimately to decide whether we should continue with it and form the business that will be outlined this evening. We believe that we can repeat the success of our founders by building a system for the future. Initial services will pay for the construction of a Fiber to the Home System and have a City-wide fiber that is not limited to phone, Internet and video that can be expanded over time. We still don’t have a real good understanding, nor do we expect to for sometime, about the magnitude of the benefits that they can be obtained by using the fiber system. But we believe that we are recommending a system that will allow us to expand and do many significant additional services in the future. Those could be things such as direct link to fire and police services to a communication from your home, home security, electric system monitoring, automatic meter reading, time of use utility rates etcetera. You will find though, that the business plan does not suggest that there is big money to be made or that’s the business that wc can use to sustain the fiber plan but that this is what we see as items that can bc developed in the future. We believe we have taken a very conservative approach in recommending the next steps. Our recommendation will be at the end of our report that the Council designate Fiber to the ttome as one of their top council priorities. We believe strongly that this is going to take a lot of time, energy and effort on the part of staff and there arc many competing priorities that are very high and of strong interest of the residents of Palo Alto. We want to make sure that fiber reaches that priority status and if not, get to the point where we can move on to something else. We would like council’s approval to continue to use our electric enterprise fund to expand the final phase project analysis and that is outlined in the plan. Council would recommend a public process for ascertaining and assuring the community’s interest, either in the form of a public vote or community meetings. Additional information is required so that the public is fully aware of and has all the understandingsof the benefits and the risks of going into this business. Following is an outline of what we are going to do this evening. I’ll give you a little bit of an overview in summary of fiber progress to date. Uptown Services (the consultant Neil Shaw) will talk about the business plan highlights. Our organization will make a risk management presentation so that we can show an independent review of what we have done. Karl Van Orsdol is with us this evening to go through with that. We will have a discussion, further recommendations from the utility and of course questions and answers and public input. I’ll say this is the beginning of the public input process. What is Fiber to the Home? There are all kinds of visions for it but briefly, this is a glass fiber that goes all the way to a dwelling or business and would have the UAC Minutes Special Meeting FTTH 3117104 -Approved 417104 Page 3 of 55 CMR21504 Attachment A ability to provide a very high speed data transfer rates - faster than DSL or cable. It contains virtually limitless capacity for information flow with a very long life span which won’t become quickly outdated, offers high reliability and data security, can accommodate evolving technologies and add-ons and offers ability to provide future services not yet thought of as I mentioned a little bit earlier. You will hear about fiber to the home, hybrid and present systems. There are very few fiber systems in the United States that have a glass fiber all the way to people’s premises. Other systems, the ones that are currently in place in Palo Alto are hybrids of glass fiber. I have been in Palo Alto for just under five years and I think I have been involved in, and the staff, for at least that period of time plus the amount of time in developing our very successful dark fiber system which is in place. We believe that there is a strong community interest in the system, there is potential for your utility to provide an additional city-wide utility service, determine if it is cost-effective to build out, that it has potential of improved telecommunication services and choices and of course synergy with other utility services and systems. We have had a trial that’s going on which has been used to evaluate construction techniques, test system reliability, test new services for phone and video, determine customer expectations and measure customer satisfaction. While the trial area is quite small we have learned significant things from both from the customer service standpoint, construction techniques and the ability to provide customers expectation and value for the money spent. Lessons that have been learned from the trial are that the staff can install, maintain and operate the fiber equipment, the fiber system can reliably deliver phone, video and Internet. ISP or Internet services are easily contracted and delivered. Networks are self diagnosing and easily maintained as long as we know what we are doing. Equipment can be modular and interchangeable. Customers expect help on their side of the connection. We will emphasize this and make sure that it is clear that we understand this business. While we have not been in a competitive environment exactly like this, we clearly know how to provide our customer service and understand construction and maintenance of infrastructure. There’s a number of accomplishments to date and next steps. I will not go through all of this except we are very good at making these kinds of charts and it works well for all of us to be on the same page and work very close together. You can see Council approved funding for the trial as far back as November of 2000. We conducted customer surveys, we presented various drafts of our plans and kept moving along towards the point where we are now. Next steps include obtaining additional public comment, move towards the recommendation to the City Council and finally to the decision whether to move ahead and go ahead with the project. UAC Minutes Special Meeting FTTH 3/17104- Approved 4/7104 Page 4 of 55 CMR21504 Attachment A The business case looked at the economic factors. We did a scientific survey of residents, current technology and cost options, known customer needs services and pricing options, trial technical and customer service experience, customer input from other municipal telecom, extensive consultant industry experience, detail perform analysis of economics and risks and economics of delivery of the three major services, video, phone and Intemet. The business plan looking at what it would take for a City-wide roll out, refinement of key assumptions in the business case, marketing strategies, product and service strategy, staffing and operation procedures and firm financial strategy. We have had the report on the Internet for two weeks. As a public organization anyone can drill down and look at the details of all of these. Uptown Services has provided the business plan summary. I will turn it over to Neil for discussion. It will take him a second to hook on the computer. That is one second through the fiber connection. Shaw: Thank you John. I am Neil Shaw and I am a partner with Uptown Services. We have been working with Palo Alto now for a long time and it seems like it has been 8 months since we were last here - but it can’t be that long. So what I want to talk about tonight is just quickly to go through the plan outline, talk about where we have come from the last time we talked and then talk about some details in the plan, but, mainly focus on the financials. If we want to dig down as John said, into the details of the marketing strategies, service delivery issues and organizational issues. I think that is best done on your own with the full copy of the report. What we want to talk about tonight is just an overview of the highlights. So in terms of what we presented July 9th of last year compared to where we are today, we have made good progress. We wrapped up the marketing strategy, the legal regulatory piece came a long way and the monthly operating budget was about half way done, we completed that, wrapped up the partnering strategy completed the service delivery processes with Palo Alto Utilities staff as well as the organizational structure. The financing was a big piece that was left to be done. So just a quick overview of the services that we have in mind for the plan. On the video side we are looking at expanded basic which will be the main flagship product alone of four tiers of digital video. Included in that would be options for high definition television, pay per view or video on demand as also all the premium channels. On the Internet side we look at five tiers of symmetrical service. The tiers run from 256K through ten megabit Internet tiers. These will all be symmetrical service as opposed to asymmetrical on your cable modem and UAC Minutes Special Meeting FTTH 3/17104 - Approved 417/04 Page 5 of 55 CMR21504 Attachment A ADSL. And the nice thing of fiber to the home is we would be able to offer unlimited intranet bandwidth in the Palo Alto system because that is virtually free if you engineer the network correctly and the tiers would only apply when you go out to the internet backbone. So the local applications that could be enabled by unlimited local bandwidth are pretty compelling. Telephone side we recommended that Palo Alto bring on a competitive local exchange carrier as a partner who would lease wholesale access on the fiber to the home system and sell either under the Palo Alto Co brands or brands on their own. So on the penetration side we are looking at little bit different penetrating assumptions than we have in business case. The reason we have difference, especially on telephone it is lower, video slightly lower, Interact is about the same, is that when you go into a business planning mode you start with a very detailed monthly budget and you build from the ground up. So this is bottoms up plan, it is not a top down strategy like the business case. So when we look at marketing budgets it is type of called on, it is type of return rates, the walk in traffic in the payment centers, everything like that we start to work both ends against the middle. These are the results we came up with based on how this thing would actually roll out. The number of direct mail pieces you would be putting out, the word and advertising you will be doing. That type of a thing so we feel very comfortable with these penetration recommendations or results. In terms of pricing we will not get into details. The details are in the plan. On the video side that state that the basic offering would be $35.00 up to your high level packages which will be close to $80.00. On the Internet side, of course these packages were developed nearly a year ago so these are going to be changed obviously but anywhere from $29.95 to $149.95. The business plan called the first 3 tiers consumer residential and the last two tiers as small business or business when in fact a residential customer could buy any one of the 5 as could a business. On the telephone side, there is a wholesale model and this is obviously going to depend on who you’ve actually partnered with. But the wholesale model would call for $8 per line as the wholesale fee and a projected sharing of a profit in a $5 range. From the expense and capital assumptions you obviously can’t sell services unless you do a lot of marketing and promotion (unless you are the only game in town). So we put into the marketing business plan, a significant amount of direct marketing awareness advertising that roll up to a budget in near or in excess of $350,000 a year. Okay. That is in addition to the pull that you would get from promotional discounts that are built into the plan. So for example if you have the rate card as Dave talked about last year, the rate card would be $34.95 for expanded basic, $29.95 for 256K symmetrical Internet. These discounts would apply over and above those rate cards as promotional offers in the first five years UAC Minutes Special Meeting FTTH 3/17104 - Approved 4/7/04 Page 6 of 55 CMR21504 Attachment A and then we’ve got a 5% discount built in for the rest of the plan. So this is a significant revenue hit that we forecasted based on the competitive environment. As far as capital expenditures these numbers are based on engineering studies that were done specifically for Palo Alto. These engineering studies are about a year old. I can tell you what we have seen in other markets that these numbers have come down. Risk assessment, risk analysis we will talk about what happens if the numbers go up. But I can tell you based on our experience that the per house passed cost of $759 would probably be lower; $825 per subscriber is going to be at least 20 % lower. Everything that we have done (and is reflected in recent business plans that we completed with other clients) is that we didn’t say that if 33% take each service that we will only deploy network interface units in of 33% of the homes. What we are going to do is to deploy network interface to 33 times 1.8 as the number of homes. The 50% increase is because not every one is going to take all three services. You are going to have inefficiencies so at the end of the plan we’ve got network face units deployed to nearly 60% of the homes passed even though our highest penetration rate is 33%. We also have got network upgrades built in to the plan in the year 10 for both network equipment and network interface units. So all this builds up to a capital budget of $42.3 million over 20 years and that includes $5.4 million in upgrades in the 10th year. In terms of financing we made a lot of strides with ASD in working through the financial assumptions and putting a real fine pencil on this. What we are looking at is a 17 year amortization with principal payments starting in the 4th year. So think of this as a 20 year loan process. The first three years will be interest only with 6% interest rate, although we have seen lower, we haven’t seen anything higher than that yet. But you don’t know when these bonds are going to be issued. What we are looking at is $34.8 total bond issue including the bond reserve and issuance cost. Short term debt, which is the debt you need to cover your working capital, includes a 5 year amortization schedule with payment starting in the 6th year. By the end of the 10th year our short term is paid off and that debit is taken on by us. Right now the assumption is that the utilities department will take that issue identified at a 4.7% rate, which is the current portfolio rate. Interest will be earned and compounded over the first five years. So it just doesn’t sit there interest free and that would require $8.6 million through early in the 4th year where we will see it turns cash flow positive. And finally cash reserves you can see the conservative nature of this plan and that the cash reserves earn 3% interest and 3% interest on bond reserves. So if you can imagine we are borrowing $34.8 million in the first year and that’s going to sit in the bank and earn 3 % but we are paying 6 % interest on it. So we are taking a little bit of a hit there but again that is the part of the conservative nature of this plan. UAC Minutes Special Meeting FTTH 3/17/04 -Approved 4/7104 Page 7 of 55 CMR21504 Attachment A So now what I would like to do is switch to the first chart which shows what is commonly referred to as EBITDA or Eamings Before Interest Taxes Depreciation and amortization. Back in the heydays of Sand Hill Road when money was falling from heaven it was really based on what’s your BDITDA: How fast is your EBITDA positive and what kind of multiples I can get on that in the 5th, 6th and 7th year. So in the case of this plan EBITDA goes positive in the third year. We include a year zero which is basically your start up year, where there is no revenue. There is a little bit of expense but you really don’t start spending a lot of money and bringing on customers until month seven which is in year one,. So in the third year our EBITDA goes positive at $3.4 million dollars. And then the next thing would be look at earnings before taxes. We added depreciation and interest, which is the interest on your debt service. So now we are taking bigger hits because we are starting to depreciate (which is a non cash item) but it still hits the books and it impacts your accounted earnings. Our earnings before taxes go positive in to the 4th year and that stays positive throughout the plan. So what we are looking at is a very healthy business. The next item would be cash flow. So when we look at cash flow we take our operating income, our operating cash flow and then we start to take away capital spending and financing costs. Now this is where we get into how much cash needs to come in to the business to fund our operating losses and in this case we have positive cash flow in the year 6 just barely $130,000. We have a little bit of a dip in the 10th year that is to pay for the $5.4 million in upgrades but by the end of the plan year 20, we are generating nearly $5 million in the cash flow for the City. So we’ll look at sensitivity related to this in a minute. Now the last item. We have this measure that we call net cash. Because it is difficult to really identify a break-even for this case when you got financing of tens of millions of dollars going into the project, you got money flowing all around so basically what we mean is that net cash is defined as total current assets ( everything except my equipment, my capital fund) minus my total debt. So the top line is basically my cumulative cash flow which is basically all of my current assets. That bottoms at around $30 million range because you remember we borrow all that money in the first year (taking it out at 6 % so we do not take a chance that the interest rate is going to go up). So we draw down on that fund over time and we bring it down to $4.3 million. That is a function of cash on hand requirements as well as my bond reserve requirements. Then we grow cash balances but we have a little blip and then we grow and then we come down again in year 10 because of our upgrades. Cash grows up over the 20 year period to almost $54 million. Now the yellow line is my net cash because my pink line on the bottom represents my total debt. My total debt bottoms out between my short- .term and my long-term debt, it bottoms out around $40-some million and then it comes up and in over 20 years it is completely paid off and my net cash goes UAC Minutes Special Meeting FTTH 3117104 - Approved 417/04 Page 8 of 55 CMR21504 Attachment A positive in the 14th year at a value of $6 million. So what that says is after 14 years if you want to exit the business, if you need to upgrade your plant, you are not upside down. It is not like you buy a Lexus and you say "I can’t afford this car payment I need to turn it in after two years" At that point you will be $10,000 upside down. This is going to be in the black in terms of the net asset value in the 14th year. And this doesn’t even include the value of your subscribers which in today’s day and age are going for $4000 per sub even as an over-builder. So the next thing we can look at is sensitivity analysis and basically what we did was we took a look at (and Karl is going to talk about this) what is the most sensitive variables in a business case and how those impact us and how bad they can get before we getting into trouble in the business case. And in this case we are looking at Internet price sensitivity. This is cash flow. Remember our cash flow went positive in the 6th year. Now what happens if we do a 10%, 20% and 30% discount on all of our Internet pricing. So we took the 256K from $30 to $27. We took the $40 from $40 to $36. This is the impact. If we have a 10% discount on all our Internet pricing we move our pay out, our cash flow positive year out by 2 years. So this says that Internet pricing is very sensitive because Internet is very high margin product and this is something you want to keep very close tabs on. But the rates that developed in business plan for Internet were already developed based on a 10 % discount to incumbent pricing. So when we look at service penetration sensitivity as it impacts cash flow, if we can get 10% more penetration we can go cash flow positive two years earlier. So we can bring that back to year 4 so that is a little bit of good news that is not completely out of the question if we get 10% more penetration. If we get 10% less penetration again we move it out 2 years and if you drop your penetration as much as 20% that’s a problem you need to do something, hopefully before the 9th year rolls around.. So, and finally, the last sensitivity analysis for cash flow would be the bond rate. The bond rate right now is run at 6%. If the bond rate were to go up to 8% you would be moving your cash flow positive period out 2 years. So you can see that within a nominal variation the plan still stays intact. There is another chart I want to look at. This shows an overall year 20 view of your total current asset, which is basically your cumulative cash number. It says if penetration for my overall services say were 10%, at the end of the plan, I would be in the Hoel $48 million dollars. So you hope that more than 10% of the public signs up for this thing. If it is 20% the system basically breaks even over 20 years. If it is 30% which is close to what our plan is you are in the $51 million surplus range. With an additional 10% penetration, you nearly double your cash in the bank. So you can kind of see how this works. Basically what this says is the more people that sign up, the more they as citizens will benefit and this is really the point of this slide. UAC Minutes Special Meeting FTTH 3/17/04 - Approved 4/7/04 Page 9 of 55 CMR21504 Attachment A One of the things that I run into all the time, is that when we get into meetings like this, we have lot of people that have a lot of input and some of the input is constructive, some of the input is not. The thing that is probably the most difficult, is these negative, supposedly "objective think tank reports" like the Beacon Hill Report or something about Progress of Freedom Foundation or something like that. Well who really funds these think tanks are the people who don’t want these projects to happen and you look at the list of the people who fund the Professors at University of Denver. They work for the Bill Daniel’s Cable Pioneer School of Business in Denver, they’re Comcast, the Verizon the SBC, the Cox and so on. So you need to consider the source. And when you look at their claims the truth always prevails and this will hopefully head off some of these at the pass. With respect to the Tacoma system, it has been claimed that the cost ballooned to a $100 million for their broadband business. Well in fact, the truth is that they spent $60 million on thcir own internal data network to connect their dams, their power plants, their substations and everything else across the vast network that they use to serve many tcns of thousands of customers. And only after that, did they seek $35 million to make coax extensions to build a hybrid fiber coax network to reach consumers and small businesses. Regarding Kutztown, PA,. they built a fiber to the home system. It is claimed that they missed their projection completely wide of the mark and actuall3’ they were within 95% of their projected numbers after their first year. ! \~ould say that is pretty good. Finally Paragould, Arkansas these are couple of cxamplcs of this information that floats around. The claim in one of these reports \vas that cable system auditor reported a net loss of nearly $1 million for the fiscal 3’car 2001. The truth was that the loss was $263,000 and that included dcprcciation and amortization, both non-cash items and what it failed to mention was that Paragould offered then and continues to offer the lowest price cable services in thc state of Arkansas. Their stated of goal is not to make a profit. Their stated of goal is to serve the community with low cost communications. Other efforts in municipal broadband exist. When Palo Alto started, I think they were by themselves, definitely not now. Dalton, Georgia launched fiber to the home in July of last year and they have currently have 33% penetration on video, 23% on Internet and 31% on phone of the homes passed and they compete with Charter. Bristol, Virginia is another Charter competitor. They launched fiber to the home in late 2002 had to battle tooth and nail to get there but are seeing 27% on video, 14% on Internet and 20% on phone. Marie, Kentucky, not a fiber to the home veteran but a hybrid fiber coax veteran nonetheless stellar results of 53% penetration for video, 40% on Internet and 30% on phone. And finally I just talked to Harland, Iowa and they have 82% penetration on video, 23% on Internet and 36% on telephone. I am not saying that Palo Alto is going to get 82% penetration of video. You don’t have that many video subscribers in the whole community, so we are not saying that. We are saying that the plans calls for 28% UAC Minutes Special Meeting FTTH 3/17104 - Approved 4/7/04 Page 10 of 55 CMR21504 Attachment A penetration of video, 33% on Internet and I think that there are some people using Internet here, maybe more that Harland in Iowa, and 29% on telephone. So if you look at the results across the United States east to west, I think we are in the ball park. Other fiber to the home projects; Lompoc, California has made an announcement that they are going to go forward, Truckee Donner is going forward, Crawford, Indiana, Salso Oklahoma, Jackson Tennessee, Provo, folks in Washington, Reedsburg and 17 other cities in Utah. There is another item that gets thrown around quite a bit. It suggests that Palo Alto will have to go on bended knees to HBO, you would have to go hat in hand to ESPN, but that you are never going to be able to get the prices that all these other big cable companies get and you’re going to be priced out of market. So we did a little research. Comcast has 21 million subscribers. They are definitely the gorilla here. But Palo Alto, as part of the national cable Co-op would have 14 million subscribers under their belt. So how can Palo Alto with 14 million subscribers behind them be any less advantaged than Time Warner at 11 million Plus and Charter with less than 6½ and so on. Yoia get my point. This is a complete fallacy and it is wrong to suggest that Palo Alto through the Co-op would be significantly ¯ disadvantaged against Comcast. I am not saying that they are going to get Comcast rates but to say that it is going to be material difference is just not the case, especially given where they stand. Last but not the least I want to address wireless. We address wireless in the business plan not to the level of detail that some had hoped. But let’s just review. Where does wireless fit with Fiber to the Home. Fixed wireless is basically wireless application that requires line of sight. They typically use 2 frequencies, in the giga-hertz range and above. You have macro and micro cell transmitters to homes and businesses where they have fixed antenna that is really required for a fixed line of sight.. This is not needed for fiber to the home. This is what fiber to the home is for. To apply fixed wireless to a fiber to the home arrangement will be a waste and counter productive. Fiber to the home can do everything that fixed wireless can do, except 10 times better. Now portable wireless is very complementary to fiber to the home. Portable would be well. I got my PDA, I got a wireless card in it. I am going to walk around, I am going to sit somewhere and work. That’s not really mobile but it is more portable. So this is like Wi-Fi hot spots of community access points where you could allow for authenticated access to the fiber network via wireless needs. So this would be good for pedestrian speeds and stationary work spaces. It is not something where you are going to say "fiber to the home user you are zipping down 101 at 80 miles an hour and put your PDA out of the window and get your email". It is not going to work that way. But it would be very compatible with fiber to the home with some strategic UAC Minutes Special Meeting FTTH 3117104 - Approved 4/7104 Page 11 of 55 CMR21504 Attachment A applications and at some locations. You can give Starbucks a run for their money or even parmer with them. In terms of mobile wireless this will be nice but there are a lot of issues. Mobility really requires license spectrum that has non-line of sights properties. Something to 2 gig or below they can penetrate buildings that doesn’t have multi path problems. But the spectrum is being used or it is not available for the Palo Alto only footprint, The spectrum is typically auctioned off in BTA’s or Very, very large blocks and it costs billion of dollars nationally. And the mobile broadband strategy is going to be driven by few players, Cingular bought AT&T and at the end of the day there is probably going to be two or three guys all the airways for mobile broadband. They will eventually converge but not for a while. Finally lets talk about the wireless graveyard. Mobile broadband. I remember in 1999 when Ricochet Metrocom came out, studies were talking about mobile broadband being billions or trillions of dollars. The billions to Ricochet were lost by the investors, me included. I am just a little bitter, and they sold all of their assets at auction for $8 million and that was a truck load of modems literally, a company bought them and they tried to do it again and it didn’t work. Fixed wireless, Sprint broadband spent a lot of money on license spectrum which is the way to go if you are going to do wireless, to offer fixed wireless services. Look at their website, they have not offered services in at least a year because they are not happy with the technology, they are not happy with the things they are seeing that are coming out and we can go down the list. Pacific Bell, Bell Atlantic spent millions on wireless cable licenses because they thought they are going to turn on the world of wireless cable TV, it didn’t work. Local multipoint distribution service 38 giga hertz point to point high speed wireless of fiber alternative in metro areas, Teletin and Winstar bad and worse, satellite, we all know what happened to Iridium, and Teledesic, Bill Gates and Craig McCaw are couple of other billionaires I don’t know exactly who is doing what. But they had this promise of putting up a 60 satellite constelIation in providing broadband to cell phones. Well I guess they can’t do it now. Now they have to do stationary points and after a while fixed wireless system is really a wired system in the home at some point and I would challenge anyone that wants to push Wi-Fi to show me a revenue generating Wi-Fi operation that has a long-term potential. That is summary of the business plan and I will turn it back over to John. Ulrich: Thank you Neil. I would like to move into the other side of the discussion and that is look at the Risk Management. Everything that we do has a risk side of it and we have asked Karl Van Orsdol who is our risk manager in Administrative Services Department to go through and give an assessment from his point of view and Karl welcome and thanks. UAC Minutes Special Meeting FTTH 3117/04 -Approved 417/04 Page 12 of 55 CMR21504 Attachment A Van Orsdol: Thank you John and good evening. As John mentioned we were asked by the Utilities in ASD to do an independent risk assessment of the Fiber to the Home Project. And what I am going to present to you tonight will be a very brief summary of those findings. And just a point of note that this risk assessment should not be considered as a substitute for a very careful and evaluative reading of the report that Neil and other staff members have done. What I am going to present to you is a very brief sort of summary of our results. The first aspect is our responsibility was to really look at stress testing of the numerous variables that Neil has included in his report on the Business Plan and to assess which variables were most important in impacting the bottom line. In our discussion we think of the bottom line as really the net cash after financing. That is ensuring that the project has sufficient funds after meeting its operating, financing, debt servicing and capital costs to fully repay the bond to have cash left over. Our assessment of this project was based on the various models that Uptown Services and staff in the utilities have completed. We did not go and buildour own financial model. In this analysis we focused on the key risks on the cost side and the revenue side that would impact net revenue after financing costs. On the cost side wc identified 5 variables and on the revenue sides we identified 2 primary variables that influenced the outcome. The first variable, the most important variable on the cost side, is the bond rate. Now the base case scenario that Nell presented assumes a 6% interest rate. However, if bond rates were to increase perhaps to 8"/o, perhaps due to a change of economic situation, then the net cash available to the project after all the financing cost were met would be reduced by $16 million dollars or approximately 29%. of the total pre cash available at the end of the year 20. It would take bond interest rates to go up to 12.34% for the project to be just at the break even cost and have no cash after financing cost. Now if a bond for the fiber to the home was tied perhaps say to the Utility, we would expect that a bond rate would be in the range of 5 to 6%. If the bond was based solely on perhaps anticipated revenues from fiber to the home project,, we would expect an expected bond rate of 8% or greater. But in either case the bond rate will not significantly impact whether the project is a profit project or not. All the factors in the model stay the same. We found 3 main cost factors that significantly influenced the financial outcome of the project. The first is customer service. Now clearly in this module the customer service is going to be key to the success of the project. The current model calls for 7 customer service reps and so on as we looked at what would happen if it was perhaps 50% more customer service reps. This addition would result only a $7 million dollar decline in cash after financing in the year 20. Of the 2 hardware costs our sensitivity now also show that perhaps 25% increase in UAC Minutes Special Meeting FTTH 3/17/04- Approved 417/04 Page 13 of 55 CMP,21504 Attachment A network hardware cost would result in a 24% or $13 million dollar decline in cash in year 20. On the control box side, a 25% increase in cost might lead to about a $6 million dollar decline in cost but these hardware cost have declined in recent years so the numbers that are in the base case are most likely the highest numbers. In fact I think in the last year control box, cost has declined by about 20% and these costs were also known prior to the implementation of the project. So they are not risks in the sense that once the investment is made we will not know the outcome. We will certainly know these cost prior to going into the project. On the revenue side, my analysis is showed that the residential Internet and cable services and their penetration were the key factors in profitability. For example if residential area Internet penetration declines by 5% over what was in Neil’s model we would have a $13 million dollar decline in net cash or about 24% of total in cash at the end of the project. It would require a decline down to 19% of Interact penetration for the project to not to have sufficient cash to meet its bond requirements. Almost a 50% drop over that is what is predicted. Secondly on the cable side, a 5% decline in penetration would lead to about 20% decline in cash after financing at the end of the project. The break even number is 21%. So again almost a 50% decline over what is predicted in the Uptown models would be required for the project to not to have sufficient bonding to meet the bond interest payment as well as capital and operating costs. And then finally the technology risk. I think our review has shown that the competitive technology risk to this project appear manageable. Wireless and satellite technologies do not, are not poised to match the versatility that a fiber network could have. Both in terms of its band width, in terms of data security as well as in a constellation of services that can be provided over a fiber network including TV, Internet, security fire protection as well as a variety of utility services to enhance the customer use of electric and gas utility and to manage their costs. So that is a very brief summary of what we have done and I am certainly open to any questions and I will hand the floor back to John. Ulrich: Thank you Karl. I am going to move into the summary and recommendation phase. Always the question that keeps coming back is why embark on the next Fiber Phase. We have spent a lot of money. We have done a lot of studies and you can see a lot of summary of the work that has been done thus far. We have an experienced staff, we had a very successful trial, we have learned how to construct and manage and provide customer service and, while the trial included a very small number of people, we think it can be increased to include the entire city based on this plan and do well. Fiber is a long-term and reliable technology. It is not going to get leap frogged. We are in the position since we know how to install infrastructure and maintain it. The fiber will have a long life and as new customers want service or changes it, we will be available to UAC Minutes Special Meeting FTTH 3/17104- Approved 4/7104 Page 14 of 55 CMR21504 Attachment A provide that service in short notice off of the backbone and the fiber system that would be constructed throughout the City. Fiber is supported by the strategic plan. Everything we do in the utility focuses around that and fiber fits very well within that plan. The fiber business case and business plan suggest, as you heard tonight, potential for business success. We find through the extensive surveys and studies that citizens feedback has been positive. People in Palo Alto know where to find us and to communicate well with us and I .think we understand what kind of services would be expected of us. Vision of an expansive future for fiber in Palo Alto focused on services for customers not just for today but what can be forthcoming in the future. Is the City capable of providing competitive services? I have outlined before and as you know, I am extremely strong proponent for the value that utilities has provided to the residents. The community can look back as far as 1896. Again we are the only city in California that offers full service utilities. We have experience in providing all these utility services. We are about, I believe, the only city that has 24 X 7 not only emergency response in utilities but we can provide even minimal customer service in your home whatever you need it, whatever time of the day you would like to have it. We only work for the 65,000 residents and businesses in Palo Alto. We don’t have a complex marketing plan that that looks at outside the city. We have been successful and competitive. Those of you that have seen me and our staff during the energy crisis I think know what that is. We have a very strong tradition of customer driven programs and services again we are accountable to the community not outside stockholders. Interesting factoid is that utility revenues provide ongoing support to central city programs and services. Did a little math and over the last hundred years we have made and provided to the City $310 million beyond the cost of providing service and running the business. This is a bit hard to see but let me, many people say now why would we need fiber? I am really happy with what I currently have. If you currently happy with what you have I don’t think in the short run fiber is going to be something that would provide you something else that you need. But as soon as you have it your want goes to a need. If you just look at the typical DSL service, we assume you have that now that’s basic speed. If you had cable modem it might be twice that. If you are using your Wi-Fi down at Starbucks this is probably about half of what you get on DSL. These are round numbers. But with the system that we are talking about this evening and based on the cost and the services once you have it at your house you will a hundred times capability of what you would have had if you had DSL. Most of us will not need a hundred times. That is really a beyond the needs of many people. But once it is in, you will have the ability and if you have a business in town or you have a need for it you will be able to get that kind of service. Projected in to the future; DSL may be three times what it is now and cable modem ten times and Wi-Fi one and a half times and you got all this. And this sounds quite, it got a lot of zeros, ten thousand. So you got tremendous UAC Minutes Special Meeting FTTH 3117/04- Approved 4/7/04 Page 15 of 55 CMR21504 Attachment A unlimited basic capability with fiber to the home. It is whether we are willing as a community to put up the money and have the utility provide that kind of service. It fits within the utility strategic plan, customer satisfaction, investing in utility infrastructure, providing superior financial performance and again the unique advantage of a municipal owned and controlled service, hand delivered products in a competitive market. What citizens think about us doing it? Well the purpose of having an open communication as we are having this evening and as many community focus groups or neighborhood meetings we expect to communicate the benefits and the risks so that at the appropriate time you would be able to vote on it and to let the city council know how strong your interest is in providing this service. It was brought to the council as far back as 1997. We did extensive surveys and suggests 50 to 70% of citizens support the utility running a broadband service with truly value reliability more than anything else. Always on and speed are both important. High reliability equals low volume of customer service calls and complaints and we believe that participants trust us to provide this excellent service. Participants want to continue the service that is on trial. Our vision for fiber in the future is to sell services to pay for the construction and maintenance of the fiber system and let fiber to the home expand our abilities and the City’s service offerings far in to the future. Is there a fiber market in Palo Alto? We have the surveys that indicate that and it shows similar results 50 to 75% interest. We believe that our results have been discounted for overstatement. And discounts result in the statistics used in the business case by 30 to 36%. The point is that I think we have done our homework. I am continually asked is it is legal for us to get into the fiber business? I am not attorney and I won’t purport to do that but we have had very extensive legal review including attorneys in Washington, D.C. that work for APPA and have been doing this for other communities. Other cities are doing it such as in Alameda, other cities are in the process of pursuing construction financing and an appropriate legal path for Palo Alto would be developed if the next phase of Fiber to the Home is approved. Some aspect of this may require citizens approval. I think the point here is we are not going to chart a path or make a recommendation, nor would the City Attorney or the City Manager recommend something that was not legal for us to do when we get to that point. Can we operate it? I mentioned that this is an area that we have already demonstrated strong success in doing. We believe we are going to have extra additional expertise and will have those individuals here as needed. Are the construction estimates correct? They were made by experienced Telecom engineers, they are based on our design standards, based on the neighborhoods that UAC Minutes Special Meeting FTTH 3/17/04 -Approved 4/7/04 Page 16 of 55 CMR21504 Attachment.A it would be build to. It has actually been supported now by the Provo actual bids and supported by the Lompoc and the Truckee Donner estimates that are very similar. It is also supported by informal discussions with other providers. As you can see though from our recommendation, one area to reduce risk is to expend the money to do a more formal design and eliminate that as a concern if it falls within the price that we are willing to pay. Potential risks. You will probably hear many of them this evening and you have heard some already. Competitor price discounts, actual cost of construction, how construction is paid for, participation levels turn out to be less than we expect and the venture ultimately fails. If you take the worst case scenario some of those were addressed in Karl’s Risk Management presentation. Our report talks about most of those, but not all of them. It puts a financial risk of failure into another report. We took a competitor’s price discounts, and price cuts over twenty years that will make cost recovering based on the three services difficult, but will save the community money in the long run. Short term competitive discounts are planned for in the Business Plan and I think are realistic. Will exact cost be known? When we prepare estimates and get bids the cost of construction will be known. If it is too high bids can be rejected. The project would not be started if the cost is too high. We are not asking for ’let’s just rush out and do it.’ We have a recommendation on how to do this methodically and reduce of the risk before we are actually out there spending lots of money. Who will pay the cost of construction? Well everyone knows ultimately customers pay for everything that we do. The plan pays off the construction loan through the user fees. All operating expenses are paid .through user fees. The project is expected to be self supporting. We have heard some of the details of how that would be done. Who pays if the venture doesn’t work? I think this is important for everybody to know. It depends on the financing. If you look at the Truckee Donner, it is based on broadband revenues only. In that case the project itself is the only risk. As you could see from Karl’s report and from Neil when you do project financing, the cost of the financing increases because the people loaning the money are taking the full risk of the business. If it’s financed by the electric utility then the ratepayers may have about 2% rate increase for fifteen years or about 70 cents per customer per month if the project fails. Now the assumption here is there is a salvage value and which is realized when the customers are sold but ultimately we are looking at this is the worst case. In the case of Palo Alto, the business and larger electric customers would have a considerably higher amount of cost involved. Again. we are not going to recommend going forward without full disclosure of this and everybody understands where that potential risk might be. UAC Minutes Special Meeting FTTH 3/17/04 -Approved 4/7104 Page 17 of 55 CMR21504 Attachment A We are also not making a recommendation that there would be any financing or any risk to the General Fund. Are participation rate estimates are accurate? Studies from the other communities that are moving ahead showed similar projections. Alameda has run broadband now for 3 years and has had excellent customer satisfaction and their actual deployment shows better results of 40 to 50%. How can we reduce our risk? Check out the financing options like Truckee. I think we need more work in that area to sort out the various options. Chart a path to minimize legal risk. We suggest in our report that’s about $70,000 expenditure. Evaluate our current business plan systems and specification upgrades that is probably a $70,000 cost, establish a panner and contract relationships. We have always been looking for parmers that would be willing to work with us. We have envisioned an open access system. We have recommended the services in the business plan for other partners to come along and utilize our fiber system. Develop construction specs as I mentioned earlier and get bids. This is $200,000, of course the money will be spent at the beginning so it wouldn’t have to be spent later on. But if we give a firmer cost estimate for actually doing the constructions we will have a better idea of how much money you need to borrow. What does the community get for taking the risk? This is all going to be in the eyes of the beholder. But at least a $15 million flow back to Palo Alto per year for broadband services. Local Palo Alto service will return some of that to .the City. A local control over the quality and cost of service, a locally owned infrastructure to carry the broadband services of the future and of course an additional asset to draw business and people and provide those kind of services within Palo Alto. Our next step - The staff requests the UAC to recommend that the council designate Fiber to the Home a top council priority in consideration with all the other things that are of high priority within the City. As I pointed earlier, this is going to take an effort by many members of the staff beyond just the utility organization to work on this. Have council approve electric funds expended for the next phase of project analysis similar to what has been done for earlier phases. Council to recommend public process for assessing community interest whether that is including a public vote, community meetings and other broad communication objectives. On the other side, we mentioned that if the council does not want to proceed with the Fiber then direct staff to develop termination protocols for the Fiber Trial. That is my last slide and I appreciate you bearing with me to go through that report. I want to make sure in summation, we spent a lot of money and want to UAC Minutes Special Meeting FTTH 3/17/04 - Approved 4/7104 ~ Page 18 of 55 CMR21504 Attachment A make sure we gave you a thorough answer to the questions that you have. We are available for Q and A and then on to the comments from the public. Rosenbaum: Thank you John, Neil and Karl. That was an outstanding presentation. I would like to welcome Dexter Dawes our fifth commissioner who is now with us. Couple of things I don’t believe we have a copy of the slides from Neil. Could those be made available to us? And once again I would ask any members of the public who would like to address us to please fill out one of these forms which are available at the front and just give them to John. Dexter what I had suggested at the beginning was that we would hear the staff report which just concluded and then perhaps for a short period maybe half an hour entertain questions from Commissioners to staff and particularly to Neil. Neil will not be with us in person tomorrow although he will be available by telephone. Then we will hear from the public and depending on the time we will either decide whether the commission should discuss the item tonight or continue the meeting till tomorrow night. So I think we are now at the phase where if Commissioners have questions for staff this is the opportunity. John. Melton: I would like to ask Karl on his sensitivity analysis. You tested the sensitivity of the penetration rates of both Internet and cable and sort of came to a break even point or zero cash point if each of those, rates fell. At what point would they reach a zero cash? It seems to me that there is some likelihood that those penetration rates might move in tandems. I wonder if you did a dual test that said how much can those two rates fall to reach a zero cash point. Van Orsdol: We did one but I think Neil has actually more up to date one. Let me... Shaw: That was a sensitivity that I flashed up there. Basically we took the penetration down for all services. The triple play we took them down 10% then we took them down 20 and then 30 and if there is another question then I can flag it and we will go to that. Rosenbaum: John do you have any other questions or you are waiting for this one? Alright. Do we have other questions? George. Bechtel: As you suggested I am just going to ask questions of Neil because Karl and rest of the guys we’ll have on tap later on. But Neil, you have changed, you talked about changing the penetration rates compared to what we talked about 9 months ago last summer. Were those new penetration rates included in the financial summary that we have in our book today? Shaw: Yes. UAC Minutes Special Meeting FTTH 3117104 - Approved 417104 Page 19 of 55 CMR21504 Attachment Bechtel: Okay. Another thing I thought was quite interesting was your talk about Tacoma. That it was a successful system and I guess that I had also read where they would have spent sixty five million dollars anyway for a network to collect data from utilities. I find that surprising because at no time has John come to us and asked us to spend that kind of money in connecting our systems. So it seems sixty five million dollars for communication network is sort of high. But if that were the case that would certainly justify what we are doing, maybe they have a much larger network than I think about. Do you have any more information on Tacoma7 Shaw: Karl has a lot. Van Orsdol: Actually yes. I spent several hours talking to Tacoma over the last week about some of these specific issues and several reasons why they spent sixty five million to do this. First is that they have four hydro generating plants. Secondly they have a population of 195,000. Third they have an area covering approximately 60 square miles and they have their own scheduling operation. So they serve the same function that NCPA does for us in the electricity side. So they needed much higher levels of communications to operate the SCADA system to integrate all this. They also wanted to move into the wholesale energy trading business and that required higher levels of band width and they wanted to optimize their hydro resources. So those are the reasons why they wanted to initially go forward with the utility side that was about $60 million dollars. There was also a couple of other issues. They stated that there is some development when they were going through this in 1997. There was a new development going on in Tacoma and because of the physical irregularities as to where this development was going it was hard to get, impossible to get any kind of band width service from the incumbent providers. In fact some were having difficult times in getting telephone service. So the utility decided that in addition to building up this service that they needed for their own internal communication and to link the universities in those city, they needed to expand the service out to the public in order to meet these other service areas of the community. Bechtel: Good. Thank you Karl.That was helpful. Maybe one more question of Neil and that has to do with the content and the ownership and so on. You were saying that we would probably have access to it. But what do you think of the possibilities of companies like Comcast buying Disney and controlling the content? As I remember in the write-up, it is not very clear where the FCC or the Telecommunications Act, I can’t remember maybe it is a Cable TV Act of early 90’s said ’No’ you cannot get have a monopoly on a content you have to make it accessible. Do you think that as we look forward we are going to have the availability of content even if content is owned by cable providers? UAC Minutes Special Meeting FTTH 3117104 - Approved 4/7104 Page 20 of 55 CMR21504 Attachment A Shaw: Well. Time Wamer is a good example of that. They own a lot of content and there is still a lot of independent content owners out there. I would think that it is difficult to say. I don’t see how Comcast could buy up Disney and then shut off everyone in the cable loop. That is 14 million subscribers. They would have to do the same thing as Time Warner and I think they find themselves in front of a senate subcommittee very quickly. So but to be honest I couldn’t say what the future is going to hold for ESPN rates, whether Comcast owns Disney or not. But there is definitely a ground swell of anger and resentment towards some that is going past the cable TV providers who are now pointing the fingers at the programmers and both the providers and programmers are on Capitol Hill a lot more than they would like to be of late. But I don’t have a good answer for you Commissioner Bechtel. Bechtel: But I think that’s at least a more positive answer then I might expect. Thank you. Rosenbaum: Neil do you have the answer for Commissioner Melton. Shaw: Yes. I do. This chart reflects the net cash not only in the 20th year but over the entire plan period and this blue line represents the base case of penetration which was the 28% video, 33% Internet and 29% phone. Basically what we did was we went in and dropped those three rates by 10% each and that takes us from a net cash value of $53.8 million down to a net cash value of $41 million. So we are looking at a drop of around $17 million dollars. And then we come down to 20% we drop another $40 million We still come down to a net cash value in 20 years to $20 million. So it is a precipitous drop from $53 million but it is not a disastrous case nonetheless. Heitzman: Neil would you mind showing the bar graph that you had that does the penetration in the 20th year. To me it is clear. The last one that you showed. Shaw: Okay. Basically this reflects if all the services were at the same penetration rate. If you had 30% penetration on all three services your cash balance at the end of the plan will be $51 million. If you penetrated 20% of homes, your cash balance will be $2.7 million and so if you only had 10% it would be $48 million in the Hoel. So this is a little bit different take on things. This is a 33% drop from 30% to 20%. So that is the answer. I don’t know if it answered your question. Melton: Yes. Shaw: Okay. UAC Minutes Special Meeting FTTH 3/17/04 -Approved 4/7/04.Page 21 of 55 CMR21504 Attachment A Rosenbaum: Do we have further questions? Elizabeth. Dahlen: Neil actually on the last chart that you showed. Is it correct that with the triple play option that the base case goes cash positive in the year 14? Is that what I saw in that last chart? Shaw: It wouldn’t go cash positive. It would break even in year 14. It goes cash positive in the 6th year with debt service, EBITDA goes positive sooner than that. So it depends on the measure you are looking at. So EBITDA goes positive in the 3rd year you put in depreciation it goes out to the 4th year. From a cash flow perspective in the 6th year. Dahlen: I guess I am referring back to the chart that showed the three triple play numbers. Shaw: Okay. Dahlen: Rightbefore the last question. While you look for that let me just ask a couple of other questions. What is the penetration of Cable TV today in Palo Alto? We have in some of the reports it does mention that satellite has about 15% penetration. What is the cable TV penetration? Heitzman: Okay. Do you have the number handy? Shaw: Somewhere between 46 and 50%. Heitzman: I think if you count the satellite it is around 74% as I recall. That information was available in the business case report where we had roughly thousand respondents then we added up projected across the community. I believe 74% was a total of everything cable and satellite. Dahlen: Of the Internet users in Palo Alto what percentage of Internet users are paying for today? I am really referring to the residential market for high speed Internet access that is greater than 2 mega bitts per second. What is the penetration of that? Shaw: The only one that would be available would be Comcast if they have delivered three meg here, do you have the research there? Heitzman: I don’t have it handy. We do have the numbers I will have to go back. I can give them to you tomorrow night. I have to go back and pull them out of the original report. It would, as Neil said it would, have to be the Cable modem users UAC Minutes Special Meeting FTTH 3/17/04 - Approved 4/7/04 Page 22 of 55 CMR21504 Attachment A percent~ I don’t remember exactly the total for broadband would be about 50% for Palo Alto. I can give you the exact numbers tomorrow night I just have to pull them out of the report. Dahlen: That would be great. What is the speed limit of DSL today? Shaw: Depends on how far you are from the central office. When I DSL from my house, I’d be getting 300K possibly. Dahlen: In Palo Alto? Bechtel: I can give you an answer. Every time I’ve checked here with PacBell it’s over 1 meg. Audience member speaking, (cannot hear clearly) Ulrich: Excuse me, if you are going to make a comment, you are going to have to come up and speak into the microphone because every word that is uttered here is transcribed and we would like to record it. Shaw: I think that the answer is here. Distance dependent the maximum currently on a DSL is 6 meg I believe downstream and not that much upstream. Cable Modem’s Comcast is going on a national program to build 3 meg down and much less up. Dahlen: I want to thank the member of the audience for the additional information. I have a question with regards to the staff, the hires that are mentioned in the. plan, particularly when it comes to sales and marketing. There is a good amount of the plan devoted to the need for sales and marketing and a fair amount of money would be put into that effort, but I could not find which individuals are going to be hired in this area. what is the projection? I mean who is going to be taking care of sales and marketing and how come we don’t have individuals mentioned for that role. Heitzman: Neil in his plan does lay out a table of types of skills and employees that would be hired. If we were to move forward, there would be an assessment as to what skill sets we need and so forth, who would be hired in each position, whether we hire from outside to bring in talent that we don’t have or whether there is existing talent in the city for some of those positions and so on. So that would be an implementation issue as to who you get for what position and what skill sets they have and where they come from. There is a Product Manager, there’s a General Manger, there’s a Technical Manager in there. I believe the is a lot of technical staff so forth so, and there is an issue of combining with existing staff so UAC Minutes Special Meeting FTTH 3/17/04 -Approved 4/7104 Page 23 of 55 CMR21504 Attachment A you utilize existing staff where possible to support this. There is an intermingling of existing staff and new staff to comprise this system and there is also the possibility that you would contract for some of the service and not all of them would be hires. There are hires in the plan but that does not mean you’re having to hire all those people, some of those people could be contracted services as well Dahlen: It just seems from the plan that there is a very important role in terms of operating this business, in getting it off the ground. When I look at the hires in exhibit 27 1 don’t see a Sales Manager or... Heitzman: Is there a Product Manager there - I believe there is? Dahlen: Well and I guess I would assume that a Product Manager is going to be really busy tracking three different business areas. Heitzman: That is basically for developing product and establishing marketing plans and so forth. Ulrich: I think it’s important to get the estimated cost into the plan. I would agree with you that we are far from determining the exact positions and how we would do it, but all of those would be very critical. I could not over emphasize customer service and product development because the whole plan hinges on a market penetration and selling the product in a very competitive environment. Dahlen: I agree, that does seem to be a critical role, I just was surprised to not see somebody under that, in that table. I just have a final question with regards to the section of the report that deals with alternative technologies and mitigation of risk. Given that cable is one of the, or perhaps the prime competitor in this sector, I thought that, it seemed that the report did not give a tremendous amount of input and information with regards to the technical potential of Internet over cable. The same would hold true for DSL. I see that a lot of input was made with regards to wireless but I wondered if you have any feedback on that and why that wasn’t mentioned more in the report? Shaw: The assumption is that the cable TV infrastructures in Palo Alto has recently been upgraded. Wall Street believed in the Cable Companies and their current upgrades, based on their current plans, to deliver Cable Modem services and the current generation of Cable Modem Services. To go much beyond that, the Cable plant is going to require much smaller node sizes, it’s going to require much more investment in fiber beyond what Comcast is going to be willing to deploy in Palo Alto. So on the cable side, they are struggling just to come up to meet the 3 megabit limit that everyone else has had for many months. On the UAC Minutes Special Meeting FTTH 3/17104 - Approved 417/04 Page 24 of 55 CMR2.1504 Attachment A telephone side it’s a little different. SBC has had project Pronto in place for the past three years to get DSL fiber connectivity to the home to reduce that DSL loop limit. Then again, DSL and its higher bandwidth incarnations like VDSL and things like that just can’t compete with the capabilities of a 100 megabit intranet with Fiber to the Home. It is noted that we didn’t have to spend as much time talking about the incumbents as we needed to, we’ll do more of that next time. The assumption was that on an investment perspective that they wouldn’t be able to afford to invest what it would take to compete with an all Fiber infrastructure. Rosenbaum: Elizabeth, I might interject with respect to your first question about video penetration, the one hard number we have is that Cable Co-op in its last years of operation had 47% penetration, numbers that come after that are based on survey results. Dexter? Dawes: Thank you Mister Chairman. I might also point out that Cable Co-op covered more that Palo Alto so we may have a chicken, a scrambled egg problem here in terms of other cities involved. Rosenbaum: No, I think that the 47% referred to just Palo Alto customers. Dawes: Okay, Thank you. I have a couple of questions. I had told the staff that I would have to be late today and I may have missed some things that I will ask about and, if so, I apologize and just go on. In this analysis I can’t find where our existing fiber ring is, I mean we have a business with revenue and cash flow which varies year by year. It had about eight hundred thousand dollars positive cash flow last year. It’s a pretty good start to expand and its also been pointed in various reports that these communication systems are important for inter, intra-city utilization which is what it was built for. But has also built up a nice business besides that. Is this in fact included in these financial projections that we have. Heitzman: I think I can answer that. The place where that would come into play would be the construction issue. The engineers that came out to Palo Alto to examine the field and so forth did look at our Dark Fiber infrastructure and would consider where it could be used in the build out of the Fiber to the Home. Now there is a limited application to where that backbone can be used in the Fiber to the Home build out, in that in some places it is utilized for other services and some places we want to leave some room for it. They did consider it’s existence in their design criteria and design estimates. Dawes: I understand, that’s on the design side. But I’m talking about on the financial side. Is it assumed that this business will carry over and we will have the revenues from the business that currently buy Dark Fiber from us and is it swept up into this financial analysis? UAC Minutes Special Meeting FTTH 3/17/04 - Approved 417104 Page 25 of 55 CMR21504 Attachment A Heitzman: No, its not swept up into this analysis. Dawes: Is it assumed that will just die and go away? Heitzman: I believe that service will still be used many of the current customers because it’s a different level of service than FTTH would be. They have their own particular needs and they want to establish their system independent of this system. So in many cases it’s not going to be affected. Some of the lower tiers of it would be affected. Dawes: But what I’m getting at is this in fact perhaps a financial contingency, positive contingency that’s not included in this analysis? Heitzman: Yeah, I believe that’s correct. Neil will correct me if necessary, but my review of the model is that the business part of this revenue stream is very much underestimated, it’s very minimally estimated in the business plan. So there is some potential there that isn’t rolled into it. Dawes: For many of these meetings I have made a point of the business uses and particularly because there is a potential that business could pay additional monies through their rates and because businesses contribute over 70 percent of our electric revenues, they would pay a vastly disproportionate measure of the under funding that would come by virtue of lower penetration. I have encouraged staff and Neil to include provisions, options, enhancements that would make this attractive to small and medium size businesses. I think that my assumption is that T1 lines are five, six, seven, eight.hundred dollars a month. I don’t know what the cost is, but it’s pretty big bucks in comparison to FTTH business rates. This can be a very positive thing for local businesses. The objections to having the possibility of higher rates would be tempered greatly. So has this offering been tailored to these kinds of people? Heitzman: The is two tiers on the Internet service are business tiers. We have recently done a business survey so we are aware what business, 86 respondents, I believe a hundred at this point, respondents) type of service they are getting currently. These two tiers are very much in the mix based compared to what they are getting at a very attractive price. So the tiers that we have showed here are not necessarily the limit of what we can do. We can certainly add other tiers and so forth to attract businesses. We have recently have gotten some information from survey work on businesses and believe that the tiers are right. They would be very attractive. The responses of the businesses when asked whether the city should provide these services was very positive when they felt they would get a discount. What you would expect from a business, right? UAC Minutes Special Meeting FTTH 3/17/04- Approved 4/7/04 Page 26 of 55 CMR21504 Attachment A Dawes: Thank you, I appreciate that and I urge you to continue to develop those benefits for businesses. Next question deals with the financing side which is still pretty murky in my mind. To my recollection, Truckee Donner used, in effect, commercial financing sources. It was mentioned that they did not encumber electric revenues to do that. If in fact we go down that path, not use tax exempt bonds, not make it a part of the electric infrastructure, it changes the cash flows. It changes the expense side of our situation and hence the curves that Neil drew for full payment of the indebtedness and the time the system turns cash positive. Is it the intent as we learn more about our potential for financing that this would be plowed in? How do you plan to address that? Ulrich: Yeah, this is one of points that I addressed during the presentation because Truckee Donner is one that tells us they have explored and they feel that they are going to be able to finance it without revenues from any other source except from the sale of services on the Internet. Dawes: So that’s not a done deal, it sounds like. Ulrich: Well no, nothing’s done till we see it. But it’s an option that apparently they have been able to do. In addition, Alameda, is going out for refinancing as they have a business that is already making money. They are able to get financing without depending on revenues from their electric or any other business. Dawes: They had a healthy down payment from their diffusing their portfolio which we don’t currently have. Ulrich: Karl will mention that a little bit more, because that was addressed in the risk assessment. Dawes: Fine, I’m sorry I missed that part. Ulrich: It’s alright, we like to say it again. Van Orsdol: If you will turn to slide 16, I addressed that specifically in terms of bond rates. If Palo Alto were to issue a bond tied to the utility we would expect the interest rate to be in the 5 to 6% range. And our conversations with bond council would be if we decided to have the bond based solely on the prospective revenues of the Fiber to the Home project, we would probably expect an interest rate around 8%. And if we had an 8% interest rate that would decrease the twenty year, year twenty cash, free cash at the end of the project by sixteen million dollars or about 29%. UAC Minutes Special Meeting FTTH 3/17/04 - Approved 4/7/04 Page 27 of 55 CMR21504 Attachment A Dawes: Thanks. Rosenbaum: I have some questions or perhaps comments for Neil on some of the numbers in the business plan. If we look at page 11 of 85, do you have a copy Neil? I’m looking at exhibit two, labeled incumbent broadband Internet offerings. The data in that table is outdated, to the degree that it figures into financial projections I think it really ought to be corrected. So do you have the table in front of you? Shaw: Exhibit one? Rosenbaum: Exhibit two. I have it on the bottom of page eleven. Shaw: Okay. Rosenbaum: \Vhcrc you say Comcast up to one and a halfmegabits, they now are at least advertising in this area that they are offering three megabits, but more importantly with SBC, they have pretty much abandoned the basic tier and their standard plus tier is now available for $30 a month with an annual contract which is something you acknowledge on page fourteen in a brief comment. Shaw: Uh hum. Rosenbaum: SBC has also introduced a new tier that provides three megabits and they are charging $45 a month for that, I assume they did that to compete with Comcast which charges $43 for their three megabits. So I think it would be helpful before this goes further to have that table corrected. If we go to page fourteen. That’s in the first paragraph that is where you mention that in terms of bundling that SBC offers the 29.95 a month service and its always available with a one year contract. If we look at page 24, exhibits nine and ten. I found it hard to correlate those two exhibits. You define what you mean by low, medium and high tiers in exhibit nine, but then in exhibit ten you introduce something called ultra high which isn’t well defined, and I’m not sure what you were thinking of for what’s called medium DSL because I think you had yet another chart in one of you view foils that you showed us tonight, I think that you were showing that 2, 4 and 6 megabits per second would all be priced at $39.95. Shaw: No, it must have been a typo it should have been that 2 would be $39.95 and 4 would be $59.95 and 6 would be $99.95. UAC Minutes Special Meeting FTTH 3117/04 - Approved 417104 Page 28 of 55 CMR21504 Attachment A Rosenbaum: No, I’m talking about the proposed rates for the city, not the SBC rates. These are city rates that are proposed city rates here. I’m looking at the CPAU column. Shaw: These rates are what, if the presentation did not reflect these rates, I apologize, but these are correct. Basically the low would be 256, the medium would be 2 , the high would be 4, the low business would be 6 and the high business would be 10. Rosenbaum. And the Ultra High? Shaw: I don’t know, that’s 4 1 guess. Rosenbaum: Presumably that’s your 100 megabit intranet, that’s what I made the assumption, is that correct? Shaw: No, all of them would have 100 megabit intranet. I mean the issue here is that we had a few too many cooks in the kitchen on these charts. Some people didn’t want tier names, some people didn’t want rate speeds, so it’s like lets call it high, low, medium, lets call it ultra high blah blah blah. So basically what we are looking at here is five tiers, the top two tiers would be assumed going towards business, and the lower three tiers would be going towards residence. In reality in a market like this you are going to have some businesses take the low tiers. So in recent studies we have done away with the low, the 256 tier and we have gone 2, 4, 6 and 10, starting at $39.95 and we’ve talked about to address the rate issue, SBC is doing a promotion, $29.95 for an annual contract and the fine print says that your rate’s going to go up to $59.95 or whatever or what have you, in the thirteenth month. Now it’s yet to be seen if they are going to do that, if they do that, they are going to have some problems. But we do build in, as I mentioned promotional discounts over the first five years, of up to 20% and then ongoing 5% operate card forever. So I’m sorry commissioner Rosenbaum that exhibits nine and ten are confusing. Rosenbaum: I’m just suggesting that they be clarified before this report goes further. With respect to SBC, nobody knows, they do say that they will, if you want to sign up for an additional annual contract at the end of the first the annual contract you will get the annual contract rate which is currently $30. Then one final comment. On page forty-two. The third paragraph under "B" you make a calculation of dollars per megabit, per second and once again it ought to state that Comcast provides three rather than one and a half megabits. Shaw: What page is that on? UAC Minutes Special Meeting FTTH 3117104 - Approved 4/7104 Page 29 of 55 CMR21504 Attachment A Rosenbaum: That is page forty two, "B" the third paragraph. Shaw: Okay. Topete: Thank you commissioner Rosenbaum, if I may make some clarification. Rosenbaum: Yeah, why don’t you identify yourself. Topete: I’m sorry, Manuel Topete, Projects Coordinator for Telecommunications. I did some research, thirty-six hours old at this time and this is basically what Pacific Bell is offering and SBC. For 384 kilo bits down and 128 up, $29.95, one year commitment. Now they have a special offer right now, if I sign with them tomorrow, I can get 1.5 down and 128 up that would normally go for $49.95 at $29.95 for a year, but the clarification is there, after a year I would have to go to $49.95. Now they are also advertising 3 megabit tier with a 128 up and they are offering this in limited areas. It needs a little bit of research on the technology since the limitations are physical for this type of service. It has to do with the usage of proxy servers and compression software, proprietary compression software. So the 3 megabits are not for dynamic down loads but rather for cache or data that has been cache in proxy that surrogate servers in the network. So in essence what they are offering really is 1.5 down and 128 up at $49.95. Rosenbaum: You don’t believe that when they say at the time you sign up for twelve months, you can get the twelve month rate? Topete: I did ask about that and the clarification was it is to attract new customers, if you are a new customer you will get it, if you are just with us after one year, your rate will goes to $49.95. That is something I have experience with. DSL, with wireless and with cable modem and now again with DSL, it’s always the same thing. Rosenbaum: Thank you. Alright, it’s now nine o’clock, we’ve got, I think we’ve got fifteen speakers. Colleagues would you like to take a short break, and then listen to the public? Why don’t we do that. I would anticipate that the commission would finish its discussion tomorrow night rather than try to do it after listening to the public tonight. Why don’t we plan that we will after heating from the public we will continue the meeting to tomorrow night? Karl? Von Orsdol: I’m sorry to interrupt, I just want to fully answer the question Mr. Melton asked earlier, I didn’t have the numbers at my finger tip, it was a 33% drop in both Cable and Internet subscribers wouldlead to a zero cash after financing. Rosenbaum: Alright, let’s take a short break. UAC Minutes Special Meeting FTTH 3/17104 - Approved 417/04 Page 30 of 55 CMR21504 Attachment A Break Rosenbaum: I would like to continue with the meeting please, would everybody please take your seats. Alright we will now hear from members of the public. I apologize for being as late as we are. I had not anticipated that the first part of the meeting would take this long. Indeed our first speaker has had to go home, that was Andrew Johnson the Vice President of Communications for Comcast but he has left us with some written comments which we have in front of us. As you come up to the microphone it would be very helpful if you would clearly identify yourself, every thing we do is recorded and the minutes and all the names and information depend on what come through the microphone. So we are going to start with Gary Lindgren and Jerry Schwart will be our second speaker. And I would encouragc cvcryone to be as brief as possible. Jerry Scharff: l’m JcrD’ Scharffand I live on Laguna Way in Palo Alto. I wanted to support commissioner Dawes in his desire to have business directed services and I have some experience in this area. Very often it’s not about equipment. The idea of reliability; these people or business many times have tremendous investments in \~hat they do, to make this a critical service requires that the Utility have a mentality and some people who really are focused on what business wants to do. Business can pay a lot of money, as you said they are at high risk as well. I think that with the proper service structure it can easily be a significant money maker for the city and l would like to encourage that. Rosenbaum: Thank you, Gary are we now ready? Gary Lindgrcn: Gary Lindgren of 585 Lincoln in Palo Alto. I have a couple of comments on the Business Plan. First, I suggest adding a few comments on the design concept for the phone and Internet service. Really in the plan it just says how well people are going to be served. What is the design concept? Is there going to be just one fiber that goes by each home and you pick off some service, or is each home going to have an individual fiber that goes back to a central office. I’m not sure and it doesn’t say at all in the business plan. I’m not looking for design of course, but just to get some idea, some comfort level as what the thoughts are. I’m sure Fiber to the Home phone service really shouldn’t, be compared directly with SBC’s phone service, you know across the street they have this huge building there, I’m not sure were talking about phone operation that’s similar to that. And a very important question, is there going to be a 911 service and what happens in the event of a power failure? I think those are important issues that need to be addressed. UAC Minutes Special Meeting FTTH 3/17/04 - Approved 417104 Page 31 of 55 CMR21504 Attachment A Then let’s see, Dick, you already addressed exhibit 2, I’ve got a table that has a lot more information here. This information comes off of a website DSL reports and this is up to date information. These are all ISP’s that serve the Palo Alto Area and as it was mentioned, SBC is offering some special deals right now and a lot of these ISP’s really have SBC backbone service except for Convent. I personally have the one Sonic.net and they have the service, the special offer for 6 megabit down and 608 up. I signed up for that for at a special rate for one year at $44.95. If you test it, at least for what I have right now with past week, it’s maybe about half that. It’s from 1.5 megabit to 6, so you know they gave me what they promised. That gives you a little bit of an idea of what real stuff is right now. Then, let’s see, then for alternative technologies on page 28, suggest, you discuss 4 G Wireless Technology as envisioned Flarion Technologies. That’s something that there’s going to be, Verizon is going to be doing something on the east coast, I think the Washington area, a demonstration program and that might be good to add some comments there. Then exhibit 24, page 63. That suggests that the per user revenue will increase with time, I think that competition is going to be pretty strong and its going to be hard to increase rates if that is what’s implied there with that table. A very minor thing, the last thing, the paragraph on network operations center talks about, it says a Windows NT. That’s been obsolete for several years, change that to Windows XP Pro. Rosenbaum: Thank you very much. Ulrich: Mr. Lindgren, could you leave your documents so we can put it with the record if you don’t mind. Thank you. Rosenbaum: Wayne Martin to be followed by Bob Evans.. Wayne Martin: Wayne Martin 3687 Bryant. I dropped off some handouts for you folks to look at. These came out of the historical file at the library, the first one is the new rates schedule for Pacific Telephone for 1948, you will notice that a single line is $3.75, today a single line change is $10.00 and change, well it’s almost $11.00 or a 400 percent increase, in 1950 when mom toddled me off to the store, I took a quarter and I got a loaf of bread, today I take twelve to fourteen quarters and I get a loaf of bread, many of you remember a gallon of gasoline was about $0.08 in those days, now it’s about 20 times higher. A telephone line in America is one hell-of-a-deal and people who have grown up under the aegis of the American phone system have the best phone system in the world, the idea that they are going to start moving away from it because someone say’s that they can save them a dollar or two with a no name telephone company is not likely. I encourage you to think long and hard about that as you go forward. UAC Minutes Special Meeting FTTH 3/17104 -Approved 4/7/04 Page 32 of 55 CMR21504 Attachment A Second page is a picture from 1951 where Pac Bell puts 120 down in a day to help Palo Alto wire its town. I don’t know, I mean in 1948 and 1951 south Palo Alto as I.understand was not part of Palo Alto proper, so I don’t even know who wired it for electricity, but Pac Bell was here to wire it for phones. The last picture is an example of a man, a guy named Fisher using a car phone in 1948, the phone company has always been at the forefront of innovation, I remember California in 1950 and 1951 with Broderick Crawford in Highway Patrol, but it seems that people were using car phones long before that time. I think that the business plan has a number of errors and omissions, I think that there is far too much boiler plate and not nearly enough substance, at least in the document on the website. An example, Comcast channel lineups don’t match the website. I found what I think I found what I think is about a hundred more channels on the Comcast website than what I saw on the plan. The business plan claims there is not much ethnic programming, yet you can find channels for Palo Alto that include Italian, Russian, Chinese and Hispanic programming on the video and most of that in digital radio channels. Terms of alternative technologies, SBC has now added a bundle with satellite Ecostar in early March that doesn’t show up in the Business Plan as a competition and also the French hardware developer Alcatel is now touting video delivered through DSL. And to answer the question about DSL speeds, a company I know of two years ago had their DSL product running at 12 Kilo or Megabits downstream. Another point. An issue about being owner operators, I checked that with the city attorney, and according to her, the Utility is simply another face of the municipal corporation known as Palo Alto. I asked if the assets of the Utility were sold would the proceeds be distributed to residents as in the case of Cable Co-op? The answer was no. So I don’t think we are owner operators, what we are, our only actual link to the municipal corporation is our ability to vote for city council members. The issue of the telephones, I was as an army officer was in the DMZ, just south of the DMZ in Korea as a company commander of a cable line unit that had high reliability, high availability as its missions. So I always look to these issues when someone talks to me about telephone companies. When I saw the name E-Tel I had never heard of them for the potential parmer for the city’s telephone operation so I looked them up on .a website. It seems that there is a mention of them in a Kentucky PUC posting in 2002 as having a 600 line user base in Monroe, Kentucky. I couldn’t find out any other information about them other than they did have some additional business with Southern Bell and so they presumably have a larger user base now. Doesn’t seem to me though that that organization is going to be able to compete at the name level and the branding level of SBC. POTS over fiber has been hawked by a number of people as being a higher quality, reality is that because it’s linked to the power grid at the NID level as well as the head-end level, it will never have higher stability than the power UAC Minutes Special Meeting FTTH 3/17104 - Approved 4/7/04 Page 33 of 55 CMR21504 Attachment A level. Most of the current battery lives right now are 8 hours of standby-by when the grid goes off, two hours of talk time. So, if you start looking at the outages you will find that as soon as you use your phone or any other part of the unit for any period of time during a power outage you will loose your phone. Voice over IP which is another way people envision using this, is a double whammy because not only does the NID need power, but also does the PC and any other information applications that actually would be accessing the net doing telephony. Another issue that is very important to me is a disaster management plan, I have seen no evidence of it in terms of backup generators, fuels and personnel. It seems to me that since we live on a couple of fault zones I think that people have heard of the Hayward Fault and the San Andreas Fault that we have some reason to believe that disaster management is something that should be on our agenda. 911 service is a problem, I suspect over time that 911 through fiber issues will be worked out but as I understand it at best you are going to get a connect to a 911 but the kinds of features that are built into class five switches such as the ability to determine the location of a phone simply by it off hook by calling 911 won’t be available anytime soon. I couldn’t tell from the business plan if this parmer would be a registered CLEC under the auspices of the California PUC or not. I saw some lists for services that generally are built into the class five switches and from doing my research there about 30 or 40 of these I saw 6 or 8 in the business plan and so business that might be interested using some of these switch features are currently have, no provisions have been made. I couldn’t get any sense out of the business plan how SBC or Comcast would respond to the targeting of their business such as 29%. I can’t believe they are going to roll over and play dead. Yet they just seem to see this year after year increase in business without any response. Point of order is that from looking at various websites the Fiber to the Home website claims that somewhere around 300 thousand, 200 to 300 thousand homes have been passed to date. FCC website seems to think it’s 500 thousand and the number of people who are actually connected to this service seems to be 130 to 180 thousand people in the United States. As another point of order the FCC claims that there are 109 million homes, 180 million access lines and 140 million cell phones. So you can see that this technology has not really taken off. Back to the disaster issue, if you look at the electric grid outages in the eastern United States large sections of the county are routinely without power for 30 days. Ice storms and hurricanes rip up the power grid pretty badly, this means that people will not be able to depend on this technology till some other form of power comes along and while it may not be necessarily important to Palo Alto at the moment it is important to the fact the technology is not going to grow at any great rate until this powering issue has been taken care of. And another point of order about the system rebuilds, the class five switches that were installed around 1980 are beginning to end their lifetime. Class five _switches are fairly expensive it is UAC Minutes Special Meeting FTTH 3/17/04 - Approved 4/7/04 Page 34 of 55 CMR21504 Attachment A the backbone of the switching network, and so if in fact that 20 years is level of extent for those switches it seems to me that whatever we use, collectors, d-slams whatever the particular technology is probably not going to have the level or lifetime of a class five switch and people are going to have start asking when is this stuff going to have to be replaced and where are those replacement numbers going to appear in the business plan. Thank you. Rosenbaum: Bob Evans, followed by Jeff Hoel Evans: Bob Evans, Galen Avenue. I also own and operate together with my parmer the Fiber Internet Center of Palo Alto in town. I will get back to the . inaccuracies of where the $2 million dollars is going to go that you are generating now from the Dark Fiber after I bring up the fact that this plan is really, really full of a lot of great generalities as these people have pointed out and its missing details. These guys here that just spoke also just mentioned that its missing details, it’s missing a lot of them. We have a hundred year plan to put the lines in the ground, this doesn’t talk about any additional cost to move the fiber, to keep the fiber going as we do things. And how are you going to move that into the ground after you hang another wire on all the poles, so that’s a big detail that’s not in this plan. I mean, I bring this up because I have a pole in my backyard that has termites in it and they want to replace it. My wife said, get them to put in the ground, so we called, we also talked to the neighbors, the neighbors were also willing to put up money. How much to put the pole in the ground? Four phone calls later my wife comes back, the guy told me to just forget it, it’s going to cost millions to put that pole in the ground. If it’s going to take us 100 years to put the poles in the ground and we start with north Palo Alto first, this plan does not address any sort of roll out for how we go hooking up the fiber and which house go first andwhich direction and how long that’s going to take. If it takes 20 years then the numbers in this plan aren’t good because they pretty much look like and they appear to be based on the fact that we can quickly wire up all the homes. Well if that’s true, then my experience in business using Dark Fiber, sad to say, I was really, really misdirected myself when I started the company to begin with. Across the street from an office that they sit in on a daily basis we have a customer that wanted fiber and we had to go to all kinds of free space optics because it was going to cost $20,000 to pull a fiber optic cable in front of one of the buildings to the building adjacent to them. This is the utility building that there is a fiber splice point in front of. The average price I have seen, in fact the lowest price I have ever gotten a quote after I pay my $500 for the engineering study is, first I don’t know if all of us will have to submit a dollar amount for an engineering study to go underneath our roses or how ever we are going to pull this thing in, but I pay $500 fight now for a study to see if a business can be connected and the lowest price I have ever seen when the fiber runs down the street and in front of the UAC Minutes Special Meeting FTTH 3/17104 -Approved 4/7104 Page 35 of 55 CMR21504 Attachment A building is about $10,000. So if we can do that for $10,000 1 really challenge the economics of being able to roll this out everywhere when we are supposed to be pulling down the infrastructure that we going to hang this on and putting it in the ground at the same time. So this has a lot of generalities, that’s just one big gross oversight that I see here. The other thing that I would like to point out is most of these towns that we listed up there with the exception of a few, were all lacking infrastructure. Tahoe Donner wouldn’t want to be putting this stuff in if they could get some decent phone service up there to begin with. So they are looking for the citizens to go ahead and put it in. Here we have gentleman who gave us a nice list of all the ISP’s in town and told us that he could get, not the quoted 6 megabits, but 3 megabits, I’m going to go sign up for Sonic Net at my house because that sounds really good for the price that he’s paying. These competitive things, when I first watched this Fiber to the Home begin and I saw it taking shape if we go back to what was claimed we were going to do and how we were going to build an infrastructure and get other ISP’s and other companies to want to go ahead and participate in providing the services. Like two of the guys have already pointed out,, the 911 service alone When the city’s got this problem when we are already paying people that we are liable for after an employee or someone hurts them to be able to say, don’t make us liable. This doesn’t have any insurance in it at all for the mom or the father at home who tried to use the 911 service over the fiber and because of some smurf attack or some sink attack or denial of service attack from some university student somewhere with a full DS3 they couldn’t get their voice over IP to work for their 911 service to for the ambulance. I’m sure that the insurance company the way it’s underwritten the power company, I don’t know how that works actually, you know people in this town have a lot of money for lawyers who can make sure that their mom or their dad is worth at least a million bucks because that phone call didn’t get answered because of that fiber service. I hate to bring this stuff up because there is really one side of me that really wants this service. And that’s the other part that’s the citizen at home who would love to see broadband access and everybody shooting video around to their relatives, but quite honestly I don’t see an investor underwriting this. I see I’m underwriting it with my property. And I’m going on the hook for the 40 million dollars. On the other hand that you build an infrastructure that somebody does know how to provide services with and I will tell you fight now that Comcast did a heck of a lot better job than Cable Co-op and they still are today. I’m also the guy who founded ISP channel and I used to have people in town and professors at Stanford call me up and demand a cable modem when I only had 20 cable modems and that UAC Minutes Special Meeting FTTH 3117104 - Approved 4/7/04 Page 36 of 55 CMR21504 Attachment A went on for years. I would getthose phone calls and I had to un-list my phone numbers so there is a true pent up demand for high speed access in town. But it’s missing the detail, lots of details. I probably have, I could go on for an hour with all the details that are missing here, it’s just too easy. I will go out of business when you want to go ahead and provide a business $99 for 6 megabits or 10 megabits, who wants to argue about a megabit when I can tell you my average customer that’s on the Dark Fiber that I lease from the City today uses maybe two, maybe one, and that’s a business with 50 employees. And I will tell you something else about them, they are very demanding, and with the number of technical people that you have listed in this you’re not going to be able to do it. Right now I have customers who expect me to go to upstream providers away from me. I don’t know if you know what that means. But somebody on the Internet who owns a big part of a network, part of AT&T or MCI’s backbone decides that they are going to block port 135. So my customer on the Fiber that we lease that we provide service to expects me to find out who the engineer is that I’m going to talk to three states away so that his packets can still make it back and forth from India along that route and you are not going to do it with the number of technical people you plan on hiring. Not if you plan on running the mail servers and being responsible for everything that goes through the network including the firewalls and other things that are going to protect people from denial of service attacks and sink attacks. I really think that the city was heading in theright direction before, this and that was when the city was looking at going ahead and getting other companies, several large companies for example, as I mentioned to Blake actually in my office, eighteen months ago when I started the company that what we should do is, the City should go ahead and encourage more of this Dark Fiber service. It’s making good money with it. There is no doubt about it. If you want to change that over to this kind of a plan, then you really, really have to think about a lot more and consider a lot more. Because building a Dark Fiber ring that the city runs in the level that say layer two, and then get a whole bunch of people to want to come on it, people, business or whatever and provide services and compete with each other. That’s the best way to do it. This is a little monopolistic and puts us in the position where we are going to go ahead and compete with two satellite providers and a cable company. When you really could be building something to encourage more business to provide services in town too. So the 2 million dollars that you are getting now, a large part of that will evaporate because I pay thousands of dollars a month, now we get the bills monthly instead of annually, my wife used to hate it every month of that year when I would got the bill and I would have to come up with thirty grand or something like that for what I pay for Dark Fiber services as we were growing. Now we pay even more. UAC Minutes Special Meeting FTTH 3/17/04 - Approved 4/7104 Page 37 of 55 CMR21504 Attachment A I’m also helping and then subsidizing one of the Fiber to the Home projects in Palo Alto that is sitting out there on Driscoll Court and trying to keep it alive and the City has made concessions as they can tell you, the fiber to that place costs money. The expenses are really high for that person to figure out they couldn’t afford the run all the way from the PAIX out to that place. So we took some technology, cut down on the number strands that they were using and also shorted up their run and ran it from our place for them to help them subsidize that. So that project would easily become a customer of the City’s too as that little business goes out of business. So I think you had a lot of little things starting up in the city that you are going to see evaporate from the Dark Fiber. Like I said one part of me, as somebody who lives in the town, I really want something like this. The other part of me says, nah, let a private enterprise do it because I don’t want to go on the hook for it if the people that we have running this can’t pay attention to the details. Why don’t we see if some VC’s, have some VC’s look over this plan and give us a study back on what they think about this. There is so many in town, you could probably find several of them would do it for free for you. Thank you. Rosenbaum: Thank you Mr. Evans. Jeff Hoel to be followed by Sanford Forte. JeffHoel: Hi, I have only a couple of remarks. Rosenbaum: Jeff please identify yourself. JeffHoel: l’m sorry, Jeff Hoel 731 Colorado Avenue. And I just wanted to say I am an avid supporter of the city wide municipal Fiber to the Home Utility for Palo Alto. And 1 think that’s what you ought to recommend to city council. I should also mention that 1 don’t agree with all aspects of the current plan and I sent you lots of detailed information saying where I don’t agree. I am hoping that maybe tonight or tomorrow night you can get into some of that stuff. If you want to know the kind of Fiber to the Home system I think would be just great, I think that’s the kind that is going into Provo right now. For example each home has a 100 megabits per second and I know that the current plan the business plan phase two that we are reviewing now does call for 100 megabits per second but in fact in previous city documents the so-called representative system couldn’t go that fast and I think that probably needs to be acknowledged. I would like to see no shared fibers, each home gets it’s own fiber, no sense in doing party line stuff, individual fibers in a fiber optic cable are cheap enough. I would like to see the kinds of components used in the system be standard spaced and interoperable and that’s another characteristic that the representative system does not have. I think all services should be provided using Internet protocol ar~5 that includes TV. In the business case that was written some time ago, the document said that nobody has proved it works. Well, now Provo has proved that UAC Minutes Special Meeting FTTH 3117/04 - Approved 4/7104 Page 38 of 55 CMIR21504 Attachment A it works well, costs less than the old way of doing it and it’s much easier to contemplate having multiple video service providers, if we ever want to do that in the future. I do like the concept of open access where you can have a number of retail service providers competing with each other to provide service. What the city does, is provide the bit moving service at the wholesale level. In the current plan that’s contemplated for phone. At least they are intending to get one retail service provider perhaps not multiple, but not for TV and possibly not for Internet, depending what they can find for service providers. The biggest problem philosophically I had with the whole document this time is all of the pricing seems to be based on what the market will bear. And I think it’s great to find out what the market will bear, just so you know what it is. But for the rest of Palo Alto’s utilities, they are priced at what the service costs plus a little bit for the general fund. That is a philosophical approach I think at least deserves some discussion. A while ago when the business plan was being contemplated, the prediction was that this would be the last document we would have to write and now the current plan say’s there is going to be a phase three. I hope that UAC will ask council to be given oversight responsibility for this Phase Three. Because my impression up till now was that after approving this current round you’d be done. Alright the $200,000 for making very detailed design for the kind of system we want, I would like to hear a little bit more about what kind of system it is, whether it’s going to be the kind like Provo has or not before spending the $200,000.00 to design every last detail of it. As far as legal concerns I think it’s too bad that we haven’t had more input from city attorneys up until now so we don’t really understand what the legal options are, particularly with respect to whether some of the services if operated at the wholesale level will not require the referendum to approve the board that reviews the TV content and stuff like that. If it cost another $70,000 to get input on those legal options then I guess we better get it. I think that’s all I have to say. Rosenbaum: Thank you Jeff. Sanford Forte Sanford Forte: Sanford Forte, 280 College Avenue, Palo Alto. The incumbent communications service providers, that is the Comcasts, the SBC’s of the world have failed our public’s interest. Palo Alto citizens deserve better, they deserve a municipal broadband network with local control. That being said, the proposed FTTH business case does not yet meet the standard for maximizing potential depth, full spectrum of choice or long term fiscal sustainability of municipal communications services here in Palo Alto. By choosing to leverage citizens communicative assets through an information utility, our municipality assumes a UAC Minutes Special Meeting FTTH 3/17104 - Approved 4/7/04 Page 39 of 55 CMR21504 Attachment A special responsl’bility to perform the business-diligence that accomplishes the following goals. One, project realistic forward risk and realistic down side risk. Two, suggest public private funding scenarios. Three, reveal local opportunity costs. Four, model management and strategic architectures that reflect the complexity of the communications sector today and moving forward. Five, model service choices that fit the customer, not the other way around. Six, provide ubiquitous communications infrastructure that serves all citizens in static and mobile environments. Seven, model unique community synergies that create embedded substantial competitive barriers to entry and maximum flexibility. Unfortunately the business diligence falls short in all of these areas. My recommendations; that UAC pass the business plan onto City Council and that Council appoint an un-funded working group to complete the following: One, perform a market diligence or complete the market diligence that better reflects the risks and opportunities of today’s communications sector and going forward. Two, pursue alternate means to fund the project. Three, ensure that personnel who understand the social and business development dynamic of communications networks are in place at CPAU before deployment takes place. Four, model a plan for a hybrid that is fiber and wireless infrastructure instead of the proposed single solution fiber infrastructure. Five, model a scaleable built to demand infrastructure deployment instead of the current build it and they will come scenario. Finally Six, ensure that local key constituencies participate in modeling how their participation in the network contributes to its optimal use and benefits and model those findings into the strategy. The above goals will maximize intra-community communications creating significant revenue, innovation and social multiplier effects. This can be done profitably if the will and vision are there. If the above goals cannot be met in the working group, I recommend the project be held back from community vote until they are. Be assured that current and future developments in communications services and the consumers who buy those services will not favor poorly diversified communications infrastructure or less then optimal consumer choice. That way is failure or little better than we have today. I just want to say I’m in sympathy also with some of the remarks that Bob Evans made. There are some infrastructure details going forward that have been omitted from the plan. I was going to mention those, Bob did it for me. I would also like to say that there is, it seems to me that there is a special bias against wireless technologies in this plan. I think we are foolish to consider less than an organic build out. The build it and we will come scenario that has been proposed by the plan I think is really too much. There are things happening in the technology sector, let me just mention just one of them. I’m not going to, because other people want to speak, I could go on for an hour or two myself. Let’s take a look at UAC Minutes Special Meeting FTTH 3117104 - Approved 4/7/04 Page 40 of 55 CMR21504 Attachment A Store and Forward, the storage and communication technology sectors are converging rapidly. Within the next two or three years you and I are going to be able to buy multi terabyte drives, Hitachi has something like a 400 gigabyte drive the size of a quarter available today. Now what does this mean? This means that when things like 3G Networks, and by the way, let me back up for a second. 3G Networks in the plan were pilloried, people were saying that they weren’t working, well Dokomo the Japanese company and part owner AT&T just today said that their subscriptions to 3G technology has doubled in the last four months. We are talking about a technology that is only in terms of its public prominence is only about two years old. Project forward ten years. Back to Store and Forward, you and I ten years hence or eight or nine years hence are out in the community with our portable device and streaming to that portable device is a movie that we are interested in or a newspaper that we are interested in or whatever, you and I go home and we turn that portable device on and we have a television set or stereo system that’s wirclcssly enabled that allows us to stream at one giga bit or more per second all the information that’s on that portable device to our entertainment device. I would submit that because the major telecommunication providers do not and don’t intend to and probably never will deploy fiber, if they do it will be thirty or forty years out before we see it universally, companies like Intel and other wireless providers and so on and content companies are looking for way to go around us because they understand that people want convenience. So what we are talking about is how pcoplc use networks, we are not talking about how fast they are, the fast, the spccd has nothing to do with what people what. People want convenience, thcy want it now, they want it where they are. That is all I’ll say and I thank you very much for your indulgence. You have done very hard work on all of this. Rosenbaum: Thank you Mr. Forte. Bob Moss to be followed by Bob Harrington. Bob Moss: Thank you Chairman Rosenbaum. Bob Moss. I’m going to begin by trying to address some of the questions that have been raised by both commissioners and the public. Penetration rate that Comcast has currently in Palo Alto is between 35 and 36%. Their penetration rate for cable modems has dropped from 13% to that Cable Co-op had when we sold the system to about 3%. This demonstrates very clearly that in Palo Alto a little incompetence goes a long way. When it comes to incompetence AT&T and Comcast are unparalleled. You asked questions about being able to buy content and we are worried about Comcast’s not selling content if they were to buy Disney. That’s not going to happen, that merger will not be allowed by either the FCC or Congress unless there are very strong requirements that the content be made available freely and at maybe even a lesser cost to other organizations. UAC Minutes Special Meeting FTTH 3/17/04 - Approved 417/04 Page 41 of 55 CMR21504 Attachment A As to the cost comparisons between Comcast and the rest of the cable industry, as you may know we used to buy programming from AT&T, originally TCI. In order to try to hamper our financials, TCI cut us off and made us go to the National Cable Co-op for programming. The difference in cost for programming was on the order of $100,000 or $200,000 a year total. It was almost unnoticeable. There is a discussion about the cost of undergrounding, figure between five and $600,000 a year for undergrounding, that’s what we used to pay. So that is built into your normal costs of doing business. In terms of what sells the service, it’s not the 10% or 20% cut in price, in Palo Alto what sells- it is performance. None of the competing services, none of them, have the capability of matching the high speed two way bandwidth that Fiber to the Home offers. That table you saw earlier where they talked about as high as 6 meg downstream and the highest upstream is only 640 K. That sucks. Comcast limits your upstream speed to only 128 or if they feel generous 256 K. So when I want to upload a bunch a pictures of our grandchildren to our kids, I have to sit there and watch, even though I have a cable modem, for as long as ten or twelve minutes, if I had a decent system I could do it in 30 seconds. That’s what people are going to go for. I don’t think you realize how many people use those digital cameras and trade pictures all over the world. I was getting pictures from my son and daughter-in-law of their trip to India last week. All over the Internet. That’s what people want, that’s what sells the service. Now let me talk a little bit about the business plan and some of the problems with it. First of all, it grossly understates the capabilities of VOIP. Cable systems that have been selling VOIP, Cox in particular, have found that their take rate within two or three years ranges from 15 to 40%. In terms of the 911 problem that’s well known in the industry and a number of companies that are in the business of making the equipment are working very hard to solve that, it’s just a matter of a year of two. They are being kind of closed mouth for competitive reasons about what they are doing and how they are doing it. But I have no doubt that you are going to be able to have 911 service on a VOIP line exactly the same as you are going to have on the telephone lines today. By the time our Fiber to the Home system is deployed. There was talk about having a Dark Fiber system put in and letting competitive business lease the system and provide service. That will never provide Fiber to the Home. There is no organization anywhere in the United States that is providing Fiber to the Home to significant, except municipal services, no commercial organization, no cable company, no telephone company is providing Fiber to the Home to existing neighborhoods. They are doing it all to green fields, to new homes, new developments. They are not going in and doing it to large UAC Minutes Special Meeting FTTH 3117104 - Approved 417104 Page 42 of 55 CMR21504 Attachment A numbers of private homes, so the only way we are ever going to get that is if we do it ourselves. It’s going to make a tremendous advantage competitively for doing business in Palo Alto. I remember when Cable Co-op first started putting in cable modems. We didn’t have it deployed yet, but they had it deployed in Fremont and we had a guy call up who was moving into the Bay Area and wanted to know if we had it. We said no. Well I understand that Fremont is going to be turning it on in a few weeks so I’m going to be moving to Fremont because I have to have that kind of service. Let’s talk about penetration rates. Penetration rate for cable modems for data service would be approximately 40% in 3 to 4 years after turn on. Why do I say that? Because we had 13% penetration, after about 3 years and we were charging $99 a month and we made no effort to promote the service, in fact we liked to discourage people. Because we were doing over 100% coax system and nobody in the world knew what the capacity of a coax data service was. We were afraid to roll it out too fast. So we intentionally priced it high and moved it out slowly, we never did find out what the capacity level was by the way. In terms of the video broadcast what we should be looking at is giving the people what they want. What we want locally not what somebody in Philadelphia wants to shove down our throats and when we bundle service we should bundle it according to people here want to see it. We shouldn’t be emulating Comcast, the last thing we want to do is offer Comcast light. I’ll give you one example, Comcast owns the Golf Channel, so we have the Golf Channel here. Cable Co-op previewed the Golf Channel, we asked people, "Do you folks want the Golf Channel?" and the answer was ’hell no’. So we didn’t carry it, but Comcast carries it because they own it. We have the opportunity to tell people that this is your system, this your interest, what do you want? And then give it to them. We have a utility system that delivers, a utility system that knows how to provide quality service and that’s important to the people here. I’ll tell you a short story, we had big storm a few years ago, the electric power was out, the Mayor of Menlo Park’s power was out for four days. The longest anybody in Palo Alto had their power out was four hours. That’s the way our utility system works. I could also tell you about the service level that Cable Co-op gave, the average outage time was one hour and forty five minutes, and that was over 10 years. The longest outage we ever had was 26 hours, the longest outage. So when people come down here and say that Comcast does a better job than Cable Co-op, they are full of it. That is not the way the system works, we know how things really do work. I would like to see you go forward with this now. Not do an awful lot of studies, not have lot of discussion, not have a lot of community meetings. Move out. Approve it. Let’s get it done. If Cable Co-op had been able UAC Minutes Special Meeting FTTH 3/17/04 - Approved 4/7/04 Page 43 of 55 CMR21504 Attachment A to borrow $25 million dollars we would have had Fiber to the Home in this city three years ago. Lets talk about the cost estimates. We had a cost estimate of what it would take to build fiber to 100 home nodes for the entire franchise area, Menlo Park, Atherton, East Palo Alto, Palo Alto. $25.3 million, that’s all it would have cost. Now let me talk about financing. The financing system you should use is very simple, you take 10% of our existing assets, those bonds that we have, 10% of them. Take that money build the system with it, with a commitment to repay that after 10 years, no later than 10 years. You don’t have to pay the 6% interest, you don’t have to worry about floating bonds, the money is sitting there, why do we need to have the money continuing to earn $2 to 3 million a quarter and just sitting there, we should put that money to work. Finally, how are we going to convince people that this is a good thing? It’s real simple, let them go and sit in the homes of the people that already have Fiber to the Home, you very soon learn you can’t be too rich, you can’t be too thin and you can’t have too much bandwidth. Rosenbaum: Thank you Bob. Bob Harrington to be followed by Mike Eager. Bob Harrington: I’m Bob Harrington and I’m in fiber trial neighborhood and so I’m here to testify that it works really well. It works so well that I was delighted to participate on the Fiber to the Home Advisory. Team that’s been working with the consultants, the utility and the staff and everyone for about two and a half years now. Really there is a huge-amount of detail in the plan before all of us, and finally it’s out in public forum now so that we are beginning to be able to discuss it. The big challenge ahead is pretty clearly - to take this very significant and sophisticated plan and communicate it accurately and fairly to our citizens. So I would encourage us to move that along because until we get it out in public debate the citizens aren’t really going to be able to figure out where the bodies are buried and kind of clear away all of the smoke. The one thing that came clear to me as I got the chance to dig into every little detail and then come up the other side with it and feel comfortable with most of the things in the plan, is that it really comes down to a community decision. Unlike other communities and I’m not an advocate of build it and they will come, I am an advocate of getting out early and discussing with the community opportunity that we all have. We can choose as a community to make this a tremendous success. Neil had a slide that showed essentially that it pays for itself at a 20% penetration. That pays the bills, you got zero cash, but it still paid all the bills. For every 1% addition to the penetration in the 20th year in the cash account is about $5 million. So the community is pretty soon going to realize that what they are looking at is a UAC Minutes Special Meeting FTTH 3117104- Approved 417104 Page 44 of 55 CMR21504 Attachment A $400 million opportunity over a twenty year period if 100% of the take rate was going to our home owned utility instead of shipping the money out of town. Now we pay a lot of taxes here, we have sales taxes, we have property taxes and we pay the bills that go to the County, goes to the State, goes to the Feds. Just some of it comes back. But when we buy our services from our municipal utility it stays in town, and that I think will become pretty clear to our public as we get an opportunity to communicate with them over the next six months I hope that it then goes to a vote so we can see how they really feel at the ballot box and if we are right and it gets a tremendous positive response then we know we have a winner on our hands. Rosenbaum: Thank you Bob. Mike Eager? Mike Eager: Hi, I’m Mike Eager, 1960 Park Blvd. Let me first off say I want to acknowledge the hard work that the utility department has put into this over many years. I have participated at many meetings and boy it’s been hard work. Regarding Uptown’s in-depth analysis, especially where they refute the Looney tunes, I appreciate that. The UAC has spent many hours on oversight, so I think it all should be acknowledged. I’m one of those concerned citizens or interested citizens that John Ulrich mentioned who showed up before the City Council seven years ago. I think his chart shows exactly what the benefits are of fiber infrastructure. Outstanding bandwidth, high reliability, you know, you name it, it’s much better than any of the other technologies. It was when we first started talking about seven years ago and it is now and, as far as I can see, it will be for the foreseeable future. I think that the city, I want to encourage you move this forward to the City Council, I want to encourage you to give them the opportunity to discuss this. I want to talk about a couple of the areas that we have been talking about tonight. One of them is the risks of this. I see some of the risks in the services provided and in the market penetration. Those are very closely tied together. The City has a Dark Fiber infrastructure, has Dark Fiber which has been profitable for some years now and that is predicated on not providing services, just provides the infrastructure, just a way for a company to lease the fiber and provide the service to another customer. The Fiber Internet people are doing that. I think that’s the model that you should adopt for the Fiber to the Home project. I think the City should do the infrastructure, I think that they could do it very well, I think that’s where their expertise lies. What they don’t have is expertise in is in being a service provider, they don’t have expertise in being a video programming or being an ISP. I think these are some of the areas that we have talked about tonight, you talk about whether it’s 256K to the Internet or2 megabit to the UAC Minutes Special Meeting FTTH 3/17/04 - Approved 4/7/04 Page 45 of 55 CMR21504 Attachment A Internet. Let an ISP take that on as their issue, let them market that service, let then differentiate their products. Palo Alto is home to the Palo Alto Intemet Exchange. We have some 140 or so people, companies there, many of them ISP’s. These people can be connected and can provide services over a city-wide Fiber to the Home infrastructure. You get your choice of an ISP with these services, the other ISP with the other services. The system that we are looking at here in the business plan is a monopoly system, one provider, one set of services. The idea that the City will select exactly what ISP services are provided and that’s it. I don’t think it’s an appropriate thing for the City to do. It’s a poor. It’s a high risk that the City will guess right, it’s something that ISP’s are experienced with and we have many that are. Let me say one more thing. I believe the product that we have described here is a me too product. It looks like, I believe that Bob Moss mentioned it as Cable, Comcast light or Cable Co-op re-visited. 10% price cut is not a compelling case. A compelling case would be strong product differentiation. Let me describe to you what I think a good product would be. First of all, 10 megabits to the Intemet, not 10 megabits down the street or 100 megabits down the street and get to the bottleneck of 256 K. Let’s give them 10 megabits to the Internet. Let’s have a couple of hundred channels not a 100 channels. Let’s do it alas carte. Let’s let people select what package they want. Let’s not say you get the silver bundle or you get the gold bundle, let’s let people choose. Let’s have dozens of music channels, let’s have dozens of intemational channels, let’s have literally hundreds of domestic channels, let’s do it for a price that’s reasonable. This isn’t blue sky, there is a company in Sacramento that is doing this. 6000 customers on fiber, 260 channels, 10 megabits to the Intemet, $50 for the Internet charge. 160 channel package is $43 bucks. So if you want this to be a successful business plan, let’s not do a me too copy of Comcast with a 10 percent price cut. Let’s do a killer system that is well within our means and will actually provide benefits to the community. Thanks Rosenbaum: Thank you Mr. Eager. Andy Poggio to be followed by David Harris. Poggio: Hi, I’m Andy Poggio, 2708 Gas Park Court. Since you have had a lot of speakers and heard a lot of things. I’m also an avid supporter of Fiber to the Home in Palo Alto. First point I would like to make is that the Internet is in its infancy, I was using it 25 years ago, and I still think it’s in its infancy. I think if we looked out 10 years from now and looked at the 10 most popular applications of the Internet in that time frame, half or less of them are in common use right now, I won’t try to predict what they are. We see email and web right now, there will be more things UAC Minutes Special Meeting FTTH 3/17/04 -Approved 4/7104 Page 46 of 55 CMR21504 Attachment A like that. They may just be starting,to be used right now and they may not have been invented yet. But there will be more reason to use the Intemet than we have now and that will grow I think for a very long time. The second point I want to make is that people that work in the networking industry, and I have from time to time, have a very simple saying, and that saying is, "don’t bet against more bandwidth" it always fails if you bet against more bandwidth. Some years ago IBM was pushing a technology a networking technology called Token Ring. IBM was a huge influence on the computer industry. An upstart called Xerox, that was invented here in Palo Alto at Xerox PARC, was pushing something called Ethernet. No one uses Token Ring today, the only advantage Ethemet had, and it had many disadvantages, but the only advantage it had was that it was faster, it offered more bandwidth. Now it just completely dominates. I think that will also be true for fiber technology to the home, that over time it will completely dominate and the people who recognized that earlier will benefit earlier. Finally, I’m sure that there are number of possible suppliers, the Comcast’s or the SBC’s that could, over time, supply Palo Alto with higher bandwidth to our homes. I also believe that the results, that the bandwidth will be lower, the quality will be lower, the cost will higher and we will see that much, much later. So I want to encourage Palo Alto to move forward and get Fiber to the Home just as soon as we can. Thank you. Rosenbaum: Thank you Mr. Poggio. David Harris to be followed by Art Kraemer. Harris: I am David Harris 455 Margarita. The first comment is the obvious one. That jobs these days are being put at places that are reached by fiber optic. Friedman in the New York Times talk about fiber optic cables that came out of the dot corn bubble made it possible for India to have jobs. If we do not have a quick way of getting access to the data and doing work with it, we will be cut out from that foreign employment and that form of business that the community needs. I’d like to touch on a couple of slightly tangential, or perhaps creative aspect here. I don’t think we have touched on the main line of discussion. One is that public benefit is not in the accounting system. We are looking at it as a business for the electric utilities. But as a citizen, if you can give me benefits, I want to vote and have this thing provided to the community. Among the possible benefits are trip reduction by telecommuting. Those poles that have gotten more and more cable are getting lots of wires, kind of looks like the old pictures from the early days of telephone phase before the switching system. Well this capacity that carries all the UAC Minutes Special Meeting FTTH 3117/04 - Approved 4/7104 Page 47 of 55 CMR21504 Attachment A information on the fiber allows the possibility of removing those other wires. That’s reliability and safety from wind storm for telephone poles. Undergrounding. To make a distinction between fiber optic, which is very easy to put underground, is not particularly harmed by water and the electric systems that are in these vault boxes. This stuff apparently is having problems because it is high power high voltage electricity and hard to underground. And another community benefit besides nice looking poles is real estate values are likely to rise if we are among the few communities that have this early. There is also a possibility of lower rates, we heard that in Consumer Reports March 2000 Page 32 that where there is a choice of cable companies the general accounting office report found cable rates are about 15% lower than a non competitive markets. So just by undergoing a project like this which offers cable services we provide a benefit to the citizens. There is an opportunity I think here that requires some work but I think it is worth thinking about it. I searched on the word billing, I am looking at the billing system discussion and in Neil’s report. It said there was basically some incompatibilities between the existing billing systems for utilities and the operation of this system. We have a particular opportunity here because all our services are provided and billing could be done even at a micro integrating level. To elaborate the obvious easy thing of a single bill is easier to pay then multiple bills. But if we can get a system that does capture the information of about who received a service from whom or what bits were transferred and be able to do billing for other companies or for start up companies, we can charge for that service. But we are unusual in having complete control of the billing thing and be providing service to that same area. It would obviously require some software work to be able to access the information., The problems he points out would have to be solved. But the potential of that is perhaps great enough that some start up company might do it using this as a test bed and give you a copy of the results for free or something of that sort. Also, by having the billing system able to create incentives for people to offer services, it may be a way of allowing things like Wi-Fi nodes to be put up in somebody’s home because they happen to live near a road where somebody would use it or things of that nature. Basically some thought on the billing system where that could be used creatively to generate additional revenues I think would be in order. Regarding content in the role of independent media marketing. Back in 1972 I came down to Stanford and took a film making course. I now could do in an afternoon. What would have been a whole quarter project in terms of film UAC Minutes Special Meeting FTTH 3117104 -Approved 417104 Page 48 of 55 CMR21504 Attachment A making, I do it on my desktop machine at home. The capacity to create content is been rising and it will get obviously still more powerful and the number of hours that people can watch stuff will not increase so the relative availability of content versus consumption will change and I think we may see social benefits from that kind of increase in production. And finally I was looking at the penetration sensitivity and also the slide concerning people who know how to use the Internet are rising. Bob gave some figures on the cable modem rates and more recent rates as a society and the economy. As people learn how to use these tools they are able to put them to work more effective. It becomes more essential to have those tools and we can expect that the penetration rates will rise over what they are now because people will be more aware of how to put these things to work. Thank you. Rosenbaum: Thank you Mr. Harris. Art Kramer. Kramer: I am Art Kramer. I live on Forest Avenue in Palo Alto. I’d like to support some of the inputs that came from some of the last few people. One of the things that happens in this business, is the fact that if you are going to provide this service, we are always at risk that comes as this guy is going to buy somebody or somebody is going to buy to keep the network from us. If you set up the dark fiber situation, and you sell to everybody, then you might get some repetitive service because somebody that comes and uses our fiber could compete with Comcast. So I would like to see a business plan that is says let’s put in the dark fiber, let’s establish some prices for leasing .to anybody ISPs, telephone companies, cable providers. I think the last person said we could provide the billing service for all these people. If we do that, we take advantage of what we do well in Palo Alto, and that is maintain the plant. We are not good at maintaining the content. That way we will get out of it we will reduce our risk. I think we need to have a business plan that is based on how much can we lease the fiber to so many people rather than how much we can sell video to a particular customer. Thank you. Rosenbaum: Thank you Mr. Kramer. Hilda Weisberg to be followed by Peter Allen. Weisberg: Thank you. Thanks for still being awake and being able to hear us even though it has been a long evening. I want to request that you grant John Ulrich’s first three requests to move fiber to the home project forward and I hope that would be as quickly as possible. There has been many wonderful supportive ideas that have come forward tonight and I am sure there will be in the future. This is a program I think will need to UAC Minutes Special Meeting FTTH 3117/04 - Approved 417/04 Page 49 of 55 CMR21504 Attachment A continue to have lots of flexibility to be able to respond to good ideas and break through technology over time rather than to tie their hands to any particular thing. I .am very excited about the possibilities that this offers to us as a community and hope that it becomes a model. I am fortunate that I have been part of the trial and I am very happy to continue to talk to others about the benefits that I have seen and to knock on doors and to encourage people to take and share this risk with us. When we were children in elementary school we did this little experiment about picking up somebody in a chair and you know no one of us or two of us could possibly pick up that fellow classmate in their chair. But a few of us together could lift that chair very easily with our little fingers.. I see the risks that have been put before us today, though we don’t know exactly what they will be. I think these people have given their very best in looking in to the crystal ball. Since the time they were looking and time has moved on, I think those risks look very acceptable to me. I hope that they will as well to other friends that I have in the community. I hope there will be enough of us that we will make this a project that something that we are proud to have supported and that will be a model now and in the future. I am very grateful for the kind of service that the utilities has been able to provide us and for the work you as a Commission have been able to do for us over the years to respond to the emergencies and challenges and opportunities and I trust you and will support you in the future. Thank you very much, Rosenbaum: Thank you Mrs. Weisberg. Peter Allen. Allen: Good Evening. I am Peter Allen. I live on Hopkins Avenue in the Community Center. I think Hilda neglected to mention that she is also a trial participant. Okay. I have been involved with this for about 6 years, more than 6 years and I think our utilities staff has done a fabulous job in putting this together so far. The plan you have in front of you many people say it is not detailed enough but it is not the final roll out. There is a lot of more work ahead of us. But the fight diligence has been done in terms of presenting a plan that sits there. You look at it and you go "there is twice the margins in this business". What we are proposing will be situated in the electric business fight now. We are protecting the revenue models that we have in town here now. I think it is a great idea. Some of my own business came to me with this. I am like who would stand by against it. I have been part of 4 companies in this town that have leased fiber from the city. To give you an idea that I know how to lease fiber from the city, I know how to operate a network like this, I know how to scale it, I know how to maintain it. UAC Minutes Special Meeting FTTH 3/17/04 - Approved 4/7104 Page 50 of 55 CMR21504 Attachment A I was a Director at Napster as well, so I know an awful a lot about content and legality of certain things. We are not going to be in the content creation business here. What we basically going to be doing is operating a network and offering services as a middleman. Alright, so let me go on a little further here. I am a beneficiary of the 7th utility here in town. Most of the people in this town have six line items on the utility bill. I have seven. The 7th one says telecom. I think this is the fight entity for this. I would discourage you from going out to the venture community to try to find partners to do this. Why? Well I am pretty tired from doing it every day right now in the current start up I am in. I am really what you could call up start up junky. I have done about 10 start ups. Three of them have gone public, three of them have been bought and four of them have failed including Napster. But my real point in saying that is that VCs is the wrong entity for this. They are the most expensive money in the world outside of the mafia. And they want a return on their money in 3 to 5 years. Here is the municipal utility we have everything in place to make this succeed. We have recovery rates of 20 or more years, we have access to municipal bonds, the cheapest money in the world other than getting it from my own parents. We have a mentality here that serves the public, we have lots of people, in trucks, we have operated a network on exactly the same scale necessary to do this. We have operated it for 100 years instead of those being just in electric distribution network. It is just the right place to do this. It is the right crucible to make this successful. I am also the one who is irresponsible for negotiating the current rates that trial members participated in. Participants pay $85 a month. They get 5 megabits per second both directions. I would also like to mention one of the companies that I helped lease fiber with here in Palo Alto was Lucent. I worked at the Bell Laboratories here under Brian Reed’s direction who helped build the Palo Alto Internet Exchange here in town which is responsible for about 20 percent of our country’s traffic passing through Palo Alto every day. That is phenomenal facility that we have within literally a stone throw of this building. What I learned really, when I was at Lucent, was that the future is fiber and wireless. And the way you differentiate between those two worlds is if it doesn’t move wire it. The last time I checked my house hasn’t moved. But another thing the people are saying is this is a bill that may come due in the future. I walked my neighborhood. I covered half of the 600 homes in my neighborhood and of the 600 homes in my neighborhood 4 or 5 years ago. I forgot the exact dates. One fifth of them, 125 homes put down a $500 check to be part of the trial. That is not a bill that they would come, that’s pay for it and you then you build it. And to my amazement the utility returned our $500 in the end. They wanted to bear the risk UAC Minutes Special Meeting FTTH 3117/04 - Approved 417104 Page 51 of 55 CMR21504 Attachment A of this. They actually loved this concept now. They owned it, they buiR it, they operated. If they understand it and you have a business plan in front of you that shows you that this is going to keep money in this town, and provide services for this town on a scale essentially what the electric utility has done for 1 O0 years and that economic model is in danger fight on. Okay so to continue on why was $85 a month for the trial participants. How was that figure negotiated? Why do we arrive at that? Well. It’s what we knew the utility, it’s a revenue buoyant business. They are not losing money on it right now okay. So what we negotiated was both a combination of what the market would bear and what it actually cost. I understand both sides of this equation and we worked well with the utilities to come up with those rates. It isn’t damn hard to do it and I think they have done a good job so far in their research. This has been incredibly reliable network. It has been phenomenal. My children, my. daughter who is actually asleep over there right now, enormously benefit from this and you wouldn’t imagine how many kids come to our house because we have a faster connection. Children are learning from this. They are more facile with the Internet than I will ever be probably. Yet also understand that the phone company will come out against us. They will say you don’t want to do this. And understand, the rest is really fear, certainty and doubt that they wish to plant in your minds. When you really come down to study it, Pacific Bell, now as we see, offered an extra digital phone line to every single home in the trails. 70 phones were provisioned for the trial and normally to provision 70 phone lines you would have to roll 70 trucks. PacBell had to roll one truck to provision the lines to our municipal services yard. One truck to provision 70 phone lines. It was cheaper for them to start this business than to provide it. Then over the summer there was an electric storm that shut out, that cut out about half of the phone lines in my neighborhood and low and behold some of those homes were serviced by fiber. You pick up the phone to connect to your fiber - guess what - the same company providing your telephone line over fiber or copper your copper line is dead, your fiber line never had a blip. It was less expensive for PacBell to maintain that network as well. So when they come before you, out of great public interest at some point in the future, to say don’t do this, it is a terrible business, you don’t want to do this, think why they are coming up with a sudden civic concern and think about the lessons we learned from the trial. It was cheaper for them to build it, operate it and maintain it. By not owning their own network but by delivering it over our fibers. So in conclusion through all my experience I would just like to say I think we should build this 7th utility for the whole town. I think it would be a great economic boom. Thank you. Rosenbaum: Thank you Mr. Allen. Arthur Keller to be followed by Ken Poulton. UAC Minutes Special Meeting FTTH 3117104 - Approved 417/04 Page 52 of 55 CMR21504 Attachment A Keller: There have been people who suggest that we should have businesses build this. Well I have been hearing people talk about creating fiber to the home for quite a number of years and so far nobody has build fiber to my home. I know it was mentioned by some of the colleagues here there is a notion that we talk to VCs. VCs want 10 times return on their investment in 3 to 5 years. And that would be great if we can get that. But this is not what this business takes. My assumption is that the City of Palo Alto Utilities would be happy with a 10 to 15 .year payback on paying off the investment and beyond that a 10% return on investment. A 10% return on the investment would be pretty good for the City. So the consideration is what kind of return does a municipal utility or government require. It is not the kind of returns that VC would handle and this is not the kind of numbers that they would understand. Sometime ago, not too long ago, there was a proposal that we shop Palo Alto. I was just standing this about noon on California Avenue and on that little concrete sign that is on the center of California Ave. abutting E1 Camino somebody put this thing on top that said shop Palo Alto.. Well that is the opportunity we have to do fight now. The profits from the several phone lines I have in my house are going to somewhere in Texas, the same community that brought us those blackouts. And I am paying for Comcast. I receive Comcast bills. Since Comcast took over Cable Co-op that is, that are one third or more higher than it was when Cable Co- op was here. So what we are seeing is profits escaping our city going somewhere else. And I’d much rather have those profits go to support the services that go to me as a 25 year resident of the city. So there is certainly a need to enhance revenue to the city. We are trying to figure out how to do that. This is one way of investing in the future. Investing in revenue for the City. One of the comments that was made is about dark fiber versus light fiber. We have a streets network that connects the various houses together. People can bicycle, people can walk, people can drive. I wouldn’t expect there to be a separate streets network for people who drive GM cars and a separate streets network for people who drive Toyotas, sort of that. People can fide bicycle, and drive cars and to some extent drive trucks down our streets network. So therefore the idea is if you provide light fiber it is a conduit. You can put lots of things across it. You can put across it phone, you can put across it Internet, you can put across it video, cable, cable TV, you can put across it radio, you can put across things we don’t know about now. Because as once it was referred to me bits is bits and things are becoming more digital and so by creating this fiber that goes to everybody’s house, that people can put whatever services they want on them. UAC Minutes Special Meeting FTTH 3117104 - Approved 417/04 Page 53 of 55 CMR21504 Attachment A That there will be an opportunity for bringing new wholesale providers to the City that can provide services that we don’t know what they are yet. There could be future opportunities of being able to sell things through this network that we don’t know about which would bring additional revenue opportunities simply by doing this. Now people have thought about what the opportunities are for fiber and we know some of the things we can use it now. Think about how long ago was the time that Alexander Graham Bell decided that copper wire could be used for transmitting telephone lines. If you think about when Alexander Graham Bell decided to invent the telephone he wasn’t inventing the telephone so that I could talk to somebody across the world making a phone call on it. He created the telephone so that towns without symphonies could hear music transmitted over the telephone from towns that had could afford symphony orchestras. So we have seen things being created and being used for much more dramatic differences than what they were originally created for and the ability of having a switching network in between allowed for one person talk to another instead of hearing essentially a cable broadcast of symphonies as was originally created. And I would suspect and I truly believe that when.we build this and I am waiting for it to be built. I haven’t seen anybody come along and say hey I am about to write a check for 40 million dollars. I am going to build it. I don’t see any community members coming .around. I mean after all this thing has been discussed for several years. If someone really wanted to come and say Yes I am the XYZ company and I want to wire the whole town with fiber where are they? Anybody want to raise your hands telling that I want to wire the town with fiber. I don’t see anybody doing that. So it is only going to happen if you guys do it and I think that it is not a matter of if you built it we will come. It is a matter of if you don’t build it nobody will. And this is a kind of thing that will be the future, we were on ground zero of creating Internet and we need to be making Palo Alto the place where the future is invented of what can be done with high speed Internet. Because otherwise we will see what is going on in Korea, where 50 and 100 megabits Internet is being put in, in Tokyo, other places around the world and we will see whether we will still competitive in Silicon Valley when that happens. Rosenbaum: Thank you Mr. Keller. Ken Poulton that will be our last speaker. Poulton: Guess I better make it good. Ken Poulton Los Robles Ave. in Palo Alto. I wanted to talk a little about the build on demand idea and in essence that is what the dark fiber system is. It’s just the backbone and really to get your connection to UAC Minutes Special Meeting FTTH 3/17104 -Approved 417/04 Page 54 of 55 CMR21504 Attachment A your house it’s build on demand down probably several streets. And someone else just told you just how expensive that is. 10, 20 thousand dollars to make a relatively short connection. So that is on the order of 10 or 20 times more expensive per connection than building out a whole system is for the per house connections. So it is the only economic way building all at once. Building it all at once is the only economic way to bring connections to everybody. Fiber to the Home is going to be a huge benefit to Palo Alto. It is going to bring new levels of services. Of existing kind of services that we know and it is going to allow us to bring new kind of services. It is going to bring revenues to the city in the long run. It is going to be our 7th utility. It is going to be the logical thing to have along with our existing utilities. There is one thing that has been overlooked in the current business plan and that is the principle of encouraging competition where you can and only building monopoly where that’s the only economic way to do things. For television, currently there are technical reasons why that pretty much economically has to be a one choice system. For telephone, apparently the regulatory reasons is why that has to be the pace. But for Internet service, that is definitely not the case. This is a case where we really have an opportunity to open the system to multiple ISPs. Let multiple ISPs, possibly including the city, provide different kinds of service plan, different kinds of options for people and have different kinds of pricing that will benefit everybody better. To summarize five surveys and a trial have said will come so let’s build it. Rosenbaum: Thank you Mr. Poulton. Indeed thank you everybody who has spoken to us and everyone in attendance. What I would like is a formal motion from somebody to continue this meeting till tomorrow night. Dawes: I so move Mr. Chairman. Bechtel: Second. Rosenbaum: We have a motion and a second to continue this meeting to 7 o’clock tomorrow night. Thank you Neil for being with us and staff and we will see you all tomorrow night. Ulrich: Thank you. UAC Minutes Special Meeting FTTH 3/17104 - Approved 4/7/04 Page 55 of 55 UAC SPECIAL MEETING ON FIBER TO THE HOME MARCH 18, 2004 CMR21504 Attachment A Rosenbaum: Good evening, this is a continuation of the special meeting of the Utilities Advisory Commission that started yesterday, March 17. Let’s take the roll, starting on my left. Dawes: Dexter Dawes, present. Melton: John Melton, present. Rosenbaum: Dick Rosenbaum, here. Dahlen: Elizabeth Dahlen. Bechtel: George Bechtel, present. Rosenbaum: Before we begin, let me mention that we had a little review in the newspaper yesterday. I’ll just read the first paragraph. "The first half of a well- publicized Palo Alto Commission meeting to discuss a recommendation to offer fiber optic cable to all City households was mainly dominhted by older gray men who spoke in an almost foreign technological language." I guess it’s a good thing we have you here with us, Elizabeth. And, who knows, perhaps we’ll do a little better tonight, but we’ll see. All right, yesterday we heard from staff, we heard from the consultant, we heard from members of the public, and tonight we have returned the issue to the Commission. We will have questions of staff and perhaps a little discussion and then we’ll be ready for motions. So, colleagues, do you have any questions for staff? Dawes: (inaudible) because these are typically more expensive than current sources of supply, and it seems to me that if we are willing to take the risk of higher electric rates to reach an objective - in this case, it’s renewable power - that this was a reasonable benchmark against which to compare the risks that the ratepayers might have to pay off some or all the bonds. So the question I sent to John was give me the numbers on what the possible impact of renewable power rate increase might be when fully implemented versus what the rate increase that the inability to service our bonds .through revenues of the fiber system might be. And so that was my question to John and he sent the answer to me by e-mail but I put having my dinner before reading my e-mails, so I didn’t see it. So, hopefully, he can either remember it or recite it to me. Thank you. Ulrich: Good evening. What I believe Commissioner Dawes is asking, those of you that have been following our attempt to increase our portfolio of supply following the change in contract with our Western Area Power Administration which changes significantly at the end of 2004. One of our plans - and one that all of you reviewed and approved by City Council - is to dramatically increase our portfolio renewable resources. Those that UAC Special Meeting on FTTH, March 18, 2004 - Approved 417104 Page 1 of 26 CMR21504 Attachment A are defined as renewable are not our hydro resources but those that would come from wind, biomass, and other obvious renewables. The Council approved of an increase up to ½ cent in our current rate which could be used towards procurement to eventually get to the 20% of our portfolio. So, in doing the math as Mr. Dawes asked, that would translate based on current rates and assuming the average customer which we use as kind of a benchmark that uses 650 kilowatt hours per month and that translates to a low $40 range for the bill. If you utilize the whole ½ cent, that would translate into $3.25 a month if we were using the 20% portfolio of renewables. We think, however, with the ½ cent premium, we probably will not have to spend that much in actual purchase price because the price of renewables is coming down. So, to give you kind of a round number, somewhere between $1.30 and $1.60, so if you want to round it off, $1.50. I think your comparison was with in our report that if the fiber system, the $40 million did not fend well in the financial world, customers didn’t come, and we had to sell the system and then take all the loss and still have to pay the bonds, what would that mean to the average customer. Again with the 650 kilowatt hour a month, that turns, out to be 70 cents on the bill of every electric customer. Now the assumption there is that you use the electric customer as the form of helping to pay for the bond or to be responsible for it should we have to pay it off. So there are a few assumptions in there but that would be the comparison. Hope that wasn’t too long of an answer to your question. Dawes: No, that was perfect. Basically, as I said, I’m trying to get some perspective on this as it relates to some other benchmark that is out there. So, thank you, John, it does answer for me. Renewables might be double what a really worse case in the fiber system might be. Rosenbaum: Elizabeth... Dahlen: May I just ask a question, John, with regards to the average residential customer we’re assuming is about 650 kilowatt hours per month. What about our large customers, the large businesses within Palo Alto? Maybe if you could give some perspective on what percentage of our electricity is sold to those businesses and what the range is in terms of kilowatt hours they’re using per month because of course the fees are higher for them. Ulrich: Sure. I didn’t come prepared to give you the total dollar amounts of some of these larger customers, but kind of a magnitude, we have probably in the electric world somewhat of a unique customer base in Palo Alto. We have 65,000 residents and roughly 28,000 customers, but 20 of those 28,000 customers pay somewhere between 50% and 70% of the entire electric bills. So, they’re very important and you can see the dramatic difference between the amount of electricity used by the large customers versus the residential. I must point out, though, that it’s quite the opposite on the gas side of the business and of course it depends on the time of the year. Dahlen: Thank you, John. Rosenbaum: Are there any further questions? George... UAC Special Meeting on FTTH, March 18, 2004 - Approved 417104 ’ Page 2 of 26 CMR2.1504 Attachment A Bechtel: I have a number of questions, some generated from last night and others from reviewing the information. So, if the Chairman will indulge me, I will move down through various pages and ask those that haven’t been answered already. One of those is that a separate organization is proposed to deal with programming matters. If we set up a separate organization, I’m interested in the form a separate organization might take. We talked about a review board that could review the programming and take charge of that. I see something that may be a little larger than that, would really be a separate utility as we talked about and that telecom utility would be in charge of programming, let’s say, selection of the programming but would rent services from the City. So, basically we would see one organization being a service provider and another being responsible for the infrastructure, the network, and so on. So, if one were to think about that, I’d be concerned about the cost saving that we talked about, about sharing people. Basically, we’d be outsourcing some mission to one organization and back and forth. The second is the separate organization would not report to you but would have a different structure. So, I’m wondering whether that had been discussed among you at staff level or with the City attorney, and so on. The different forms that this other organization could take would provide the arm’s length relationship to protect the interest of those people who are concerned about programming and government control of that. Ulrich: I think you’\c covered a number of areas in your questions. I’ll see ifI can focus on the ones that you’re interested in. I would not say that we have not spent a very significant amount of time to delve into the kind of structure or the best govemance to have. We thought the best approach is to determine that this is a business we want to be in, but then wc have to structure it for several reasons, one, we would have to be real clear about the governance related to the federal communication expectations and other legal requirements, particularly that we would have to have an arm’s length relationship with the City because you’d have to negotiate and have basically a franchise agreement with the City that would be as fair to anyone else who has a franchise so that you’re not giving the City or the fiber utility any additional benefits beyond what would be given to anyone else. The other part is related to the content, and there are some requirements that the content be decided upon independently of the government organization. So, I think our plan would be to look at all of those things and then determine what would be the appropriate governance to manage and operate the utility. I think many of those alternatives could work depending on what would be the obligation for how the business was structured with all those things in mind. The existing utility we currently have could be part of the organization by being responsible for the maintenance and operation, for example, of the infrastructure and do it on a contract to this other entity that might be there. So there’ll be a number of things that you could do, but, candidly, we have not spent a lot of time doing that. In your business plan you can see the staffing recommendation which, I think, is not what you’re referring to. You’re looking at the overall governance and how it would work in relationship to the City govemment who essentially would own it. Bechtel: Let’s talk about the last point you raised. Of course you talk about the staffing, and, let’s say, we set up a, what I would call, a telecom company or telecom line of UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7104 Page 3 of 26 CMR21504 Attachment A business or so on and that staffing is appropriate for that. But we’ve also talked about perhaps using some of the City staff, your staff and the other departments, so we probably could get some savings along those lines. But let’s come now to the fact that if we have not settled governance and we’ve not dealt a lot with that, and let’s say we recommend to the Council and the Council decides go ahead with a referendum or a straw vote or what have you, a Charter change in the November election, I see it would be very difficult to write arguments to propose something to the citizens to vote on without having the governance issue dealt with almost right away. One of our former Commissioners, Rick Ferguson, sent us an e-mail and he pointed out some of the timelines in a very nice letter I received today. The timeline is fairly critical. We really don’t have a lot of time to prepare for an election in 2004. So, I believe in many cases - at least I personally believe - that governance issues far outweigh the technical issues or design issues that you’re proposing to spend the money on. So, I’m almost persuaded that we should spend $200,000 in dealing with the governance issue and making sure that we have our hands wrapped around that before I would spend money asking for bids or asking for proposals for system design. That’s very strong in my mind tonight. Another issue deals with the finances. We’ve talked about leaving the money in Palo Alto. Some very good points were raised last night about this utility saving our money. But in our financial plan, nowhere do we list a line item that says transfers to the General Fund. Certainly if we use a pro forma plan, there is profit after, say, year 4, 5, 6, depending on how penetration does. So there are monies there. Certainly we have cumulative cash of $50 million, let’s say. There’s money there. That was not in there. I think we need to also present that as part of our financial plan of how this new utility would return money to the City. If we don’t include that, I think we’re really misleading people. We’re talking about keeping this cash sitting in this new entity’s cash box, and that’s certainly not what we had in mind. I don’t believe we also covered franchise taxes. Were franchise taxes included in some of the operating expenses? Heitzman: Generally speaking, the franchisee passes on the taxes to the customer. That’s what Comcast does. It’s just a transfer from the customer through the franchisee to the City. It’s a 5%... Bechtel: It’s about $3 as I recall looking at my Comcast bill. Ulrich: As I mentioned earlier, we would have to have a franchise agreement with the City, and my assumption would be that we would be on equal footing with the current incumbents and they pay a fee and that is an income to the City, so the City does get money from this business and that’s part of the cost of doing business in Palo Alto. Bechtel: Now, what about property taxes? Ulrich: What about property taxes? Bechtel: I’m assuming that operations that have equipment here also pay property taxes to the state, at least to the county. This entity would not, is that correct? UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7/04 Page 4 of 26 Ulrich: That’s correct. CMR21504 Attachment A Bechtel: So, basically, the return to the citizens of Palo Alto is through the profits of this plus Other revenue, of course paid certainly by the ratepayers, by the people that sign up, would be the franchise taxes. Those two are the sources of revenue for the citizens, at least going back into the General Fund. Heitzman: The cash that we build up, the reason it doesn’t say it goes to the General Fund is because the consultant and we felt that thi~ is a policy decision. We recognize that this money is here, but the portion of that goes to the General Fund is something that City Council or someone in the governance mode would make a decision about. So, we’re just saying this money, is available, how it gets distributed would be a policy decision. That’s why it doesn’t say it in the plan. A third source of money for the citizens is, of course, any savings they get because this is a lower rate they pay so there is money left in their pockets. So you might say there are three things: the franchise fee, the cash however it gets back to the City, and whatever savings because it’s a lower-cost service. Bechtel: Presumably it’s a lower-cost service, and I guess that’s our intention certainly to do that. The other issue that was raised last night and in the past has been our pricing. One of the speakers talked about cost plus pricing. That would be in line with what we have done certainly in our other utilities where we pay for the commodity, we pay for the distribution. In your discussions, did you ever talk about pricing along the lines of cost plus pricing? And that leads me to a second part of that which I thought was a very innovative way which is an a la carte plan where you pay by the channel and so on rather than paying by a tier, you pay by the channel. Did you ever discuss that with Neil at all? Heitzman: First of all, the idea of cost plus pricing is done mainly in what we have a monopoly in, so we know that eventually we’re going to recover all these costs. As it is, with the pricing that we have, which is more market based but trying to stay below the market price, we would recover all the capital costs in roughly 14 years. That’s a pretty good horizon as it is. So, to try to mimic a monopoly pricing, you would probably have to push your payoff out 30 years like you might have on Calaveras Dam or some other piece of property that you might have a monopoly business. So there’s kind of a tradeoff between the fact that we’re being competitive, we’re trying to recover our costs. There’s nothing to say that once we’ve recovered our capital costs, we can’t go to cost plus pricing or something else that we feel is more appropriate. But I think part of the idea is to get that paid off in a reasonable amount of time since it is a competitive business and is more risky than your monopoly business is. The idea of a la carte pricing, in fact the idea of pricing altogether, I think, is something we need to recognize. In this business plan we’re proposing a starting point. By the time, let’s assume everything goes forward as business happens, a lot of this product packaging and pricing will have to be determined by the marketing professional to meet market conditions and so forth to make sure that we.’re competitive in the market. So, I wouldn’t look at these prices as absolute or the pattern that we have here as absolute. It will be developed using information from UAC Special Meeting on FTTH, March 18, 2004 - Approved 417/04 Page 5 of 26 CMR21504 Attachment A customers such as customer focus groups, work with customers, other competitors’ pricing and so forth to come up with packages and prices that meet market demand, the customers’ needs, and still meet our revenue needs. So, whether we went to a la carte or something like that, if that is something the customer base shows a great interest in, I am sure ~omething will be developed. Bechtel: Well, again, I’m assuming that my colleagues will vote along with me affirmatively to recommend this to the Council and the Council will recommend to go ahead as well. So let’s talk about that. If we propose the same old, same old service, I believe we are not going to gain the attention of people in Palo Alto and I don’t believe necessarily they will support it. I believe that our surveys have been very positive, and people really believe, as I said last night, that the City is doing a good job, with our City Auditor’s results on that. But I don’t believe we can just promise that the future will be better and that we’ll look at things in the future. We’re trying to sell a $40 million system, and with the expectations of our citizens being very, very high, I think we’re going to have to be more innovative. And I think, again, I’d rather see money spent elsewhere rather than designing the system in the next month. Dealing with issues like that, how do we package this so it’s an innovative product or line of products? I’m not sure that Neil and Uptown is the right person to talk to us about products. Every time we’ve heard him in the last - and I don’t mean to be critical of him but I know what I’ve read - and it’s pretty much conventional sorts of programs, very popular, very appropriate for rural areas, not so appropriate, I believe, for an embedded city like Palo Alto in a 2-1/2 million people metropolitan area surrounded by two large cities on each end of us, and also having some really great people offering services. So we’re going to have to do a better job, I believe, in coming up with products. I don’t think we can put them off in the future and say, "Look, we’ll think about those things and we’ll do more surveys," and we’ll ask them. I think we’re going to have to make proposals to people in order to get them really interested in this system. Heitzman: First of all, the plan that Neil and his partner did is, as you said, pretty plain vanilla, but the intent here, this is a business plan and what we’re trying to show is that there’s very solid basis for this business. One of the surveys was very particularly designed specifically to find out how customers would respond to a 10% discount, and the basis of that survey is where you finally filter it through all the market analysis and overstatement adjustment and so forth to come up with these penetrations. So the plain vanilla of a 10% discount is what comes from a solid basis. It comes from customer input that has been de-rated and so forth to make up for those who say they will do one thing but don’t do it. And then you get these revenue streams out of that. So it was done in a way that - yeah, the competitors, Comcast and people that these guys have worked for before, it’s done the way they would do it. Now, that doesn’t mean we are unable to be more creative, but for the business case, which is going to be the financial basis and so forth, you have to have a solid base and that’s what they strive to do. We are in our next phase, there’s a public input funding that we are asking for and that is the phase where you could spend some time with focus groups and so forth, getting a little more creative in the design and coming up with something tailored for Palo Alto. I think that’s part of what we want to do, but we have to be able to move into that phase to do that kind of UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7104 Page 6 of 26 CMR2.1504 Attachment A work. The other thing is, too, you don’t want to lay all your chips out two years before you actually get billed because your competitors will say, "Heck, they’ve researched that, they got all that data, and that’s what the customers want, why don’t we do it first?" So there are issues in that regard, too. Ulrich: Mr. Bechtel, I think it would be helpful to go back some of the first questions you asked. You’ve said them several times and pretty soon I’m going to start to believe those are the tactics you’re suggesting we follow. You’ve mentioned the governance versus looking at the cost of construction. The reason we put the report and recommendation together the way we did was it allows our owners to give us direction on what are the kinds of things that are the most important to do. It also gives you the option to recommend funding to do all of them or some portions of them. I happen to think it would be important to also know more accurately what the cost of construction would be based on today’s environment as opposed to the continual guessing that starts to get a life of its own. If you repeat $40 million enough, it will all of a sudden it becomes the actual price to do it. So I think it’s important to know that, but I think what’s paramount is that all of these issues that relate to what the public should have knowledge of and vote on should be laid out in the form of the appropriate questions to ask in the ballot. So I think it’s important to get the governance model, recognize what changes would have to be made in the charter, ordinances, or the kind of business structure you mentioned earlier so the public can vote on that, have an understanding of what we’re going to get. That’s going to take crafting of the legal strategy and the business strategy, and that requires us to spend more time and effort on it, I thought it was important to provide this final report so we can now make the decisions and have the community involved in do we want to go ahead and do this and to what extent, how fast, and, as we point out in this report, how it fits in with the other important issues that the City has to grapple with so that the community decides if this is the important thing to do. So that before anything would go on the ballot- and you recall in the document is kind of a timeline - some of those things can be done in parallel depending again on how much time and speed you want to have and how much money to spend. So we can then agree on the date and what should go on the ballot. Some of those are all going to be based on the ability to get them on the ballot in the right format so it meets the requirements of the county for the election. So I think we ought to talk and spend as much time as necessary so you get confidence and comfort that we laid out a plan that allows for getting the answers to all those questions before we ever ask anyone to vote and encumber ourselves for a $40 million project. The other area is the one you mentioned a bit about the services. We thought it was important to be able to point out the kinds of services that what we’ve heard from the community they would like to have and focus on whether could we make some money on that and set up a viable business; if so, when there’s a lot of track records from other places that have done this. But when you start moving off into the more innovative areas, which I think is probably the most exciting part of this, why build this thing if it’s not going to have the ability to take us into many, many years down the road and provide innovative services that people can’t even think about now but could be added on. I think that’s the real strength of this, is that you can do that; and, again, this is a community that will own this system so we’d be motivated and focused on providing the kinds of services UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7104 Page 7 of 26 CMR21504 Attachment A people would want to have, and we wouldn’t care if it wouldn’t fly in Redding or somewhere else. So I look at all those questions and those things you’ve said in a very positive way that we can pull all those together, and, again, we would never ask the community to vote for something that they didn’t have a full picture of risks and rewards. Bechtel: Well, I appreciate the fact that you put the proposal to us certainly in a dollar form which I think we always like for the next phase anyway - that’s what I’m referring to, with various line items. I’m sure we can tinker with the line items and maybe that’s what I’m doing tonight. So what I’d like to do is turn it back to the Chair or others of my colleagues for more questions so I can digest what you said and take my next stab at some other things later on. Rosenbaum: Thank you, George. Do we have further questions? John... Melton: I wanted to sort of pick up on your last comments and focus more specifically on the timeline, particularly the November 4th ballot. From the report, it seems pretty clear that while you don’t have all your legal opinions in a row yet, something is going to have to go on the ballot for the people in the City to approve in connection with the (inaudible) all the existing customers we have would stop being subscribers to the dark fiber ring and would become subscribers to the commercial offering that the FTTH top tier would provide. Heitzman: We have many different types of customers that use the dark fiber. We also have about 20-30% of those customers (inaudible) the utilities and so forth. So there is an amount of fiber that’s in the ground not fully utilized. This is in answer to your first question. What is not utilized is available or whatever is needed for fiber to the home would be studied and we would determine how much of that fiber we would use, how much we would supplement in order to leave some for other use, for utility use or whatever, or other City use and then use what we can without starving ourselves somewhere else. So as far as utilizing the system, it would be integrated and take advantage of what we have to the extent it doesn’t damage it somewhere else. When you lookat our customer base, it would be my belief that you would lose a small amount of the customer base with fiber to the home. Our customers tend to be a different type of usage than would be using the fiber to the home system. A lot of is customers who want to have proprietary routes and so forth. Melton: Good. So my conclusion from last night was that because none of this revenue was included in this plan that this is sort of a contingency, the carry forward of some or substantially all of our existing $1.2 million last year of dark fiber revenues would be folded into the revenue base of this new concern. Heitzman: In other words, the business plan does not consider that dark fiber revenue as part Of its revenues. So that dark fiber revenue would largely be added to the business plan. Melton: Is that a statement or a question? UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7104 Page 8 of 26 CMR21504 Attachment A Heitzman: I’m stating it is not rolled into the business plan and it would be added to the business plan. How’s that? Meltbn: Thank you, Blake. That’s what I wanted to hear. Heitzman: Okay. Dawes?: Second question raised by the gentleman who left before he made his speech, the General Manager of Comcast whose letter I read last night. He covered a number of points. Clearly he thinks it’s a difficult business to manage and makes it clear he thinks the City’s biting off a lot in that regard. But that’s not the part that worried me. I think we’re up to that task. What did worry me was the inherent conflict of interest he talked about, a regulator and a competitor all in the same breath. I’ve always been under the assumption that while the City grants a franchise and the company bills the franchise fee to its customers and pays it over to the City that that’s where it stops, that there is no continuing obligation or no continuing regulation that goes on with, I guess, the exception of what becomes an agreement at the time that that franchise is either (1) extended or (2) novated over to a new owner, a.k.a. Comcast where the City Council has extracted promises and commitments to upgrade the system which in fact they’ve done. Clarify for me what regulatory authority they, the City Council, has over the incumbent provider. Ulrich: I’ve got to say that I’m not an expert on the current franchise agreement. That’s not part of the Utilities and so I don’t have a day-to-day working knowledge of it. Our Director of Administrative Services is responsible to the City Manager for administration of that contract and negotiation of it. From what I know of it, I don’t see that there would be - this is not legal, it’s just my opinion - a conflict between the parts of the City doing that. The City Council is always the decision-maker on decisions like that and they approve our rates and they also live in the City. So I don’t see where that would be a conflict: As I mentioned earlier, my expectation is that this business would have an arm’s length relationship with the City and that we would negotiate terms and conditions of the franchise agreement just like anybody else, and I’m sure our legal advisors would make sure that that happens. Dawes: One short paragraph in which he says in here "because of the potential conflict arising from the City’s dual role as a regulator and competitor, all regulatory actions taken by the City which may fall with a heavier hand on us than on the City would potentially open a legal due process claim." i don’t know if that’s a threat of litigation or what it is, but can I assume that this was taken into account by our legal staff in acknowledging that they didn’t see anything wrong with going ahead with this thing? I have some other comments about their opinion and the write-up, but at least they haven’t said no yet. Ulrich: Of course always when you have a document like that, you’re not sure exactly what their meaning is and it’s unfortunate they’re not here to explain that. But in my UAC Special Meeting on FTTH, March 18, 2004 - Approved 417/04 Page 9 of 26 CMR21504 Attachment A expectation, you’re always going to get someone who is going to throw up something and say this could be a legal issue. Some of what you’re talking about has been considered, but, again, this is part of our continued due diligence before we make a recommendation that would go to the ballot or ask the City Council that it would have thorough legal review. We are not intending to set up a company that would be a risk to the City. Dawes: Thanks, I wanted to respond to the issue of cost plus pricing that Mr. Hoel raised last night and George talked a little bit about. When you’re running basically a fixed-cost business which this is in large measure, cost plus pricing doesn’t mean anything because the volume is what counts and I totally agree with what your response was, Blake, in which you indicated that once we have a positive cash flow, we’re servicing our debt, we’re making transfers to the City coffers, then we’ll look at rates, too. If we’re coining money until it’s coming out of our ears, then we’ll consider a rate cut just like we would if the electric company did the same. So it’s a fixed versus unit subscriber issue. Last item on my list at this point is process. This process - and I guess the whole so- called Palo Alto process which I find somewhat nauseating - I tend to be a cut to the chase kind of a person and we’ll get into this a little later on tonight- but I am clueless as to what this proposal is all about. We’re not asking the City Council to do anything other than to create a priority. If this is going to be on the November ballot, we’ve got to do something, do something quick, make up our minds, and I just don’t know why it’s not an up or down recommendation rather than this sort of beating around the bush. And, how are you going to get from here to there in November and basically beat around the bush? Ulrich: Was that a question? Dawes: Touche, yes it was. Ulrich: Who were you directing that to? Dawes: I’I1 direct it to Blake. Ulrich: So we’re all together on this. As you know, we spent a lot of time putting this together in our recommendation, and it’s done in an environment that we believe that requires this kind of scrutiny before the decision is made. I think that’s what you pay the staff to do, not to give you a "everything’s going to be fine and trust us." It’s trying to show the process we believe is important to do along with the risks and rewards of this business. I doubt if there will to be very many times when you’re going to have a staff sit up here and talk about a $40 million endeavor that is not part of the existing utility but we believe is one we’ve studied, spent a lot of money on and it’s one that we’ve built a recommendation in that we’re asking that you consider and take forward to the City Council. Dawes: More about this later, but thank you. UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7/04 Page 10 of 26 CMR21504 Attachment A Rosenbaum: John, let me follow up on this last point by Dexter. You know I’m always interested in process. I used to be on the inside and knew what was going on. This business plan was dated last August and our original intent was to hold the meeting that we held last night in September. And according to the newspaper, the City Manager’s offic~ held things up because they wanted, I guess, a more balanced presentation. Six months later, what we get is the original business plan plus a very bland non-committal 9- page report from staff which says very little along with a recommendation, which I quite honestly regard as gratuitous, that we ought to tell the City Council how to set their priorities. Clearly, not much was accomplished in the six months and it might be helpful to us if we could understand just what’s going on with the Utility and the non-Utility staff. Ulrich: Well, I’m not going to move very far in that direction. It appears that you’ve already come to some conclusions which I’ve never even thought of before so you have far more insight into this than apparently I do. I operate, I think, an organization and do what I believe is most appropriate on behalf of the people who pay my salary, which is the City and the customers in the Utility and that’s what we’ve done. I’ve communicated with you on numerous occasions the delay, if you want to call it that, of putting this together. But I think ultimately - and that, I guess, will be borne out - as we go forward that was a prudent thing to do and that the report I gave you, that you have, is a first class product. You have to decide what you’d like to do with it. We have a recommendation. I think there are a number of prudent steps that need to be taken including the involvement of the City Council and the residents on whether this is a project that should get a high priority as something of this magnitude should. But clearly there may be other things within the City that have higher priority that need to be considered in context to this one, and I think it’s appropriate to present it that way. Rosenbaum: I guess normally the Council sets its own priorities and I assume if the City Manager takes the view that, you know, Council - we can’t get to this unless you tell us what we shouldn’t be doing. That’s one thing, but I’m not comfortable with a recommendation that we attempt to tell the City Council what they ought to do with their priorities. That’s why I bring up that point. And the other thing is clearly very little was accomplished in six months. There were people who were worried about getting this on the ballot in November and this sort of a process is clearly not going to come to a conclusion in June and perhaps we have to think of something much simpler if we want to have a ballot issue ready by June. Do we have further questions? Elizabeth: I just wanted to follow up on some of the comments that were made last night by the residents and interested parties. There were many comments and I would say sort of a myriad of different opinions and thoughts with regard to the business plan. This is the business plan that we are evaluating, the one that was provided by Uptown. Lots of different ideas on how this could be rearranged, changed, modified. There were a couple of thoughts that I thought it might be nice if you could address. Specifically, one was the City provide the infrastructure for this fiber to the home but not run the service offerings. Others would be running those services. We simply provide the operation maintenance, construction of the utility portion of it. I know I’ve talked with you about this before so UAC Special Meeting on FTTH, March 18, 2004 - Approved 417/04 Page 11 of 26 CMR21504 Attachment A I’d thought it might be helpful, if you have a chance, to respond to that concern from the residents. The second one is the issue of whether or not you could offer this service as just an internet service, not having the three play package but internet only. I thought it would be nice if you could answer. Heitzman: I’ll take the latter one. When you consider the costs - and it actually helps with the first one - when you consider the costs of the infrastructure and the type of revenue streams you could get just from the internet, you can’t afford to do it really unless you just want to do it as a public interest thing and consider that you’re not going to get your money back. The reason the business plan has the three services is because it takes those three services to get a sufficient revenue stream to support paying off the debt and so on. Now, within the plan, just to be clear about it, the way it’s set up, the video service is in the plan basically a monopoly City offering. The phone company is a third- party CLEC offering. The internet is modeled to have competitors on the system. But the customer survey information tells us that citizens are interested in seeing us participate and basically very solid about our service and wanting to see us as a service provider. So that’s one reason why we’re there. Ulrich: Let’s just add a little to that. In the earlier view, and we got a lot good input from our consultant on this, we looked at can we be a business or basically own the infrastructure and lease it or rent it out to others? We made some attempts in that area when we were doing the trial and we have had openings to potential parmers in this and have not gotten very far. This is an interesting business and some of it is based on in a sense a monopoly in a propriety ownership of something so it precludes others from being a partner. We’re open to that and would look forward to having that kind of a relationship if it turned out to be the best for all of us. The other part, though, is that this has always been envisioned if we are going to be an ISP or we’re going to provide video services, we would always be available for someone else to come and provide those kinds of services, provided they pay the appropriate fee for coming on and either be in competition. We look at that as a way of providing alternative service options to the residents so you get some competition and you get services that people want. So we’d be an open access. The model that’s put together is the one that we think has the most financial interest for the customers who want to sign up for the popular services and allows for competition which would then allow us to collect money from people using it, and I think it would do the public good by having a way for competition to take place. When I mentioned about the ownership or doing the infrastructure somewhat in response to Mr. Bechtel about the governance and whether somebody else should make the decision about the programming and then the Utility operate the system, I was saying of course we would be open to that. That ultimately has to be the decision of the City and how they want to do it. But we’re very good at owning and maintaining and operating and providing high-quality service on infrastructure - that’s our superior area - and can do it well. So these are the options where we see the monies can be made but it’s got huge potential for other competitors to come on and try to provide additional services. Does this get closer to where you’re... UAC Special Meeting on FTTH, March 18, 2004 -Approved 4/7104 Page 12 of 26 CMR2.1504 Attachment A Dahlen: It does, and I think it’s helpful for everyone to understand all of the different options that you have explored and you have gone to great lengths to evaluate their feasibility. This is the plan you’ve come up with and I think it’s important to know. Dawes: Actually, I didn’t understand whether or not the openness to having additional operators come on extended to television or not. At one point you said that’s going to be proprietary and later on in your discussion, you seemed to imply that we would open to everybody, telephone, intemet, and also TV. But I don’t get it at this point. Heitzman: The plan models it as if we’re the sole provider. The reason it’s that way is because it’s just an expensive operation for a second party to come in. It doesn’t mean that we would disclude them from coming in. It’s simply that odds are if we’re here on television or the video, other people won’t want to come in. Dawes: So we can say this is an open access system but the City will be providing TV or video and anybody else who wants to come in and provide video against us, that’s okay. The bandwidth is adequate to handle both sets of services. Ulrich: Right. It’s going to be a matter of how do you price and provide thataccess. What would be the terms and conditions of... Dawes: It’s unlikely, but we’re open to it. Make me an offer. Ulrich: Right. Thc othcr part I think you mentioned was this part about being on the telephone side. Thc business model assumes there would be a CLEC or someone that would contract with us to provide that service. We would not be, the City would not be the telephone provider. Dawes: I understand. Would you have more than one telephone operator? Ulrich: Sounds kind of exciting to me. Dawes: Do CLECs compete with each another for customers? The answer to that is yes, too? Ulrich: Sure. Dawes: Good. Ulrich: Not that I’ve thought about the business model for that. Rosenbaum: George, Bechtel: Coming back to the same point raised by others about open access and so on, and other people on the system and wholesale versus retail, reminded me that many e- UAC Special Meeting on FTTH, March 18, 2004 - Approved 417104 Page 13 of 26 CMR21504 Attachment A mails that we got - by the way, I counted 29 e-mails from 5 individuals in the last 2 weeks but all of which were very, very helpful - but one mentioned, I believe, the mission statement. I’ve read the mission statement various times and we have one for CPAU, and I was wondering whether that got exercised much in your review or is this Neil’s proposal? I find that rather weak, and I particularly think we could solve some of the problems if we address the mission statement and put in the words we’re talking about tonight about open access, wholesale/retail model, and so on, just so the mission statement is on page 1 of 85 in the Uptown report. It says the City of Palo Alto’s broadband business venture would provide excellent value to its citizen owners and will be the preferred broadband service provider through a combination of excellent customer service, fair pricing, and enhanced product performance, all done in an environmentally sustainable manner. I think if we spent some time, and not necessarily tonight, but at least gave us, gave people an indication of what we’re talking about, and really talk about what is the mission? Let’s put some time on that. If we did our mission statement, I think we could describe what we’re really trying to accomplish to everyone. So, back to my original question, did you discuss this at all in your meetings and this was considered the best you could come up with? Heitzman: I’ll take the blame for it, how’s that? George, basically, this is modeled after - maybe I shouldn’t even say this - if you look at the utility mission statement, this is kind of a paraphrase, putting the titles in the same spots and verbs in the same spots. We wanted to be compatible with our current mission statement. Maybe that’s an afterthought when you look at the purpose, maybe it’s not the fight one. Ulrich: What Iwas looking at, Mr. Bechtel, in the presentation last night, slide #24 says does fiber to the home fit with the strategic plan and while the audience may not be entirely familiar with the strategic plan, all of you on the UAC except for Mr. Melton have been over the strategic plan with us numerous times. And, as you know, we measure our results around how well we do our strategic plan. The reason for putting it in slide 24 is to show how fiber can fit, and Objective 1 is customer satisfaction through delivery of valued products, invest in utility infrastructure, provide superior financial performance, unique advantages of municipal ownership, and deliver products in a competitive market. We’ve had that in our strategic plan for a number of years so we shouldn’t be going off into some area if we don’t believe it’s part of the objectives of the utility. So we can always make the mission statement a little better if that’s what we’re trying to do. Bechtel: Well, come back to how I started the evening with, is basically in support of your proposal and then trying to make it so that other people in this town can support it, people who are not so familiar with it as the people in this room, the people who were here last night, and those of us here at the table. So I think a mission statement - I’m not sure it should be in the ballot argument - but perhaps properly done could describe what this venture is all about. So I really wanted to come to the point whether you’re satisfied with it or with it just kind of as Blake said - I think he answered the question, which is, modeled on our own electric utility. Maybe we ought to go back and look at our missions statement again there as well. I think that the wholesale versus retail, we need to really UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7104 Page 14 of 26 CMR21504 Attachment A have that open access. Those are the kinds of words I really think we do have right up front so that people very clearly from wherever they’re coming from know what we’re talking about. Ulridh: Well, I want to totally agree with that. We don’t want to get into the position as the newspapers say we’re just talking about, what is it, foreign technological language. I think it’s important we’re able to communicate this. Again, this is a very important decision, a lot of money in an area that will be new to many people in Palo Alto. We’re open to - I think I mentioned it last night - is be able to go out and have meetings in neighborhoods to talk about this and get more input from people in the community on what we should be doing. Rosenbaum: I’ve got one very small point. Last night I had a little back and forth with Manuel over the question of whether the 1-year term offered by SBC for their internet, which is currently priced at $30, was renewable, and I said it was and Manuel said it wasn’t, that you would have to go to the monthly rate which is currently $50 a month. I did a little research, and I am correct. I wonder does the staff agree that I am correct so that we’re all on the same page? Ulrich: I know you and I had a chance to discuss this a little bit and our objective is never sit here and disagree over an item like this in particular. When I went back and looked at the website, and we also made additional telephone calls, I now have more information than I ever thought I cared to know about the marketing plans for not only SBC but for Alameda Telecom and also Comcast, and I’m not sure which one is the best. But to get to your point, you stated that the $29.95 - and this is going to be a good advertisement for them because they’re going to get full marketing tonight on this - that the $29.95 is an introductory offer. If someone calls SBC they’ll be pointed towards the basic package or the one that looks like the best value is the standard plus package, and you can have it .for $29.95. The only way you can get it according to Sales and also discussion, you have to sign up for it on the internet. And then, where the intriguing part comes in is, as Mr. Rosenbaum pointed out last night, is what happens at the end of the year? Well, when you talk to them on the telephone, they’ll readily tell you that the contract, the year is over, and if you don’t renew it, it reverts to, depending on which package you select, the $49, the $54.90, anyway a higher price. However, you have the option, if there is a continued special package available, to pick up on that without reverting to.this month to month. So, what it seems to be, comes the end of the year and whether they call you or not, but you call them on the telephone, they will offer you whatever the package is at the time. If it’s still $29.95, you can have that; if it’s something else, you can have that. So I take that as you can rely on the $29.95 for 12 months and then depending on what happens at the end of that whether they’re still aggressively marketing it or offering these packages, you can have whatever package is there for that additional year. It turns out that Comcast has a similar program, different period of time, but you can get it for $19.99. And they offer higher upstream speed for that $19.99. However, that’s only for four months and then you go to the $42.95. So I think there is really good marketing out there. Oh, and by the way, in the small print, if you want the special deal with SBC after the 12 months, you must also order and have UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7/04 Page 15 of 26 CMR21504 Attachment A part of the program, either a long distance or a local toll, as part of your package. So there’s a number of fine print and an excellent marketing effort. There was no intent last night to get into an argument or dispute on that. Rose’nbaum: John, I think a simple yes would have been a sufficient answer. Ulrich: No, I put a lot of time into making those phone calls and I think (inaudible). Rosenbaum: I guess I was trying to distinguish between the teaser rates offered by Comcast, which everybody understands are teaser rates that are not renewable, and what SBC is at least at the moment offering. Ulrich: We could learn something from this and have our own teaser rates. Rosenbaum: All right, if there are no... Bechtel(?): Mr. Chairman, may I just add an addendum to that? I have my SBC bill and they’re very clever. I originally signed up for DSL for $49.95 some years ago. I called them up and when they extended me their offer, they’re showing (inaudible) a $20 discount. The $49.95 is still there, but I’m getting a $20 discount. So the net is correct but they are holding their options open to dump that discount. Rosenbaum: Yes, well clearly that’s true, there are no guarantees anywhere, but that is the current situation. Elizabeth... Dahlen: I just wanted to point out that this is excellent marketing that we’re doing tonight for our incumbent providers. Just kind of note, within the business plan, I know there are questions with regards to perhaps the message and content of the mission statement, but if you turn over to page 3 of this report, the paragraph ends with the term "FTTH dynamic and vital" which I definitely caught because those are two words that are typically not used by government bodies. So I just want to praise them for that. Ulrich: We’ll remove it quickly. Dahlen: Perhaps it was an oversight. Ulrich: We don’t know how to spell that. Dahlen: One of the questions that came to mind in going through the business plan that I did want to bring up is with regards to the content channels that would be provided. There is a list in the report with regard to the channels that are provided by the incumbent providers. There’s also a comment with regards to what the national cable co-op could get in terms of the cable channels they’re readily having access to and then there’s the additional channels that we would have to go out on the market and purchase. They indicate in the report that those channels that the co-op has access to are indicated with an asterisk. I just have to point out that I never found which channels that co-op does offer UAC Special Meeting on FTTH, March 18, 2004 -Approved 417104 Page 16 of 26 CMR21504 Attachment A versus the channels that we would have to go out and buy. I don’t know the offerings that the co-op has and I think there are some key channels that would be critical to our customers and I wouldn’t mind if you could just say something about what channels are not provided and the cost considerations of going out on the market to get those channels. And before you answer, Blake, I have one additional question with regard to the ethnic channels because that was a point that was made in the report that there were not enough ethnic channels available from the current providers. We have also received a lot of e- mails with regards to what the current providers do provide and the variety of ethnic programming. But, setting that aside, the concern with regards to getting these special ethnic programs - and we have a very diverse, multi-cultural community here in Palo Alto - so there are many different ethnic channels that would be of interest I’m sure to the customers. What are the cost considerations? It would seem to me that these are very specials channels that may be costly to get and you’d be having to provide many different ethnicities when you go about getting that type of content. So has any analysis gone into that that goes beyond what’s mentioned in the report which is essentially this is something that we’re going to provide? I’d just like to see what the meat is behind that. Heitzman: Of course this is a moving target as far as what’s available to the co-op and what the competition is providing. First of all, I guess you could recognize that we have other municipalities, other small businesses that are using the co-op and they are providing the service that is being used by their customers. So I wouldn’t say that using the co-op would put you at such a disadvantage that you can’t attract customers. When we were getting into this programming, we looked at several alternative sources to the cable co-op which are available and we haven’t been able to follow up to see exactly what we could do with them. There are other sources of programming available other than the co-op and some of these sources have very interesting programming that’s not available at other places. There are some issues there that we have to deal with and see whether we can capture that line of programming. So I guess what I have to say is that we’v~ looked at it but there’s no conclusion exactly how to deal with this. The additional channels that you’re more concerned about as being more expensive aren’t really these ethnic channels. The ones that are really more expensive are the ones like HBO and there’s some kind of (inaudible) with ESPN and so forth that you get tied into a bunch of other bundles that you may not want but you have to buy the whole thing. So those are actually the expensive ones that are more difficult. Some of those are handled through the national co-op and some of those are not. But that’s really where the twisting starts happening at some of these popular sports channels. Maybe not everyone wants to subscribe to it but you have to subscribe to it in order to get it. for anybody. There are issues like that you have to deal with. But that’s where we go to partnering. Partnering is something we want to do in the next phase to tie down some of these parmers that.can potentially provide us with the kind of programming that we want. Dahlen: Just to clarify on that, so some of the key channels like ESPN and HBO and some of the really attractive ones are not currently available through these co-ops? UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7/04 Page 17 of 26 CMR21504 Attachment A Heitzman: No, I’m not saying that. I’m saying that that type of channel is the one that is expensive. Most of those are available to the co-ops, but there are a few that aren’t. They’re more of the big, but lower, like Starz, I can’t tell you exactly which ones they are, but there are a couple of those that aren’t available to the co-ops. Ulrich: I might add, more anecdotally, I had an opportunity earlier this week to meet two utilities directors that had fiber coax systems and talking about this content because, as you recall, earlier we were concerned about the competitive difference between what a Comcast could provide because of their huge size and what this co-op could provide. I think Neil addressed the customer base and the ability to buy the program and not have a significant cost disadvantage. But in talking to both of these people I found that they were quite satisfied with the co-op and being able to get the products their communities would like to have. We did not get into the cost difference. My assumption was that if there was a particular set of programs, that the customers that wanted that, they would be willing to pay the cost for that product even if it was higher than some other channel because that was something they wanted. So we could, if it was available and it had a higher price, we would make that as an offer to those individuals who wanted to purchase it. Dahlen: So that would become a special package for those customers. Ulrich: Sure, again that’s the beauty of owning a system, you can provide the content that people want. Rosenbaum: Alright, seeing no further questions, let’s see if we can put together a motion. Dexter? Dawes: I gave some thought to this whole issue and how to get the ball rolling with the Commission, and would like to offer up this motion as an alternative of just a straight endorsement of staff’s recommendation. I’m sure it will be debated and probably changed as we go through the evening. I will read it and then I’ll pass it out. My motion is the UAC recommends the City Council authorize the formation and construction of the FTTH project pursuant to the FTTH business plans Phase I dated May 7, 03, and Phase II dated March 17, 04 subject to an advisory vote to be placed on a November 04 ballot. UAC recommends no additional funding for the project until the project is approved by the City Council. Upon approval additional funds for public relations and legal analysis (but not engineering design) be authorized pending the advisory vote. So with my comments earlier about cutting to the chase and abbreviating the Palo Alto process, this is my suggestion. So, John, here is one for you if you want to have a copy. Bechtel: Second. Dawes: The second part addresses the process issues which is ’we’ve done it guys and gals, gray haired old men and young women’ and that the Council has got to get off it’s UAC Special Meeting on FTTH, March 18, 2004 -Approved 4/7104 Page 18 of 26 CMR21504 Attachment A duff and make a decision. If they say ’go’, we’re going to go like crazy and put it on the ballot and keep on going. That’s my statement. Rosenbaum: Thank you Dexter. Before getting to George’s comments as the seconder, I’m having a little trouble with the last phrase. ’Upon approval of additional funds for public relations and legal analysis without engineering design authorized pending the advisory vote’. That has a clear meaning but it escapes me at the moment. Dawes: Well it means that staff has asked for $390,000 be authorized and I’m saying that my intent is to say that once the City Council has accepted this proposal, that they then would authorize additional funding. Additional funding was in the two items on page 9 of 9, they call the public information program, I’m saying it’s PR that’s $50,000. Engineering design and specifications, we don’t need it until the public says go or no go. I don’t see putting any money into system design until we have a project and I don’t know what ’conduct business process, performance testing, and remediational analysis’ is $70,000 so I threw that out. Then it says ’conduct preliminary legal assessment of a legally defensible path for establishing an FTTH business very important because we still have some stumbling to go along that path at $70,000 so I guess I would say we recommend the City Council authorize $120,000 between their approval and the vote. Rosenbaum: Alright, I think that clarifies the intent. So the UAC is recommending that if the City Council approves the project, that the City Council also authorize the $120,000 to be spent prior to the November advisory vote. Dawes: Subject to Mr. Bechtel’s approval, I agree that that’s the way we will rephrase this. Rosenbaum: Alright, George as the seconder would you like to comment on the motion? Bechtel: I think the easy decision tonight is to say no, don’t go ahead. Tell the Council we don’t believe in going ahead. I think that’s really easy for us to say. It’s too expensive, we don’t know whether Palo Altans really want it or not, do they really need the City’s services, I’m happy with what I have today. All of those are things that make it easy to say not to go ahead but I’m going to support Dexter’s motion. I think we have feedback from our City that Palo Altans are, for the most part, happy campers. Our own utilities surveys on this particular project and on other surveys, say they are happy with the utilities. So I believe our staff can pull this off as much as we talk directly to them and ask them why they.., what was happening during that six months last summer. I think we all know what went on. I think we ask a lot of questions about wanting legal advice and I know our own City staff is pulled in a lot of different ways. I really do believe that is why you couched the motion, or your proposal in the way you did to make this a top five priority as opposed to the simple and direct way that Dexter did. But I like Dexter’s approach, it cuts to the chase. ! believe that the financials, I believe Dexter is the one on the Council here that is the most knowledgeable, maybe not most knowledgeable but most opinionated perhaps, the most direct and the one I can count on to look at the risks from a financial point of view so I’m happy with that. In the past, I’ve UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7/04 Page 19 of 26 CMR21504 Attachment A always been supportive of this as much as I’ve been critical of some of the details thinking we ought to say more, we ought to promise more, we should be more direct. That’s the reason I’m supporting the motion. The last item, before I turn it over to my colleagues, I do want to talk a little bit to the issues that Dick raised about clarifying the motion. I believe we need to spend more money than Dexter has proposed because I believe we’re not sure what the nature of that vote is going to be. Now certainly, they will count this as advice to the Council so we’re not really dictating or writing a motion for them so they can deal with this as they will but I think the intent of this was that we need at least, the money we need to spend is on preparing for a vote in November so whatever money is needed, I would support. Rosenbaum: It will be that we have to have something before the Council in June, I think staff will be hard pressed to come up with a statement supporting an advisory vote by June never mind getting any legal analysis and some determination of what the City Charter requirements might be. So John I would prefer the wording that we have but you are certainly free to propose an amendment or maybe you and Dexter can work out something acceptable. Dawes: Let me clarify something Mr. Chairman. You said that you thought in your experience it would be difficult if not impossible for staff to pull together the required, what I call legal issues, to go on a November ballot such as a charter amendment. So the timeline then would look like, subject to an advisory vote in November, assuming a ’yea’ then there would be another ballot proposition, say in the Spring of 05, which would deal with the legalities of the situation. Rosenbaum: If necessary. Dawes: If necessary. Rosenbaum: John, is that thinking acceptable to you? Melton: Yes, you certainly have much more experience than I do on what the time frames are to get these things accomplished.If that’s not a feasible idea, then we shouldn’t propose it. Rosenbaum: Elizabeth? Dahlen: I think I’d like to just take a moment to offer some of my thoughts on the matter. And I will get specifically to the recommendation made by Commissioner Dawes. My experience is not in the telecommunication business. However, a technology has been put in front of myself and my colleagues. It’s not clear to me how exactly how we selected the technology or why but I am relying on staff and consultant’s conclusions that this is the right technology to be looking at and evaluating although some may question that. As we sit here today, and as a UAC member, I am looking at this in terms of what this technology brings to the customer, the Utility, and the City. I think it’s important to bear in mind, the big picture here, is that we’ve been asked to evaluate a UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7104 Page 20 of 26 CMR2.1504 Attachment A plan that at the end of the day provides faster Internet access. The business plan expects that roughly 2/3 of the users will. not be buying at speeds faster than 2 megabytes per second which is what you can get today from the existing technologies. This implicitly says that people do not need the 10 megabits per second based on what I’ve seen in the documents. Now if we proceed with this business, what does that imply? Well, we have to also provide cable TV and telephony to make this business case work. And right off the bat we can see this implies we will be competing with some very big companies who have a very strong vested interest in Palo Alto. Given that competitive landscape, the City of Palo Alto Utility will not be the first to market, ~they will be the third, fourth, depending upon the service area to market and to complicate these matters, getting into this business, the service business area, implies that the City must set up separate emities to provide these services as well as separate oversight boards to oversee the activities and to address content issues et cetera as was clearly laid out in the business plan. This will not be easy nor has it been done by the City of Palo Alto before. Hence, there are many unanswered legal questions to which my colleagues have been referring to this evening. On the face of it, these look very complicated and involved. I think we’re all aware that in the last month the City has invested a lot of time and effort into looking into these legal questions and trying to come up with their best analysis of what the landscape looks like. I think we saw some of that in the write up from the City. Financing and setting up these entities will require large majority voter approvals and in many cases, as we saw in the reports, a 2/3 majority approval. The financing of the business center itself, may have a negative impact on the General Fund and the electricity rates as was pointed out in the report. The latter point being particularly concerning to our big electricity customers who would be impacted the most if this business were to go south. And I think we’ve also heard the details as to how large those impacts could be, or at least the framework of them. I think it’s also important to note that the existing technologies will likely continue to improve and new technologies may emerge to compete. Essentially what I have done is to summarize what’S been presented to myself and my colleagues in these documents in the reports by the City staff and by the consultants. Hence, there is the question that begs to be answered as to why would the City of Palo Alto want to go into this business. If Palo Alto had chosen to go down this path five years ago, we would have faced a very different market situation and that window has closed to us. Today the landscape looks very different. We have a lot of competitors and we have a lot of significant risks. It’s not apparent to me that the incremental benefits to the citizens of Palo Alto are commensurate with the time and effort that will be required to make this a successful business. Particularly beating in mind all of the issues, the risks, and other concerns that have been brought to light in these documents and by members of the public today, and in the newspaper articles that have been written on the subject. Hence, had we had the original recommendation that was provided to the City, I would have had a very difficult time going forward with that. However, I have looked at the motion that’s been offered by Commissioner Dawes and seconded by Bechtel and I’d like to offer an amendment to it which would read something, and the purpose of this amendment is to make clear that this recommendation would be asking City Council to make a recommendation to the voters and hence, I’m going to offer the following wording; The UAC recommends that the City Council UAC Special Meeting on FTTH, March 18, 2004- Approved 4/7/04 Page 21 of 26 CMR21504 Attachment A evaluate the FTTH project pursuant to the FTTH business plan Phase I dated May 7, 2003 and Phase II dated March 17, 2004 and provide a recommendation to the voters which should be, and then we can argue over the details here, subject to an advisory vote to be placed on the November 2004 ballot. I think it’s important to make clear that we would like the City Council to make a recommendation to be carded out to the voters. I am also concerned with the wording here of the formation and construction of the FTTH project because I think those words implies that this recommendation is going forward with the formation and construction of the project so I would ask if Commissioner Dawes would be willing, I’d like to amend that portion of it. I also want to raise the issue with regards to $120,000 of additional spending. This motion has been asked, recommended to put an issue on the ballot for the November ballot. We’ve already heard that there are issues with regards to whether or not this money could be spent before the timeline of June. I believe that the City has done a lot of legal analysis. They may not have all of the answers right now but they have been a thorough as possible to prepare the documents here today. I’m uncertain and I would like to flesh this out a little bit more with my colleagues as to the necessity of any additional funding and I would think these documents could go to the City Council for evaluation and from there, and based on their recommendations, be formatted into an issue that could be put on the ballot for an advisory vote. I’ll open up that discussion to my colleagues. Rosenbaum: Alright, let’s pursue Elizabeth’s point. Perhaps we can try to clarify the significant difference that you feel... Bechtel: Point of order, Mr. Chairman, I did not hear a second for the amendment. Rosenbaum: That’s a very good point but what I was going to suggest is that we attempt to clarify the intent of the amendment and perhaps it will become clear. So, as it’s worded now we recommend that the City Council go ahead with this project but then we say subject to an advisory vote. Are you objecting to ’subject to an advisory vote’? Is your point that City Council ought to make a definitive statement and then submit that to the public? Dahleni That is exactly my point, that the City Council make a definitive statement and submit that to the public. Not that we say to go ahead with the project as it’s described, in my mind, with the wording authorize the formation and construction of the FTTH project. Rosenbaum: Remember there are two issues here. We are making a recommendation and the recommendation that appears to have three votes is that we recommend this project go forward. There is a secondary issue which I thought you were getting to, that it is, as it’s worded now, it says the City Council should go ahead but subject to an advisory vote which might in a sense be letting the City Council off the hook. Are you suggesting the City Council make a definitive statement and then submit that to the voters? Dahlen: Yes, that is what I’m recommending. UAC Special Meeting on FTTH, March 18, 2004 - Approved 417104 Page 22 of 26 CMR21504 Attachment A Rosenbaum: Alright, with that understanding, Dexter what would you think of accepting that as a friendly amendment? DaWes: Let me take a stab at what Elizabeth is getting at, I’m still not quite sure. It would seem the UAC recommend the City Council approve the FTTH project business plan and either authorize or approve or propose an advisory vote be placed in the November ballot. Let me improve on that, the City Council approve the business plans and propose and or schedule an advisory vote for the November ballot. Is that what you’re after? Dahlen: No, not quite and I’m not sure I got all your wording there. What I’m recommending is that we say the UAC recommends that the City Council evaluate the FTTH project. Dawes: That’s not acceptable. We have to make a recommendation up or down. We’re not going to bounce the ball back to the City Council and say it’s up to you. Either we’re going to give guidance, do itor don’t do it. Rosenbaum: Elizabeth, I think it’s implicit that the City Council will evaluate our recommendation. It’s not necessary that we say that. So I’m back to my original question. Do you object to the subject to an advisory vote rather than saying the Council approve and schedule an advisory vote, is that a significant point of your concern? Dahlen: Actually, I think the most significant point is whether or not we approve going forward with the FTTH project. And given Mr. Dawes comments, I would not vote for that and do not recommend going forward with the project. Let me retract my friendly offering there. Dawes: No, It’s our job to be very specific and make recommendations and not to punt. So I’m glad to hear you have an opinion. That’s what we’re here for. Bechtel: I was wondering whether it would be acceptable to Commissioner Dahlen that the City Council place an advisory vote that would authorize the formation and construction of the project on the ballot. In other words, we are recommending to the Council that they put an advisory vote that would, in fact, the voters would be approving the formation and construction and if they vote up the project goes ahead and if they don’t they vote it down. Essentiall.y it’s the same thing but our recommendation is just for the advisory vote. Rosenbaum: I guess my thought, and Dexter could respond, is that the word authorize and advisory are perhaps inconsistent. I think advisory is the correct word if at this time if indeed something is going to be done in November. Rosenbaum: Alright, I think it’s my turn. We all have to weight the benefits versus the risks. My personal evaluation leads me to the conclusion that we should not go forward. UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7/04 Page 23 of 26 CMR21504 Attachment A I’m going to talk at a greater length than I usually do as to why I reach this conclusion. Municipal utilities historically exist because the private sector was unable or unwilling to provide reliable service at a reasonable price. This was certainly true for electricity many decades ago and it’s true of telecommunications today in rural America. Small towns are often characterized by having an outmoded cable system, no digital capacity, certainly no cable modem. The telephone company has no interest in making the investment required for DSL. In my sense there are many parts of rural America cut off from modem communications and in that situation I think it makes perfect sense for a municipal utility to provide telecommunications. Without that you have an impact on the desirability as a place for the people to live and there is also a serious effect on economic development not to have these services. And providing this service makes a great deal of sense and indeed may be vital to a town’s survival. What are the benefits of a municipal system in Palo Alto. Let’s run down, let’s start with video. We would be the fourth entry into the market. Comcast has just modernized their system, they provide digital channels, as many as you want, they provide high definition service. We have satellite providers, two in number. They provide all digital service. On occasion we hear comments about poor service from Comcast. For some reason, I have never heard any customer of one of our satellite systems complain at all. The business plan, in terms of price does call for a small reduction in price relative to Comcast but as it turns out the satellite dish providers offer yet a lower rate so that the business plan recommendation is somewhere in between what Comcast charges and what is available to anyone today who is concerned about the cost of Comcast. So all in all, it’s hard for me to find any significant benefit as far as video is concerned. Now what about broadband, the second leg here. We already have two competing suppliers with modem systems and including reliability. In terms of price, the business plan suggest we charge $40 a month for service that SBC is already offering $30 a month. Clearly this makes no sense and it’s in the business plan that way because the incumbent monthly charges was not updated, the business plan goes back to August. And clearly we would not attempt to compete with such a price differential. But if we indeed, we would have to lower our price to $30, this would have a very significant effect on our finances and will reduce the margin that staff has suggested exists, quite a bit. Now, the one benefit of fiber to the home clearly is speed. There is no doubt about that. Unfortunately, the enhanced speed is of little to no use to the general user of the Interact. There are no killer applications which require ultra-broadband. Conceivably these might be developed in the future but this is going to be a very slow process. If nation-wide broadband is going to be defined by the capabilities of DSL and cable modems then there is not going to be any market for applications which require ultra-bandwidth and they simply will not be developed. High speed is vital to people who are trying to move large files in and out of their home computer and clearly the system that is being proposed would enable them to do that readily at a price far lower than they could get that service from SBC. Now back in the Fall of 2002 when we had a public hearing, when we had one speaker who had a great deal to say, we asked him to submit something in writing and he did. He used a phrase which I thought was very apt. He referred to what was UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7/04 Page 24 of 26 CMR2.1504 Attachment A being suggested as ’bandwidth welfare ’. I think that was just the right term. The system that is being suggested will provide a vital service to a few people at the cost of submitting everybody to the risk of a $40 million investment. Another benefit that’s been suggested and this is more in terms of marketing, is bundling. I haven’t said anything about telephone because everybody knows about telephones. But clearly if we offered all three services we can bundle them and the customer just gets one bill. As a consumer, this has never had a great deal of appeal to me but all the marketing gurus seem to think this is wonderful so I assume there has to be something to it. And the point is made, that we could offer three services where the incumbent only has two. But the reality is Comcast is very soon going to begin offering telephone service. This has proved to be enormously successful to Cox in San Diego offering telephone over cable and I’m sure Comcast will get there soon and they will have the three services. Poor SBC, they’re in a little more difficult position because their missing service is video. There actually is commercially available equipment which enables you to transmit video over ordinary telephone copper wire. Its in commercial service with a number of small phone companies because they are trying to compete with cable modems in their area. I’ve never heard any of the larger phone systems, the Baby Bells, had any interest in them. What SBC has announced they are going to do, and I haven’t seen the roll-out yet, they are going to partner with one of the satellite dish companies and market their service so they too will be able to offer three services on one bill. So, it doesn’t seem as if we’re going to have any bundling advantages. Alright, that’s my analysis of the benefits. What are the risks. The main one is financial. Will the combination of price and penetration in a highly competitive environment yield sufficient revenue to cover our costs? That is the risk, we’ve got projections that this is not a problem, they are projections and essentially you’ve got to invest the $40 million and then find out. There are technological risks. The one everybody talked to is wireleis. I’m going refer specifically to Wi-Max which is grown-up Wi-Fi. I don’t think this issue has been properly addressed. There would be no reason for Palo Alto, in lieu of a fiber system, to offer a wireless system. We already have two sources of broadband, what’s the point of offering a system that would be comparable in bandwidth to what we already have. And there is a second difficulty. This whole project has not been staff driven, it’s not been driven by City Council. It’s been driven by a group of residents who are interested in the gold-standard for communications which is fiber to the home. So any effort by the Council or the staff to suggest an alternate, would number one, be met with derision and number two, would cause all political support for this project to disappear. That is not the threat. In my view, if Wi-Max turns out to be technically and financially feasible, and by that I mean if somebody can offer two or three megabits of band-width with reasonable reliability and security for $25 a month, you will have a very powerful competitive challenge. Not only to the City if they were in the business, but also to the incumbent providers. And I’m confident that the incumbent providers would attempt to raise all sorts of legislative and regulatory barriers to keep that from ever happening and i UAC Special Meeting on FTTH, March 18, 2004 - Approved 4/7104 Page 25 of 26 CMR21504 Attachment A suspect if we were in the business, we’d be fight in bed with the incumbent providers objecting to this service. The second technological risk has to do with who will survive in the fiber to the home business. And also, what is the best system. This is technology that’s in its infancy. Two cities that have installed it, Kutztown, Pennsylvania, Bristol, Virginia, very small; Grant County also very small. They’ve got an installation. As we hear from Jeff Hoel, quite often there seems to be more than one way to go about this. I don’t know that this has all been figured out but I think in a couple of years probably the market will determine what is the best system. And the market is likely to determine which of the suppliers are going to survive a shake-out which I’m sure will occur. So in a sense, we are both too late and too early. We’re too late because over the last couple of years, both of the incumbent providers have improved their systems and lowered prices. And we’re too early because we don’t know if Wi-Max will be feasible or just another over-hyped technology and we really don’t know what the best approach to fiber to the home is going to be. So it’s for these reasons that I do not think that this is a project that the City should pursue. If there are no further comments, I think we are ready. Let me once again, read the motion as it’s currently stated. MOTION: The UAC recommends that the City Council authorize the formation and construction of the fiber to the home project pursuant to the Fiber to the Home Business Plan Phase I, dated May 7, 2003 and Phase II dated March 17, 2004 subject to an advisory vote to be placed on the November 2004 ballot. The UAC recommends no additional funding for the project until the project is approved by the City Council. Upon approval by the Council, the UAC recommends that an expenditure of up to $120,000 be authorized for public relations and legal analysis but not engineering design. I think we are ready for a vote. All those in favor please say aye. "Aye. Aye, Aye." Those opposed. "Aye (meaning nay), Nay." That motion passes on a three to two vote. I personally want to express my thanks to the staff and all the members of the public who have been with us for these two years. And I’m pleased that the UAC has taken a stand, although not ’the stand’ and is ready to move this up to the Council for the next level of decision. Thank you all. Adjournment 21:19:57 UAC Special Meeting on FTTH, March 18, 2004 - Approved 417104 Page 26 of 26 CMR21504 Attachment B MEMORANDUM TO:UTILITIES ADVISORY COMMISSION FROM:UTILITIES DEPARTMENT DATE: SUBJECT: MARCH 17, 2004 (AND MARCH 18, IF NECESSARY) FIBER TO THE HOME (FTTH) BUSINESS PLAN PHASE 2, FINAL REPORT RECOMMENDATION : With this report, staff has completed the Phase 1 (technical trial) and Phase 2 (business case study) analyses of the Fiber to the Home (FTTH) Project. Staff recommends that the Utility Advisory Commission (UAC) recommend to the City Council that the FTTH project be made a City Council Top 5 priority if the Utilities Advisory Commission believes, after reviewing the business case study and this preliminary summary of risk issues, that the FTTH project should continue to the next phase. If FTTH becomes a City Council priority, then staff from key City departments, including, but not limited to, the City Manager’s Office, City Attorney’s Office, City Auditor’s Office, and Administrative Services Department, would be directed to incorporate this project into their work plans for 2004 to prepare a proposal for the project for the City Council, and potentially the voters of Palo Alto. Staff recommends that the UAC recommend Council approval of additional funds of $390,000 to implement Phase 3, which will involve an in-depth risk analysis and require a significant commitment of staff time from key City departments in addition to the City of Palo Alto Utilities (CPAU). Issues that will be further addressed in that analysis -- financial, legal, operational and political are summarized in this report. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report Page 1 of 9 CMR2.1504 Attachment B BACKGROUND: Elecixonic communications are an integral aspect of life. The potential for electronic communications by means of a fiber-to-the-home (FTTH) project in Palo Alto has prompted residents, businesses and policy makers to consider the administrative, financial, legal and political feasibility of that project. A City-owned and operated FTTH project would entail the deployment of a dark optical fiber backbone and related electronic equipment to facilitate the provision of communication services, including video, voice, and data transmission, as well as access to the Intemet. The FTTH project has been an ongoing project since the City Council approved the FTTH Trial on November 13, 2000. In May 2001 construction ofthe.FTTH Trial in the Community Center Neighborhood began. The construction involved City and contractor crews. Service to the trial participants began in October of 2001. The trial participants consisted of 66 units including homes, a school, a library, and the Civic Center. Local phone service, (through Pacific Bell), video service (local channels only) and Internet data service have all been tested over the FTTH Trial system. CPAU staff is doing the operation and maintenance of the FTTH hardware and network. The Internet service provider (ISP) and customer support are outsourced to local Palo Alto companies. Current fees offset annual expenses. ¯ Once the trial became operational, an FTTH advisory team was formed to advise staff and provide a review of aspects of the project such as data, plans, activities and alternatives. A sampling of team activities include updates on the trial, interaction with the business case and business plan team, presentations about other municipal efforts, and presentations by providers of alternative systems (such as wireless). The team includes representatives from the City Manager’s Office, Administrative Services (finance), Utilities, City Council, UAC, and a citizen participant in the FTTH Trial. Two extensive surveys of utility customers and Palo Alto residents were conducted and incorporated into the business case. Both surveys indicate that there is sufficient consumer interest in City of Palo Alto for the delivery of phone, Internet and video service to support City-operation of the FTTH system. Staff continues to research suppliers of fiber equipment and fiber optic services and examine equipment at test facilities, demonstrations, and field sites. Staff frequently communicates with engineers who design fiber systems and with operators of existing systems. Staff is in continuous correspondence with the early municipal adopters of FTTH and broadband service deployments regarding the financing, design and operation of their broadband facilities. In May 2002, Uptown Services was hired to complete a business case study. On December 4, 2002, the Utilities Advisory Commission (UAC) accepted the business case and Fiber to the Home (FTTH) Business Plan Phase 2, Final Report Page 2 of 9 CMR2.1504 Attachment B recommended that the City Council approve moving forward with a fiber business plan study. The business plan prepared by Uptown Services is enclosed with this report. The business plan (like the business case) models the technology, product design, and market in an intentionally conservative way. The models used in the business plan are similar to those used by current providers of competitive video, Internet and phone services. These models provide a framework for pricing and revenue projections and establish that, in the nominal case, a fiber utility can be a viable financial entity. Because the business model presented focuses on the financial viability of the FTTH system, it excludes the value of public benefits such as the money that might be saved by residents and businesses that did not subscribe to the City service but received lower prices from its competitors because of the availability of the FTTH system. DISCUSSION Staffhas completed the Phase 1 (technical trial) and Phase 2 (business case study) analyses of the FTTH Project. In considering whether to move into Phase 3 of the FTTH project, staff has prepared a risk analysis of the factors to be considered by the UAC and ultimately by the City Council. These risks fall into four main areas: operations, financial, legal and political. Operations: The business case and business plan studies center on the costs, revenues and physical feasibility of building the infrastructure and operating a FTTH business in Palo Alto. This section addresses the operations issues. Construction costs and revenues from services are addressed in the financial section. Because of the competitive nature of this business, it is necessary that day-to-day business processes operate accurately, quickly and efficiently. CPAU already engages in activities similar to operating an FTTH system. These activities include: constructing, operating and maintaining infrastructure and handling customer service and billing. The existing billing system, customer service center, and other areas of CPAU have been reviewed by Uptown Services and recommendations have been made to modify these to handle the complexities associated with an FTTH customer base. The development of operations guidelines and performance tests for these and other systems are critical path items that must be completed in Phase 3. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report Page 3 of 9 CMR21504 Attachment B As discussed below in the legal analysis, an operating entity independent of the City may be necessary because the City can not exercise editorial control over cable television and video content, and cable content is an important element of FTTH services. The business plan provides the following: A twenty year pro forma of the finances of construction and operation of the business A monthly budget for the first two years of operation Provisions for sales, marketing, system upgrades, vehicles, product costs, etc. in the budget A staffing plan that includes 22 new Full Time Equivalents (FTE) to operate the business The proposed staffing level is based on existing municipal broadband business operations. The new FTTH staffing would bring additional expertise required to operate the system, including additional technical staff to handle network management, head end operations and the technical parts of customer service. In addition to the potential customer benefits, the FTTH network would provide benefits to CPAU through several opportunities for service and operational improvements. Specifically, two-way communication from customer sites via .the FTTH network would allow sophisticated and less labor-intensive remote meter reading. This remote reading could be used for both monthly billing and real-time meter reading. Real-time meter reading would enable the development of accurate load profiling by customer class and be used in utility load analysis and improved rate design, including the creation of a real-time rate structure. In addition, load control can be ubiquitously implemented over fiber, with real time monitoring of load changes and follow-up adjustments to meet load goals. Such monitoring and control options could allow CPAU to commit to cost reducing electric energy contract obligations, or exercise distribution system protection during emergencies. Phase 3 of the FTTH study would require further investigation of these opportunities. Financial and Risk Analysis: The deployment of an FTTH system citywide is both capital- and labor-intensive. Where the acquisition of video content is necessary to obtain and maintain a customer base, the costs of obtaining that content for the small economic market that Palo Alto represents likely will be relatively high. The financial viability of an FTTH system and its ability to compete with other parties for high quality content are key issues that must be considered. A risk analysis, Summary Report of Risk Assessment, was conducted by the Administrative Services Department and provided in Attachment C. The risk analysis was conducted to identify the key variables impacting the "bottom line," or net cash after financing, and to quantify the impact of up or down movements in these variables. The key risk variables Fiber to the Home (F’I-I’H) Business Plan Phase 2, Final Report Page 4 of 9 CMR2.1504 Attachment B identified on the revenue side included, cable and Internet penetration levels - in other words, what percentage of Palo Alto residents will actually subscribe to each of these services. Key risk variables on the cost side included long term borrowing rates~ costs of manufacturing and installing both the fiber network and the "control box" units to each household, and customer service staffing levels required. Some of these risks are less "controllable," in that their dollar impacts cannot be quantified before the project is implemented. For example, market penetration levels and required customer service levels would not be known until the project is well underway. (While these cannot be known in advance, the Business Plan uses the actual customer service costs and subscription rates occurring in Alameda’s operation.) On the other hand, other risk factors are quantifiable before the project is implemented, and therefore these impacts are more "controllable." For example, construction costs of infrastructure and equipment would be known prior to launching the project, when bids are opened. Bond rates will be known before the bonds are actually issued. Technological breakthroughs will occur in fiber and competing technologies. Staff and its consultants believe that these will not diminish the advantages of fiber, however, the potential for a major negative financial impact from competing technologies should not be ignored. Legal: Federal and California laws are implicated by the City’s provision of these services. Both Federal and California law are also in a state of considerable flux. The courts, the Federal Communications Commission, and Congress are struggling with the issues of whether and how to classify and regulate broadband networks and Internet protocol-based networks and the services offered over them. Historically, telephone services, cable television, and data transmission have been regulated differently. As these technologies merge, the inadequacy of the current regulatory models becomes evident. At the same time, competing ideologies and powerful economic interests battle in both legislative and administrative forums over the appropriate role of local, state, and federal regulation in promoting competition. Therefore, legal advice in this area must often be qualified with the information that there is disagreement among courts or proceedings pending in front of state or federal regulatory bodies. In this report, staff addresses some major issues in summary fashion. Much additional work will need to be done as this project proceeds and as it gains definition. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report Page 5 of 9 CMR21504 Attachment B Authori _ty to Operate a Communications/Information System By California law, Palo Alto has. a constitutional right to establish and operate a communications system. The scope of this right is not clear-cut, however, because the types of communications systems and the services offered on them have not yet been clearly classified by federal authorities. California has not attempted, as have some states, to prohibit the establishment or operation of communications/information systems by cities or prohibit or limit the types of services offered on these systems. What might be considered unclear is whether a municipality’s right to establish and operate telecommunications systems and cable systems extends to non-telecommunications systems and non-cable systems, where the type of communications service determines the classification of the communications system. Cable Content Federal law prohibits the City, as the local franchising authority, from itself exercising editorial control over the content of cable communications, should it own the ~able system that facilitates the provision of cable services. Therefore, if the FTTH project includes multi- channel video/cable services, the City must create a separate legal entity to editorially review (and determine) the content of cable communications. Because this entity must be independent of the City Council’s authority, CPAU cannot be that entity because the Director is accountable to the City Manager, who in turn is accountable to the City Council. Article I, Section 22 of the Charter of the City of Palo Alto, adopted in 1983, authorizes the City Council to appoint an independent board or boards for cable television matters. However, because the success of an FTTH project depends greatly on the selection and pricing of content, a different kind of entity may be necessary. It is probably not feasible to set up a board that only makes programming decisions for a different entity that makes management decisions on other aspects of operations. Ifa charter amendment is needed, a simple majority of the Palo Alto electorate is required. A second issue to keep in mind is that the pricing of"cable television" programming is not regulated. The actual prices charged by providers such as HBO or ESPN to system operators such as Comcast is confidential. It is generally believed that larger buyers obtain more favorable rates than small ones, and the content-providers value their relationships with large system operators. This makes it likely that the "per subscriber" cost for the sort of programming needed to attract consumers to the FTTH project will be higher than that paid by the current franchise holder. Palo Alto would be a small system even if it allied itself with other "independents" in a buying cooperative. Staff does not believe an action alleging "predatory pricing" would be successful. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report Page 6 of 9 CMR21504 Attachment B Franchise By Califomia law, a person must obtain a franchise from a local franchising authority before it may construct a cable system. While the term "person" is not defined by California law applicable to cable systems, California law construes the term "person" to include public agencies. The California law requirement to obtain a franchise on terms similar to those imposed on other cable franchisees is an issue that must be considered. The Palo Alto Charter does permit the City Council to grant cable television franchises; all other franchises must be approved by the electorate. Financing The deployment of an FTTH system citywide is both capital- and labor-intensive. It is also expensive. The business model proposed does not rely solely on FTTH revenues to make it viable; it assumes that other city funds such as general funds or utility enterprise funds can be used as well if necessary. To the extent that a portion of the FTTH project’s costs is integral to electrical utility operations, those costs may, and probably should, be charged to the electric utility funds, and ultimately, the electricity customers. Similarly, to the extent the City Council wishes to spend current general revenues on FTTH operations, no vote of the public is required. However, if general funds are to be pledged to back FTTH bonds, as a backup for anticipated FTTH revenues, these general obligation bonds require approval by a two-thirds vote. To the extent the costs of the FTTH project are charged to Palo Alto customers of the electric utility or a newly-created telecommunications utility, whether or not the City’s electric utility customers make use of the services, the tax implications under California Propositions 13 and 218 of the FTTH project must be considered. The charging of a fee that is unrelated to actual use or immediate availability of use could be considered a special tax, requiring a two-thirds voter approval. The charging of a fee to a parcel that receives or is able to immediately receive communication services by means of the FTTH project, whether or not the City’s electric utility customers make use of the service, could be considered a property-related fee, requiring a two-thirds voter approval, or alternatively, an affirmative vote of parcel owners. Again, this requirement would not apply to charges for aspects of the FTTH project properly viewed as integral to other utility operations. Electoral Approval Regardless of the form of financing pursued for the FTTH project, staff has been advised, and believes, that voter approval of a Charter amendment specifically authorizing the establishment of the FTTH project is highly desirable. Communications is a highly competitive business, and legal challenges from potential competitors should be expected. A clear authorization from the voters to proceed will reduce, but not eliminate, the risk of Fiber to the Home (FTTH) Business Plan Phase 2, Final Report Page 7 of 9 CMR21504 Attachment B claims based on a failure to obtain voter approval as may be required by California law. It would also tend to strengthen the resolve and financial commitment of those voters who vote in favor to the FTTH project and lend support to any City Council decision to incur the legal and marketplace risks inherent in the project. Political: A number of difficult challenges are currently facing the City, and a decision by the City Council to devote considerable staff resources to support the FTTH project will have to weigh this project against others also demanding attention. These include, but are not limited to: Long-range financial health of the General Fund Retail sale enhancement activities Implementation of the new SAP financial system Storm drainage system rehabilitation Library facility renovation and expansion Major land use proposals Long-term energy supply PG&E bankruptcy Enron bankruptcy These are not the only issues facing the City, but they are examples of the issues that are currently the responsibility of the staffmembers who would be critical to further defining the FTTH project and potentially preparing it for a ballot measure. Making the FTTH project a Top 5 priority would unquestionably have an impact on these other key initiatives. The issue of a ballot measure is also a political issue, especially in the next 18-24 months as other matters may be placed before the voters at the same time. The Palo Alto Unified School District will need to return to the voters in 2004 to renew the parcel tax passed to fund school programs. It is possible, because of the City General Fund’s continued malaise, that a business license tax or increase in the transient occupancy tax may have to go to the voters in the next two years. In addition to competing issues on the ballot, the City Council will need to consider the fact that recently, City proposals such as financing of storm drainage system rehabilitation and library system improvements, as well as other issues have not been successful with voters. Analyzing the reasons for that lack of success and determining whether they may also apply to FTTH is part of the deliberative process for the City Council. NEXT STEPS Staff recommends that the UAC recommend to Council that FTTH become a Top 5 Priority project. If this recommendation is not accepted, then develop a termination plan for the Fiber to the Home (FTTH) Business Plan Phase 2, Final Report Page 8 of 9 CMR21504 Attachment B FTTH Trial. If the recommendation is approved, then Council should be informed that the next phase of analysis is expected to require additional funding of approximately $390,000 and involvement from various City departments to conduct the following work: Develop and fund a public information program; invite citizens to express their views regarding FTTH through various forums. ($50,000) Complete an engineering design and specification of a Palo Alto specific system, including a cost estimate. ($200,000) Define key partner and service provider relationships tl’irough RFPs and other official processes. Conduct business process performance testing and remediation analysis. ($70,000) Conduct a preliminary legal assessment of a legally defensible path for establishing a FTTH business (i.e. follow all applicable laws, codes, etc.) and utilize legal support. ($70,000) Develop a complete finance plan and conduct financial analysis. Establish the business structure, governance requirements and a detailed staffing plan and costs. Establish key off ramps and criteria for terminating the project prior to construction if any key adversity develops. Develop operation guidelines as a critical path item to be completed prior to making large-scale financial commitments to the project. ATTACHMENT A: Staff Summary Regarding FTTH B: Final Phase 2, Uptown Services Report C: Summary Report of Risk Assessment of FTTH D: Financial Pro Formas PREPARED BY: BLAKE HEITZMAN Manager Utilities Telecommunications DEPARTMENT HEAD APPROVAL: JOHN ULRICH Director of Utilities Fiber to the Home (FTTH) Business Plan Phase 2, Final Report Page 9 of 9 CMR 21504 Attachment C Staff Summary Regarding FTTH Introduction: This attachment includes additional detail regarding research accomplished to date. In the final section staff provides a cost estimate for continuing the Fiber to the Home (FTTH) research needed to more clearly define key risks and cost issues. Exhibit 1, Sample Schedule (attached) provides an example of a timeline with potential decision points for this project. The sample schedule and dates shown in Exhibit 1 is for illustrative purposes only and represents the potential timeframe for a project of this magnitude. Background: Through several years of the FTTH trial and the current year of the business case study, the City of Palo Alto Utilities (CPAU) staff has developed a solid understanding of the issues related to the design, construction and operation of a FTTH utility in a competitive environment. In summary, this research involved the following activities: FTTH Trial: The trial consists of 66 units including homes, a school, a library, and the Civic Center connected via an optical fiber network and is operating successfully with minimal operating and maintenance effort. This project demonstrated that a FTTH system is technically feasible, provides high performance and reliability, and can be operated by CPAU staff. It also provided a test bed for evaluating technologies, product performance, installation and operations processes. go Business Case: The business case, developed and prepared by Uptown Services, evaluated different possible technologies and determined that, in the nominal case, a FTTH utility can be economically viable over the 20-year construction bond period. Surveys: Two extensive surveys of Palo Alto residents were conducted. The results when evaluated through standard market analysis techniques predict sufficient customer participation to operate a viable broadband service delivered over a FTTH utility. In addition, a study of Alameda customers was conducted and it found strong support for their municipally operated broadband services. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Staff Summary Page 1 of 6 CMR 21504 Attachment C FTTH Advisory Team: An advisory team was created to assure a broad understanding of the issues involved in creating a FTTH utility. The team included members from CPAU, the City Manager’s staff, the Utility Advisory Commission, the City Council, and the community. eo Community Dialogue: Through ongoing discussions with community members, staff benefited from the broad technical expertise that resides in the Palo Alto community. Business Plan: The plan was prepared by Uptown Services and is enclosed with this report. The business plan (like the business case) models the deployment technology, product design, and market in an intentionally conservative way. These models are similar to those used by current providers of competitive services. A conscious decision was made to exclude the value of public benefit in the creation of the business plan. The model provides a framework for pricing and revenue projections and the model results indicate that, in the nominal case, a FTTH utility can be a viable financial entity. Based on market conditions, the actual deployment or product design and pricing may differ, and such market conditions may harm or help the financial viability of the endeavor. go Vendor Interviews: Suppliers of FTTH equipment and fiber optic services are being interviewed frequently and equipment is being examined at test facilities and field sites. Conversations with engineers who design FTTH systems and operators of existing systems are also being held. Staff has organized this summary into seven major areas: market, capitalization, risk analysis, operations, governance, legal and public benefit. A short description of each area and staff recommendations regarding each follows. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Staff Summary Page 2 of 6 CMR 21504 Attachment C 1. Market The following items contributed to staff’s understanding of the market: a) Detailed studies of Palo Alto customer needs: The studies indicate that there is an interest in Palo Alto for quality Interact, telephone and video services. Additionally, citizens have indicated that they have faith that the City can meet those needs. Key attributes of the first survey are: i. An independent third party, Datacycles, conducted the survey. ii. 111. iv. Vo vi. vii. Requests for survey participants were sent by postcard to roughly 5000 randomly selected CPAU customers, and nearly 1000 responses were r~ceived. Respondents were given the choice of three different avenues of response: Intemet, e-mail, or paper survey. Survey results indicated a substantial "gap" between the level of service expected by customers and the level delivered by the incumbent providers of Intemet and video services. Results also indicated that a substantial portion of the Palo Alto population believes that a city service would more fully meet their needs for these services. b) The telephone service questions on the first survey were insufficient to draw any conclusions. A second follow-up survey produced a strong indication that city-sponsored telephone services would be in high demand. The second Palo Alto survey (by telephone) demonstrated that at a 10% discount from incumbent pricing, the Palo Alto market would support a positive business case. The second survey showed a weaker interest in Intemet service than the first, but stronger interests in video and telephone service. Alameda Survey: In addition to surveying potential Palo Alto customers, staff felt it would be valuable to understand how current customers of a municipal broadband service provider felt about their municipal provider. In conjunction with Alameda, Palo Alto commissioned a survey of existing Alameda Power and TeleCom customers. 750 customers were surveyed, and of those 334 responded, thereby achieving a 45% response rate to the survey. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Staff Summary Page 3 of 6 CMR 21504 Attachment C c) The survey results indicated a preference for the Alameda service over the customer’s previous service providers. Internet service satisfaction of Alameda customers was rated 52% higher than previous providers. Video service satisfaction of Alameda customers was rated 30% higher than the previous provider. ii.Good pricing, better service and having fees contribute to the city were the top three reasons given by Alameda customers for switching to the Alameda service. Fiber to the Home (Premise) Trial Results: The initial 12-month FTTH Trial period was intended to give both CPAU and residents experience with the benefits, costs and risks of installing and operating broadband fiber optic service. It was not designed to test pricing for services. The trial did demonstrate a strong preference for the quality and reliability of telephone, Internet, and video services provided over fiber. Specifically, the reliability and speed of FTTH Internet were cited as providing added benefits for conducting private and business activities, such as transferring large files, handling correspondence, etc. from the home. At the school, a single FTTH connection supports the entire computer lab. The survey results are included in the business case documents. Other Cities Nationwide: Uptown Services conducted a survey of other municipalities and the survey generally demonstrate that many other cities and municipal utilities across the country are either engaged in, or researching broadband businesses. Typically mature broadband deployments by other municipal utilities have market penetrations that are in the range of those proposed in the FTTH business studies for CPAU. 2. Capitalization Several engineering scoping studies of the capital build out were Completed in the FTTH business case. The original engineering study involved site examinations and on-site discussions with CPAU engineering staff to clarify rules, practices, etc. that are used in Palo Alto. Alternative architectures including single fiber, two fiber, HFC, and blown fiber constructions were studied in Phase I of the business plan. The May 7, 2003, Phase 1 Final Report integrated information from actual bids received for other FTTH projects around the country. These new figures may be skewed by recent poor economic conditions, however they also reflect improvements in construction and manufacturing methods that should be reflected in a Palo Alto construction bid process. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Staff Summary Page 4 of 6 CMR 21504 Attachment C The current investment estimate is approximately $40 million for a citywide build- out of FTTH with penetrations as described in the Uptown Services report. This cost is consistent with the iProvo (Utah) build-out estimates based on bids received in their solicitation process. Actual FTTH costs for CPAU will probably be somewhat less than this projection because of improved construction and manufacturing techniques. In any case, the decision to build the system can be made after the construction costs are fully known (post-bid opening). If bids are higher than expected, Palo Alto can choose to not sign a contract to build, elect to put the project on hold pending receipt of acceptable bids, or terminate the project. 3. Operations FTTH is a customer-centered business. It is essential that a detailed billing statement be generated correctly for every subscriber every month. Service trucks must run on time. Service staff must be skilled and effective. Legal support must be responsive, and customer support must be polite and responsive. Management and marketing must respond quickly and intelligently to competitive threats. Failure in any of these or other areas can jeopardize the business if not corrected quickly. All of this implies that all associated business functions must be analyzed in detail, execution methods developed, standards set and systems tested prior to making the final commitment to a FTTH business: Any impediments to a smooth and effective operation must also be removed or significantly streamlined. Included in the processes should be a method for replacing any unsatisfactory component of the business system within a specified time frame. 4. Public Benefits The end-user bandwidth made available to Palo Alto households and small businesses would increase approximately 10-fold upon introduction of the fiber network. Furthermore, this capacity is available in both directions, which surpasses the installed capacity of the current providers. The Uptown Services report analyzes the system economics based on only the three core businesses because staff chose to not cloud the report with earnings projections from services not yet defined. However, a fiber optic system is capable of delivering many other services, some of which may generate additional revenue, and some of which may add value to the community. However, it is noteworthy that the benefits of competition are a somewhat quantifiable benefit to the community. Based on the business plan, FTTH can operate successfully at rates less than are generally being charged by incumbents. Without competition, the incumbents are unlikely to provide lower rates in the long run. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Staff Summary Page 5 of 6 CMR 21504 Attachment C 5. Governance The governance structure and the operating management will have to collaborate to manage the FTTH project successfully. This issue will be addressed in the next phase if this project is continued. 6. Legal The legal issues to be resolved are declared in the main body of the staff report. 7. Financial Risk Analysis Administrative Services Department staff has prepared a risk analysis of the FTTH business as modeled in the business plan. This Summary Report of Risk Assessment is included as a separate attachment to the staff report. 8. Sale Value There is an entire industry in this country of establishing businesses with the intent of making a profit on the sale of that business. It is not staff’s intent that the FTTH business be considered for that reason, but it is noteworthy that a similar enterprise in Pennsylvania was sold on a $4,000 per customer basis. Even with inadequate penetrations such a sale would recoup a portion of the initial costs of the project. Staff believes that 50% of the construction costs can be recovered through the sale of the asset, if the business proves to be unsustainable. This would leave 50% to be recovered from the ratepayers. This calculates out to a 2% rate increase for a 15 year period, or approximately 70 cents per month on the average residential electric account over that period. [Note: Cable Co-op sold for approximately $79 million (175% of its $45 million debt), thereby leaving no debt for its previous members.] Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Staff Summary Page 6 of 6 CMR21504 Attachment D Fiber to the Home Business Phase II Final Report Plan City For of Palo Alto Utilities 1007 Elwell Court Palo Alto, CA 94303 UTILITIES Neil V. Shaw Prepared By Uptown Services, LLC 5650 Greenwood Plaza Boulevard, Suite 225E Greenwood Village, CO 80111 303-290-9756 nshaw@uptownservices.com March, 2004 August, 2003:Uptown Draft Phase 2 Report CPAU FTrI-I Business Plan Uptown Services, LLC I. EXECUTIVE SUMMARY ...............................................................................1 II.PRODUCT PLAN ..........................................................................................8 , A.LINES OF BUSINESS ............................................................................................8 B.COMPETITIVE PRODUCT SET AND PRICING ...........................................................8 C.SOURCES OF DIFFERENTIATION AND VALUE .......................................................14 D.TARGET MARKETS ............................................................................................17 E.CPAU PRODUCT STRATEGY .................................................................................20 II1. ALTERNATIVE TECHNOLOGIES AND MITIGATION OF RISK ................28 A.WIRELESS TECHNOLOGIES ................................................................................28 B.VOICE OVER INTERNET PROTOCOL (VOIP) .........................................................34 C.PRINCIPLES FOR HANDLING CURRENT AND FUTURE IMPLIED TECHNOLOGICAL RISKS 35 D.IDENTIFICATION AND EVALUATION OF NEW TECHNICAL COMPETITORS .................36 E.PRICING STRATEGIES FOR COMPETING WITH ALTERNATIVE TECHNOLOGIES ..............36 F.MARKETING STRATEGIES FOR HANDLING COMPETITORS ..........................................37 IV. MARKETING AND SALES PLAN ...............................................................37 Ao A. B. Vl. SALES PLAN .....................................................................................................37 MARKETING PLAN .............................................................................................43 COMPETITIVE RESPONSE AND PR PLANNING .....................................47 EVALUATE IMPLICATIONS OF A MAJOR COMPETITIVE RESPONSE .........................47 STRATEGIES TO ADDRESS INCUMBENT MISINFORMATION CAMPAIGNS ..................51 MONTHLY OPERATING BUDGET AND FINANCIAL STATEMENTS ......59 B. C. D. REVENUE .........................................................................................................59 EXPENSE .........................................................................................................64 CAPITAL REQUIREMENTS ..................................................................................68 FINANCIAL STATEMENTS ...................................................................................69 VII. PARTNERING STRATEGY ........................................." ................................72 Ao VIDEO PROGRAMMING PARTNER ........................................................................73 LOCAL TELEPHONE PARTNER ............................................................................73 INTERNET RETAILERS .......................................................................................75 VIII.ORGANIZATION STRUCTURE ..................................................................75 Ao ORGANIZATIONAL CHART AND PHILOSOPHY .......................................................75 STAFFING LEVELS AND BUDGET ........................................................................76 SKILLS AND FUNCTIONAL ROLES ..... ........ ...........................................................78 IX.CORE PROCESS ANALYSIS .....................................................................80 A.BILLING ............................................................................................................80 B.CUSTOMER SERVICE AND SALES .......................................................................81 C.SERVICE PROVISIONING ....................................................................................82 D.INSTALLATION ...................................................................................................82 E.NETWORK MAINTENANCE AND REPAIR ..................................................................82 F.NETWORK OPERATIONS CENTER (NOC) ...............................................................82 X.SUMMARY ..................................................................................................83 August, 2003:Uptown Draft Phase 2 Report Page ii CPAU FTFH Business Plan Uptown Services, LLC I. Executive Summary This document presents the recommended business direction and operating principles for City of Palo Alto Utilities (CPAU) to deliver broadband services to the Palo Alto market. As a business plan, the analysis and strategies presented focus upon how this market opportunity should be approached from a range of business dimensions including marketing, product design and pricing, organization structure, financial planning, and considerations of risk and competitive behavior. It does not present analysis on whether or not CPAU should undertake this opportunity as this has been addressed within the context of a previous feasibility study. While fiber to the home (FTTH) is the term consistently used throughout this report, the fact is that this proposal recommends optical fiber be installed past virtually every premise in Palo Alto, residential and business. It is contemplated that fiber-enabled services will be offered to each residence and business in the community. It should be recognized that this proposed project could just as accurately be named fiber to the premise (FTTP), but we have chosen to retain the FTTH acronym for the sake of consistency. Mission Statement With this approach in mind, Uptown recommends that the Council adopt the following sub- Utilities mission statement for the FTTH service: "The City of Palo Alto (its broadband business venture) will provide excellent value to its citizen-owners, and will be the preferred broadband service provider through a combination of excellent customer service, fair pricing, and enhanced product performance all done in an environmentally sustainable manner." Sources of Differentiation and Value As a later market entrant with the most advanced technology for delivering mass-market broadband services, the two primary opportunities for Palo Alto to demonstrate higher value and set itself apart from the incumbents are 1) improved product performance and 2) lower prices. The capacity and reliability characteristics of FTTH versus incumbent network architectures will enable broadband services, especially Internet, to provide unique benefits for the subscriber. The most visible advantage that the Palo Alto fiber network will offer subscribers, both residential and business, is the increased capacity to offer improved data and video services. The network architecture provides unique new product opportunities versus the incumbent network architectures. Greatly increased speed is the "killer application" that will be immediately available from the new CPAU FTTH network. The FTTH architecture advantage lies in its ability to improve services that most Palo Altans are already familiar with and are using. The realistic maximum downstream throughput for the HFC and DSL architectures utilized by incumbents is currently about 1.5 Mbps, and just 128 Kbps to 256 Kbps upstream. With FTTH, Palo Alto will be able to have 10 Mbps available for each premise as a realistic and achievable attribute of its Internet product. Furthermore, the bandwidth advantage of FTTH can be extended to August, 2003:Uptown Draft Phase 2 Report Page 1 of 91 CPAU FTI’H Business Plan Uptown Services, LLC the upstream patl~ (data sent from the home to the network) as well by providing Internet ’ tiers (different classes of service each priced differently) with symmetric (same speed for both uplink and downlink data streams) bandwidth. For video, there will be a capacity advantage as well, but it will not be as dramatic and immediately perceivable as the advantages for data services. The CPAU fiber-optic system will have greater bandwidth capacity for video services than the 750 MHz available on the Comcast HFC system in Palo Alto. This will become increasingly important over time as the limited capacity of the Comcast network becomes exhausted, particularly by the much greater bandwidth requirements of each high definition television channel (HDTV). Even today, most urban market HFC networks are at or near capacity for the bandwidth allocated for video services. Product Strategy As established during the Feasibility Study of this project, the lines of business (LOB’s) being considered are video services, high-speed intranet and Internet access, and local and long distance telephone services. Video: The pricing of incumbent video services is the primary attribute that CPAU can target to achieve market share. The price of Comcast Expanded Basic has grown substantially over the last five years through an annual series of rate increases. With Comcast’s Expanded Basic cable service at $41.25 per month and digital packages ranging from $51 to almost $90 monthly, CPAU has an opportunity to serve citizens better through improved pricing. CPAU should carefully select channels for its lineup so that it can add the most value and yet contain programming costs. Internet: For Internet access, CPAU should use its fiber technology to revolutionize broadband Internet service in Palo Alto. To significantly improve the value of data services residents and small businesses receive from CPAU, the initial product strategy involves three primary tactics for the service. First, provide three tiers of residential service and two tiers of small business service as characterized by the throughput and feature sets they support. Second, provide up to 100 Mbps speeds to end users for "on network" data transfers over the CPAU intranet (within the local network), where capacity is abundant. While this is powerful feature of the Palo Alto fiber-optic network, it does not exist in the incumbent’s networks. This feature could turn out to spawn many innovative applications that become a series of very significant extra benefits enjoyed exclusively by subscribers to CPAU FTTH Internet service. Local video monitoring and conferencing, video education on demand, movies on demand, and a first class e-mail server with full photo privileges and spam control are all potential offerings. Third, provide symmetrical downstream and upstream data rates across all tiers, which is a major paradigm shift for mass-market Internet services. Where capacity has a variable cost structure, CPAU staff will need to manage cannibalization1 risk of the upper tiers by carefully selecting service attributes for each Internet service tier. Refers to the risk of unnecessarily moving subscribers from a higher revenue tier to a lower revenue tier by offering the lower priced tier at too low of a price. August, 2003:Uptown Draft Phase 2 Report Page 2 of 91 CPAU FTrH Business Plan Uptown Services, LLC Telephone: As staff’s pricing principle for telephone services, Uptown recommends that the Council approve staff’s ability to establish wholesale terms with service provider(s) who agree to offer telephone service packages which are competitive with the incumbent service provider, and agree to participate in bundle incentives across other FTTH services. This business plan does not contain specific product recommendations for the local telephone line of business because CPAU will wholesale this service and will not set retail pricing. A working assumption of a retail $25 local telephone package with 6 calling features is assumed below in the bundling strategy. This would assume a 15% discount over SBC’s Sensible Solutions package. As CPAU F’I-rH gains fiber-optic network operating experience serving Palo Alto subscribers, innovative product and service offering possibilities that are both financially feasible and cost effective will undoubtedly become evident. Uptown recommends that Council grant staff the authority to design, develop, price and deliver new FTTH products and services to maximize the financial and competitive potential of the venture. Of course, staff should also be granted the authority to modify and/or discontinue existing products or services, without limitation. This authority should serve to keep CPAU FTTH dynamic and vital. Pricinq Philosophy and Strateqic Guidelines The recommendations for the pricing strategies presented in this business plan are driven by a set of principles that Uptown and CPAU share about the telecommunications and broadband sectors: Principle: That Council direct staff that price should not be the only differentiating factor for telecommunications services offered on the FTTH network. Principle: That Council direct and enable staff to use bundling as necessary to prevail as the preferred provider in the market place. Principle: That Council direct and enable staff to exercise the advantages of FTTH to prevail as the preferred provider in the market place. Principle: That Council direct and enable staff to provide equal or better service at equal or less price, so long as the long range capitalization and operation costs are met, even to the point that transfers to the City’s General Fund may be zero in some years. The pricing strategy can be summarized as follows: Reasonable, but not excessive, price discounts will be employed relative to incumbent operators. We generally define reasonable as a 10% discount for comparable services. Within lines of business, employ product package designs that encourage and reward subscription to optional services (e.g. premium channels with video or calling features with telephone). August, 2003:Uptown Draft Phase 2 Report Page 3 of 91 CPAU FTTH Business Plan Uptown Services, LLC Across lines of business, deliver price discounting via multi-product incentives (such as bundling) so that, in return for less revenue per product offering, CPAU can realize greater revenue per subscriber and the positive retention effects of bundling. Limit reliance on price discounting by delivering value through other means, such as improved product performance and improved local support services. Risks Posed By Alternative Technoloqies Of all the technological risks facing FTTH, wireless appears to garner the most attention and serious consideration. However, it is Uptown’s opinion that wireless technologies will not be capable of delivering the kind of reliable bandwidth required to support a compelling voice, video and data bundle; Certainly there are applications for Wi-Fi as an alternative to wired LANs in homes, businesses and public meeting places ("hot spots"). But the technology has too many limitations: Security: All signals are easily intercepted in the "open" air. This has been bothersome to many potential users. Quality of Service: Service varies from location to location and by time of day. At any time competitors can compete in the same airspace, thus degrading the quality of all Wi-Fi services. Limited Throughput: Just like cable modem technology, the system utilizes large blocks of shared bandwidth. This leads to lower throughput per user as more subscribers are added to the network. ¯Data Only: Wi-Fi was not designed to carry voice or video services in wide area configurations. This puts the technology at a disadvantage when bundling is a key element of any product strategy. Ooeratin_cl Budqet and Financial Analysis As the attached financial statements show, the FTTH business plan is very sound. With a combination of approximately $40.0 million in debt and equity, the FTTH operation provides very reasonable returns to the bondholders and the City of Palo Alto. Gross margin is projected to be greater than 60% for the majority of the plan. Operating cash flow goes positive in the five year and grows steadily to nearly $7.0 million in ten years. Finally, the business generates over $62.5 million in cash and $62.7 million in owners’ equity over the 20 year life of the plan. Sales Plan Inbound Sales: Uptown recommends that CPAU create a small team of broadband service representatives that will sell and service customers over the telephone. With this strategy, the current utility representative would complete the customer care transaction for the utility service and then inform the customer of the availability of CPAU’s broadband services and ask for agreement to transfer the call to a broadband services representative. The call would then be warm transferred and the utility representative would drop off the call after the broadband representative takes over. August, 2003:Uptown Draft Phase 2 Report Page 4 of 91 CPAU FTrH Business Plan Uptown Services, LLC Outbound Sales: Uptown recommends that outbound telemarketing be used by CPAU during the first two years of operation as the F’I-I’H network is being built. Along with direct sales, this channel is an excellent tool to inform households and small businesses of the availability of CPAU broadband services where the network is ready. Although telemarketing is becoming less acceptable to the general public, we believe it is very appropriate for CPAU to use this channel since these homes and small businesses are already CPAU customers. By Year Three or Four of the operation, CPAU will likely cease using this as a sales channel. Direct Sales: Uptown recommends that CPAU establish a door-to-door direct sales team which follows network construction activity during the first years of operation. This strategy borrows from the sales tactic used by cable operators in the 1970’s as they originally constructed their cable networks. As construction finished in a particular neighborhood, technicians (who did double duty as sales staff) went to each home to inform the resident that cable was now available and attempted to make the sale. Given the similar construction activity for CPAU, this direct sales approach should be followed as the FTTH network is built. Payment Center: At its City Hall location in downtown Palo Alto, CPAU has a payment center facility where customers may pay their bills in person. This customer traffic, in a similar nature to the utility inbound call traffic, is a natural sales opportunity for the broadband services. Online Sales: Uptown is recommending that CPAU incorporate into its website a capability to not only advertise, but also take orders for broadband services. At a minimum, this could be the ability to capture online leads and then close these prospects through outbound telemarketing. It would be better to truly enable an online order to be placed and fulfilled completely within an online environment, and this should be possible with minimal software investment. Most of the major MSO’s (multi-system operators) and ILEC’s (incumbent local exchange carriers) are using online ordering today as a viable sales channel. In general, the following trends will be driving the channel mix during the first two years and over the long term: During the initial construction of the network, both outbound telemarketing and direct sales will have a large share of units sold as they follow the construction activity. They will be the first sales contacts made with newly passed homes. In the medium term, inbound calls and the payment center will have a larger share of units sold as the utility and broadband representatives become better at selling these new services and as outbound and direct sales activity decreases and eventually ceases altogether. In the long run, the online sales opportunity will grow as consumer online purchasing activity increases in general. Marketinq Plan Several strategic objectives need to be realized as key components of the marketing plan: August, 2003:Uptown Draft Phase 2 Report Page 5 of 91 CPAU F’TrH Business Plan Uptown Services, LLC Marketing Objective 1: Achieve the necessary community support for the project among both community leaders as well as citizens (as both residents and small business owners). This is realized through the brand positioning of the new venture. Marketing Objective 2: Achieve a positive image for the broadband service and the organization and people behind it, whether as a subsidiary unit of CPAU or a separate entity. This is also realized through the brand positioning of the new venture. Marketing Objective 3: Achieve sufficient market awareness among Palo Alto’s residents and small businesses of the ability to receive broadband services via the new FTTH network. This is realized through the advertising and direct marketing programs, plus word-of-mouth among existing subscribers. Marketing Objective 4: Define and differentiate the value of these services in the mind of these residents and small business owners compared to incumbents who provide video, Internet, and telephone services today. This is realized through the advertising and direct marketing programs, plus perceived value by existing subscribers who tell their friends. Marketing Objective 5: Stimulate market demand for CPAU’s broadband services through promotion and direct marketing activities. This is realized through the direct marketing programs. Brand Positioning: CPAU is a strong brand in Palo Alto that has built a solid reputation for customer service over more than 100 years. For the FTTH project, the key is to extend this image into its performance in offering broadband services so that this image is protected and even enhanced and so that the positive utility image can help CPAU prevail as the preferred provider over the incumbents. Awareness Advertising: The Palo Alto market is part of the greater San Francisco DMA (Designated Market Area), which is the 5th largest in the US, reaching over 2.5 million households. Obviously, Palo Alto is only a fraction of this DMA. Therefore, more localized forms of advertising and local promotion needs to be deployed. This does not mean the advertising and promotion program will not be successful, as other municipalities (including Alameda Power & Telecom) have used a localized advertising program with success. Given these limitations, and borrowing from examples such as Alameda, Uptown recommends the following tactics for creating local-level awareness of CPAU broadband services: Print Advertising (newspaper). The Palo Alto Daily News, the Palo Alto Weekly and the San Jose Mercury are possibilities. Outdoor (billboards and other signage opportunities). Local Sponsorships Direct Marketing and Promotion: The direct marketing program will benefit from the community-level scale of CPAU. These tactics involve targeted marketing with specific messages and promotional offers. The objective is to get the recipient to respond with an information or purchase inquiry. The most important direct marketing tactic is direct mail, but others are viable as well. Uptown recommends: August, 2003:Uptown Drat~ Phase 2 Report Page 6 of 91 CPAU FITH Business Plan Uptown Services, LLC Direct Mail Bill Inserts Events Marketing/Public Relations Sales Collateral: The third marketing budget category is sales collateral which provides funds for the production of door hangers as a leave-behind for the direct sales team and install kits, which are instructional materials for new customers. Door Hangers Install Kits Organization Structure The overall organizational philosophy being recommended is that CPAU leverage the current management team and structure for the first area of activity (management focus) and that staff be added based upon incremental workload to support the second area of activity (customer operations). This approach is not only efficient, but it has been successfully used by other utilities that have entered the broadband sector using an organizational approach that closely integrates the incremental headcount into the existing utility organization. The overall organizational strategy for CPAU’s broadband initiative can be summarized in the following objectives: Organizational Objective 1: Achieve organizational efficiencies through a common management structure with the current utility department. Rather than creating a new, standalone organization, the organizational design should fit under the current functional departments of CPAU as it exists today. Organizational Objective 2: Identify and recruit talented front-line employees to staff the incremental operating positions that the new work activity generated by the broadband business will create. These are activity-based positions primarily involving customer support functions. Organizational Objective 3: Internally staff key positions that interface directly with customers to best control the quality of customer service that CPAU delivers to its broadband customers. External contractors will be used selectively where needed, and primarily for those job functions that are driven by short-term activities to initially launch the broadband venture (e.g. network construction, direct sales, outbound telemarketing). Organizational Objective 4: Establish agreement across CPAU management to equally prioritize broadband operations with existing utility functions so as to ensure that proper emphasis and balance is provided. Especially within frontline departments, there is a risk that employees designated to support broadband services could be re-assigned from their established duties in supporting the new venture. August, 2003:Uptown Draft Phase 2 Report Page 7 of 91 CPAU FTTH Business Plan Uptown Services, LLC II.Product Plan A.Lines of Business A’s established during the Feasibility Study of this project, the lines of business (LOB’s) being considered are video services, high-speed Intemet access, and local and long distance telephone services. There will be other associated LOB opportunities facing the broadband venture, but they will not be "baked into" the operating assumptions and this business plan since the level of certainty surrounding their financial value and potential risks have not been established within this project or among CPAU’s peers who have entered the broadband sector. These opportunities may present possibilities for additional revenues, reductions in operating expenses, or both. Examples of ancillary LOB’s could be: Security Monitoring Service Automated Meter Reading WebTV applications B. Competitive Product Set and Pricing The definition of the CPAU product set begins with the current incumbent product offerings. As the late market entrant across all three LOB’s, Palo Alto’s broadband services should be defined to leverage incumbent product limitations and provide the greatest value possible. For this reason, a clear analysis on the incumbent offerings and how CPAU’s products will compare is warranted. Competitive offerings will be addressed below from the perspective of the video channel lineup, video packages and prices, Internet packages and prices, telephone packages and prices, and bundles involving these three LOB’s. 1.Video Comcast is the market share leader for video services in Palo Alto. As such, Uptown will use them as the winning benchmark for CPAU to use in designing its video product structure and pricing. Satellite video services (DBS) has approximately 15% market share in Palo Alto and has very similar product packages, but with lower prices. Because of satellite’s minority share position and because the product design is similar to cable, Comcast is presented as the incumbent benchmark by which to set CPAU video product strategy. However, it is advised that CPAU continue to monitor both satellite and Comcast in the future and be prepared to respond to any repositioning by either. a) Channel Lineup Comcast offers a robust channel lineup with 160 (173 if Premier Tier channels are counted) channels made available across limited basic, expanded basic, and digital packages. It has taken advantage of the added capacity from its two-way upgrade to 750MHz and is offering digital music, pay per view (PPV), and five high definition television (HDTV) channels. It carries a significant number of local broadcast channels as well. The two primary weaknesses of Comcast’s channel lineup are its lack of ethnic-oriented programming and low number of premium screens (the number of movie channels). The first can be significantly leveraged in a sophisticated market such as Palo Alto. The August, 2003:Uptown Draft Phase 2 Report Page 8 of 91 CPAU FTrH Business Plan Uptown Services, LLC second is less of a weakness and is due to the fact that Comcast only carries west coast video feeds for its premium channels, whereas other video sources can offer east coast feeds as well. The value to the consumer from this is marginal since adding the east coast feeds doesn’t actually add programming; it just adds a second time window in which to see the programming. All in all, the Comcast lineup is strong. CPAU should carefully select channels for its lineup so that it can add the most value and yet contain programming costs, This is recommended as a major operating principle and is covered in the CPAU Product Strategy section of this business plan. Comcast Limited Basic Packa.qe 2 INF -- KTVU 11 TVGUIDE CHANNEL 20 IND -- KFSF 3 NBC -- KNTV 12 UPN -- KBHK 21 IND -- KCNS 4 IND -- KRON 13 WB -- KBWB 22 CSPAN 1 5 CBS -- KPIX 14 INS -- KDTV 23 CSPAN 2 6 IND -- KICU 15 DISCOVERY CHANNEL 24 SHOWTIME 7 ABC -- KGO 16 INP -- KKPX 25 IND -- KTLN 8 IND -- KTSF 17 PBS -- KCSM 26 COMMUNITY PROG. 9 PBS -- KQED 18 INT -- KSTS 27 GOVERNMENT ACCESS 10 PBS -- KTEH 19 IND -- KTNC 28 LOCAL ORIGINATION Comcast’s Expanded Basic Package 39 ESPN 2 51 ANIMAL PLANET 63 COMEDY CENTRAL 40 FOX SPORTS BAYAREA 52 ABC FAMILY CHANNEL 64 E! ENTERTAINMENT 41 TBS SUPERSTATION 53 NICKELODEON WEST 65 COURT’IV 42 USA NETWORK 54 CARTOON NETWORK 66 HALLMARK CHANNEL 43 MTVWEST 55 THE DISNEY CHANNEL 67 IND --WGN 44 VH1 56 CABLE NEWS NETWORK 68 SCI-FI CHANNEL 45 THE NATIONAL NETWORK 57 CNN HEADLINE NEWS 70 BET 46 LIFETIME 58 CNBC 71 HOME SHOPPING NETWORK 47 ARTS AND ENTERTAINMENT 59 FOX NEWS CHANNEL 72 TV LAND 48 BRAVO 60 MSNBC 73 COMMUNITYPROG. 49 AMERICAN MOVIE CLASSICS 61 WEATHER CHANNEL 74 COMMUNITY PROG. 50 THE LEARNING CHANNEL 62 THE HISTORY CHANNEL 75 THE MOVIE CHANNEL August, 2003:Uptown Draft Phase 2 Report Page 9 of 91 CPAU FTI"I-I Business Plan Uptown Services, LLC Comcast’s Digital Channels 120 NOGGIN 198 SHOWTIME- (HD)404 OUTDOOR LIFE NETWORK 121 DISCOVERY KIDS 201 DISCOVERY HOME &405 THE GOLF CHANNEL LEISURE 122 TOON DISNEY EAST 203 HGTV 406 OUTDOOR CHANNEL 125 NEWSWORLD INTL 215 NICK GAMES & SPORTS 407 ESPN CLASSIC 126 NICKTOON 220 DISCOVERY HEALTH 408 SPEEDVISION 128 BLOOMBERG 222 THE HEALTH NETWORK 471 VH1 COUNTRY 135 M’IV 2 230 TBN 472 MTV HITS 136 G4 231 INSPIRATIONAL LIFE 473 VH1 CLASSIC 137 TRIO 240 INTERNATIONAL CHANNEL 474 VH1 SOUL 138 WISDOM 271 DISCOVERY TIMES 476 FUSE 161 THE GAME SHOW 272 DICOVERY SCIENCE 481 BET ON JAZZ 162 BBCAMERICA 273 NATIONAL GEOGRAPHIC 501 TURNER CLASSIC MOVIES 182 OVATION 274 DISCOVERYWlNGS 502 WE 183 STYLE 275 THE BIOGRAPHY 503 IFC CHANNEL 184 ABC- (HD) 276 HISTORY INTERNATIONAL 504 LIFETIME MOVIE NETWORK 185 NBC- (HD)294 TECH TV 505 SUNDANCE 188 PBS- (HD)401 FOX SPORTS WORLD 506 FOX MOVIE CHANNEL 197 HBO- (HD)402 ESPNEWS Comcast’s Premium Channels 518 ENCORE EAST 555 HBO SIGNATURE WEST 520 ENCORE LOVE STORIES WEST 557 HBO FAMILYWEST 522 ENCORE MYSTERY WEST 561 CINEMAXWEST 524 ENCORE WESTERNS WEST 565 MORE MAX WEST 528 ENCORE TRUE STORIES WEST 576 SHOWTIME WEST 530 ENCORE ACTION WEST 578 SHOWTIME TOO WEST 534 STARZ! WEST 580 SHOWTIME SHOWCASE WEST 536 STARZ! THEATER WEST 582 SHOWTIME EXTREME WEST 537 BLACK STARZ! EAST 591 TMCWEST 551 HBOWEST 593 TMC XTRAWEST 553 HBO 2 WEST August, 2003:Uptown Draft Phase 2 Report Page 10 of 91 CPAU FTrH Business Plan Uptown Services, LLC Comcast’s Pay Per View/Diqital Music 801 IN DEMAND PPV 1-D 844 THE HOT NETWORK DIGITAL 802 IN DEMAND PPV 2-D 851 SPICE 803 IN DEMAND PPV 3-D 852 SPICE 2 804 IN DEMAND PPV 4-D 853 PLAYBOY 805 IN DEMAND PPV5-D DMX 37 Channels 806 IN DEMAND PPV 6-D b) Video Packages and Pricing The pricing of incumbent video services is the primary attribute that CPAU can target to achieve market share. The price of Comcast Expanded Basic has grown substantially over the last five years through an annual series of rate increases. With expanded basic cable at $41.25 per month and digital packages from $51 to almost $90 monthly, CPAU has an opportunity to serve it citizen customers best through improved pricing. As stated, this is an industry-standard video product design and represents a typical structure, whether cable or DBS. The Comcast video product structure is presented in Exhibit 1. The one unique aspect to Comcast’s Palo Alto design is the use of a "Premier" digital tier, which is not included in any package, but must be purchased separately for $4.99 per month. Clearly, Comcast is using this tier to isolate these 13 channels and their cost from being applied across a given subscriber base which would provide a relatively small return for these channels. This is a viable strategy for CPAU as well. Exhibit 1- Comcast Video Packaqin.q Structure Limited Basic Expande d Basic Digital Classic Digital Plus Digital Silver Digital Gold Digital Platinum $12.20 $41.25 $51.20 $56.20 $67.20 $78.20 $89.20 Channels 2 - 28 Channels 2 - 75 Channels 35 Digital 13 for $5.00 2 - 75 Channels $4.99 -Included Extra Channels 35 Digital 13 for $5.00 2 - 75 Channels $4.99 Included -Included Extra Channels 35 Digital 13 for $5.00 2 - 75 Channels $4.99 Included 1 Premium Included Extra Channels 35 Digital 13 for $5.00 2- 75 Channels $4.99 Included 2 Premiums Included Extra Channels 35 Digital $5.00 2- 75 Channels $4.99 Included 5 Premiums Included Extra August, 2003:Uptown Draft Phase 2 Report Page 11 of 91 CPAU FTH-I Business Plan Uptown Services, LLC 2.Internet SBC offers DSL Internet access and Comcast offers cable modem service in Palo Alto. Although DSL holds the majority of the broadband Internet market share in Palo Alto, both of them need to be considered in CPAU Internet strategy because their packaging designs are so different. (1) Product Tiers and Pricing SBC is the only incumbent provider to tier the service; Comcast has one residential Internet product offering only. Their respective Internet products are presented in Exhibit 2. Given the differences in upstream speed, availability from a coverage perspective, and speed, Comcast should be viewed as the price leader at $42.95 when bundled with a cable subscription ($57.95 without it). The SBC tiers are interesting given the desire of CPAU to tier its Internet service as well. However, the market "gravity" will be centered upon the Comcast 1.5 Mbps price point. This needs to be considered in creating the CPAU Internet products. Exhibit 2- Incumbent Broadband Internet Offerinqs Comcast Up to 1.5 Mbps$42.95 or $57.95 $39.95 $49.95 $59.95 $139.95 256 Kbps SBC Basic Up to 384 Kbps 128 Kbps Standard Plus 384 Kbps- 1.5 Mbps 128 Kbps Deluxe 768 Kbps - 1.5 Mbps 256 Kbps Expert Plus 1.5 Mbps - 6.0 Mbps 384 Kbps SBC charges $200 for a technician-assisted install but offers a free self-install kit. Activation is free if ordered online or with a one-year contract. This is an interesting aspect that CPAU must consider in its product design. (2) Features SBC’s DSL product features are more robust than those of Comcast and benefit from the brand affiliation with Yahoo! They are: 1 Dynamic IP address Personalized SBC Yahoo! DSL homepage Customized SBC Yahoo! DSL browser SBC Yahoo! Mail account with 25MB of storage, POP access and email forwarding Up to 10 additional SBC Yahoo! Mail accounts with 10MB of storage each, POP access and email forwarding SBC Yahoo! Messenger with high-quality video SBC Yahoo! Photos and Briefcase with 110MB of online storage Three SBC Yahoo! Classifieds basic ads August, 2003:Uptown Draft Phase 2 Report Page 12 of 91 CPAU FTTH Business Plan Uptown Services, LLC Three SBC Yahoo! Auctions listings Three Consumer Reports® guides SBC Yahoo! Parental Controls Firewall software to help shield your computer from unauthorized access Unlimited nationwide dialup Internet access Palo Alto’s product design must prevail over this package, either through pricing or packaging or a combination of these elements to achieve a superior value for its subscriber. 3.Telephone SBC is the dominant provider of local telephone service in the Palo Alto area so it is used as the benchmark. Its major telephone products are summarized in Exhibit 3. Comcast does not offer cable telephony in Palo Alto. (1) Product Packages SBC has organized its telephone offerings into three primary local telephone packages as well as a newly introduced "all distance" package that is meant to compete with MCI’s The NeighborhoodTM. These four packages likely represent about 50% of its telephone subscribers in Palo Alto, with the rest buying individually rated telephone lines and ala carte features. These rates are presented in the next section. SBC charges a non-recurring connection fee of $33.01 to activate local telephone service. Exhibit 3- SBC Telephone Packaqin.q Structure M~nthly i Number PriCe of Lines $21.95 1Value 5C/minute Solution Sensible $31.95 1 Included Included 6 5C/minuteSolution Complet e $39.95,1 Included Included Included Included 6 5C/minute Solution All $48.95 1 Included -Included 2 IncludedDistance Mail Pro ,; PrbteCt: ID .....Distance Included 2 (2) Features SBC charges the following monthly recurring fees for each calling feature when purchased outside of its telephone packages: Main Line or Additional Line ................$10.69 Wire Pro ................................................$ 2.99 August, 2003:Uptown Draft Phase 2 Report Page 13 of 91 CPAU FTTH Business Plan Uptown Services, LLC Phone Protect ......................................$ 3.99 Call Waiting ..........................................$ 3.23 Voice Messaging ..................................$ 7.95 Caller ID ................................................$ 6.17 Priority Ringing ..................................................$ 3.23 Three-Way Calling ...............................$ 3.23 Busy Call Forwarding ..........................$ 3.23 Call Forwarding ....................................$ 3.23 Remote Access to Call Forwarding....$ 0.95 Delayed Call Forwarding .....................$ 2.75 Call Return ............................................$ 3.23 Speed Calling 8 .................................................$ 3.23 Anonymous Call Rejection ..................$ 1.90 The Business Plan calls for the telephone service to be provided by a wholesale provider (or partner). In the selection of the FTTH telephone service provider CPAU must consider that provider’s ability to field a winning offering and to combine with CPAU to bundle all three services. 4.Bundles SBC calls its bundle "SBC Total Connections" and markets it to consumers as a way to "save time, save money and simplify your life". SBC covers four LOB’s (local telephone, long distance, Internet access, and wireless) with this bundle design and can bill all of them on one bill. Currently, SBC advertising mentions savings of up to $275 per year, yet it is unclear what the customer receives in savings versus purchasing each service separately. Local telephone is required as the "qualifier" for the bundle and SBC requires two additional products from the other three. If DSL Internet is selected, Total Connections customers receive the Basic Internet Package for $29.95/month, but this is the same price being run on promotions without the bundle and is always available with a one-year contract. For wireless, Total Connections customers receive 20% off their wireless service. For long distance, there is no discount at all. For Comcast, the extent of its bundling design is to offer a $15 discount on the price of its cable modem service ($42.95 versus $57.95). Comcast offers telephone service but does not actively market the service at this time beyond the former AT&T Broadband markets where it was deployed prior to acquiring these systems. Palo Alto must bundle and promote its services in ways that make true economic and convenience sense to its customers. C.Sources of Differentiation and Value As a later market entrant with the most advanced technology for delivering mass market broadband services, the two primary opportunities for Palo Alto to set itself apart from the incumbents are improved product performance and lower prices. The capacity and reliability characteristics of FTTH versus incumbent network architecture will enable broadband services, especially Internet, to do more for the consumer. The fact that the City of Palo Alto does not share the same private sector financial performance August, 2003:Uptown Draft Phase 2 Report Page 14 of 91 CPAU F’r’I’H Business Plan Uptown Services, LLC expectations presents a pricing opportunity as well. Whereas incumbents must pay back the significant capital investments in their networks as well as continue earnings g[owth as expected by the financial markets, Palo Alto has a different standard for "profit" expectations. While there is a need to diversify revenue sources for the city and to manage the risk of a significant bond offering, there is less strain on price levels compared to incumbents measured against private market standards. 1. Product Functionality The most visible advantage that the Palo Alto fiber network will offer to consumers and small businesses is the increased capacity to offer improved data and video services. The network architecture provides unique new product opportunities versus the incumbent network architectures. Greatly increased speed is the "killer application" that will be immediately available from the new CPAU FTTH network. The FTTH architecture advantage lies in its ability to improve services that most Palo Altans are already familiar with and are using. The realistic downstream throughput for HFC and DSL architectures is currently about 1.5 Mbps. With F’I-rH, Palo Alto will be able to have 10 Mbps available for each premise as a realistic and achievable attribute of its Internet product. Furthermore, the bandwidth advantage of FTTH can be extended to the upstream path (data sent from the home to the network) as well by providing Internet tiers (different classes of service each priced differently) with symmetric (same speed for both uplink and downlink data streams) bandwidth. Both DSL and cable modems limit their upstream capacities to about one-fourth of their downstream capacity. Especially within the commercial sector, a symmetrical design provides a significant advantage over the incumbents, particularly in a sophisticated community where delivery of data from home businesses or research is an important capability. The survey of Palo Altans commissioned by the CPAU indicates that currently 40% of residences have offices, and that percentage is growing. For video, there will be a capacity advantage as well, but it will not be as dramatic and immediately perceivable as the advantage for data services. The CPAU fiber system will have greater bandwidth capacity for video services than the 750 MHz available on the Comcast system in Palo Alto. This will become increasingly important over time as the limited capacity of the Comcast network is exhausted. Even today, most urban market HFC networks are at or near capacity for the bandwidth allocated for video services. Although this seems odd given the massive cable upgrades in the last few years (usually from 400-450 MHz to 750-860 MHz), it has occurred because of the following: A tremendous expansion in the number of digital channels. A likewise increase in the number of screens (multiplexes) offered by the premium channels. The advent of Video On Demand (VOD) and an increase in the number of Pay Per View (PPV)channels. The launch within the last 12 months of high definition television (HDTV) channels and their 4 times greater consumption of bandwidth compared to a standard digital channel. For telephone, there are no specific product functionality benefits being derived from the FTTH network within the mass market. There will certainly be significant capacity to August, 2003:Uptown Draft Phase 2 Report Page 15 of 91 CPAU FTI’I-I Business Plan Uptown Services, LLC serve large commercial accounts, but this would not be a source of differentiation as there is fiber capacity from numerous sources (including CPAU) to serve this market today. 2.Pricing PhilosoPhY (1)Pricing Trends and Key Beliefs The recommendations for the pricing strategies presented in this business plan are driven by a set of principles that Uptown and CPAU share about the telecommunications and broadband sectors and how firms in this space compete and generate returns for shareholders or constituents. These beliefs are: Voice, video and data services offerings have ample opportunity to provide value to consumers across a number of dimensions beyond the price attribute alone. Long distance has been a painful exception to this rule for the industry, and serves as case study of the negative effects of commodity-like pricing. Principle: That Council direct staff that price should not be the only differentiating factor for telecommunications services offered on the FTTH network. The most significant pricing tactic emerging within the telecommunications sector is bundling. The major service provider categories of cable operators and local exchange carriers are rapidly elevating bundling to a fundamental component of their marketing strategy. It is apparent that the telecommunications industry will be battling for market share with bundled offerings for the foreseeable future. .Principle: That Council direct and enable staff to use bundling to prevail as the preferred provider in the market place. The perceived need for greater bandwidth and data capacity has now gone beyond the early adopter consumer market as evidenced by accelerated growth in broadband Internet services compared to narrowband access. This translates into a substantial opportunity for CPAU to rely on the ’throughput’ advantages of its fiber network as the primary source of value. Principle: That Council direct and enable staff to exercise the advantages of FTTH to prevail as the preferred provider in the market place. At the same time, consumers are demanding a better deal from municipalities who enter this market. This is consistently heard from focus groups and was seen in the increase in purchase intent in CPAU’s quantitative telephone survey for 10% lower price versus price parity. Principle: That Council direct and enable staff to provide equal or better service at equal or less price, so long as the long range capitalization and operation costs are met, even to the point that transfers to the City’s General Fund may be zero in some years. (2) Pricing Philosophy Given this set of beliefs and the mandated responsibility for the City to generate sufficient revenues to retire the up-front capital requirements of this project, Uptown recommends a conservative use of price discounting. This means the following: Reasonable, but not excessive, price discounts will be employed relative to incumbent operators. We generally define reasonable as a 10% discount for comparable services. August, 2003:Uptown Draft Phase 2 Report Page 16 of 91 CPAU FTI’H Business Plan Uptown Services, LLC Within lines of business, employ product package designs that encourage and reward subscription to optional services (e.g. premium channels with video or calling features with telephone). Use this strategy to increase average revenue per user (ARPU) and provide value for more product subscription versus offering the same product for less. Across lines of business, deliver price discounting via multi-product incentives (such as bundling) so that, in return for less revenue per product offering, CPAU can realize greater revenue per subscriber and the positive retention effects of bundling. Customer retention data from the cable industry indicates that the voluntary churn in three-product bundles is significantly lower than that of an analog-only subscriber. Limit reliance on price discounting by delivering value through other means, such as improved product performance and improved local support services. With this approach in mind, Uptown recommends that the Council adopt the following sub- Utilities mission statement for the F’I-I-H service: "’The City of Palo Alto (its broadband business venture) will provide excellent value to its citizen-owners, and will be the preferred broadband service provider through a combination of excellent customer service, fair pricing, and enhanced product performance all done in an environmentally sustainable manner.’" D. Target Markets For the purposes of this business plan, Uptown has defined a consumer segmentation scheme so that the target market can be generally characterized and so operating strategies can be determined relative to the target markets for CPAU. Although this is an actual customer segmentation approach used by a major MSO, this segment design and associated household characteristics are qualitative in nature as it relates to Palo Alto. To effectively utilize a customer segmentation scheme, CPAU will need to perform data analysis of the specific Palo Alto market. CPAU is in a good position to do this because it already has a substantial level of customer information. By enhancing its customer database, software programs (such as SPSS) can be used to quantitatively define CPAU’s specific market segments. These programs ’find’ the natural customer groupings within the data and are able to draw out the meaningful variables that separate and characterize one segment from another. Given the need for this to be a data-lead process, Uptown and CPAU cannot define the target segments beyond a strategic level at this time. However, for the purposes of establishing the strategy within this business plan, the broadband consumer segmentation presented here will suffice. Principle: That Council enable staff to further segment the market and develop winning products based on additional market research and analysis. (1) Segmentation Structure The purpose of establishing a segmentation structure and a subset target market for this project is two-fold. First, it enables a broadband operator to separate households into probable differences in needs and wants as it relates to broadband services. Some households have very little need for a particular broadband service and therefore place a low value on it. These segments need to be identified so that the operator can focus its August, 2003:Uptown Draft Phase 2 Report Page 17 of 91 CPAU FTrH Business Plan Uptown Services, LLC energy and resources on households where the perceived need is greater and it can generate a financial return. This leads to the second purpose of segmentation; establishing a target market. Within the greater segmentation scheme, the operator can define its best opportunity, in terms of types of households, on which to focus its marketing strategy. Like most segmentation designs, Uptown proposes a needs-based segmentation. The different levels of needs for broadband services, combined with other meaningful household characteristics, are used to characterize different household groups, then a segment pattern emerges such as that presented in Exhibit 4 emerges. Exhibit 4- Broadband Consumer Seqments Importance of Broadband Values Defining Characteristic Breadth of TV Content Internet Involvement Communicatio n Consolidation Choice Income- Constrained High. IV is primary form of entertainment Low Medium. Likely to have kids Low High. Attracted to discounted alternatives TV Households Low Low Medium Low Medium Love the Internet High High High. Most likely to have kids at home High. Likes convenience of one-stop for video, voice and data Low. Value technical capability over choice Shoppers. Love a bargain Medium High. Emerging majority of high-speed Internet users High Medium. Not important if conflicts with best value High. Looking for a deal Technology Avoiders Low Medium Medium Low Medium Older, loyal households Medium Low. Dial-up users Lower. Least likely to have kids Low. Primary interest is video only Low. Very loyal to a known brand (2) CPAU Target Market Because of their current and anticipated broadband services purchasing behavior, Uptown recommends that three of the six segments be designated by CPAU as the primary target market. These segments are Video Mainstream, Net Centrics, and Multi- Provider. These segments are highlighted below in Exhibit 5. The rationale for this recommendation is the following: August, 2003:Uptown Draft Phase 2 Report Page 18 of 91 CPAU ~ Business Plan Uptown Services, LLC Exhibit 5- Proposed CPAU Tarqet Market (Illustrative Characteristics) Share of Homes Passed Share of Basic Video Video Penetration Digital Penetration High-Speed Internet Penetration Cable Telephony Penetration Number of Services Per Household Share of 3 LOB subs Income Index (1.0 = Avg.) Median Age Households with Kids 22%6% 6% 13% 3% O% 9% 1.2 1% 0.5 11% 88% 4% 1% 1% 1.1 o% 7% 13% 94% 25% 1% 3% 1.3 1% 100% 100% 47% 19% 5% 9% 1.5 100% 0.9 1.2 42 42 64 46 43 These segments likely comprise a majority of the Palo Alto market. In the major urban market from which this data was developed, these three segments represented a full two-thirds of the market. By targeting only 3 of the 6 segments, CPAU can achieve the benefits of focused business tactics and yet still be directly addressing the majority of Palo Alto households. These three segments, but especially Net Centrics and Multi-Provider, are much more likely to consume more than one broadband service. This makes them the most likely to respond to bundle service offerings. They will generate the highest level of Average revenue Per User (ARPU) as well. In this example, 98% of "triple-play" subscribers came from these three segments. The Multi-Provider segment is particularly open-minded about switching service providers. This explains the much lower penetration of cable video service in the example data presented. By nature, they are shoppers who will go for the best August, 2003:Uptown Draft Phase 2 Report Page 19 of 91 CPAU ~ Business Plan Uptown Services, LLC deal and are willing to expend the time and energy to find the best deal and explore new options. This makes them potentially very receptive to switching to CPAU for broadband service. E.CPAU Product Strategy A key objective of this document is to establish business principles that are to be approved by Council and adhered to by staff in the execution and operation of the business. The first operating principle of the fiber team is to be able to articulate what products will be offered and how they will be defined, packaged, and priced to meet the strategic objectives of CPAU. To meet this objective, the team has taken the following approach to defining the product and pricing strategy: The definition of CPAU’s broadband product strategy begins with an assessment of the current product offerings of the major incumbent players and is the reason for the detailed competitive assessment included in this business plan. These players hold the current market share that CPAU will be competing for. The success of the CPAU product design will be measured by how much perceived customer value is delivered relative to these competitive offerings. Principle: That Council empowers staff to define its products relative to those of the incumbents and to exploit opportunities for differentiating CPAU as the preferred provider. The necessary and appropriate level of detail is to define the significant products, their major attributes, how they should be organized into package and bundle designs, and their pricing. It is not feasible in this business plan to define every attribute and functionality. The third operating principle is that as the product development process unfolds toward commercial launch, the venture’s management team will make bundling, packaging, and pricing decisions within guidelines approved by Council. 1.Video a) Sourcing Programming Content CPAU’s video feed may be sourced out of a headend facility that is already providing a video feed within the greater Bay Area market. This could be an ideal partnering opportunity. The relationship aspects are presented in Section IV of this document. Uptown will assume that CPAU will have the ability to assemble their video channel lineup from among the current channel carriage that this headend facility has today. In other words, CPAU can restructure the channel selection and placement, but would need to be judicious about requiring or paying for the capital costs to carry new channels. This headend currently has a broad range of video content being assembled into several channel lineups for different client locations today. Uptown recommends that Council approve a poficy that staff partner with the provider to expand the channel base only after customer research reveals the necessity of doing so to remain the preferred provider. In order to secure licensing rights to distribute video programming, CPAU should join the National Cable Television Cooperative (NCTC). The NCTC is an organization of independent cable television companies serving more than 14 million cable TV August, 2003:Uptown Draft Phase 2 Report Page 20 of 91 CPAU FTTH Business Plan Uptown Services, LLC subscribers throughout the United States. It is a not-for-profit organization and is a purchasing cooperative for its members. The co-op negotiates and administers master affiliation agreements with cable television programming networks, cable hardware and equipment manufacturers and other service providers on. behalf of its member companies. Through joint purchasing and negotiation, the NCTC functions similarly to a multi-system operator (MSO), taking advantage of volume discounts offered by programming networks, hardware manufacturers, and other providers. NCTC member companies save an average of $4 to $12 per subscriber on programming costs alone. CPAU will qualify to join the NCTC as one of the many municipal utilities engaged in the business of providing television reception or service to the public, primarily by means of a cable television system consistent with the definition of a "cable television system" in section 602 of the 1984 Cable Act. Unfortunately, not all video channels that CPAU will want to provide are under NCTC contract. For example, the cooperative is currently attempting to re-negotiate its MTV license agreement, but cannot offer MTV-owned channels at this time. Those channels that can be licensed under NCTC terms are indicated with an asterisk below. For the remainder, CPAU will have to individually negotiate license agreements for all others. Between this and re-transmission agreements for broadcast channels, the city should anticipate taking 6 to 9 months to complete the process. b) Channel Lineup Within the video line of business, the most important aspect of product definition is the channel lineup. This determines which programs are available to customers and at what level of subscription (package or tier) they must be to receive a particular program. Based on a previous legal opinion, we believe that a governing board (Programming Committee) will have to be established to regulate the video content provided by the FTI’H business, however Uptown recommends that within the content approved by the board, staff shall have the authority to package and price content to prevail as the preferred provder in Palo Alto. Given this aspect of the product, the selection and placement of programming is a key determinant of perceived product value. Video subscribers are very particular about specific programs and can have strong feelings and significant loyalty about their programming choices. Therefore, this part of the product definition is fundamentally important. Staff will engage in market research to determine the extent of these customer inclinations and how to use them favorably. But also weighing into this decision is programming cost. The cost to carry a particular channel varies dramatically across the channel lineup. Some channels can cost in excess of $1 per subscriber per month, while others can be 5 cents. Furthermore, some video programming costs are rising at margin-eroding rates that far exceed inflation as well as the operator’s ability to keep up via annual rate increases. For example, the major sports programming brands (ESPN and Fox, for example) have been raising their prices by 10 to 15% annually for the last several years. For this reason, some video service providers establish optional tiers of digital channels that are not included in the packages and must be purchased separately. Comcast is doing this in Palo Alto with its Premier Tier of 13 channels for an extra $4.99 per month. Although CPAU would not know exactly which channels it may want to separate into a fully-optional tier of this nature until specific costs and customer interests are known, Uptown recommends that staff take this approach to control the cost of the overall video packages. August, 2003:Uptown Draft Phase 2 Report Page 21 of 91 CPAU FTTH Business Plan Uptown Services, LLC As Palo Alto begins the process of entering the video services sector, these two issues need to be addressed because they will impact customer perceptions of value and the ultimate operating margin that CPAU will be able to realize within this line of business. It;s not an easy strategy question because these two ’realities’ of this sector are in conflict with each other. But this fact will be a driving principal as Uptown presents its video product strategy recommendation below. c)Packaging and Pricing Uptown recommends that CPAU follow industry-standard packaging designs for its video service. There are two reasons for this. First, it is much easier for consumers to comprehend and evaluate the CPAU video offering to their current video service if the packaging structure is similar. Second, standard package designs can be used effectively to control programming costs and target certain programming to the specific households that are willing to pay for it. The packaging and pricing strategy being recommended can be summarized as follows for each of the video service categories: ¯Limited Basic: Low need to compete. Price to match incumbent pricing. ¯Expanded Basic: Strong need to prevail. Price to beat incumbent prices. ¯Digital Packages: Strong need to prevail. Price to beat incumbent prices. ¯Premium Channels: Moderate need to prevail. Price to beat incumbent prices. ¯High Definition: Low need to compete. Price to match incumbent pricing. With the pricing guidelines in mind, Uptown recommends the following package structure and pricing for CPAU’s video offering as summarized in Exhibit 6. Exhibit 6 - CPAU Video Packaqes Limited Basic Analog Basic Digital Basic One Premium Two Premium s $12.20 $34.95 $45.95 $10.95 Extra $18.95 Extra 19 Channel s 56 Channel S 56 Channel S 56 Channel S 56 Channel S 52 Channel S 52 Channel S 52 Channel S 11 for $3.00 Extra 11 for $3.00 Extra 11 for $3.00 Extr_a 1 Premium 2 Premiums Include d Include d Include d $5.00 E~ra $5.00 Extra $5.00 E~m August, 2003:Uptown Draft Phase 2 Report Page 22 of 91 CPAU FTTH Business Plan Uptown Services, LLC Five 56 52 11 for Premium $31.95 5 Include $5.00 Extra Channel Channel $3.00 Premiums d ExtraSssExtra As a confirmation of this strategy and to ensure that appropriate emphasis is being placed on delivering customer value, Uptown has plotted the monthly price of the CPAU and Comcast video packages against the number of channels received. This is presented in Exhibit 7. Although this can only approximate value as consumers place different levels of value on each channel, it provides a visual confirmation of how the packages are competitively positioned. Exhibit 7- Customer Value Analysis - Video Customer Value Analysis - Video Services CPAU (dark circle) vs. Comcast (light circle) 200 150 100 5O 0 $0 $20 $40 $60 $80 $100 Monthly Price Limited Basic Expanded Basic Digital Classic Digital Plus Digital Silver Digital Gold Digital Platinum Limited Basic Expanded Basic ODigital Basic Digital Basic + 1 Pay Digital Basic + 2 Pay Digital Basic + 5 Pay NOTE: Graph 1 excludes Comcast and CPAU Premier Digital Tier, as it is additional to its package fees. Uptown strongly recommends that the CPAU entry-level digital package be positioned as the ’Fighter Brand’ among the CPAU packages. The marketing strategy behind this approach would be to select the most attractive video package (the fighter brand) versus the incumbent and use that in CPAU’s advertising and promotion. This package would establish CPAU’s perceived value relative to the competition. Finally, and most importantly, these value perceptions should transfer across CPAU’s entire product range and brand, thereby delivering upon the Mission Statement. This strategy has two tactical implications. First, that CPAU should not discount evenly across the entire video product line. Second, that CPAU should determine where it could best differentiate and prevail there. Uptown believes that this is the digital basic package. August, 2003:Uptown Draft Phase 2 Report Page 23 of 91 CPAU FTrH Business Plan Uptown Services, ].;LC d) CPAU Versus Incumbent Price Comparison The comparison between CPAU and Comcast’s video products, and the amount of discount that CPAU would offer, is summarized in Exhibit 8. Exhibit 8- Incumbent Pricinq Comparison Non-Recurring Analog Basic Digital Packages Digital Tiers Premium Channels Ala Carte Services Installation - New Customer $24.99 $24.99 No Upgrade - Existing Customer $15.99 $15.99 No Limited Basic $12.20 $12.20 No Expanded Basic $41.25 $34.95 Yes Digital Classic $51.20 $45.95 Yes Digital Plus $56.20 NA - Digital Silver $67.20 $56.90 Yes Digital Gold $78.20 $64.90 Yes Digital Platinum $89.20 $77.90 Yes Premier Tier $4.99 $3.00 Yes HBO $12.99 $11.95 Yes Cinemax $12.99 $11.95 Yes ShowtimeiThe Movie Channel $12.99 $11.95 Yes Starz!$12.99 $11.95 Yes Encore NA NA - PPV Movie (non-adult)$3.99 $3.99 No High Definition $5.00 $5.00 No 2. Internet a) Packaging and Pricing Uptown recommends that Council approve a policy that staff configure Internet products which offer greater value (in the form of speed and features) at lower prices. Uptown is making this recommendation (summarized in Exhibit 9) as a result of a fundamental belief that the marketplace will demand more and more bandwidth for data services and that CPAU will be uniquely positioned to deliver it to the mass Palo Alto market. Given this, the emphasis for customer value should be on increasing product speed and throughput. Accordingly, we believe the general strategy should be to use fiber technology to revolutionize broadband Internet service in Palo Alto: Provide 100 Mbps speeds to end users for "on network" data transfers over the CPAU intranet (the local Palo Alto network), where capacity is abundant. August, 2003:Uptown Draft Phase 2 Report Page 24 of 91 CPAU FT’fH Business Plan Uptown Services, LLC Manage cannibalization2 risk of the upper tiers by carefully designing Internet tier offerings with clearly differentiated perceived values and capabilities, always mindful that Internet bandwidth capacity has a variable cost structure. Provide symmetrical downstream and upstream data rates across all tiers, which is a major paradigm shift for mass-market Internet services. Exhibit 9- CPAU Broadband Internet Offerinqs Residentia I $29.95Low Medium High Low High 256 Kbps 256 Kbps $39.95 2 Mbps 2 Mbps $59.95 4 Mbps 4 Mbps Small $99.95 6 Mbps 6 Mbps Business $149.95 10 Mbps 10 Mbps Note: Indicated speeds are for Internet transfer rates. Transfer rates on CPAU’s Intranet are expected to be 100 Mbps. b) CPAU versus Incumbent Price Comparison The comparison between CPAU and Comcast’s Internet products is summarized in Exhibit 10. Exhibit 10 - Incumbent Pricinq Comparison Low DSL $39.95 NA $29.95 25% Medium DSL $49.95 NA NA NA High DSL $59.95 $42.95 $39.95 33% or 7% CPAU Ultra High NA NA $59.95 Exclusive Low Business $139.95 NA $99.95 29% CPAU High Business NA NA $149.95 Exclusive 2 Refers to the risk of urmecessarily moving subscribers from a higher revenue tier to a lower revenue tier by offering the lower priced tier at too low of a price. August, 2003:Uptown Draft Phase 2 Report Page 25 of 91 CPAU FTTH Business Plan Uptown Services, LLC 3.Telephone a)Packaging and Pricing As staff’s pricing principle for telephone services, Uptown recommends that the Council approve staff’s ability to establish wholesale terms with service provider(s) who agree to offer telephone service packages which are better than those of the incumbent service provider, and agree to participate in bundle incentives across other FTTH services. This business plan does not contain specific product recommendations for the local telephone line of business because CPAU will wholesale this service and will not set retail pricing. A working assumption of a $25 local telephone package with 6 calling features is assumed below in the bundling strategy. This would assume a 15% discount over SBC’s Sensible Solutions package. Although final negotiations will need to take place between the third party telephone retailer and CPAU, Uptown believes that terms consisting of fees per access line as well as profit sharing of net income are realistic for CPAU’s wholesale pricing. 4.Bundles Uptown recommends that Council approve staff bundling of FTTH products to prevail as the preferred provider, so long as the bundled products cumulatively meet Council approved pricing guidelines. The broadband services industry is seeing an increase in the importance of services bundling as a marketing tactic to accelerate penetration of optional services (Internet and local telephone) and to entrench the current customer base from video competitors. It is being used effectively by a number of the major national incumbent brands, including Cox and SBC. Bundling can be very effective in accelerating the sell-in of Internet and local telephone services, as evidenced in a major urban market when a cable operator introduced a price point bundle design for video, telephone, and Internet (see Exhibit 11). August, 2003:Uptown Draft Phase 2 Report Page 26 of 91 CPAU FTTH Business Plan Uptown Services, LLC Exhibit 11 - Monthly Sales Impact of Bundlinq 10 Months Prior Months After Internet Phone Source: Data from a major urban market. Cable operator results during 2002. The improvement in the financial health of the service provider is probably even more important than the sales impact realized from bundling. By reducing subscriber churn and improving revenue per subscriber (ARPU), bundling can improve profitability, even though it uses price discounting to attract subscribers. In the same market, the following financial metrics realized from the subscriber base where bundling was being used are presented in Exhibit 12. Exhibit 12 - Financial Impact of Bundlinq Average Re~ [ ~ M on t hi ,,, Per User (Mofithly) 3 Products 2 Products Digital Video Analog Video $119 $80 $51 $34 0.3% 0.8% 1.4% 2.7% Source: Data from a major urban market. Cable operator results during 2002. Given the above strategic considerations, Uptown proposes the potential bundle design presented in Exhibit 13, consisting of both two and three-product offerings. It should be August, 2003:Uptown Draft Phase 2 Report Page 27 of 91 CPAU FTTH Business Plan Uptown Services, LLC noted that the stated savings (ranging from 4 to 10%) is additional to CPAU’s already discounted rates. Exhibit 13 - CPAU Bundle Offerinqs "Medium’ Tier Internet Local Telephone (w/ 6 features) Total: $99.95ODigital Basic + 2 Premiums ’High’ Tier Internet Local Telephone (w/ 6 features) Total: ..........................$13495 Digital Basic ’Medium’ Tier Internet Total: $79.95 Digital Basic + 2 Premiums ’High’ Tier Internet Total: $119.95 10% 10% 7% 4% Comcast Digital Classic:S51.2 Comcast Cable Modem:S42.9= SBC Sensible Solutions:S3119 Total: $126.10 Comcast Digital Gold: $78.20 SBC Expert Plus: $139.95 SBC Sensible Solutions:S31.9 Total: $250.10 Comcast Digital Classic:S51.2 Comcast Cable Modem:S42.9’, Total: $94.15 Comcast Digital Gold: $78.20 SBC Expert Plus:$139.95 Total:$218.15 21% 46% 15% 45% III.Alternative Technologies and Mitigation of Risk A.Wireless Technologies Wireless technology has continued to evolve over the past several years into a viable broadband alternative technology for certain applications. While FTTH is the superior architecture for delivering voice, data and video services, there are a number of wireless systems that still may pose limited risks for Palo Alto’s FTTH endeavors. The following sections detail the capabilities of the main broadband wireless alternatives and their potential impacts on the proposed FTTH system. 1. Licensed Wireless Technologies The FCC divides wireless services into two basic categories - licensed and unlicensed. Licensed technologies operate in bands that are assigned to specific owners of the given August, 2003:Uptown Draft Phase 2 Report Page 28 of 91 CPAU FTFH Business Plan Uptown Services, LLC spectrum. These slices of spectrum are typically assigned for a given application like public safety or cellular telephone service. Broadband wireless systems that operate in these licensed bands are described next. a)Multichannel Multipoint Distribution System Multichannel Multipoint Distribution System (MMDS) was originally established for the transmission of television signals (wireless cable television service). Today’s cable operators drove most wireless cable television companies out of business. Wireless Internet service providers now primarily use the spectrum. These providers offer services though roof-mounted antennas that must have a clear line-of-sight to a central transmission tower. MMDS spectrum was originally granted as broadcast (one-way) only. But since the virtual elimination of the wireless cable operator and the advent of high-speed cable modem Internet services, the FCC now allows two-way services via this spectrum. They have limited the reverse path to just two out of the 33 channels available in the spectrum. Those operators seeking more reverse channel spectrum are required to file with the FCC for additional two-way frequencies. MMDS-based services are typically deployed via a "macro-cell" network. Such a network is based on a single transmission tower at which all subscriber antennas are aimed. A single transmission tower will generally cover an area 35 miles in any direction. This saves start-up costs for an operator, but it typically requires more complex or powerful (expensive) equipment at each customer site. The alternative approach to macro-cell is "micro-cell." Micro-cell networks move the transmission sites closer to customers. Such an approach is more expensive up front, but can save money on customer equipment and may allow signals to penetrate structures. Building penetration capability would eliminate the need for roof-mounted antennas, thus simplifying the installation procedure considerably. A properly configured MMDS network can offer high-speed Internet services with performance that is comparable to most cable modem services. The equipment at the central site and the subscriber location are actually very similar to their cable modem counterparts. The main difference is how the signal is transmitted to the home - over the air versus via fiber and coax. Sprint Broadband owns the primary MMDS licenses for the Palo Alto area. They built a network in the Bay Area and began offering service, but have since stopped installing new subscribers. They have announced that they are unhappy with the current generation of MMDS equipment and will not be expanding into new areas or installing any new subscribers until the vendor community makes improvements. The following notice is posted the on the Sprint Broadband website: "Sprint remains hopeful that the advantages of the next-generation of fixed wireless technology, which includes self installation, no line-of-sight limitations, increased capacity, and the ability to offer voice services will make fixed wireless a viable consumer broadband product. Sprint has taken a leadership role in next-generation development and will continue to monitor solutions." August, 2003:Uptown Draft Phase 2 Report Page 29 of 91 CPAU FTTH Business Plan Uptown Services, LLC It is not clear when Sprint’s issues will be resolved because the MMDS provider / supplier community appears to be locked in a stalemate over who commits to major changes first. In any case, MMDS-based offerings in Palo Alto will not pose a significant risk for the foreseeable future. b) Local Multipoint Distribution System Local Multipoint Distribution System (LMDS) is a relatively new form of high-speed wireless telecommunications technology. The FCC set spectrum aside in the early 1990’s for use by service providers wishing to provide fiber optic-like capabilities in urban and suburban areas of the U.S. Spectrum auctions were completed in the mid- 1990s and re-auctions were completed in 1999-2000. Two bidders were dominant in the initial and subsequent auctions - Teligent and Winstar. Leading vendors of LMDS equipment at that time were Motorola and Nortel. LMDS technology has the capability to provide very high capacity connections for voice, video and data within a three-mile range. Operating at 38 GHz, the system requires line- of-sight from building-mounted antennas to the serving tower. LMDS services were being targeted toward mid-sized and large businesses that needed highly reliable high capacity services, but didn’t have access to a fiber ring. LMDS solutions will typically be more expensive to deploy and support than cable modem or DSL-based Internet services. LMDS operators in the U.S. did not enjoy the success that they had hoped following the auctions. The industry was plagued by delays in equipment delivery and the massive capital costs incurred to construct the base infrastructure. Winstar and Teligent are both bankrupt. Their stocks are no longer traded in the NASDAQ system. According to FCC records, LMDS spectrum in Palo Alto has been licensed to XO Communications, Inc. (formerly NextLink) and Winstar. XO has recently emerged from Chapter 11 bankruptcy, but Winstar is gone for good. Uptown was unable to determine if any LMDS infrastructure has been built in the area. In any case, in can be reasonably assumed that LMDS will not play a competitive role in Palo Alto for many years. c)Broadband Satelfite (1)Constellation Based Services Much has been made of the crop of broadband satellite development ventures that seek a share of the cable modem and DSL markets. Companies like Teledesic and Astrolink are feverishly working on high capacity Internet satellite platforms that will serve the high-speed needs of consumers and businesses. Plans call for constellations of 60+ satellites orbiting the Earth and communicating with millions of subscribers via small roof-mounted dishes. Capacity per subscriber is expected to be over 1.5 Mbps at the time of launch in three to five years. There are a few broadband satellite providers that have launched service for the ISP and commercial markets, but a truly affordable high- speed consumer service (Teledesic and Astrolink) will take longer to develop. Analysts predict that the broadband satellite market may be strong for underdeveloped countries, but that the U.S. will have already been served with DSL and cable modem services by the time these networks are operational. Besides time-to-market problems, satellite signals will not be capable of penetrating building structures, thus the need for a August, 2003:Uptown Draft Phase 2 Report Page 30 of 91 CPAU F’I’TH Business Plan Uptown Services, LLC roof-mounted dish. Finally, broadband satellite operators have given up on mobility, which takes away one of the greatest intrinsic benefits of any wireless Internet solution. (2) DBS Based Services DirecTV was the first satellite provider to introduce a satellite based Internet access service - DirecPC (now called DirecWay). The original DirecWay service sent Internet downloads (downlink) to the subscriber via satellite and subscribers were required to use a dial-up connection to send information back (uplink) to the.lnternet. This limitation was due to the high cost of subscriber-based satellite uplinks, but these costs have since come down enough for DirecWay to offer two-way services over their own network. A telephone line is no longer required. Customers must purchase separate data receivers, but DirecWay is offering a $69 start- up fee if the subscriber agrees to pay a monthly fee of $99 for the first twelve months. Regular monthly service runs $69 for unlimited usage. Downstream data rates for DirecWay appear to be in the 384 - 512 Kbps range. StarBand service is a two-way satellite based Internet access system offered in partnership with Dish Network. Before StarBand, Dish did not have an Internet access service. They chose to wait for a two-way system rather than invest in a technologically inferior telephone return solution. StarBand is delivered to customer locations via a larger dish than the typical Dish Network antenna. This new dish is 24"x 36" compared to a standard 18" dish for DirecTV and Dish Network. A larger dish is required to generate enough power for the return path (uplink) to the satellite. Dish Network video services can also be received over the new StarBand dish. Download speeds are limited to 500 Kbps and upload speeds are limited to 150 Kbps. d) 3G Wireless Cellular telephone networks have been deployed ubiquitously across the U.S. Voice technology for wireless networks is now mature and the industry has turned its attention toward Internet services. With over 250 million cellular handsets in use throughout the world, equipment suppliers and standards groups are working hard to develop and introduce standardized high-speed Internet services that operate on cell phones and other hand held devices. Low to medium speed offerings are currently available that offer maximum bandwidths of 9.6 to 56 Kbps. Higher speed solutions will be deployed over the next several years in phases or "generations." The ultimate high-speed Internet access solution for cellular telephone providers is called 3G or Third Generation Wireless. 3G wireless capabilities hold the promise of delivering speeds of 144 Kbps at high speeds, 384 Kbps at pedestrian speeds and 2 Mbps for fixed stations. Consumers are becoming more and more mobile every year as evidenced by the nonstop adoption of cell phones around the world. This dramatic mobility trend has intersected with the Internet economy. The market for high-speed mobile Internet services is expected to experience explosive growth over the next ten years. In fact, wireless operators expect that data service revenue will eventually be larger than voice service revenue. 3G wireless applications may offer a boon to wireless operators, but should not pose any significant risk for the FTTH system. First, 3G wireless will not have the capability that FTTH brings to the average residential and small business user. The technology will still be expensive to deploy, which will likely keep it in the premium category for most August, 2003:Uptown Draft Phase 2 Report Page 31 of 91 CPAU FTrH Business Plan Uptown Services, LLC wireless operators. For example, the latest rage in the cell phone market is built-in digital cameras. However, wireless operators plan to implement pricing schemes that charge by the image (or message) sent to and from each device. This approach is not likely to drive the type of usage that a FTTH system could support. 2. Unlicensed Wireless Technologies A number of wireless systems have been developed in recent years that exploit the advantages of the license-free bands set up by the FCC. Some of these systems have been developed based on standards that have been established by bodies like the Institute of Electrical and Electronic Engineers (IEEE), while others have been developed based on vendor-specific specifications. The top alternatives for each category are outlined in the following sections. a) Standards Based Systems (Wi-Fi) The top standardized wireless LAN system in the unlicensed category is Wi-Fi (Wireless Fidelity). Wi-Fi is the industry term given to the family of 802.11 (a, b and g) wireless LAN standards. The latest Wi-Fi standard (802.1 lg) offers the best of both earlier standards (a and b). It has the capability to transmit up to 54 Mbps of data and interoperates with systems running either 802.1 la or 802.1 lb. While the stated throughput is 54 Mbps, 20 Mbps is usually the best most 802.1 lg systems are expected to produce. This is due to the high level of error correction (overhead) required in the license-free bands. (1) Benefits Two primary benefits of a standardized system are interoperability and reduced cost. Both of these advantages stem from the ability to purchase hardware and software from multiple suppliers without fear of system failure. Access points (bridges and routers), end-user cards and antennas are all reasonably priced given the healthy competitive environment in the vendor market. Access points can be purchased for less than $600 and tri-mode PCMCIA cards are less than $150 each. (2) Drawbacks While operating in a license free band may be free, it comes at a great cost to network operators and end users. Unlike licensed spectrum, the bands that Wi-Fi utilizes are open to any number of operators and sources of interference. For example, for low power household electronics like cordless telephones and microwave ovens, the FCC set aside 2.4 GHz for the primary Wi-Fi band. Wi-Fi standards have been carefully crafted to overcome these sources of constant interference, but they can still cause service interruptions or degradation without warning to the service provider or end user. Wi-Fi does not tolerate a multiple service provider model very well either. For example, if two service providers are offering service in the same geographical area, they are required to cooperate on channel assignments for their respective Wi-Fi networks. Even if they do cooperate, there is no guarantee that another rogue operator will not intentionally interfere with the "legitimate" networks. The most troubling aspect of Wi-Fi systems today is the lack security~ Wireless systems are inherently less secure than fiber systems by their very nature. Any technically adept person with a laptop and directional antenna can drive down the street and view the various Wi-Fi networks broadcasting packets. August, 2003:Uptown Draft Phase 2 Report Page 32 of 91 CPAU FTTH Business Plan Uptown Services, LLC Recently, a Palo Alto Weekly reporter was able to access sensitive information from one of the Palo Alto Unified School District network servers simply by connecting her laptop via Wi-Fi to the server. She then reported her experiences in a series of newspaper ai-ticles, heightening community awareness of the security challenge facing Wi-Fi. Should anyone be intelligent, sneaky and very persistent, they should be able to break the 128 bit wireless encryption protocol (WEP) that Wi-Fi uses to keep its traffic secure from hackers. Wi-Fi suppliers and service providers are scrambling to introduce more robust encryption approaches, but the issue remains a problem for any individual or enterprise that plans to use Wi-Fi. b) Proprietary Given the aforementioned limitations of the current Wi-Fi systems, some companies have chosen to implement their own systems using proprietary approaches. Two of the main solutions-providers are discussed next. (1)Wave Rider Wave Rider offers a wireless Internet system that operates in the 900 MHz band. Wi-Fi elected to use the 2.4 GHz and 5.1 to 5.8 GHz bands due to the limited availability of usable spectrum in the 900 MHz band. However, the 900 MHz band is the only one that offers true non-line-of-sight capability from the transmit tower to the end user radio. Given the longer wavelength of a 900 MHz waveform, it is able to travel through trees and buildings over long distances. Wave Rider quotes a serving radius of 1.5 miles from a transmitter to an indoor end user radio. This enables Wave Rider subscribers to complete their own installations and skip the hassle of mounting an antenna on the roof or under an eave. The primary drawbacks of the Wave Rider system are limited bandwidth and high cost. A Wave Rider transmitter has the capability to broadcast 2.5 Mbps to all radios within an 8-mile radius (outdoor antennas are required beyond 1.5 miles). This is compared to 54 Mbps for 802.1 lg. The ability to compete with cable modem and DSL speeds is clearly limited with a total shared bandwidth of only 2.5 Mbps. Cost is also high for this system. A "starter system" runs $6,500 and includes enough equipment to serve just six end users. At $1,000 per end user, this approach is likely to be the last resort for any ISP seeking broadband alternative to dial-up. (2) Motorola Canopy Motorola has introduced a new wireless platform named Canopy. Motorola is infinitely qualified in the ways of wireless and determined that they could build a better system than Wi-Fi for providing broadband Internet access. The Canopy system operates in the 5.1 to 5.8 GHz band and provides up to 10 Mbps to subscribers within 10 miles of a central transmitter. The recommended configuration calls for a six-sector transmitter serving up to 1,200 subscribers. Subscribers would be required to install their antenna on the outside of their home or business such that clear line-of-sight could be attained to the transmitter location. Canopy utilizes the precise timing of the Global Positioning System (GPS) to control all network traffic, which minimizes packet collisions and thus the need for repeated retransmission of lost or corrupt packets. This approach also results in low latency of August, 2003:Uptown Draft Phase 2 Report Page 33 of 91 CPAU FTrH Business Plan Uptown Services, LLC transmission (< 20 ms). Latency refers to the time it takes for a packet to reach its specified destination. Summary Of all the technological technological risks for FTTH, wireless appears to garner the most attention and serious consideration. However, it is Uptown’s opinion that wireless technologies will not be capable of delivering the kind of reliable bandwidth required to support a compelling voice, video and data bundle. Certainly there are applications for Wi-Fi as an alternative to wired LANs in homes, businesses and public meeting places ("hot spots"). But the technology has too many limitations: 1.Security: All signals are easily intercepted in the "open" air. This has been bothersome to many potential users. 2.Quality of Service: Service varies from location to location and by time of day. At any time competitors can compete in the same airspace, thus degrading the quality of all Wi-Fi services. 3.Limited Throughput: Just like cable modem technology, the system utilizes large blocks of shared bandwidth. This leads to lower throughput per user as more subscribers are added to the network. 4.Data Only: Wi-Fi was not designed to carry voice or video services in wide area configurations. This puts the technology at a disadvantage when bundling is a key element of any product strategy. B. Voice Over Internet Protocol (VOIP) VOIP refers to the process of using a standard Internet Protocol connection (Ethernet) to complete a standard telephone call. What started as a fun hobby for people wanting to save money on long distance charges has evolved into a "ready for prime time" application. Early versions of VOIP required end users to use their computer as the "telephone." Either the user employed a headset or they used the built-in microphone and speaker in the computer. Connections were often of poor quality and had the feel of using a push-to-talk radio system. With the high level of broadband adoption, the VOIP exPerience has changed dramatically. 1. Competitive Threat or Potential Partner- Vonage A company named Vonage has introduced a radical new way to use a broadband connection for telephone service. Vonage sells VOIP equipment and services to DSL and cable modem subscribers. When a subscriber signs up for service they are required to take a new telephone number. However, the new number can come from virtually anywhere that Vonage has purchased prefixes. Given the middle ground in which the company is operating, they have chosen not to certify as a CLEC in the markets they serve. In essence, their network looks like one that a giant multinational corporation might deploy. Subscribers are given a special adapter that connects his or her LAN to their telephone line. This adapter interacts with the Vonage network over the subscriber’s broadband connection and performs all translations from analog to IP and back again. August, 2003:Uptown Draft Phase 2 Report Page 34 of 91 CPAU FITH Business Plan Uptown Services, LLC Vonage markets a high value local plan with 500 minutes of long distance for $40.00 per month. They also have a number of other long distance packages (including international calling). Vonage sells direct to end users without the cooperation of their b~’oadband provider, but they are working to cut different wholesale and reseller deals with cable providers throughout the US. A few deals have been struck with small operators, but nothing major has been announced. Uptown spoke to the Vonage head of business development, Phillip Giordano, about the possibility of using the FTTH system in some manner. Mr. Giordano expressed limited interest in partnering with CPAU, but detailed the basic terms of their wholesale and resellers agreements. The stated terms were very unattractive, thus Uptown recommends that CPAU not consider Vonage as a potential partner at this time. With respect to Vonage as a potential risk to the FTTH system, there are several issues yet to be resolved. First, it isnot clear that the FCC will continue to allow Vonage to operate without obtaining the appropriate federal and state certifications. Second, Vonage is currently requiring that subscribers change their telephone number. This is due primarily to the fact that only registered CLEC’s are allowed to participate in local number portability (LNP). LNP allows subscribers to change service providers without changing their telephone number. It is unclear just how many subscribers may be willing to change their telephone number to save on telephone service. Finally, Vonage is not providing lifeline service. If the power goes Out, so does their service. Subscribers may not realize they don’t have access to 911 until it’s too late. 2. Summary VOIP is here to stay. The early problems with the hobbyist versions are long gone. The technology is being used successfully in private networks around the world. FTTH systems can provide the bandwidth required to deliver a high quality VOIP based local telephone service. In fact, many of the Ethernet based FTTH systems use the same approach as Vonage, except their adapters are integrated into their network interface units (NIU’s). It is also possible that CPAU may partner with a CLEC that uses some level of VOIP in their network. Providers like Vonage may have limited success in bypassing CPAU to provide VOIP services directly over a high-speed Internet service connection. However, it is more likely that CPAU and its CLEC partner will also use VOIP to offer the best local and long distance services in the Palo Alto market. C.Principles for handling current and future implied technological risks In today’s fast paced world of technology, it can be very tempting to overreact to real and ¯ imagined threats. This is why it is critical to adhere to some fundamental principles when evaluating the level of risk posed by any new broadband or interactive technology. Some of these principles are listed here: Get the facts about standards, performance, cost and availability of the underlying technology. Get the facts about service quality, performance, price and availability of the services being offered. Perform financial due diligence on each potential equipment supplier’s ability to produce mass quantities of products. August, 2003:Uptown Draft Phase 2 Report Page 35 of 91 CPAU FTITI Business Plan Uptown Services, LLC Perform financial due diligence on each potential service provider’s ability to survive a start-up period amidst other providers. Following these principles will position CPAU as an objective analyst, thus allowing for the most comprehensive and fact-based assessment of each possible new component of risk. These baseline facts will also provide the necessary foundation for evaluating the actual level of threat that the new technology in question will pose to the FTTH operation. D.Identification and Evaluation of New Competing Technologies 1.Identification Identification of new competing technologies is not going to be difficult in the current overly hyped hi-tech industry. The industry in so starved for the "next big thing" that it will grab onto just about any technology or application that offers a glimmer of hope for resurrecting the glory days of the late 1990’s. For example, Wi-Fi hot spots have been the darling of the hi-tech and mainstream press for more than 18 months. McDonald’sTM is currently rolling out hot spots in their restaurants throughout the Bay Area, supported by a significant marketing and advertising campaign. Only recently has the issue of profitability (or lack thereof) for hot spot providers begun to make its way into the technical press. This demonstrates how it may be very easy to spot the latest technical approach for broadband, but the real challenge will lie in evaluating the likely risk that it poses. 2. Evaluation Evaluating the level of risk posed by a new technology is rooted in the principles listed above. A good risk assessment will start with a thorough fact-gathering process on the technology and the service provider(s) that plan to exploit it. Then, the process needs to focus on assessing the suppliers’ and service providers’ ability to survive and thrive in a fiercely competitive market. Once the facts have been gathered and an assessment made regarding the likelihood of survival for the suppliers and service providers, CPAU should then evaluate how the new service will compare to its FTTH-based peer. E. Pricing strategies for prevailing among alternative technologies A key advantage that CPAU will have with the FTTH system is the ability to bundle voice, video and data services. If Comcast continues to delay the introduction of their telephone service in Palo Alto, this would make CPAU the only provider of bundled services in the market. In can be assumed that SBC will continue to be aggressive in their telephone and Internet bundling, as will Comcast with video and data, but CPAU will be sole provider of voice, video AND data services. It is highly unlikely that a new technology will come along that offers the capability to bundle these three services on the same system. CPAU should leverage this ability by offering the types of bundles described in the Product Planning section of this business plan. CPAU should resist the temptation to slash service-specific pricing in the face of new competing technologies. Instead, CPAU should strive to make their bundles more compelling and "sticky", such that the new providers would not be able to offer similar levels of value. August, 2003:Uptown Draft Phase 2 Report Page 36 of 91 CPAU FTTH Business Plan Uptown Services, LLC F. Marketing strategies for handling competitors Marketing strategies should be developed on an individual case basis, depending on the nature of the risk being addressed. All marketing efforts should be honest and straightforward. CPAU need only remind the citizen-owners of the CPAU FTTH system that profits from the business remain in Palo Alto, another good reason to support the home team. Competitors have tried to derail cities’ service-improvement efforts with campaigns featuring misinformation and doubt. Regrettably, they have succeeded in some cases. But with a quality FTTH system as the proposal, CPAU will be well positioned to take the high road. IV. A. Marketing and Sales Plan Sales Plan 1.Inbound Sales a) Strategy Recommendation The current CPAU organization has a small department of 4 or 5 inbound customer service representatives who take new service orders and provide customer care to the subscriber base of the utility. These representatives are trained on all CPAU services and handle all telephone-related activities toward the customer. This group is handling about 48,000 calls per year. Uptown views the inbound sales program for CPAU as having two primary components: Sell-In Opportunity: Ability to "proactively" sell broadband services on everyday utility calls Campaign Opportunity: Ability to use advertising and promotions to create inbound demand for broadband services The inherent call volume that CPAU receives represents a strategic opportunity for the utility department in reaching prospective broadband customers, quickly and efficiently. This is the sell-in opportunity and it is an advantage both in terms of volume as well as timing. For those moving from one residence to another, it is common to reconsider their service providers when they change their place of residence. The electric utility is one of the first service provider contacts made when moving. When that call comes in, CPAU has an opportunity to present its broadband service options, most likely before the prospect has contacted alternative telephone, Internet, and television services providers. From a sales process perspective, CPAU has twoalternatives for implementing its inbound program. One alternative would be to add the broadband services to the scope of responsibility of the existing CPAU service representative team. This option may or may not require additional headcount as the current care organization is mostly staffed to cover hours of operation versus staffing to call volume. The other alternative is to create a second small team of broadband service representatives. In this scenario, the current utility representative would complete the customer care transaction for the utility services and then inform the customer of the availability of CPAU’s broadband services and ask for agreement to transfer the call to a broadband services representative. The call would then be warm transferred and the utility representative would drop off the call after the broadband representative takes over. August, 2003:Uptown Draft Phase 2 Report Page 37 of 91 CPAU FTTH Business Plan Uptown Services, LLC There are advantages to each alternative. For the first, there will be a lower total operating expense requirement for CPAU to staff customer care representatives with a single pool of service representatives covering both utility and broadband services. There is also greater process simplicity because the call is not transferred beyond the representative that originates the call. For the second alternative, the advantages are that the broadband representatives can be specifically trained for these services and will have a more limited scope of their knowledge base because of this. The second advantage would be that this scenario better supports a two-system environment for OSS if CPAU continues to use Banner for its utility services and selects a second subscriber management system for its broadband services. The utility representatives would continue to only use Banner and the broadband representatives would only have to use the new system, with neither of the representatives having to toggle between systems during the same care transaction: Uptown recommends that CPAU budget for and begin initial operations using the second sales process alternative. The reasons for this are two-fold: 1)The advantages of having CPAU’s customer care representatives trained specifically for broadband services at commercial launch are likely to outweigh the staffing efficiencies associated with a combined care organization. The complexity of supporting all three LOB’s is extensive, since the three service groups can be very different from each other in terms of product functionality. Exacerbating this is the requirement for the representative to also be able to speak to the outsider’s product advantages and disadvantages as they relate to the CPAU broadband offerings. This is necessary because these representatives will be selling the services against these outsiders and will also be attempting to "save" customers who call to disconnect these services in favor of the competition. 2)The likelihood that CPAU will need to implement a second SMS system, in addition to Banner, is probably greater than 50%. For the reasons mentioned above, this would mandate a two-system environment in a combined care group, which is less than ideal. After the initial ramp up of broadband operations (likely Year 3), it is recommended that the broadband care organization be integrated into the existing utility care organization to realize scale efficiencies from a combined operation. In addition to gaining the knowledge focus at the outset, this would give CPAU a substantial period of time to integrate the SMS systems, should that be the IT strategy that they choose to pursue. The marketing campaigns represent the second source of inbound call volume. The tactical programs will generate a certain level of response, and these will be sales opportunities for the inbound representatives. Because these calls represent a response to specific broadband advertising, the calls can be dialed directly to the broadband representative and the close rate will be much higher than on sell-in calls. b) Operating Targets The monthly Key Performance Indicators (KPIs) are presented below in Exhibit 14, and explicitly define the sales assumptions around the size of the sales opportunity for both sell-in and campaign generated inbound calls. These are the key performance metrics that drive the unit sales and subsequently connects in the financial statements of the August, 2003:Uptown Draft Phase 2 Report Page 38 of 91 CPAU FTTH Business Plan Uptown Services, LLC business plan. The KPI’s are presented in monthly "snapshots" to present the gains in operating efficiency and performance over time as sales skills are improved. The total units are summarized at the end of this section under Channel Mix. Exhibit 14- Inbound Sales Operatin,q Tar.qets Metric Month 1 Month 12 Month 24 Sell-In Utility Call Volume 800 800 800 Opportunity Transfer Rate 35%50%50% Sales Calls (homes 3 137 400 passed adjusted) Close Rate - Video 8%11%15% Close Rate - Internet 10%15%15% Close Rate -8%12%12% Telephone Units Sold -All LOBs 1 52 168 Campaign Direct Marketing 198 7,403 13,000OpportunityContacts Response Rate 2.5%2.5%2.5% Campaign Calls 5 185 325 Close Rate- All LOBs 40%50%50% Units Sold -All LOBs 6 278 488 Total Units Sold -All LOBs 7 330 656 Inbound Note: Performance metrics included in this analysis represent industry-standard levels among broadband service providers. 2.Outbound Sales a) Strategy Recommendation Uptown recommends that outbound telemarketing be used by CPAU during the first two years of operation as the FTTH network is being built. Along with direct sales, this channel is an excellent tool to inform households and small businesses of the availability of CPAU broadband services where the network is ready. Although telemarketing is becoming less acceptable to the general public, we believe it is very appropriate for CPAU to use this channel since these homes and small businesses are already CPAU customers. By Year Three or Year Four of the operation, CPAU will likely cease using this as a sales channel. b) Operating Targets Exhibit 15 presents the KPI’s for the outbound sales channel. Months 11 and 23 (November) are used as the example since outbound telemarketing is not planned in December due to the holiday season. The size of the calling list is initially constrained August, 2003:Uptown Draft Phase 2 Report Page 39 of 91 CPAU FTITI Business Plan Uptown Services, LLC by homes passed, and the completion rate is limited to 65% given poor/no telephone numbers, do-not-call exclusions, etc. Close rate improves slightly over time as sales skills develop for these services and market awareness improves. Exhibit 15 - Outbound Sales Operatin.q Tar.qets Metric Month 1 Month 11 Month 23 Outbound List 66 2,346 3,500 Completion Rate 65%65%65% Outbound Contacts 43 1,525 2,275 Close Rate - Video 5%’ 6%6% Close Rate - Internet 6%8%8% Close Rate -6%8%8% Telephone Units Sold- All LOBs 7 335 501 Note: Performance metrics included in this analysis represent industry-standard levels among broadband service providers. 3.Direct Sales a) Strategy Recommendation Uptown recommends that CPAU establish a door-to-door direct sales team for its broadband services. This strategy borrows from the sales tactic used by cable operators in the 1970’s as they originally constructed their cable networks. As construction finished in a particular neighborhood, technicians (who did double duty as sales staff) went to each home to inform the resident that cable was now available and attempted to make the sale. Given the similar construction activity for CPAU, this direct sales approach should be followed as the FTTH network is built out, neighborhood by neighborhood. b) Operating Targets Exhibit 16 presents the KPI’s for the direct sales channel. Similar to outbound telemarketing, November is used because direct sales will not be selling for the full month of December. It is anticipated that this sales team will start with one sales person (who will subsequently manage the direct sales team in addition to personally selling). The team will grow to 4 sales agents over time as the network construction proceeds, adding more residences and businesses to the prospective subscriber list. Uptown expects that close rates will improve over time in this channel as subscriber experiences with the fiber system multiply, existing subscribers recommend fiber services to others, representatives’ sales skills improve and product expertise increases. August, 2003:Uptown Draft Phase 2 Report Page 40 of 91 CPAU FTI’H Business Plan Uptown Services, LLC Exhibit 16 - Direct Sales Operatin,q Tar,qets Metric Sales Staff Sales Days Per Month Sales Person Days Sales/Rep/Day - Video Sales/Rep/Day- Internet Sales/Rep/Day - Telephone Units Sold -All LOBs Month 1 1 20 2O 1.0 1.3 1.0 65 Month 11 4 20 80 1.3 2.0 2.0 420 Month 23 4 20 80 1.5 2.5 2.0 480 Note: Performance metrics included in this analysis represent industry-standard levels among broadband service providers. 4.Payment Center a)Strategy Recommendation At its City Hall location in downtown Palo Alto, CPAU has a payment center facility where customers may pay their bills in person. The inbound representatives staff it. This customer traffic, in a similar nature to the utility inbound call traffic, is a natural sales opportunity for the broadband services. b) Operating Targets Exhibit 17 presents the KPI’s for the CPAU payment center. Based upon data provided by staff, we have estimated monthly traffic at 500 visitors. We further estimate that about 50% of in-person contacts at this channel would be willing to listen to a sales presentation by payment center representatives and be provided with sales collateral (brochures). Similar to the inbound channel, sales opportunities will be limited at the outset due to the small number of homes passed. August, 2003:Uptown Draft Phase 2 Report Page 41 of 91 CPAU FTFH Business Plan Uptown Services, LLC Exhibit 17 - Payment Center Operatin.q Tar,qets Metric Center Traffic Presentation Rate Presentations (homes passed adjusted) Close Rate - Video Close. Rate -lnternet Close Rate - Telephone Units Sold -All LOBs Month 1 500 50% 2 Month 500 50% 86 12 Month 24 500 50% 250 10%10%10% 10%10%10% 8%12%12% 1 27 80 Note: Performance metrics included in this analysis represent industry-standard levels among broadband service providers. 5.Online Sales a) Strategy Recommendation Uptown is also recommending that CPAU incorporate into its website a capability to not only advertise, but take orders for broadband services. At a minimum, this could be the ability to capture online leads and then close these prospects through outbound telemarketing. It would be better to truly enable an online order to be placed and fulfilled completely within an online environment, and this should be possible with minimal software investment. Most of the major MSO and ILEC incumbents are using online ordering today as a viable sales channel. b) Operating Targets. Exhibit 18 presents the KPI’s for the online sales channel. In general, Uptown expects online to generate about 10% of all orders during the initial years of the venture. We further expect that within this channel, there will be a higher proportion of Internet orders given the profile of a consumer who orders through this channel. Exhibit 18 - Online Sales Operatin.q Tar.qets Metric Month 1 Month 12 Month 24 Orders Per Month 10 150 150 Percent with Video 20%30%30% Percent with Internet 50%50%50% Percent with 20%35%35% Telephone Total Units Sold 2 53 53 August, 2003:Uptown Draft Phase 2 Report Page 42 of 91 CPAU FTTH Business Plan Uptown Services, LLC 6.Sales Channel Mix Exhibit 19 summarizes the channel mix, or distribution of unit sales across all of CPAU’s sales channels. The data in this table are extracted from the two-year operating budget and demonstrate the evolutionary pattern over time. In general, the following trends will be driving the channel mix during the first two years and over the long term: During the initial construction of the network, both outbound telemarketing and direct sales will have a large share of units sold as they follow the construction activity. They will be the first sales contacts made with newly passed homes. In the medium term, inbound calls and the payment center will have a larger share of units sold as the utility and broadband representatives become better at selling these new services and as outbound and direct sales activity decreases and eventually ceases altogether. In the long run, the online sales opportunity will grow as consumer online purchasing activity increases in general. Exhibit 19 - Sales Channel Mix Inbound Outboun Direct Payment Online d Center Video Year 1 28%21%37%2%12% Year 2 40%25%23%3%9% Internet Year 1 22%20%41%2%15% Year 2 32%26%27%3%12% Telephon Year 1 22%21%45%2%10% e Year 2 33% 28% 26% 4% 9% B. Marketing Plan This marketing plan outlines the approach CPAU will take in generating and capturing the market demand within the Palo Alto market for improved video, Internet and telephone services. As a new entrant to the market and to the broadband sector, the marketing approach will be important to ensure that sufficient awareness is created and that this can be translated into achievement of sales and revenue targets. In achieving this goal, several strategic objectives need to be realized as key components of the marketing plan: Marketing Objective 1: Achieve the necessary community support for the project among both community leaders as well as citizens (as both residents and small business owners). This is realized through the brand positioning of the new venture. Marketing Objective 2: Achieve a positive image for the broadband service and the organization and people.behind it, whether as a subsidiary unit of CPAU or a August, 2003:Uptown Draft Phase 2 Report Page 43 of 91 CPAU FTH-I Business Plan Uptown Services, LLC separate entity. This is also realized through the brand positioning of the new venture. Marketing-Objective 3: Achieve sufficient market awareness among Palo Alto’s residents and small businesses of the ability to receive broadband services via the new FTTH network. This is realized through the advertising and direct marketing programs, plus word of.mouth among existing subscribers. Marketing Objective 4: Define and differentiate the value of these services in the mind of these residents and small business owners compared to incumbents who provide video, Internet, and telephone services today. This is realized through the advertising and direct marketing programs, plus perceived value by existing subscribers who tell their friends. Marketing Objective 5: Stimulate market demand for CPAU’s broadband services through promotion and direct marketing activities. This is realized through the direct marketing programs. The marketing plan consists of the overall brand positioning, the advertising program, and the direct marketing promotions program. These dimensions of the marketing program address the above objectives and ensure they are sufficiently budgeted. 1. Brand Positioning CPAU is a strong brand in Palo Alto that has built a solid reputation for customer service over the last 100 years. For the FTTH project, the key is to extend this image into its performance in offering broadband services so that this image is protected and even enhanced and so that the positive utility image can help CPAU prevail as the preferred provider. The first step in accomplishing this is to establish the value of the fiber network itself and the unique role that CPAU can play as a community-based provider of broadband services. This is done on two levels. First, the community should benefit from educational and information resources such that the benefits of this kind of network to the city of Palo Alto are understood. Second, the homeowners and small business owners who would actually use and pay for these services should understand what they can do for them and how they are different from the video, Internet, and telephone services they have today. The sources for competitive differentiation for CPAU in the broadband sector are derived from the capability of an all-fiber network, its ability to price services fairly, and its ability to transfer its utility services expertise into the broadband sector. a)Improved services capabilities The product strategy section of this business plan clearly outlines the potential for CPAU to redefine the mass market for data services by taking advantage of its fiber bandwidth. For video, it will similarly launch the most advanced applications such as high definition television (HDTV) and video on demand (VOD). b) Reduced prices and increased value CPAU will bring better services pricing and increased value to Palo Alto consumers and small businesses in three ways; August, 2003:Uptown Draft Phase 2 Report Page 44 of 91 CPAU FTTH Business Plan Uptown Services, LLC First, it will offer discounts compared to the "rate card" prices of incumbents. Across the three lines of businesses, it is strategically targeting a 10% discount. In the product section of this business plan, the discounts range from 0 to 17% savings for CPAU video services and 7 to 29% savings for CPAU Internet services. Telephone is not specified due to the wholesale strategy. Second, especially for Internet service, providing greater product capability will enhance customer value. As an example, Comcast provides about 1.5 Mbps downstream Internet bandwidth for $43 per month. This equates to about $29 per 1 Mbps throughput. Given proposed CPAU Internet tiers, this value relationship could improve to less than $15 per 1 Mbps. Finally, CPAU will add value by bundling two or three services with additional discounts for its better customers. These bundles will be advertised and will help differentiate CPAU from incumbents who today do not or cannot offer all three services. c)Improved customer service Beyond the image advantage, CPAU will be able to realize operational improvements in customer service through its smaller scale and local community operations. 2.Advertising and Direct Marketing Program Uptown defines the advertising tactics into three categories; awareness advertising used to generate brand recognition and affinity, direct marketing promotions used to directly support sales activities, and sales collateral used to indirectly support sales activities and provide fulfillment materials on new-connects. a)Awareness Advertising While the community scale and focus of a municipal broadband system has advantages cited in this business plan, there is one weakness relating to advertising efficiency. This is the inability to buy media across an entire media market (known as Area of Dominant Influence, or ADI, and now being defined as Designated Market Area, or DMA, by the FCC). The Palo Alto market is part of the greater San Francisco DMA, which is the 5th largest in the US, reaching over 2.5 million households. Obviously, Palo Alto is only a fraction of this DMA. These market scope definitions are important to CPAU’s marketing plan because they define the reach of television advertising within a market. For broadcast advertising, media agencies purchase "spot" buys which consist of advertising coverage that reaches all homes in a given DMA. This is one of the reasons why cable operators have been clustering their systems in the last five years, to gain efficiency in marketing efforts by having their service area cover an entire ADI. For CPAU, this won’t be possible, and this is why neither television nor radio advertising are recommended. Instead, more localized forms of advertising and local promotion need to be deployed. This does not mean the advertising and promotion program will not be successful, as other municipalities (including Alameda Power & Telecom) have used a localized advertising program with success. Given these limitations, and borrowing from examples such as Alameda, Uptown recommends the following tactics for creating local-level awareness of CPAU broadband services: August, 2003:Uptown Draft Phase 2 Report Page 45 of 91 CPAU FTYH Business Plan Uptown Services, LLC Print Advertising (newspaper). The Palo Alto Daily News, the Palo Alto Weekly and the San Jose Mercury are possibilities. Outdoor (billboards and other signage opportunities). Local Sponsorships b) Direct Marketing and Promotion The direct marketing program will benefit from the community-level scale of CPAU. These tactics involve targeted marketing with specific messages and promotional offers. The objective is to get the recipient to respond with an information or purchase inquiry. The most important direct marketing tactic is direct mail, but others are viable as well. Uptown recommends: Direct Mail Bill Inserts Events Marketing/Public Relations c) Sales Collateral The third marketing budget category is sales collateral which provides funds for the production of door hangers as a leave-behind for the direct sales team and install kits, which are instructional materials for new customers. Uptown recommends: Door Hangers Install Kits 3. Marketing Budget Uptown has developed the marketing budget based upon actual budgets of other municipal broadband providers who have successfully secured market share as well as our operating experience as managers in cable systems prior to our consulting days. In general, cable operators are spending 3 to 4% of total revenues on marketing spending, which is reflective of the competitive nature of the industry. Because a benchmark to revenue is not valid as CPAU enters the market, we have instead relied more on specific dollars budgeted by a representative municipal broadband market, one that is similar in size and demographics to Palo Alto. The funding for each marketing tactic is driven by the following assumptions for cost activity by line item: Newspaper: $10,000 in print ads in local newspapers in 5 flights per year. Outdoor: Supports newspaper ads with 5 flights per year at $5,000 each. Local Sponsorships: $18,000 per year. Events Marketing and PR: Funds one launch event at $30,000 and one event per quarter thereafter at $10,000 each. Direct Mail: $0.75 to produce and $0.37 to distribute a direct mail piece to 90% of all homes passed each month. Per piece costs are high due to low volume. August, 2003:Uptown Draft Phase 2 Report Page 46 of 91 CPAU FTTH Business Plan Uptown Services, LLC Bill Inserts: $0.25 to produce and $0.05 to distribute a bill insert to all homes passed once each quarter. Per piece costs are high due to low volume. Sales Collateral: 1.25 door hangers for every newly upgraded or built home at a production cost of $0.75 each. Also includes 1.25 install kits for each video and Internet new-connect at a production cost of $1.50 each..~ The summary of the marketing budget is presented in Exhibit 20. Exhibit 20 - Marketin.q Bud.qet Summary Awarenes S Advertisin g Newspaper Outdoor Local Sponsorshi ps Direct Mail Events Marketing & PR Bill Inserts Sales Collateral Total Marketing Budget Budget as % of Revenue Year One Budget % Of $50,000 $25,000 $18,000 Budget 42% Budget Year Two % Of Budget $50,000 $25,000 $18,000 26% $47,612 22%$174,720 48% $60,000 27%$40,000 11% $4,745 2%$20,632 6% $14,626 7%$34,135 9% $219,984 -$362,487 34%-8% V.Competitive Response and PR Planning A.Evaluate Impfications of a Major Campaign by Competitors This section of the business plan addresses competitive risk. The reaction by incumbents to the City of Palo Alto entering the broadband sector cannot be known in advance. Therefore, the scenarios presented in this section are speculative. Even on a market-by-market basis, the response by incumbents to municipal broadband efforts has varied substantially, ranging from price reductions (or foregone rate increases) to no response at all beyond normal marketing and sales activities. It is even more speculative to establish what may happen over time in such a fast-paced industry. Therefore, the role of this section is to present a general notion of the range of risk that CPAU undertakes if the status quo does indeed change, and describe general strategy options in how to deal with such a risk. A final note, this section is focused upon marketplace decisions and reactions after CPAU launches, not the incumbent tactics involved in preventing CPAU’s entry. That is covered in the next section. August, 2003:Uptown Draft Phase 2 Report Page 47 of 91 CPAU F’ITH Business Plan Uptown Srrvic~s, LLC 1.Sources of Market Risk Within the broadband sector, it is most likely that marketplace risk from competitor actions will arise from a fundamental change in one of the following areas: sudden shift in technological capability or innovation price war erupts with ensuing drops in retail pricing change in legislation or regulatory policy change in a competitor’s resources (e.g. a merger) Given recent activities among the ILEC and MSO incumbents, Uptown believes the scenario with the greatest probability of occurring is a price war. Although technology is evolving within the telecommunications industry, we believe price erosion is a greater risk for CPAU than a technology "leap frog" for the following reasons: First, FTTH is a leading edge technology and has capacity and future-proof characteristics that severely limit the likelihood of it being technologically surpassed in a time frame that would hurt CPAU. Second, Uptown does not view Wi-Fi as a substitute to FTTH. It may complement and offer product extension possibilities, but it will not be a serious market share risk-of-loss to a fully utilized FTTH system. Third, incumbents are still repairing their balance sheets from DSL and HFC upgrades that have created significant debt. Their focus is on ea.rnings, not making major capital investments in their networks. Given this rationale, Uptown envisions that the competitive response scenario that would be most realistic (but one we would not consider "likely" by any means) is a price war via a ’loss leader’ strategy that would be introduced by an ILEC or MSO incumbent. This represents a situation where one of the major incumbents, all of whom offer services across multiple lines of business, aggressively competes for market share in one LOB by implementing a massive price reduction in another. Real-world examples of this within telecom are the introduction of any-distance telephone service, first in wireless (which first rated long distance the same as a local call) and then by MCI and the other ILECs (who are combining local and long distance service at one flat rate). The recurring pattern has been one of bundling services and changing the pricing metaphor for one of the bundle ingredients (in the examples above, long distance). Above all, MSOs need to retain video subscribers and ILECs need to retain telephone customers. Uptown believes that, if necessary to retain acceptable market share, the incumbents would look to Internet as a loss leader. In addition to protecting their core businesses, there is an additional rationale for why the incumbents would look to their Internet service to use it as a loss leader. For telephone service, residential local service rates are already low given their history of benefiting from subsidization from business rates. Even with wireless competition, local rates have held (although long distance has been bundled in). The same price floor effect is true for video, where programming cost increases would prevent drastic price changes. If CPAU has tremendous success in launching its FTTH network and captures significant community interest and subscription, especially with a very high-capacity Internet access service, one or both competitors could take a drastic step by aggressively reducing August, 2003:Uptown Draft Phase 2 Report Page 48 of 91 CPAU FTTH Business Plan Uptown Services, LLC Internet prices to keep their video and telephone subscribers. This could be done via some form of bundling so that they receive a retention benefit from the price drop. This could not only impact the pricing abilities of CPAU at this tier, but possibly at higher tiers as well, as the value dynamic may be impacted. Of course, this assumes that CPAU Internet service features are exactly the same as the incumbents Internet service features, which they are not. The capabilities of the CPAU fiber-optic network far surpass the network and service capabilities of any incumbent, especially in the data services category, so it is more logical that CPAU would counter with data offering features that no incumbent could match, while holding the price points steady. 2.Strategic Response Alternatives a)Product Options Ideally, CPAU can continue to prevail as preferred provider based upon the unique. product qualities of the services that it offers and not respond by also dropping prices. This may or may not be possible, but with its fiber network, CPAU will be better positioned than any other incumbent to respond with product value versus lower prices. With the video and telephone LOB’s, the fiber network does not provide a de facto source of product differentiation, but the fiber network does in the case of the Internet. As long as CPAU can budget for and cover.the operating expense associated with the data traffic it is sending to its Internet backbone connection, it can offer substantially larger capacity to end users. Furthermore, this capacity can be provided not only in the downstream path, but in the upstream path as well, with a symmetrical design that would be superior to the residential product designs of the incumbents. The effectiveness of CPAU’s ability to use product enhancement to avoid dropping its prices in response to price risks is dependant upon the extent to which Palo Alto households and small businesses perceive a need for substantially greater Internet capacity. For all this capacity to matter, customers will need to see the value in their improved data communication capabilities versus just getting Internet access at cheaper prices. It is difficult to predict how quickly the mass market will be able to evolve its need for much greater bandwidth. It has taken about five years for broadband Internet growth to outstrip narrowband growth and truly begin supplanting the older technology, and there are no in-market examples to look to at this time for mass market Internet access in the 10 Mbps range. However, Uptown believes that the applications and uses of the Internet by the mass market will rapidly drive bandwidth demand. For this product strategy to work effectively, CPAU should take whatever steps it can to accelerate the market demand in Palo Alto for 10 Mbps capacity versus status quo levels of 1 Mbps. This could take the form of applications that utilize greater throughput and should be part of the marketing and advertising supporting CPAU’s Internet service. b) Pricing Options The most important aspect of CPAU’s pricing strategy relative to controlling price risk is to tier its Internet service offering and to use bundle pricing across LOB’s. Both of these pricing strategies are recommended at tlie outset and are included in the product section of this business plan. The defensive quality of bundling is that it uses subscription to other services to reduce the vulnerability of losing a subscriber to a price drop for one product. The defensive quality of tiering Internet service is that it creates levels of August, 2003:Uptown Draft Phase 2 Report Page 49 of 91 CPAU FTTH Business Plan Uptown Services, LLC pricing which go beyond what can becompared to incumbent prices, should .a price war break out. With these tactics in place, and with the defensive product strategy outlined above, CPAU will minimize its exposure to a price war scenario. However, price changes may still have to be made to achieve market share goals, especially if price war occurred early on in the life of this project when scale efficiencies have not been realized. In this case, market forces could necessitate a re-pricing of some Internet tiers. This in turn would alter the subscriber dispersion across the tiers because higher tiers may now be more affordable. c)Legal and Regulatory Options The likelihood of a price war emerging in Palo Alto as a result of CPAU’s entry into broadband is directly related to the ability of the incumbents to reduce prices only in Palo Alto. As major players with millions of subscribers, deep discounts cannot be applied aaross their subscriber base without financial disaster. Instead, incumbents will attempt to isolate price decreases to markets where competitors are taking market share. However, this can be interpreted as discriminatory pricing because it results in the incumbents’ subscriber base in a non-competitive area subsidizing the price reduction in the competitive area. This has indeed occurred in some municipal broadband markets, with resulting legal challenges. One example is the reaction by Charter to the Scottsboro (Alabama) Electric Power Board’s offering of video services in 1999. In this market, Charter offers Expanded Basic for $24.95 with over 200 channels. In three nearby communities, Charter charges from $72.90 to $77.90 for approximately 150 channels. In a docket (CS Docket No. 01 - 129) filed before the FCC on this matter, the SEPB asserts that Charter is selling Expanded basic in its market, in response to competition, below cost. Current legal activities around this issue center upon the 1996 Cable Act as containing provisions intended to prevent such predatory pricing behavior. Unfortunately, there is some level of ambiguity in the Cable Act. On one hand, it prohibits unfair methods of competition and requires uniform rate structures. But it also excludes areas of effective competition from its uniform pricing requirement. This can be seen in section 623(d): "UNIFORM RATE STRUCTURE REQUIRED. A cable operator shaft have a rate structure, for the provision of cable service, that is uniform throughout the geographic area in which cable service is provided over its cable system. This subsection does not apply to (1) a cable operator with respect to the provision of cable service over its cable system in any geographic area in which the video programming services offered by the operator in that area are subject to effective competition, or (2) any video programming offered on a per channel or per program basis. Bulk discounts to multiple dwelling units shall not be subject to this subsection, except that a cable operator of a cable system that is not subject to effective competition may not charge predatory prices to a multiple dwelling unit. Upon a prima facie showing by a complainant that there are reasonable grounds to believe that the discounted price is predatory, the cable system August, 2003:Uptown Draft Phase 2 Report Page 50 of 91 CPAU FTI’H Business Plan Uptown Services, LLC shaft have the burden of showing that its discounted price is not predatory." Furthermore, section 628(b) provides an avenue for the FCC to further define policy such that competition should not be hindered: "This provision is a clear repository of Commission jurisdiction to adopt additional rules or to take additional actions to accomplish the statutory objectives should additional types of conduct emerge as barriers to competition and obstacles to the broader distribution of satellite cable and broadcast video programming. In this regard it is worth emphasizing that the language of 628(b) applies on its face to all cable operators." To date, there has not been an interpretation of regulatory policy or legislation that has prevented this action by an incumbent, but it is still a fairly new issue and the FCC has not put concrete preventative measures in place. The FCC’s Eight Annual Report on Competition for the Delivery of Video Programming (FCC 01 - 389) concluded with a concern that it does not have authority to prevent these practices: "The vast resources of a large MSO may simply prove too much if brought to bear in a targeted fashion against a single system entrant. Moreover, we are concerned about the signal such targeting may send to others who would compete in the [video] market, and particularly to the financial markets to which a new entrant may well be dependent for resources. However, it is not clear that we have specific statutory authority to address these kinds of problems directly. There has been some suggestion that our authority to prohibit anticompetitive acts or unfair practices under section 628 of the Act would reach targeted and predatory competitive responses. Alternatively, it may be that we would have to seek additional authority from Congress in order to combat such practices, which tend to limit competition and discourage new entry." Given the present state of this issue, CPAU can enjoin with legal and regulatory activities that are pursuing the predatory pricing issue, but an explicit determination of the outcome and impact to its business plan cannot be established, other than to understand the full scope of financial risk posed by this scenario if price reductions are the only viable course for CPAU. These impacts are described in the following section. B. Strategies to Address Incumbent Misinformation campaigns Incumbent operators have used many different methods in their attempts to keep municipally owned utilities from entering the cable, telephone and Intemet businesses. All of their tactics are rooted in a set of faulty assertions that are commonly referred to as the "Munitoons." A play on the Warner Brothers’ cartoons "Looney Tunes", Munitoons is the name given to a compilation of reports and position papers authored by a number of "independent" professors and think tank employees. A team of professors wrote the August, 2003:Uptown Draft Phase 2 Report Page 51 of 91 CPAU }-T12-I Business Plan Uptown Services, LLC odginal report from the University of Denver (DU), the same DU that is home to the ~ Daniels3 School of Business and the National Cable Television Museum. These reports describe a cautionary tale for citizens and legislators in areas where a municipality may be considering the construction and operation of a cable television system. The DU report called out the misdeeds of several public power broadband pioneers and warned of the terrible outcomes that would come to pass for any other municipality that wanted to do the same. This section provides an overview of the basic arguments presented in the original DU report and the two follow-on reports from Cole, Raywid and Braverman and the Beacon Hill Institute. 1. Underlying false premises of Munitoons William (Billy) Ray is the General Manager of the Glasgow Electric Plant Board (Kentucky). Glasgow was one of the first municipal utilities to overbuild the incumbent cable system and they’ve also been one of the most heavily scrutinized in Munitoon reports. This is why Ray is one of the most qualified experts in addressing the lies and falsehoods propagated by incumbents. Mr. Ray recently spoke on this topic at the APPA National Conference in Nashville (June 16-18, 2003). Based on his experience and the recent efforts of incumbents to thwart other municipal broadband projects, he has boiled the Munitoons campaign down to six key suppositions (Uptown has added a few more to Ray’s list):. 1.Municipal broadband projects are risky and unprofitable. 2.Local governments have no business providing broadband services. 3.Local governments don’t pay taxes. 4.Local governments have a conflict of interest - they regulate the competitors. 5.Everyone does not use broadband services, but everyone still pays. 6.Local governments cross subsidize, abuse monopoly power and use voodoo accounting. 7.Municipal broadband deployments lead to a loss of free speech in the community. 8. Local governments enjoy unfair advantages in the deployment of broadband. 9. These "unfair advantages" bring harm the public. The following sections address the false principles behind each one of these suppositions. 3 Bill Daniels made millions in the operation of Daniels Cable systems. He later formed Daniels and Associates, the leading broker of cable systems in the U.S. Before his death, he was one of the University of Denver’s largest benefactors. August, 2003:Uptown Draft phase 2 Report Page 52 of 91 CPAU FTrH Business Plan Uptown Services, LLC a)Municipal broadband projects are risky and unprofitable The broadband industry is risky and there is no getting around it. Since the telecom bubble burst in the Year 2000, over 500,000 jobs have been lost, 70 telecom companies have gone bankrupt and $3 trillion in investor capital has vanished. However, this is not the result of municipal ownership of broadband systems. It is actually the product of over-reaching by some of the corporate programs. In this same period, municipal systems offering competitive cable television and high-speed Internet services thrived (see Business Plan Phase I Final Report, April 28, 2003). So, in the realm of risky ventures, municipally owned systems appear to have weathered the storm much better than their publicly traded competitors. With regard to profit, no broadband system turns a profit in its formative years. Municipal systems are not typically established to generate huge profits. They are expected to service their debt and contribute to the general fund of the municipality, but many other benefits flow from municipal ownership of a broadband system. Competition usually leads to lower prices, which means budget relief for all, not only those households and businesses that purchase broadband services, but also those who choose to remain with the incumbents, since the incumbents typically mush lower their prices and improve service to remain competitive. Billy Ray estimates that the community wide reduction in cable rates has saved the cable users in Glasgow over $32 million since the municipal system became operational (15 years ago). b) Local governments have no business providing broadband services The role of a local government is to provide services that would not be "profitable" for private sector companies to provide (based on each company’s definition of "acceptable profitability"). For example, if a 100 Mbps Intranet service would not be profitable for a private corporation to provide (using their definition of acceptable profitability), but it could be proven that the residents and businesses in the City of Palo Alto would benefit greatly from such a capability, it is perfectly acceptable for the City to step in and provide such a service. If a municipality requires the installation of broadband network capability to best protect its citizens from monopolist practices, enhance the innovative capabilities of its constituents, attract high paying employers and strengthen its tax base, that body should be free to go forward with such an initiative. In the end it is the citizen’s voice that counts, not the incumbent cable and telephone providers’. c)Local governments don’t pay taxes Local governments do not pay taxes, but all municipally owned utilities make payments to the general fund in lieu of taxes. It can be assumed that the CPAU broadband business will also be making such transfers once a minimum level of cash flow performance has been reached. In fact, once these transfers begin, they will likely be much larger than any taxes paid by a comparable private sector operator. This is because local taxes are paid according to assets owned in the local area. Cable operators are typically very aggressive in their accounting and depreciation methods, so the book value of local system assets is usually quite low. This makes the taxes paid to the municipality low. Payments made in lieu of taxes are based on a fixed percentage of revenues or income. Another popular misconception is that municipal broadband operators don’t pay franchise fees. This is not true. They pay based on exactly the same franchise fee schedule as any incumbent, by law. August, 2003:Uptown Draft Phase 2 Report Page 53 of 91 CPAU F’FFH Business Plan Uptown Services, LLC d)Local governments have a conflict of interest- they regulate the competitors Local governments do not "regulate" a cable television provider - that is the role of the FCC. If the Palo Alto Council "regulated" the cable television provider, you would expect Council would have mandated improved services long ago. Municipalities also have no authority over either Internet or telephone providers. While cable franchises are still required by municipalities, these agreements do not impact the operator’s ability to set price or the types of services they wish to offer. The only meaningful authority remaining for a municipality is controlling the use of its rights of way (ROW). This must be carried out in a non-discriminatory manner and any qualified provider has the right to apply for use of ROW. In any case, municipalities are required to create a level playing field for all providers, including their own broadband system. So, no municipally owned operation would be allowed to enjoy preferential treatment with regards to franchise or ROW issues. e) Broadband service are not used by everyone, but everyone still pays Does every citizen use every park and drive on every road in the City? Does every homeowner use the fire department every year, police? Do childless homeowners pay for building and maintaining schools that they’ll never use? What about libraries and museums? Why would a state of the art broadband system that no other provider is willing to build for Palo Alto be any different than these other City facilities? When a City enters the broadband business, it is usually because the venture will serve the general public interest. While some citizens might not use the services offered, the system will completely pay for itself over time and will not require any tax or utility funding after becoming cash flow positive. f) Local governments cross subsidize and use voodoo accounting On its face, cross subsidization is not illegal. Cable and telephone companies do it all the time. It allows them to offer services below cost in competitive markets (to keep market share), while maintaining high prices and profitability in non-competitive markets. It is assumed that a municipally owned broadband system will leverage the economies of scale of the core utility throughout the service delivery and operations functions. But, it is also assumed that the fully allocated costs of those capabilities will be applied to the broadband business’ bottom line. Voodoo accounting is much easier to pull off behind the closed doors of a private enterprise or publicly held corporation. The transparency of the municipal governance process and extensive auditing functions make it nearly imposs!ble for a municipality to "cook the books", especially in Palo Alto, where many citizens watch local authorities like hawks. g) ¯ Municipal broadband deployments leads to a loss of free speech Another reason offered to stop municipal broadband deployments is the loss of free speech that is created in the local market. Munitoon authors proffer that municipally owned systems "discourage private investment and encourage flight from the market." Free speech is then degraded as a result of one less provider in the market, leaving the .municipality in control of what consumers see and hear in the community. In fact, the lack of investment by the private sector is what drove cities like Glasgow (Kentucky), August, 2003:Uptown Draft Phase 2 Report Page 54 of 91 CPAU FTrH Business Plan Uptown Services, LLC Paragould (Arkansas) and Muscatine (Iowa) to build systems themselves. Then, when unhappy consumers abandoned the incumbent’s outdated system, the cable provider found it more convenient to sell their remaining subscribers to the municipality than to invest in rebuilding their network. Glasgow, Paragould and Muscatine are the only municipalities where the incumbent cable operator has chosen to sell their subscriber base and exit the market. At last count, there were over 100 municipally owned cable systems in the U.S. Regarding free speech, there is no evidence that a municipally owned system offers a materially different channel line-up than a privately owned cable system. In fact, many municipalities have created independent programming boards to manage the channel selection on their cable system. Such an independent board may be required in Palo Alto. It is also interesting to note that many municipal cable systems are offering a full complement of adult programming, including Spice, Playboy and Pay Per View. h)Local governments enjoy unfair advantages in the deployment of broadband Munitoons authors allege the following unfair advantages exist for municipal broadband operators: August, 2003:Uptown Draft Phase 2 Report Page 55 of 91 CPAU F’ITH Business Plan Uptown Services, LLC Exhibit 21 - "Unfair Advantaqes" Possessed by a Municipal Broadband Operator Unfair Advantage 1. They can allocate costs of the broadband unit to the core utility business They can receive tax-exempt bonds and low interest financing not available to private companies They use ROW on preferential terms while delaying competitive efforts to use the same routes and facilities They use the power of eminent domain, which private companies cannot use Response Allocation of costs is something competitive businesses do regularly. However, Palo Alto will likely operate this business as a new department with it’s own budget. This business unit will be responsible for covering its costs. Tax exempt funding has certain restrictions that private companies would likely find onerous. Also, a number of municipal telecom deployments have been funded with taxable bonds. It is illegal to discriminate regarding rights- of-way use. Palo Alto has no need to use eminent domain to build the CPAU FTTH system. 5.Operate without a franchise or under Palo Alto is required to operate under the terms less onerous than the incumbent same franchise conditions as Comcast. 6.Avoid paying franchise fees and other fees and taxes that private companies are required to pay Exercise their regulatory power in a discriminatory manner that disadvantages private companies Use municipal property, plant, equipment and people at little to no cost Subsidize their telecom efforts through tax increases or utility rate increases Franchise fees would still be collected and paid by CPAU. CPAU would not pay taxes, but would make transfers in lieu of taxes to the City’s general fund. Palo Alto is a fair and honorable city. To suggest otherwise insults its citizens and its government. CPAU plans to leverage existing assets, using economies-of-scale to lower costs, thereby permitting lower rates. The business will require working capital to build and operate. These moneys will be paid back, along with the entire bond amount, with income generated by subscribers to the FTTH system. Economies-of-scale may actually permit all utility rates to decease. i) Unfair advantages enjoyed by municipafities bring harm to the public According to Munitoons reports, the following chain of events is set off by a municipal broadband project: August, 2003:Uptown Draft Phase 2 Report Page 56 of 91 CPAU FTTH Business Plan Uptown Services, LLC o Municipal broadband operators under-price their competitors. The savings generated by lower rates are "illusory" because they are actually subsidized by higher taxes, utility rate increases and loss of revenues from other sources in the community. The unfair advantages held by the municipality deter the private cable and telephone companies from investing in their infrastructures. The low rates charged by the municipality may be a short-term boon to the community, but they will not produce the cash reserves required to upgrade the broadband network in the future. 5.Finally, all tax and ratepayers are left to shoulder the burden of the broadband system when only a portion of them actually uses it. As the listed counter arguments show, this chain of logic breaks down from the start. While it can be shown that some municipal systems are pricing their services much lower than the competition, it cannot be shown that this strategy has lead to the aforementioned unintended consequences listed. In any case, Uptown has recommended against steep discounting. Instead, CPAU will win subscribers with a more balanced approach of lower price, higher performance and better customer service which all add up to a much higher level of valuable services for the same or less money. The financial projections are based on the fundamental assumption that there will continue to be healthy competition in the Palo Alto broadband market. The financial plan also includes hefty investments for network and NIU upgrades in the tenth year of operation. Finally, the plan clearly indicates there will be a need for cash investments into the business during the early years of the business, but this is all paid back within 15 years, plus or minus two. 2. Detailed counter strategies for false attacks The truth is the best counter strategy to all Munitoons misrepresentations. Most of the assertions made by Munitoons authors are based on their limited knowledge of the facts and extrapolations thereof. a) Get the Facts Several resources exist that will assist in developing a detailed counter-attack against the anticipated Munitoons-based "fear uncertainty and doubt" (FUD) campaign. With over 100 municipal broadband projects in operation and many more in the planning stages, there is a wealth of experience on which CPAU will be able to draw. Specifically, the Tri-City Broadband website, www.tricitybroadband.com, provides a "blow-by-blow" description of the battle that three Illinois cities (Geneva, Batavia and St. Charles) waged against competitors to win approval to move forward with a broadband system. While the referendum was defeated (secured 40% approval), a fierce fight was waged by a grass-roots group of broadband-loving citizens (with a budget of less than $5,000). The primary weakness of the Munitoons approach is the lack of facts in their descriptions of so-called "municipal failures." In playing on the fears and doubts of municipal leaders and citizens, the competition delights in painting all projects with the identical broad brush. Fortunately, this leaves plenty of gaps in their treatment of the facts, which can be easily filled in by the municipalities that have been attacked. The August, 2003:Uptown Draft Phase 2 Report Page 57 of 91 CPAU FTTH Business Plan Uptown Services, LLC staff and community activists with the Tri-City Broadband project compiled responses from most of the municipalities that were deemed to be failures by competitors. Appendix A outlines the results of the Tri-City fact-finding effort. b) Organize If Palo Alto decides to proceed with the FTTH business then getting organized is the next critical step in countering the FUD campaigns that competitors will wage against any FTTH initiative. Should a citywide vote by citizens be required to approve any aspect of the CPAU proposal, it is our understanding that CPAU will not be allowed to promote the FTTH project within 90 days of any such vote. This will leave the telling of the FTTH side of the story to interested citizens and groups, while the incumbents are allowed to promote their story unrestrained. Tri-City Broadband formed a citizen group called Fiber for our Future Committee. Unfortunately, the group was grossly under- funded compared to the incumbents and could not match the persistent barrage of print and television advertising against the project. It is assumed that CPAU will fund the development of an educational strategy to inform Palo Alto citizens about what has been learned in its studies so far. Citizen advocacy groups will need to carry the banner for the 90 days leading up to any election and be creative in the execution of any election plan’s recommendations. Assuming a limited budget for the citizen-driven campaign, these groups will need to host many town hall educational forums, organize "get out the vote" calling efforts and focused voter education campaigns. c) Take the Initiative While competitors may have been absent from the last several UAC meetings, it can be assumed that they will insert themselves once a City Council vote nears. Typically they will attempt to lobby City Council members on an individual basis, behind closed doors and through well-crafted "informational" letters. Their business interest is best served if they are able to stop the initiative before the citizens are even allowed to vote. If the City Council chooses to let the issue go to a vote, Competitors will most likely prepare for and wage a major battle. Their FUD campaign will be carried out using a series of print, radio and television ads. They will also conduct "market research" to gain an understanding of the public’s opinion regarding the City’s proposed entry into the "risky world of telecommunications." Instead of sitting back and waiting for the inevitable barrage of FUD, CPAU should go on the offensive soon after making the decision to proceed. This section has spelled out the charges that have been used time after time to delay or stop proposed projects all over the country. CPAU should be pro-active in dispelling the myths associated with municipal broadband. At a minimum, specific responses should be presented to the press and spelled out in editorials. Ideally, CPAU should invite one or more of the General Managers from the "failed" broadband operations to a Palo Alto City Council or town hall meeting. Even better, challenge Competitors to a live debate on public access. Let them bring their best and brightest Munitoons authors and go a few rounds with the people that went to the trouble to find the truth. However it might be executed, the advocacy campaign will need to succeed in two primary areas: August, 2003:Uptown Draft Phase 2 Report Page 58 of 91 CPAU F-TrH Business Plan Uptown Services, LLC Dispel the FUD that Competitors will attempt to generate. Demonstrate to the voting public that FTTH will benefit the entire community, not just a subset of users. VI. Monthly Operating Budget and Financial Statements Uptown created a new budgeting tool for this business planning effort. The new model offers the capability to look at the business from both monthly and annual views. This allows for a much. greater level of granularity than the FSN Business Model used during the business case development and analysis phase. The following sections describe the primary sections of the budget model and outcomes that it produced for the F’i-I’H business4. A.Revenue 1.Subscriber Forecast and Dispersion Across Tiers The market penetration levels were established for each line of business during earlier phases of this study and are derived from the quantitative research survey. At the core of the revenue model, these penetration rates have been combined with the pricing assumptions from the product section of this document along with numerous other metrics that define revenue. Exhibit 22 provides summary statistics from the 24-month operating budget. 4 The start date for the budget model is July 1, 2004. The first six months of operation are treated as a start- up period, with the first paying subscriber getting installed during January 2005. The model then covers twenty years, in monthly increments. Annual summaries are provided. August, 2003:Uptown Draft Phase 2 Report Page 59 of 91 CPAU FTITI Business Plan Uptown Services, LLC Exhibit 22 - End Of Period Results By Quarter Video Internet Telephon e Homes Passed Subscribe rs Penetratio n Revenue Subscribe rs Penetratio n Revenue Subscribe rs Penetratio n Revenue Year 1 Q1 Q2 Q3 Q4 1,05 3,21 5,97 8,22 9 9 9 5 103 379 928 1,49 8 10%12%16%18% Year One = $258K 126 478 1,11 1,83 9 4 12%15%19%22% Year One = $358K 91 399 1,01 1,64 6 0 9%12% 18%20% Year 2 Q1 Q2 Q3 Q4 11,83 16,39 20,95 24,19 5 6 6 4 2,807 3,419 4,292 4,953 21% 21% 2O% Year Two = $1,940K 2,945 3,966 4,990 20% 5,734 25% 24% 24% 24% Year Two = $2,464K 2,644 3,560 4,401 Year One = $138K 4,987 21%22% 22% 21% Year Two = $743K Conclusions On these metrics include the following: Homes passed reflects a 2-year construction schedule per the original feasibility study Penetration is measured against homes passed, and can fluctuate as the rate of construction accelerates (in Year 2). Revenues are stated as gross revenues, but are net of promotional discounts. Year 1 and 2 revenues are higher than the original feasibility study as an outcome of more specific definition of services pricing. A key driver of gross revenue is the distribution of subscribers across the various package or tier levels available for video and Internet services. Because the range of prices from the lowest package to the highest can be substantial, the dispersion of the subscriber base across these levels is a primary driver of total revenues (and ARPU as a summary statistic). The operating budget contains the following dispersion metrics (Exhibit 23) for each level of Internet and video service (telephone is not included because of a wholesale design). August, 2003:Uptown Draft Phase 2 Report Page 60 of 91 CPAU F’FI’I-I Business Plan Uptown Services, LLC Exhibit 23 - Subscriber Dispersion Across Packa.qes Package Month 1 Month 12 Month 24 Video Limited Basic 4.7%3.9%3.9% Expanded Basic 33.6%29.3%29.3% Digital 1 26.4%30.8%30.8% Digital 2 15.3%16,2%16.2% Digital 3 10%10%10% Digital 4 10%10%10% Internet Tier 1 33%29%25% Tier 2 31%32%33% Tier 3 11%12%13% Tier 4 16%17%18% Tier 5 9%10%11% 2. Discount Budget (Contra Revenue) A common practice within the telecommunications industry is to incorporate promotional offers into marketing and sales programs. These discounts are normally applied as reductions to the recurring rate of a particular product for a defined period of time, generally between one and three months. In some cases, these discounts last longer when combined with contract commitments. Uptown expects that CPAU staff will likely employ promotional offers from time to time to enhance the effectiveness of its marketing programs and accelerate subscriber growth. From a business plan perspective, it is important to "fund" price discounts of this nature so that revenue targets are adjusted accordingly. These discounts are viewed from a financial perspective as contra revenues, meaning they simply subtract from the realized top line revenues of the venture. From its experience in mature incumbent operators, Uptown believes that discounts will run at about 5% of gross revenues with a stable customer base. Since CPAU is entering the market and is building its broadband customer base from scratch, the early years of the venture will see a much higher percentage of revenues being offset by promotional discounts. In this business plan, Uptown has included discounts at 25% of gross revenue at Month 1, dropping to 15% and then 5% by months 12 and 24, respectively. These discounts only apply to video and Internet services, as telephone is wholesale. 3.Other Revenue Sources The following additional revenues are included in the 24-month operating budget as important components of optional services that lift ARPU. Uptown has conservatively August, 2003:Uptown Draft Phase 2 Report Page 61 of 91 CPAU FTTH Business Plan Uptown Services, LLC used industry-standard benchmarks as guidance in setting the pricing and incidence of these optional services among CPAU’s subscriber base. a)Installation Revenues In theory most incumbents have established rate card prices for installation or activation of service. In practice many of these fees are waived, either on a promotional basis or through management policy that enables these charges to be waived by sales representatives. Especially in the video and Internet sectors, providers are wary to charge an upfront fee when they are trying to lure subscribers away from competitors. Accordingly, the operating budget does not contain revenues ascribed to video installation and only includes them on "premium" installs for Internet. This reflects the trend over the last 12 months where providers offer Internet self-installs for free but charge a fee if the customer needs a technician to visit the premises and complete the install. CPAU should take the same approach to control its field operations expenses and provide the customer with options that meet their needs. Uptown has set the pricing for self-install at $50 with a take rate starting at 25% in Year 1 and decreasing over time to 14% at the end of Year 2. Uptown assumes this metric decreases over time as the market becomes more comfortable with a do-it-yourself (DIY) approach, and as more neighbors help neighbors. b) Premium Video Channels. Incremental premium channel revenues are derived from analog (Limited Basic and Expanded Basic) customers who elect to receive HBO, Showtime, etc. It should be noted that incremental premium channel revenues are not realized from digital subscribers as these services are packaged into the digital tiers. The number of premium channels selected is the variable that differentiates each package. In the operating budget, it is assumed,that 40% of analog subscribers are buying an optional premium channel in Year 1 and that this declines (due to upgrades to digital over time) to 29% at the end of Year 2. Ala Carte premium channels are priced at $11.95 each. c)Additional Box Revenue The operating budget has 20% of all video subscribers renting an additional set-top box for $4.95 per month. This percentage remains flat. d)High Definition Television The operating budget has 10% of all video subscribers renting a high definition television (HDTV) converter for $5.00 per month starting in Year 1. This percentage grows to 22% by the end of Year 2. e)PPV/VOD The operating budget has 25% of all video subscribers renting an average of 1.5 (buy rate) pay per view or video-on-demand movies (per month) for $3.99 per viewing. This percentage remains flat. The operating budget does not include revenues from adult PPV. f) Number of Lines The operating budget has telephone subscribers using an average of 1.3 lines per household. Although CPAU is not the retailer, its wholesale terms will be based upon the August, 2003:Uptown Draft Phase 2 Report Page 62 of 91 CPAU FTTH Business Plan Uptown Services, LLC number of access lines and we assume a wholesale rate of $8.00 per line. The incidence of additional lines remains flat. g’) Calfing Features and Long Distance Because this line of business is wholesale, additional revenues are realized by CPAU as a percentage of net income with its retail partner. This is assumed at $5 per month and reflects all revenues (line revenues as well as features and long distance revenue) contributing to net income of the third party retailer. h) Telephone installation charges Uptown assumes that CPAU will charge the retail telephone provider a nominal installation charge per new subscriber. The operating budget includes a $25 installation charge per new telephone subscriber. The CLEC will choose whether or not to pass this charge along to their end users. 4.Summary Statistics a)Average Revenue Per User Average revenue per user (ARPU) is presented in Exhibit 24 as derived from the. operating budget. The significant increase in ARPU in Year 2 is due to the initial effects of promotional discounts wearing off from Year 1. Although dispersion towards higher-level packages increases ARPU, the primary driver is promotional discounting. For Internet, the dispersion changes account for $4 the ARPU increase from Year 1 to Year 2, with the balance being a significant reduction in discounts per subscriber as the’ customer base begins to achieve scale. Exhibit 24 - Averaqe Revenue Per User Year I Year 2 Year 5 Year 10 Video $43.26 $49.49 $59.91 $66.14 Internet $48.49 $53.66 $65.35 $72.95 Telephone $19.79 $17.54 $15.68 $15.53 b)Churn rate The monthly churn rate is an important metric in that it has a ripple effect through the financial statements in impacting cash flow and the ability to grow market share. The telecommunications industry experiences a higher rate of subscriber churn than many other service industries. Service providers separate monthly churn (percent of subscribers who disconnect in a given month) into voluntary and involuntary categories. Voluntary churn represents moves and customers switching to another provider of their own volition. Involuntary churn consists of subscribers who are disconnected by the provider due for non-payment. Uptown used standard operating benchmarks in setting the figures presented in Exhibit 25. August, 2003:Uptown Draft Phase 2 Report Page 63 of 91 CPAU F’VFH Business Plan Uptown Services, LLC Exhibit 25 - Monthly Churn Rates ~lonthly i~lonthly I~lonthly Total Voluntary Churn Involuntary Churn Churn Video 2.4%0.8%3.2% Internet 3.0%1.2%4.2% Telephone 2.6%1.0%3.6% B. Expense This section describes the relevant details related to the expense portion of the FTTH budget model. 1.Cost of Goods Sold (COGS) The budget model includes detailed COGS calculations for the video and Internet services being offered over the FTTH system. CPAU will not incur any direct costs associated with delivering wholesale telephone services, so that COGS is $0 for that service. a) Video COGS Video COGS can be summed in one word - programming. Programming costs vary from less than 10¢ to over $2.00 per channel. Unfortunately, the costs for some channels have been growing at very high rates, which is one of the reasons for more frequent rate increases by cable operators. Uptown had assumed that this trend could not continue and that the FCC or U.S. Congress would introduce some form of rate control. This has not been the case, so the budget model uses much higher programming rate increases than were used in previous versions of the FSN Business Model. Exhibit 26 shows the projected growth rate and resulting programming costs for each tier of video service. August, 2003:Uptown Draft Phase 2 Report Page 64 of 91 CPAU FTTH Business Plan Uptown Services, LLC Exhibit 26 - Proqramminq Costs by Video Tier Annual Increase Limited Basic Expanded Basic Digital 1 Digital 2 Digital 3 Digital 4 Gross Margin 2004 $1.00 $13.98 $18.38 $22.76 $25.96 $29.21 N/A 2005 10.0% $1.10 $15.38 $20.22 $25.04 $28.56 $32.13 50% 2006 10.0% $1.21 $16.92 $22.24 $27.54 $31.41 $35.35 49% 2007 5.0% $1.27 $17.76 $23.35 $28.92 $32.98 $37.11 53% 2008 3.0% $1.31 $18.29 $24.05 $29.78 $33.97 $38.23 53% b)Internet COGS Like video COGS, Internet COGS is dominated by one factor. In this case, it is the cost of bandwidth to the Internet backbone. The backbone connection costs approximately $250 per Mbps and CPAU will need to purchase enough capacity to provide the stated level of service for each tier of Internet service. Uptown has shared the method of calculating the required amount of bandwidth to the backbone with CPAU staff. However, it is not recommended that these calculations be published in this plan. 2.Operating Expenses a)Distribution (Sales Channels) Per the previously outlined sales plan, Uptown recommends that CPAU employ five sales channels for the FTTH venture. The detailed assumptions for each of the proposed channels are discussed next. (1) Inbound Call Center One of the mainstays for selling FTTH services will be the FTTH inbound call center. It is assumed that a significant number of calls from the core utility will be forwarded to the FTTH center where a qualified group of customer service representatives (CSR’s) will then attempt to sell video, Internet and telephone services to potential subscribers. The budget model includes (7) headcount for taking these calls from the main call center. These CSR’s will also be responsible for customer care, so seven full time equivalents (FTE’s) will be allocated to this function. (2)Outbound Telemarketing Outbound telemarketing will be used during the formative stages of the FTTH business. This function will be contracted to a qualified call center on a "fee-per-sale" basis. Outbound calling will be used through 2006 at a cost of $60 per feature sold. August, 2003:Uptown Draft Phase 2 Report Page 65 of 91 CPAU FTTH Business Plan Uptown Services, LLC (3) Direct Sales Door-to-door selling will also be used by the FTTH operation. This tactic has proven to be very effective in other areas and will employed through 2006. This function will be contracted to a qualified firm or local organizations at a cost of $45 per video sale and $50 each per Internet and telephone sale. (4) Payment Center It is assumed that there will be a FTTH payment center location where customers will be able to come in and pay their bill or sign up for service in person. While this will not be a major source of new sales, it will serve as a long-term channel for broadband business. It is assumed that the inbound call center will located in the same facility as the payment center. This will allow for coverage of the payment center counter by one or more the seven inbound call center CSRs. (5)Online Ordering Online ordering will also be used. The budget includes $1,500 per month in expense for technical support ($500) and e-commerce services ($1,000). General & Administrative Expenses (1)Staff Costs and headcount Exhibit 27 shows the projected staffing levels and the start dates for each position. Exhibit 27 - General & Administrative Staffinq Position LoadedStartSalaryOverheadCost General Manager Jul-04 $120,000 $72,000 $192,000 Analyst Sep-04 $55,000 $33,000 $88,000 Product Manager Sep-04 $75,000 $45,000 $120,000 Operations Manager Sep-04 $90,000 $54,000 $144,000 Service Supervisor Sep-04 $60,000 $36,000 $96,000 Data Technician1 Oct-04 $80,000 $48,000 $128,000 Head End Technician1 Oct-04 $80,000 $48,000 $128,000 Head End Technician2 Nov-04 $80,000 $48,000 $128,000 Dispatch Nov-04 $55,000 $33,000 $88,000 Field Techl Sep-04 $60,000 $36,000 $96,000 Field Tech2 Sep-04 $60,000 $36,000 $96,000 Field Tech3 Oct-04 $60,000 $36,000 $96,000 Field Tech4 Oct-04 $60,000 $36,000 $96,000 Field Tech5 Nov-04 $60,000 $36,000 $96,000 Field Tech6 Dec-04 $60,000 $36,000 $96,000 Total $1,055,000 $633,000 $1,688,000 August, 2003:Uptown Draft Phase 2 Report Page 66 of 91 CPAU FTTH Business Plan Uptown Services, LLC (2)Professional Services The budget includes line items for the different types of professional services that will be contracted during the early years of the broadband business. Broadband consulting services will be used to assist in the development and launch of the business. Legal council (outside and inside) will be needed to support CPAU through the likely challenges on the legal and regulatory front. A public relations firm will be needed to create a comprehensive public relations plan for the launch of the system. It is assumed that some training will need to be completed that is not covered in the cost of equipment and systems being purchased. Finally, an accountancy will be required to set up the accounting framework of the new broadband department. Exhibit 28 - Professional Services Contract Service Broadband Consulting Legal/Regulatory Public Relations Training Accounting Total 2004 $210,000 $160,000 $95,000 $6o,000 $100,000 $625,000 2005 $245,000 $60,000 $0 $0 $0 $305,000 (3) Billing It has been assumed that billing for video and Internet services will be processed by a stand-alone billing system to be purchased before launch. The budget includes a monthly expense of $0.25 per video and Internet subscriber to account for the expense of creating and mailing those bills. A capital line item of $30,000 has also been included to pay for the billing platform itself. This assumption is based on actual discussions with a specific billing system provider. (4) Marketing The detail for the proposed marketing budget is presented in Exhibit 29. August, 2003:Uptown Draft Phase 2 Report Page 67 of 91 CPAU FTrH Business Plan Uptown Services, LLC Exhibit 29 - Marketing Expenditures by Type Contract Service 2004 2005 2006 2007 2008 Awareness Advertising $46,500 $99,975 $104,974 $110,222 $115,734 Direct Mail $24,000 $176,160 $132,120 $132,120 $132,120 Events Marketing and PR $30,000 $40,200 $40,200 $40,200 $40,200 Bill Inserts $2,400 $20,880 $20,880 $20,880 $20,880 Sales Collateral $7,800 $36,348 $36,348 $36,348 $36,348 Total:$110,700 $373,563 $334,522 $339,770 $345,282 % Of Total Revenue:53.7%6.9%3.8%3.3%3.1% (5) Bad Debt Expense Bad debt is assumed to be 1% of revenues for the life of the plan. Annual bad debt grows from $103,000 in 2008 to $175,000 at the end of the plan (2024). (6)Transfers to the General Fund The budget includes the capability to make transfers to the City’s General Fund. No transfers have been included at this time, but should they occur, it is likely they will come from the Cash account. (7)Travel and Entertainment A $5,000 monthly travel and entertainment budget has been included over the life of the plan. C.Capital Requirements 1.Capitalized Engineering It.has been assumed that a third party engineering and construction management firm will be hired to engineer the FTTH system and manage its construction. This contract will last the length of the construction process and is budgeted to cost $335,000 through 2006. 2.Outside Plant 62% of the total capital budget is made up of materials and labor associated with constructing the FTTH system. The cost of building a FTTH system has been declining over the past several years, but the budget reflects a constant cost of $759 per meter passed for the life of the plan. The budget also includes $100 per meter passed for network upgrades in 2014. August, 2003:Uptown Draft Phase 2 Report Page 68 of 91 CPAU FTTH Business Plan Uptown Services, LLC 3.Subscriber capital a)Network Interface Units The second largest capital cost (26%) in the FTTH budget is network interface units (NIUs), the units installed at a subscriber’s residence or business to convert the optically transmitted information into signals that can be understood by standard television sets, telephones, network routers and computers. The cost of these devices has also been declining and it has been assumed that the trend will continue into the future. Previous versions of the FSN Business Model were based on the assumption that the number of NIUs required was equal to the maximum number of subscribers for any single service. This was based on the notion that most subscribers would purchase all three services. The budget reflects a more conservative approach and assumes a greater number of single and two service households. Using this approach introduces a factor of 180% to the previous NIU calculation. For example, CPAU would need to install 1.8 times the maximum number of subscribers for any given service. NIUs are budgeted to.cost $725.00 in 2004 with a steady decline to $436.50 by 2008. The budget also includes $150 per NIU for upgrades in 2014. b) Set Top Boxes Set top boxes account for 5% of the total capital budget in the new model. Standard ’ digital boxes are budgeted at $235 each, with HD boxes at $400 each. These costs are also expected to decline over the life of the plan. 4.Vehicles It has been assumed that CPAU will need to purchase new vehicles for the outside technicians in the budget. A total of $290,000 has been budgeted during the first 12 months of operation for pick-up trucks and bucket trucks. 5. Head End Equipment This category covers the cost of all equipment required to process a video signal and put it on the FTTH system. $1.75M has been budgeted to cover the costs of installing the equipment required to support the following services - analog video, digital video, VOD, HDTV and FM radio. These costs are based on recent installations and other municipal build-out budgets. 6. Enterprise Equipment Enterprise equipment is defined as the computers, routers and switches required to make the back office run. A little more than $100,000 has been budgeted for the network operations computers, billing system server and head end based Ethernet switches and routers. D.Financial Statements Financial statements for the FTTH venture are attached as Appendix X. The following sections detail the highlights of the budget in the context of the income statement, statement of cash flows, financing description and balance sheet for the venture. August, 2003:Uptown Draft Phase 2 Report Page 69 of 91 CPAU FTrH Business Plan Uptown Services, LLC 1.Income Statement a) Gross Margin The definition of gross margin is total revenue minus costs directly related to delivering services (COGS). Gross margin for video, Internet and telephone services are all very strong based on the pricing strategies recommended by Uptown, so it should be expected that the venture would enjoy a healthy overall gross margin. This is the case with gross margins starting at 54% in 2005 and growing to 68% by 2009. High gross margins are not uncommon in capital-intensive businesses that require large marginal profits to pay back a large investment in infrastructure. This business also requires maintenance of a large operating budget for functions like sales, marketing, customer care and billing (SG&A). Large gross margins can be gobbled up quickly by high human resource and marketing budgets. This is addressed next. b) Operating Margin- EBITDA Operating margin is defined as gross margin minus operating expenses like marketing, customer service, operations and management. This is also referred to as earnings before interest, taxes, depreciation and amortization ("EBITDA"). EBITDA is commonly used as a key measuring stick for the health of a business. A company with negative EBITDA cannot fund its own operating expenses and is forced to either draw on cash reserves or look for outside sources of funding (debt or equity). EBITDA in the FTTH budget model looks reasonable for a venture of this size. Operating margin goes positive in 2007 and stays positive for the remainder of the plan. EBITDA levels grow year-over-year as well. This generally is one sign.of a strong business plan. c)Net Income Net income is defined as operating income minus depreciation minus interest on debt minus taxes. Given the high level of debt and depreciating assets, net income stays negative for the early years of the plan. Net income goes positive in Year 5 and cumulative net income goes positive in Year 9. While depreciation and interest begin to trail off slightly at this point, it is the growth in operating margin that lifts net income into the black. Net income is not as clear an indicator of health as operating margin, given the non-cash nature of depreciation. Calculation of cash flows takes depreciation back out of the picture. 2.Statement of Cash Flows a) Cash Flow from Operating Activities. As the name implies, cash flow from operating activities is defined as the net income plus depreciation (add back) less any required increases in working capital. Working capital is calculated in the budget model as the sum total of cash on hand, one month in accounts payable due (negative), one month in accounts receivable (positive) and two months of inventory (positive). Given its composition, working capital should be expected to grow over the life of the plan. So, this cash flow measure will only grow if net income growth outpaces that of working capital. August, 2003:Uptown Draft Phase 2 Report Page 70 of 91 CPAU FTrH Business Plan Uptown Services, LLC Cash flow from operating activities goes positive in Year 4. It continues to grow through the rest of the plan. b) Cash Flow from Investing Activities Capital investments are very high in the first five years of the plan. The total invested through 2008 is slightly less than $32.0 million. Spending then trails off to approximately $500,000 per year until the year 2014 when NIU and network upgrades require $5.5 million in funding. It is assumed that any bond used to fund this project can only be used to fund capital expenditures. This is the reason equity invested by CPAU has been introduced to the plan. This is discussed next. c) Cash Flow from Financing Activities Like any business, the FTTH business has two choices in funding vehicles - debt or equity. Most businesses use some combination of the two. Investors receive equity ownership and possible dividends in return for their investments, while lenders receive payments of principle and interest for theirs. It is clear that any bond proceeds would be classified as debt in the budget and Uptown has also chosen to treat CPAU cash infusions as debt. The bond amounts have been calculated according to a single round of funding in the first year of the plan. Actual proceeds would not be used until needed on a monthly basis. These draws are depicted in the business plan budget as monthly "drawdowns." It has been assumed that interest would be paid for all bond debt, but that principal payments would not be required until the start of the fourth year of the plan. The budget includes principal payments starting in Year 4 for the bond. The budget also includes financing from the core utility. This is discussed in the context of net cash flow next. d)Net Cash Flow (Utility Loan) Net cash flow is defined as the sum total of three aforementioned cash flows (operating, investing and financing). Without additional investment, the business generates negative net cash flows through 2006. This is due to the high cost of operating the business without a correspondingly high revenue stream. The business becomes self- funding (positive net cash flow) in 2007; so additional investment is only required through 2006. It is assumed that the FTTH venture would borrow the amount required to maintain positive cash from the core utility. The total utility loan required is $6.7 million. The budget includes interest.payments on the outstanding loan balance starting in the first year of the plan. Principal payments start in 2007 and continue until the debt is retired. The current budget uses a five year amortization schedule for the utility loan. With this level of investment by the City, net cash flow remains positive for the entire plan. Cumulative cash flows grow to $5.8 million in five years and $32.7 million over 15 years. e) Terminal Value Terminal value is defined as the value of the business if it were to be sold instead of continued: Many companies are valued as some multiple of their forward-looking EBITDA, Depending on the industry, multiples range from 1 to 30. A conservative August, 2003:Uptown Draft Phase 2 Report Page 71 of 91 CPAU FTI~-I Business Plan Uptown Services, LLC estimate for a broadband business might be 7 times EBITDA. At this measure, the FTTH business would be worth $55.0M in 20 years, which would amount to $3,131 per account. For a "sanity check", this is compared to a recent sale of an RCN system in Pennsylvania that sold for over $4,000 per subscriber. Assuming an EBITDA of less than $400 per subscriber, this system sold for more than 10 times EBITDA. Uptown believes it is reasonable to use 7 as the EBITDA multiplier in the calculation of terminal value and internal rate of returns discussed next. f) Returns- No Financing (Unlevered) The budget model calculates returns for the business plan using two methods - levered and unlevered. The unlevered return is based on cash flows that do not include financing activities (debt and equity). A levered return is based on the actual financing plan projected that is detailed in the overall plan. For the unlevered case, terminal value is calculated for the final year of the plan (2024) and added to the overall cash flow for the purposes of determining internal rate of return (IRR). As the financial statement shows, IRR for years 2019 and 2024 are projected to be 5% and 11% respectively. Returns without terminal value in 2019 and 2024 were projected to be 5% and 9% respectively. g) Returns - Levered For the levered case, terminal value is calculated for the final year of the plan (2024) and added to the overall cash flow for the purposes of determining internal rate of return (IRR). Any remaining debt is subtracted from the final year’s cash flow as well. This measure of IRR is not applicable for a plan without equity investment. 3. Financing Debt was used to fund negative cash flows for the FTTH venture. See Section C (Cash Flow from Financing Activities) for a complete description of the proposed financing strategy. 4.Balance Sheet By all accounts the balance sheet for the FTTH business looks strong. Current assets (cash, inventory and accounts receivable) are at least 200% of current liabilities (accounts payable) starting in 2005 through the rest of the plan. Debt is paid off steadily over the 20 year period and retained earnings grows to more than $66.5 million by the end of the plan. VII. Partnering Strategy CPAU will seek out partners of different sorts for video, Internet and telephone services. It was hoped that a Bay Area cable television provider could provider head end services to the FTTH system. Additionally, it has been assumed that the FTTH system will be opened to third party retail ISPs that would provide services directly to their end users. Finally, it has been assumed that CPAU will offer one retail CLEC exclusive access to be the sole provider of telephone services on the F’I-I’H system. These strategies were developed first in the business case phase and further refined during phase one of the business planning effort. Updates for each approach are provided in the following sections. August, 2003:Uptown Draft Phase 2 Report Page 72 of 91 CPAU F1TH Business Plan Uptown Services, LLC A. Video programming partner There are a number of local cable television providers that could provide head end services to CPAU. Uptown has been pursuing a deal with the leading contender, but discussions have slowed while legal issues are studied. It would not be appropriate to disclose the possible partner at this time. CPAU staff has taken the lead in the effort to overcome the issues raised. In the meantime, Uptown will continue to budget for a CPAU-provided head end. The following table shows the significant differences in the business case, based on the head end sourcing strategy. Exhibit 30 - Business Case Assumptions for Different Head End Sourcinq Options Head End Source Assumption CPAU Third Party Video head end capital cost $1.5M for full head end $250K for hub electronics Staffing 2.0 head end techs 1.0 head end tech Monthly costs $0 $10,000 head end service fee As Exhibit 30 shows, sourcing a head end from a third party saves over $1 million in up front capital and the cost of one head end technician over the life of the plan ($96,000 loaded annual cost). It is assumed the annual cost of leasing head end services would be approximately $120,000. This is based on proposals that have been proffered to other Uptown clients in similar situations. The net cash impact on the project would be a reduction of $1.25 million in capital in return for an additional $24,000 in annual expense. Not including interest, the break-even point for this scenario would exceed 52 years. So it is clear that partnering would benefit the City when it comes to head end services. B. Local Telephone Partner Uptown has found a likely candidate to provide retail telephone services on the FTTH system. E-Tel, of Paducah, Kentucky, has expressed interest in partnering with CPAU for telephone services. They currently provide local and long distance telephone services on the Murray Electric System (MES) HFC system in Murray, Kentucky. They are experiencing great success in their relationship with (MES) and appear to be in a position to provide first class telephone services over the FTTH system. Sample terms for a retail telephone partnership in Palo Alto are summarized in Exhibit 31. August, 2003:Uptown Draft Phase 2 Report Page 73 of 91 CPAU FTFH Business Plan Uptown Services, LLC Exhibit 31 - Terms of Retail Telephone Partnership Term Services Provided by e-tel to retail subscribers Key responsibilities of e-tel Key responsibilities of CPAU Compensation paid Description o Local telephone ¯Custom calling features ¯Enhanced services o Long distance telephone .Third party long distance access ¯Purchase and maintain telephone switching equipment ¯Billing and collections for aforementioned telephone services ¯Provide and market aforementioned telephone services ¯Provide a sales force to properly market e-tel provided services ¯Provide a technician available for repair and installation 24/7 -Make all required regulatory filings (local, state and federal) o Provide transport services from head end connection to telephone port(s) on the subscriber NIU ¯Provide space contiguous to head end for e-tel telephone equipment o Provide office space for e-tel customer contact personnel ¯Provide a single point of contact for all telephone related provisioning and customer support issues ¯Provide and maintain customer premises equipment (NIU) required to offer telephone services Monthly fee for the following fixed cost items: to CPAU 2. 3. 4. ® Building lease (per square foot) Administrative overhead Operation and maintenance of broadband plant Staffing dedicated to telephone operation Monthly fee per subscriber NIU 50% of net income generated from Palo Alto telephone operation Based on e-tel’s experience with MES, it can be assumed that CPAU will receive approximately $13.00 per telephone subscriber as awholesale fee from e-tel. Uptown August, 2003:Uptown Draft Phase 2 Report Page 74 of 91 CPAU FTTH Business Plan Uptown Services, LLC has used the e-tel relationship with MES as a baseline for comparison to future offers from other CLECs. CPAU should plan on completing a formal selection process prior to locking into the final retail telephone provider for the FTTH system. C.Internet Retailers Uptown had hoped to enter into detailed discussions with the top national retail ISPs operating in the Palo Alto market. Unfortunately, calls to AOL, Earthlink and MSN so far have not been returned. It would appear that these companies are either not interested or have higher priorities. CPAU may have better luck garnering attention for their wholesale Internet offering once the project moves from the planning stage into implementation. VIII.Organization Structure A.Organizational Chart and Philosophy By entering the broadband services sector and building a new FTTH network, CPAU will increase its operational activity from current levels. This will occur in two areas. First, there will be three new lines of business to manage. Second, there will be greater operations activity from launching, installing, and supporting these services on a day-to- day basis. The overall organizational philosophy being recommended is that CPAU leverage the current management team and structure for the first area of activity (management focus) and that staff be added based upon incremental workload to support the second area of activity (customer operations). This approach is not only efficient, but it has been successfully used by other utilities that have entered the broadband sector using an organizational approach that closely integrates the incremental headcount into the existing utility organization. The overall organizational strategy for CPAU’s broadband initiative can be summarized in the following objectives: Organizational Objective 1: Achieve organizational efficiencies through a common management structure with the current utility department. Rather than creating a new, standalone organization, the organizational design should fit under the current functional departments of CPAU as it exists today. Organizational Objective 2: Identify and recruit talented front-line employees to staff the incremental operating positions that the new work activity generated by the broadband business will create. These are activity-based positions primarily involving customer support functions. Organizational Objective 3: Internally staff key positions that interface directly with customers to best control the quality of customer service that CPAU delivers to its broadband customers. External contractors will be used selectively where needed, and primarily for those job functions that are driven by short-term activities to initially launch the broadband venture (e.g. network construction, direct sales, outbound telemarketing). Organizational Objective 4: Establish agreement across CPAU management to equally prioritize broadband operations with existing utility functions so as to ensure that proper emphasis and balance is provided. Especially within frontline departments, there is a risk that employees designated to support broadband August, 2003:Uptown Draft Phase 2 Report Page 75 of 91 CPAU FTrH Business Plan Uptown Services, LLC services could be re-assigned from their established duties in supporting the new venture. Cross training of employees between related jobs will be important to control costs and improve subscriber satisfaction. With this organizational philosophy in mind, the following general structure is recommended for those functional area impacted by the broadband operation. Exhibit 32 - Recommended Orqanizational Chart B. Staffing Levels and Budget The "staffing" of the broadband organization can be sourced through hiring incremental staff as full time CPAU employees, adding the new broadband lines of business to existing staff responsibilities, aggressive cross-training of CPAU staff to add broadband competencies, or by contracting with external firms providing labor services. This business plan recommends a combination of these sourcing options, as reflected in Exhibit 33. Exhibit 33 - Headcount Source By Functional Area Functional Add Duties to Hire Incremental OutsourcedAreaCurrent Staff Staff Marketing X X Sales X X Field XOperations Customer Care X Engineering X - Ongoing X - Initial Design Construction X August, 2003:Uptown Draft Phase 2 Report Page 76 of 91 CPAU FTTH Business Plan Uptown Services, LLC The operating budget sets aside expense dollars to fund the use of external contractors for the initial engineering design of the network, the actual network construction, the use of outbound telemarketing and direct sales during the startup phase of operations. The budget for additional salaried employees is driven by the following incremental headcount plan, which is benchmarked against a broadband utility serving a market of similar size to Palo Alto. This is presented in Exhibit 34 and indicates that 22 incremental headcount are required. Exhibit 34 - Incremental Headcount for Broadband Operations Department Title Management General Manager Analysts/Ops. Support Product Manager Operations Manager/Supervisor Data Technician Field Technicians Headend Technicians Customer Care Service Supervisor Service Representatives Dispatchers Total Incremental Headcount CPAU Business Plan 1 1 1 1 1 6 2 1 7 Benchmark Utility 2 1 1 4 2 1 1 22 18 The budget required to create these additional positions is driven by the following wage assumptions for each position. These annual salary costs are unloaded and are budgeted at a 60% loading in the operating budget. $120,000 = $120,000 x 1 General Manager $55,000 = $55,000 x 1 Analyst $75,000 = $75,000 x 1 Product Manager $90,000 = $90,000 x 1 Operations Manager/Supervisor $80,000 = $80,000 x 1 Data Technician (Tier 2) $360,000 = $60,000 x 6 Field Technicians $160,000 = $80,000 x 2 Headend Technicians (Tier 2) August, 2003:Uptown Draft Phase 2 Report Page 77 of 91 CPAU FTTH Business Plan Uptown Services, LLC $60,000 = $60,000 x 1 Service Supervisor $55,000 = $55,000 x 1 Dispatcher $385,000 = $55,000 x 7 Service Representatives $1,440,000 Annual Staff Budget (Unloaded) C.Skills and Functional Roles The operational role and responsibility of each functional area that support a broadband services organization are the following: Marketing: Creates and implements advertising and promotional programs to enhance brand image and generate demand for services to assist in sales activities. Sales: Consists of representatives who are staffed among the various sales channels to make contact with prospective customers and write sales orders. Field Operations: Conducts customer installs and service calls (repair) at the customer premise. Customer Care: Consists of service representatives whom are front-line employees providing a range of customer service activities over the telephone. Activities supported in this functional area are customer care, billing, inbound sales, and dispatch. Responsibilities within each of these areas are: Customer Care: Take repair calls and initiate a trouble ticket if necessary. Provide telephone support for customer service problems. ¯Billing: Answer billing questions and provide billing information as needed. ¯Inbound Sales: Inform prospects of the services available and assist the customer in selecting services. Explain how CPAU services compare to competitor offerings. Job functions and responsibilities will be defined as follows for the 10 titles associated with broadband operations. Where indicated, existing CPAU titles will be used. General Manaqer 0 Title: new CPAU position. ~i Salary Range: Budgeted at $120,000 annual. Position Responsibilities: Responsible for the operational performance of CPAU’s broadband services including the profit and loss and overall financial performance, achievement of business plan targets, and customer service provided to broadband customers. Sets the overall strategic direction for CPAU’s broadband initiatives in conjunction with the governing board. Analyst o Title: new CPAU position. August, 2003:Uptown Draft Phase 2 Report Page 78 of 91 CPAU FTrH Business Plan Uptown Services, LLC ®Salary Range: Budgeted at $55,000 annual. Position Responsibilities: Responsible for providing informational support to the general manager including reports, data analysis, benchmarking, and other analytical activities needed to manage the business. Product Manaqer Title: new CPAU position. Salary Range: Budgeted at $75,000 annual. Position Responsibilities: Responsible for providing strategic and tactical direction for CPAU’s broadband services including product design, pricing, and new product development. Operations Mana.qer/Supervisor Title: new CPAU position. Salary Range: Budgeted at $90,000 annual. Position Responsibilities: Responsible for the day-to-day supervision and coaching of the field technicians, data technicians, and headend technicians. Data Technician (Tier 2) Title: new CPAU position. Salary Range: Budgeted at $80,000 annual. Position Responsibilities: Responsible for monitoring and maintaining field and headend data services facilities and hardware. Field Technicians ¯Title: Existing CPAU position titled "Utility Field Service Representative" ¯Salary Range: Budgeted at $60,000 annual. ¯Position Responsibilities: Responsible for providing installation, disconnect, and service/repair support at the customer premises and elsewhere in the field. Headend Technicians (Tier 2) Title: new CPAU position. Salary Range: Budgeted at $80,000 annual. Position Responsibilities: Responsible for the day-to-day operation of the headend to ensure seamless delivery of video signal and Internet traffic. Service Supervisor ° Title: new CPAU position. o Salary Range: Budgeted at $60,000 annual. August, 2003:Uptown Draft Phase 2 Report Page 79 of 91 CPAU FTTH Business Plan Uptown Services, LLC Position Responsibilities: Responsible for the day-to-day supervision and coaching of the service representatives. Dispatcher ,Title: new CPAU position. ¯Salary Range: Budgeted at $55,000 annual. ¯Position Responsibilities: Responsible for directing the day-to-routing of the field technicians to ensure maximum field productivity and response to customer needs in the field. Service Representatives ¯Title: Existing CPAU position titled "Customer Service Representative" ¯Salary Range: Budgeted at $55,000 annual. Current CPAU salary is $54,891 (Step 5) Position Responsibilities: Responsible for taking service, billing, and sales inquiry calls from customers over the telephone. These representatives create work orders (for new orders and change orders) and create trouble tickets (for repair calls). IX.Core Process Analysis Uptown completed a high level analysis of the core processes for the new broadband services operation. It has been assumed that the bulk of the FTTH operation would be contained in a stand-alone operating unit, but this new unit will also be required to operate within the broader CPAU environment. Uptown’s analysis has focused on the capability of existing CPAU personnel and systems to support new FTTH processes. Process flows for the core FTTH processes have been completed and have been provided to CPAU staff. Summaries of findings and recommendations for each area are provided in the following sections. A. Billing The current utility billing system is not capable of processing pay per view billing information for cable television subscribers. The system is also not capable of billing transaction level detail for telephone services. The billing system provider has expressed interest in developing such capabilities (telephone would not be a priority for CPAU), but the time and cost of such an endeavor are not known. Given the complexity of billing for video services and the intricacies involved with integrating with the set top box control system, Uptown recommends that CPAU invest in a stand-alone billing system for the FTTH business unit. There are several systems in the market that provide the capability to bill video and Internet services. They are affordable and have been in use by small to medium sized cable operators for many years. Uptown has evaluated a billing system from Great Lakes Data Systems and found it to be sufficient to use for planning purposes. Start-up costs should be less than $50,000 for hardware and software and the cost of operation August, 2003:Uptown Draft Phase 2 Report Page 80 of 91 CPAU FTTH Business Plan Uptown Services, LLC appears to be very low. There are certainly other options in the market and CPAU would be well served by completing a formal selection process prior to implementation. B.Customer Service and Sales The general assumption relative to both customer service and sale functions is that its own group of representatives will support FTTH, separate from the group that currently supports the core utility. One of the primary challenges to this approach will be to smoothly integrate the new group of customer service representatives (CSRs) with the existing CPAU team. It is assumed that all calls to CPAU will be routed through a voice response unit that will prompt the caller for their choice of operating units, if that choice was not already indicated by the telephone number dialed. This is currently done to route trash collection customers directly to the private provider. The following sections provide summaries for the process impacts related to sales and customer service. 1.Sales The current CPAU service center will not be capable of supporting a significant level of FTTH sales activity. It is assumed that FTTH sales opportunities identified by utility CSRs will be transferred to a specialized group of FTFH sales representatives that have been given the appropriate training on all services being offered on the FTTH system. This approach creates the following issues for the current CPAU processes: Core utility representatives will need to be trained on identifying (qualifying?) FTTH sales leads and transferring them to the broadband group. FTTH representatives should be on the same internal telephone system to allow for fast and effective transfers from the core utility group. F-I-rH representatives will need to have access to the customer information entered into the utility billing system (Banner) at the time that the potential FTTH subscriber is transferred to the FTTH center. This is going to be an issue, because some new utility service orders are completed one or more hours after the initial request for service is taken. 2.Customer Service The current CPAU customer service center is at full capacity and would not have the capability to tackle FTTH related customer service. Uptown recommends that CPAU create a separate customer service group for the FTTH operation. This is due to the complexities involved with selling three services and the focus required to get the new business off the ground. It can be assumed that broadband services will introduce new challenges that will require immediate and intense focus by a small number of experts. This would not be possible in a larger call center environment with many competing priorities from the core utility business. It is assumed that the customer service department will be staffed to provide coverage from 8:00 am to 9:00 pm Monday through Saturday. Customer service and sales calls will be handled during these times, including help desk and technical support for Internet services. After hours support will provided in emergency situations, but 24 x 7 customer service coverage is not being recommended. Some clients have chosen to outsource overflow sales and help desk functions to third party providers. This may be an option for broadband as well, but Uptown has budgeted for 100% in-house coverage. August, 2003:Uptown Draft Phase 2 Report Page 81 of 91 CPAU FTTH Business Plan , Uptown Services, LLC C.Service Provisioning Service provisioning is defined as the process of completing an order for new or modified service. This process is typically kicked off once the service representative has ¯ entered a new order in the customer information system (ClS). Service orders (paper and/or electronic) are issued to the appropriate departments and technicians go about completing the required steps to complete the order(s). At this time it appears that the provisioning processes for FTTH services will be driven by the broadband CIS. Banner is not capable of interfacing with any set top box control system and FTTH technicians will be responsible for completing all broadband service requests. This will include installing new service drops, NIUs, inside wire and set top boxes. Therefore, it would make more sense to have the provisioning process begin and end with the broadband CIS. The Great Lakes ClS is capable of provisioning video and data services through a service order based workflow process. It can be assumed that the FTTH operation will issue its own service orders, that will be completed by FTTH qualified technicians and administrators. While the F’I-I-H CIS will be stand-alone, Banner will need to be synchronized with the FTTH CIS in order for utility representatives to know which customers have broadband services. Banner will not need to contain the exact level of service detail, but a general list of "dummy" service codes will need to be created that reflect the basic services that a FTTH subscriber might be using (video, telephone and/or Internet). D.Installation. It is assumed that subscriber drop and NIU installations will be completed using contract laborers. Once the initial crush of installations has passed, it can be assumed that service technicians will take on the role of installations themselves. E. Network Maintenance and Repair The current plan calls for a stand-alone team of technicians responsible for service calls and network maintenance for the FTTH system. Given the specialized nature of the technology and the related training, it only makes sense to keep these duties focused on a small group of technicians during the formative years of the FTTH operation. It is assumed that outside technicians will fall into two basic categories - service and network. Service technicians will be responsible for completing service orders for subscriber related problems (drop, NIU, inside wire, etc.), while network technicians will be responsible for completing maintenance and repair of the core FTTH network. F. Network Operations Center (NOC) A network operations center (NOC) can connote different images depending on the given frame of reference. A NOC for Sprint or SBC might be a typical "Star Wars" room filled with computers and video lined walls. Given the advances in network monitoring capabilities and the fault free nature of FTTH systems, it is more likely that the CPAU FTTH NOC will be much smaller. For example, the entire Palo Alto FTTH system could be monitored and alarmed using a Windows NT based workstation equipped with the latest in element management software. The system can be set up to automatically dispatch technicians and escalate through layers of management. So, the FTTH NOC could be placed anywhere. It is recommended that a primary NOC station be placed in August, 2003:Uptown Draft Phase 2 Report Page 82 of 91 CPAU ~ Business Plan Uptown Services~ LLC or near the head end and that a back up be placed in a 24-hour CPAU operations facility. Redundant back-up power is recommended and budgeted for. X. Summary Uptown has described a detailed list of recommendations for CPAU’s proposed FTTH business. These recommendations are listed in each section of this document and are based on the fundamental tenets of the strategies approved by the UAC in 2002 and 2003. Uptown continues to recommend that CPAU pursue the development of a FTTH network in Palo Alto. August, 2003:Uptown Draft Phase 2 Report Page 83 of 91 C’PAU FTrI-I Business Plan Uptown Services, LLC APPENDIX A: Municipal Responses to MuniToons Charges (1.)Tacoma, Washington Tacoma Power has built a broadband network capable of providing video and data services to homes and businesses throughout their service territory. They have named it the Click! Network. (a) The Charge To pay for increased capital costs for their fiber system, Tacoma Public Utilities imposed a 50% surcharge on local electric bills. (b) Response From The Utility In a letter from (edited for length): Diane R. Lachel Government and Community Relations Manager Click! Network, Tacoma Power "Click! Network was constructed primarily for the utility’s use, and would have been built whether we deployed commercial services (cable TV, Internet services and data services) or not. To date, Click! serves 21,500 cable TV customers (32% of the homes the network passes), 6,500 high-speed Internet over cable modem customers, and several dozen businesses with high-speed data lines. Our commercial revenues are covering our operating expenses. Efficiencies to the utility have been considerable since Click! facilities are connected to remote terminal units on utility poles around the city. Electric technicians can monitor the health of the power network and dispatch repair crews to exact locations, in a fraction of the time it used to take. Eventually, the utility will be able to automatically connect and disconnect power services and read meters, increasing operational efficiencies. Attempts by others to thwart competition should be examined carefully. Competition in Tacoma has meant increased customer service by all providers, lower prices, more choice and a boost to economic development. Since Tacoma Power’s investment in Click! Network, the City of Tacoma now markets itself as "America’s Most Wired City" and has lured high-tech businesses to the area, An important note, those opposing your efforts have erroneously connected Tacoma Power’s surcharge during the energy crisis with Click! Network, when in fact the two have no connection at all. At the beginning of the energy crisis (winter 2000), Click! was already constructed in Tacoma and Tacoma Power had over $100,000,000 in cash reserves, which is triple the amount we carry on an operating basis for contingencies. The utility was determining the best way to invest it when the energy crisis hit. Unfortunately the $100,000,000 was not enough, and the utility chose to initiate a surcharge. Those with questions about Click! Network can find additional information at our website at www.click-network.com." August, 2003:Uptown Draft Phase 2 Report Page 84 of 91 CPAU FTI’H Business Plan Uptown Services, LLC (2)Coldwater, Michigan . The Coldwater Board of Public Utilities also operates a broadband network and has been attacked in Munitoons documents. (a) Charge Number One The Coldwater Board of Utilities entry into the telecommunications business has been a failure. (b) Response from the Utility In a letter from (edited for length): Lindy Cox Communications Manager The Coldwater for the Board of Public Utilities "1 just want to set the record straight. We are not losing money. We are actually operating in the black. We currently have 65% of the homes in Coldwater that have cable television service. We also have 50% of those customers receiving High Speed Internet service. (c) Charge Number Two A Comcast ad stated - "Other municipal utilities provided nearly $3M in loans to help build the system in the late 1990’s. These loans were never repaid and were later converted into equity investments." (d)Response from the Utility Lindy Cox Communications Manager The Coldwater for the Board of Public Utilities The statement is basically correct, except it’s actually a little less than $3M, but that fiber & equipment was actually constructed for the utilities backbone and it connects the electrical substations, the water towers, the lift stations and a number of our offices. That equipment is also available for future remote meter reading and electrical demand functions and that sort of thing. The electrical, the water and the wastewater departments own that equipment & fiber and it is actually maintained by the telecom department, but we don’t own it. That explains the transfer of equity to the departments who actually loaned us the money to construct that portion of the network. The statement is basically correct, but it’s kind of taken out of context if you will." (3)Hillsdale, Michigan (a) Charge Number One The City of Hillsdale, Michigan entry into the telecommunications business ended in failure. (b)Response from the Utility August, 2003:Uptown Draft Phase 2 Report Page 85 of 91 CPAU FTTH Business Plan Uptown, Services, LLC In a response from (edited for length): Rick J. Rose City of Hillsdale, Michigan The City of Hillsdale did extensive work toward the construction of a broadband telecommunication utility, but we were never able to get a financing package that was affordable. We had voter approval to issue $10,000,000 in revenue bonds, but our timing with the financial community was very poor. We were looking for money at the time many telecom businesses were in deep financial trouble. All of our research indicated that we could build a self-sustaining telecom utility and save our residents significant amounts of money. When we failed to attract any investment with the revenue bond approach we went back to the voters and asked for permission to issue general obligation bonds to build the project. The incumbent cable company defeated this effort and we dropped the project at that time. Hillsdale’s broadband utility did not fail, as it was never constructed. The tactics that are being used by the incumbent providers are the same used all across the country to keep out municipal competition. A community can do this and make it work if there is deep community support. For a municipal that has built a broadband system and is making work contact Lindy Cox with Coldwater Board of Public Utilities at Icox@muni.cbpu.com. We did accomplish getting Comcast to build out fiber into our community and offering some of the broadband services we were working toward, but we still do not have competition. (4) Kutztown, Pennsylvania Kutztown is one of a handful of utilities that has actually deployed an operational FTTH system, throughout their entire service area. They currently offer a menu of video, Internet and telephone services on their system. (a) The Charge Doing business as Hometown Utilicom, Kutztown completed construction of a FTTH network. To date they have only achieved a 14% penetration rate. (b) Response from Utility In a letter from (edited for length): Frank P. Caruso Director of Information Technology The Borough of Kutztown The Borough of Kutztown and its Fiber Optic to the Home deployment is no.__.~t as reported by some, a failure. Our launch officially occurred August 2002 and we are approaching our 500th customer and 1000th billed service. In less than one year we are within 95% of our target, 25% market share, that we anticipated would occur after one year of service. Today we have built to housing complexes and rental apartments, ready to serve our college market when school begins in the fall. Kutztown Objective Encourage economic development and growth in the community Accomplished Reduce overall end user monthly expense for voice, video and dataAccomplished August, 2003:Uptown Draft Phase 2 Report Page 86 of 91 CPAU FTFH Business Plan Uptown Services, LLC Create additional revenue stream to keep taxes low Accomplished Keep the resident and business money in the community Accomplished Open the door for advanced services where broadband is requirementAccomplished Why build a system where services already exist? Kutztown’s original plan focused on building a "Distribution System" whereby private enterprise could provide their services at a scale un-comparable to the existing 50-year- old infrastructure. Our goal was to be the "hub" for converged services. The fiber optic technology allows multiple services across the same infrastructure without large investments in the field. The only failure that occurred was the lack of cooperation by the large telephone and television service providers. We advertised looking for business alliances to help with this build and become the service provider of choice. Instead, we were forced to build our own television system. A local ILEC/CLEC read about our build and contracted us for telephone services. They did not know how this would work, the concept of not owning lines to the hew to them, but after numerous meeting and planning sessions everyone felt comfortable to make a go of it. Kutztown Key Points The public was ready for a change and we addressed their concerns Government should share the responsibility in economic growth Government should be a major employer in the community Competitive systems create a "checks and balances" for the end user Fund the project with taxable bonds to allow private enterprise business alliances We are in touch with our customers to serve their immediate needs Reported Results Landlords now have the ability to rent bedroom space rather than entire apartments. Each renter can have a separate billing account for voice, video and data. Routers allowing multiple shared computer usage without limitation, users have flexibility Residents assist with television content requests Our FREE computer education program to HU customers is stronger than anticipated Home businesses pay reasonable fees to operate as a "home based business" Some users have reported a savings of up to $60 per month, due tothe elimination of extra telephone lines, premium television cost and Internet monthly fees Personal rewards and benefits August, 2003:Uptown Draft Phase 2 Report Page 87 of 91 CPAU VITH Business Plan Uptown Services, LLC I see it and hear it everyday. Residents once against the government bringing services into the community now support the effort. The overall benefit is beginning to take shape earlier than we anticipated. New student housing now builds toward meeting our finer specifications, which enhances he Kutztown University student ability to use broadband off-campus. State of Pennsylvania In line with the direction of the Pennsylvania Department of Community and Economic Development, Kutztown’s efforts have been recognized as a leader in the Information Technology for 2003. We have been awarded the Governor’s award for Information Technology. This is important because the state of Pennsylvania has a goal to keep college graduates working in Pennsylvania. Economic growth and broadband deployment are a priority. Personal Note Private business and government can move their country into the 21st century by cooperating with each other. Governments and private business can compliment each other. We are finding this now, Kutztown is forming new business alliances with security companies, Internet gaming companies, Virtual Private Networks and advanced television services. Government can be the "hub" or "gateway" needed to reach he home. Why is this important? Because private business cannot build the technology solution that allows multiple service provisioning across the same media. When Kutztown started in 2000, there were 10-15 interested communities looking into FTTH. Today there are over 200. We have had visitors from Michigan, Massachusetts, Alabama, Pennsylvania and others looking into economic growth and development by building similar infrastructures. These builds would not be happening if communities were happy and content with current services and offerings. Monopolized services have no place in today’s world. Communities must take the lead to encourage advancement in technology or they will continue to get "what is available by the single service provider." (5)Paragould, Arkansas (a) The Charge City Light Water and Cable was audited by an independent auditor for fiscal years 2000 and 2001. The auditor concluded that the cable department reported a net loss of $906,644 for fiscal year 2001. City Light Water and Cable is in the eighth year of its operation. (b) Response from Utility In a response from (edited for length): Rhonda Davis Chief Financial Officer city Light Water & Cable Paragould, Arkansas August, 2003:Uptown Draft Phase 2 Report Page 88 of 91 CPAU FTrH Business Plan Uptown Services, LLC Our 2001 audit report (which is on our website -www.clwc.com indicates that the cable department had a "net loss" of $263,114. Anyone that has a basic understanding of financial statements will know that "net loss" is not "cash flow." Non-cash expenses (depreciation and amortization) of $230,592 are included in the net loss. We are anticipating a rate increase this year. Our goal is to keep rates just at the level to pay debt and maintain the system - we are not in the business to make big profits. In response to the statement I supposedly made "The programming costs are killing us" - programming cost do increase every year. Anyone that enters into this business needs to be prepared for that. Several years after we went into the cable TV business we started charging a "Programming Cost Adjustment (PCA)" which passed cable- programming costs into the customer each month. For example, if the cost of programming to provide 64 channels per month to each customer increases by $1.25, that amount is passed through to the customer. With programming cost being passed through, the only time the utility should have to have a rate increase would be for operating and maintenance expenses, or if debt is issued for a major capital project- which should not be often. Our last increase was in 1999. Our rate for 64 expanded basic channels is $22.87 per month. In a town 15 miles from here their cable company is Cox - their rate is $35.50 for 53 channels. To our knowledge we are the lowest priced cable TV service in our state and probably the surrounding states. The competing cable company (Cablevision, Inc.) sold to the city in 1998. Our citizens have a cable programming selection committee made up of a cross-section of the community. They decide the programming that will be carried. Our customers like being able to have a say in the programming they get. The level of service offered to our customers was a drastic improvement over the previous provider. In addition, they can personally talk with management of the cable division and express their opinions and make suggestions. While entering the cable TV business was a major task for the utility it has been good for the citizens of our town. We could easily charge rates sufficient to show big profits - so the headlines can look more favorable - but that is not what we are in the business for. We are here to offer a top-rate service at the lowest price possible, while still maintaining financial soundness. That is why the citizens voted to spend the money and issue the debt to build and maintain their own system. It was a wise choice. (6)Glasgow, Kentucky (a) The Charge. Glasgow had to issue revenue bonds on three occasions in order to finance the cable system because it has consistently lost money since it began operating in the early 1990’s. (b) Response from Utility In a letter from (edited for length): William Ray General Manager Glasgow Electric Plant Board Glasgow, Kentucky August, 2003:Uptown Draft Phase 2 Report Page 89 of 91 CPAU FTTH Business Plan Uptown Services, LLC Well, this is the first time I have seen our project classified as a failure because we had to issue bonds! This charge is ridiculous. The Glasgow Electric Plant Board does issue revenue bonds about every three years. We do this to finance our capital construction projects. We finance all projects that are going to be depreciated over twenty years so that the customers getting the services from those projects also pay for them over their useful life. This is common for municipal projects of this sort. It has nothing to do with our entry into the cable or Internet business. Anyone who knows anything about the issuing of bonds or borrowing of money knows that this is not easily done unless one has a solid financial background and predictable good business plan for the future. We have both. Our bonds are consistently rated AAA-. This rating is not issued to financially failing projects. Perhaps the most salient response to this competitor argument is that they gave up and sold out to us in 2001! After competing with them for many years in Glasgow, the competitor came to us in November of 2000 and asked if we would buy their remaining customers in Glasgow as they were giving up the battle of competing against us. We accepted their offer and in April, 2001, issued bonds to purchase their system and their remaining customers. They packed up and left town. Do you think this is the bond issue they were talking about? The truth is our project is an overwhelming economic success. For nearly fifteen years now, our project has delivered the lowest cable rates in North America to the 14,000 residents of Glasgow, KY. We sell a 70 channel cable package for $18.95 per month. Those savings to the 8,000 homes and businesses in Glasgow over the last fifteen years now total over $32 million. I rest my case. (7)Braintree, Massachusetts (a) The Charge Financial statements for 2000 show a transfer of nearly $2.2 million from it’s electric utility to the broadband business unit. (b) Response from Utility In a letter from (edited for length): Donald L. Hetherington Acting General Manager Braintree Electric Light Department Braintree, Massachusetts I wanted to take a few additional minutes to try to "set the record straight" as it concerns Braintree Electric Light. It was totally frustrating to see disparaging remarks about Braintree used in such an unsavory manner on a website so many states away. The Braintree Electric Light Department is a municipal utility serving the Town of Braintree for over 100 years. In the mid 1990’s the Department had to replace its copper wire based communications system due to obsolescence and failure in services. It was decided to replace this system with the most advanced system available at the time, HFC. This was done for electric department purposes: communications, high speed relaying and data transfer. August, 2003:Uptown Draft Phase 2 Report Page 90 of 91 CPAU FTrH Business Plan Uptown Services, LLC In addition to a cash in-lieu of tax’payment made to the Town the Department provides services (at no cost to the tax payer) to the Town wherever a synergy exists. Once this HFC infrastructure was in place it was realized that at minimum cost to the Department it could extend its internal telephone services to all municipal buildings, fire stations, schools, etc. offering 4 digit dialing and voice mail at no cost so the Town could use those tax dollars that were being paid to the telephone company more effectively elsewhere. This was followed by offering high-speed data, computer networking, email, etc. again at no cost because we were doing all of this for our own use, no tax dollars involved. Over the course of the next several years the Town’s Cable Advisory Committee approached the Department to go into the cable business because they were totally frustrated in dealing with the cable company. In each of the first two instances the Department declined. On the third request and following a non-binding community vote overwhelmingly indicating the citizens wanted this to happen, we went into the cable business. Today, after only 2 & ½ years and essentially no marketing for the last year, we have about 40% market share of both TV and ISP. There has been NO electric department subsidization of the cable operations, NO tax money involved in any way or manner. The bonding obligation to "build" the cable operations along with all other related expenses is being paid from Broadband revenues. Our Electric rates are, I believe, the 2nd lowest in the State and our Broadband rates are the lowest that I am aware of. It is interesting to note that whenever the other provider in Town announces rate changes (increases) for their service areas Braintree is significantly absent from the list of towns. It would seem that competition does work. It was never the intent of BELD to be the only provider, but we do want to be the provider of choice. To imply that we are not successful is a gross misstatement; again 2 & ½ years, 40% market share, no advertising and averaging 40 new customers a month beats all expectations. As an added note, the Electric Department is also using the system for its original intent - that did not get lost in all of this. We will be reading electric meters, water meters, doing customer activations and shut offs, Broadband customer activations and shut offs and electric system outage detection all over the HFC system starting this year. August, 2003:Uptown Draft Phase 2 Report Page 91 of 91 CMR21504 Attachment E Summary Report of Risk Assessment of the Fiber to the Home (FTTH) Project During the months of July and August 2003, the Administrative Services Department (ASD) staff carried out a review of the risks associated with the FTTH project. This analysis was based on the financial model developed by Uptown Services and focused on their recommended scenario. The analysis identified the key variables affecting the financial outcome of the project and carried out quantitative stress testing on those variables. In addition, the review included a summary assessment of the importance of qualitative variables (legal, technological, and competitive) that were not addressed in the Uptown analysis. The purpose of this review was to provide an independent analysis of the risks associated with the FTTH project. In particular, the. review focused on the potential "downside" or negative events whereby operating and financing costs required by the project could not be covered by incoming resources. The analysis covered key cost variables including interest rates, capital investment costs, and marketing and customer support costs. The analysis also reviewed key revenue variables including customer adoption rates for both cable TV and Internet, the pricing of services, upgrade pricing, and auxiliary revenue sources. Summary of Results The analysis highlighted several factors that significantly impact the financial outcome of the project. Financial Risks The key risk factors on the revenue side are: Penetration rates for TV and video Penetration rates for Internet The rates of market share growth cannot be known until the project is well under way and significant amounts of capital are expended. Our current modeling indicates that the baseline penetration rates presented in the Uptown analysis are susceptible to changes in the economy, competitive pricing and other factors not in City FTTH control. Additionally, strong, possibly predatory price pressure by the Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Summary of Risks Page 1 of 4 CMR21504 Attachment E incumbent providers could target FTTH service in an attempt to deny it the required customer base to break even. If, for example, overall Intemet service penetration plateaus at 31.3% (rather than 36.3% as assumed in the baseline model), net cash decreases by $13 million, or 24% in year 20. If video penetration plateaus at 26% (rather than 31% in the baseline), net cash decreases by $11 million or 20%. The risk factors on the cost side include: *Long-term bond rates o Cost of producing and installing the network interface unit (NIU), or control box, in the home o Cost of manufacturing and installing the fiber network Required customer service staffing levels If the long-term bond interest rate increased to 8% (up 2% from the baseline assumption), net cash in year 20 would decrease by $16 million, or 29%. It is important to note that the issuance of approximately $31 million in debt does not appear to significantly impact the ability of CPAU to raise other bond funding for infrastructure or other investments. One of the strategies in the Long-Term Electric Acquisition Plan is to acquire potential generation and transmission capacity. This may involve approximately $50 to $100 million in additional debt that could be accommodated along with the FTTH financing without impacting bond ratings or the associated interest rates. The managers of the FTTH business would know before issuing the debt whether the costs of that debt were prohibitively high. In that sense this risk factor is somewhat manageable. Similarly, the costs of manufacturing and installing the control box and the FTTH network would be known before expending the capital required. These risks can be controlled through contract ceilings and other provisions to limit FTTH downside risks. Additionally, technology developments will tend to drive these costs downward, further limiting FTTH risks. However, to give an idea of the impact of these factors, if the control box cost increased by 25%, net cash in year 20 would decrease by 11%, or $6 million. If the fiber network costs increased by 25%, net cash would decrease by 24%, or $13 million. Lastly, should customer staffing levels detailed in the base model not provide the level of service expected by end users, it may be necessary to add additional representatives. This may be necessary to ensure excellent "word of mouth" advertising, which will be essential to maximizing market share early on. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Summary of Risks Page 2 of 4 CMR21504 Attachment E However, it should be noted .that significantly increasing customer staffing levels is quite costly. For example, increasing the number of customer service representatives in the first three years from seven to ten (and then keeping staffing at that level for the remainder of the project) results in a loss in after-financing cash in year 20 of about 13%, or $7.1 million. This risk could be limited by adding staff through outsourcing arrangements as opposed to adding full-time permanent staff. Competitive Risks Competitive risks from the technology standpoint do not appear significant at this time. While the incumbent cable TV organization is adding fiber to the backbone, this build out will not extend to the so-called "last mile," the connection from the "backbone" to the end users. This "last mile" represents approximately 85% of total network costs, and would remain a technological advantage of the FTTH system. While implementation of wireless technology is quicker and cheaper to market, the technology does not represent a credible threat at this time because bandwidth is limited, security and interference are significant drawbacks, and environmental (visual and other) and health risks require further investigation. Satellite Internet systems represent an alternative with major drawbacks. Upstream communications are much more limited than fiber, installation and monthly charges are considerable higher, and the service only operates on a fraction of the installed user base. Important legal issues still need to be settled and are discussed in the CMR. Some of these revolve around whether a separate board must be created to oversee content offered by FTTH. Moreover, the incumbent providers of similar services are likely to mount a vigorous public relations and legal challenge to this project which could lead to costly delays in the project. Staff recommends strongly that additional funding be included in the budget for legal costs as the existing budget is inadequate. The business case budget calls for $220,000 for legal costs, of which $160,000 is for the first six months. Additional legal budget may be needed if legal challenges occur. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Summary of Risks Page 3 of 4 CMR21504 Attachment E While many legal risks require further consideration, it is clear that the FTTH can limit its vulnerability to legal action by 1) providing for public comment through a referendum process, 2) ensuring strict compliance with existing state and Federal law and regulations, 3) enact a charter amendment to ensure a separate board to exercise editorial control over video content, and 4) negotiate a franchise agreement with the FTTH business which is similar to the City’s agreement with the incumbent video provider. Other Risks An additional risk is the commitment of the citizens and governing bodies to this project for its projected duration. The project’s expected financial payoffs are long term. In the short term, there will be significant losses. For example, during the first five years of the project, total debt is expected to exceed $39 million and cumulative net income will reach -$11 million. It is expected that net income will be positive by year 11 and that debt will be repaid before year 20. In this scenario, Palo Altans will have to tolerate short-term deficit to enjoy the long-term benefits from this project. Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Summary of Risks Page 4 of 4 CMR21504 Attachment F Annual Financial Statements (All Figures in 000’s) Income Statement Palo Alto FTTH Revenue Inst,311at~on Recumng Total Revenue: Cost of Goods & Services ~nstallat~on Recumng Total COGS 2004 2005 2006 2007 2006 2009 2014 2019 2024 $0 $62 $161 $53 $32 $30 $17 $15 $15 $0 $692 $4,986 $9,476 $11,253 $12,494 $16,058 $17,762 $19,508 $0 $754 $5,147 $9,529 $11,285 $12,524 $16,075 $17,777 $19,523 $0 $o $o $118 $256 $86 $39 $23 $9 $5 $5 $225 $1,628 $2,908 $3,568 $4,018 $5,539 $6,501 $7,556 $343 $1,885 $2,994 $3,607 $4,041 $5,548 $6,506 $7,560 Gross Margin: Other Cost: Distribution Cost G&A Cost Total Other Cost: EBITDA Depreciation Interest Earnings Before Taxes Taxes Net Income Cumulative $0 $410 $3,262 $6,534 $7,678 $8,482 $10,527 $11,271 $11,963 54%63%69%68%68%65%63%61% $44 $612 $1,183 $685 $694 $700 $731 $767 $805 $1,084 $2,180 $2,287 $2,414 $2,486 $2,553 $2,803 $3,041 $3,303 $1,128 $2,792 $3,471 $3,103 $3,160 $3,253 $3,534 $3,808 $4,108 ($1,128)($2,381)($209)$3,432 $4,498 $5,230 $6,993 $7,463 $7,855 ($64)($572)($1,619)($2,174)($2,249)($2,276)($2,223)($1,725)($1,519) ($784)($2,090)($2,000)($2,090)($2,060)($1,985)($1,536)($929)($112) ($1,617)($4,387)($3,895)($1,080)($70)$73t $3,443 $5,541 $7,737 $o $o $o $o $o $o $o $o $o ($I,617)($4,387)($3,895)($1,080)($70)$731 $3,443 $5,541 $7,737 ($1,617)($6,004)($9,899)($10,979)($11,049)($10,318)$2,836 $25,944 $60,074 Cash Flows Cash Flows From Operating Activities Net Income + Depreciation Increase in Working Capital Total Cash Flows From Investing Activities Capital Expenditures Total 2004 2005 2006 2007 2008 2009 2014 2019 2024 ($1,617)($4,387)($3,895)($1,080)($70)$731 $3,443 $5,541 $7,737 $64 $572 $1,619 $2,174 $2,249 $2,276 $2,223 $1,725 $1,519 $132 ($476)($143)($111)$9 ($11)($12)($6)($6) ($1,421)($4,292)($2,418)$983 $2,189 $2,996 $5,654 $7,260 $9,250 ($3,089)($11,046)($14,990)($1,680)($997)($652)($5,427)($272)($262) ($3,069)($11,046)($14,990)($1,660)($997)($652)($5,427)($272)($262) Cash Flows From Financing Activities +Equity Issued Dividends Paid +Debt Issued -Bond Issuance Cost -Debt Repaid Total Net Cash Flows Cumulative $o $o $o $o $o $o $36,255 $4,385 $2,786 ($696)$0 $0 $o $o $o $35,559 $4,385 $2,786 $o $o $o $o $o $o $o $o $o $o $o $o $20 $0 $0 $0 $0 $0 $o $o $o $o $o $o $0 ($1,216)($2,724)($1,903)($2,350)($3,169) $20 ($1,216)($2,724)($1,903)($2,350)($3,169) $31,048 ($10,953)($14,621) ($677)($25)($380)($1,676)$4,639 $5,819 $31,048 $20,095 $5,474 $4,797 $4,772 $4,392 $6,107 $27,158 $53,833 Returns: Unlevered Cash Flows + Terminal Value Total: 2004 2005 2006 2007 2008 2009 ($4,511) ($15,338) ($17,407) ($697) $1,191 $2,344 ($4,511) ($15,338) ($17,407) ($697) $1,191 $2,344 20t4 2019 2024 $227 $6,988 $8,988 $0 $227 $6,988 $8,988 Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Financial Pm Formas Attachment D Page 1 of 2 CM~21504 Attachment F IRR%:NIA NIA N/A NIA N/A NIA NIA 3%8% Returns: Levered 2004 2005 2000 2007 2008 2009 2014 2019 2024 Investor Cash Flows $0 $0 $0 $0 $0 $0 $0 $0 $0 + Cash Surplus/Deficit $31,048 ($10,953) ($14,621)($677)($25)($380)($1,676)$4,639 $5,819 + Terminal Value $0 -Less: Debt $4,025 Total:$31,048 ($10,953) ($14,621)($677)($25)($380)($1,676)$4,639 $9,845 IRR%:NIA N/A -12%-10%-10%-9%-16%NIA NIA Terminal Value Per Household Served $0 Financing 2004 2005 2006 2007 2008 2009 2014 2019 2024 Debt, Beginning of Month + Bond Drawdown + Utility Loan Drawdown Bond Repaid Utility Loan Repaid Debt, End of Month $0 $32,230 S36,615 $39,401 $39,421 S38,205 S22,445 S12,433 ($856)$3o,8o5 $o $o $o $o $o $o $o $o $1,425 $4,385 $2,786 $20 $0 $0 $0 $0 $0 $0 $0 $0 $0 ($1,216)($1,291)($1,742)($2,350)($3,169) $0 $0 $0 $0 $0 ($1,433)($161)$0 $0 S32,230 S36,SlS $39,401 $39,421 $38,205 $35,480 $20,543 $I0,083 (S4,025) Equity, Beginning of Month $0 $0 $0 $0 $0 $0 $0 $0 $0 + Equity Issued $0 $0 $0 $0 $0 $0 $0 $0 $0 -Dividends Paid $0 $0 $0 $0 $0 $0 $0 $0 $0Equity, End of Month $0 $0 $0 $0 $0 $0 $0 $0 $0 Balance Sheet Assets Current Assets: Cash on Hand Cash Reserves Bond Reserve Requirement Invento~ Accounts Receivable Total Current Assets 2004 2005 2006 2007 2008 2009 2014 2019 2024 $100 $100 $100 $100 $100 $100 $100 $100 $100 $27,719 $16,766 $2,145 $1,468 $1,443 $1,063 $2,778 $23,829 $50,504 $3,329 $3,329 $3,329 $3,329 $3,329 $3,329 $3,329 $3,329 $3,329 $0 $384 $247 $212 $114 $64 $17 $7 $5 $0 $179 $621 $794 $940 $1,044 $1,340 $1,481 $1,627 $31,048 $20,658 $6,342 $5,803 $5,826 $5,600 $7,464 $28,647 $55,465 Capital Equipment Less: Accum Depr $3,089 $14,135 $29,125 $30,805 $31,802 $32,454 $39,565 $40,947 $42,280 ($64) ($635) ($2,255) ($4,429) ($6,678) ($8,954) ($19,665) ($29,477) ($37,494) Total Assets $34,074 $34,156 $33,212 $32,179 $30,950 $28,999 $27,365 $40,116 $60,250 Liabilities & Equities 2004 2005 2006 2007 2008 2009 2014 2019 2024 Liabilities Current Liabilities: Accounts Payable $232 $319 $481 $508 $566 $608 $757 $860 $972 Total Current Liabilities $232 $319 $481 $508 $566 $608 $757 $860 $972 Long Term Liabilities Total Liabilities $36,255 $40,640 $43,426 $43,446 $42,230 $39,505 $24,568 $14,108 ($0) $36,487 $40,959 $43,907 $43,954 $42,795 $40,113 $25,325 $14,968 $972 Owners Equity Paid in Capital Retained Earnings Total Equity $o $o $o $o $o $o $o $o $o ($1,617) ($6,004) ($9,890) ($10,979) ($11,049) ($10,318) $2,836 $25,944 $60,074 ($1,617) ($6,004) ($8,899) ($10,979) ($11,049) ($10,316) $2,836 $25,044 $60,074 Total Liabilities & Equities $34,870 $34,955 $34,008 $32,975 $31,747 $29,796 $28,161 $40,912 $61,047 Fiber to the Home (FTTH) Business Plan Phase 2, Final Report - Financial Pro Formas Attachment D Page 2 of 2