DSL.net Forced To Scale Back Amid ISP Turmoil

Despite a coincidence in timing, DSL.net’s decision Friday to lay off 90
employees and shut down 250 central offices (COs) nationwide has little to
do with an appeals court decision made earlier this week.

The broadband and dial-up Internet service provider’s announcement,
however, does underscore the troubles many Internet service providers
(ISPs) are facing in provisioning high-speed Internet services for its
customers.

Tuesday, the U.S. Court of Appeals in the District of Columbia upheld a
ruling by the Federal Communications Commission, which says that incumbent
local exchange carriers (ILECs) are not required to offer discounted
pricing of advanced telecommunications services to Internet service
providers (ISPs).

The ruling, while not a surprise, is a blow to many ISPs who are trying to
glean a profit from the largely unprofitable residential digital subscriber
line (DSL) business. Providers counted on discounted pricing from the
Bells to increase its margins, but the FCC and the courts felt a proviso in
the Telecommunications Act of 1996 addressing the discounted sale of
advanced (Internet) services applied only to the end-user.

ISPs hoped to get a break with the Association of Communication Enterprises
(ASCENT) challenge, which would have overturned the FCC’s assertion that
ISPs and end-users weren’t both eligible for retail rates.

It’s a decision that had little impact on DSL.net’s financial problems,
however.

The company specializes in symmetric DSL (SDSL), a high-end service (read
more expensive) used in the business world. Another flavor of DSL,
Asymmetric DSL (ADSL), is commonly considered a residential product because
of its relatively low price.

By bundling its SDSL offering with other services, like Web hosting and
routable IP addressing, the ISP has been able to charge much more for its
service than ISPs with residential accounts. It’s much easier to offset
DSL costs with customers able to afford such extraneous services. The
monthly bill for DSL.net’s basic business package costs $149 a month,
compared to the going rate of $50 for residential service.

What DSL.net had in common with its peers in the residential market,
however, was an incredible monthly cash burn rate, the result of a
too-fast, too-much deployment strategy. Acknowledging its mistake,
executives have been making cost-cutting measures since November, 2000.

There has been slight improvement. Net losses decreased, from $29 million
in the fourth quarter of 2000 to $26 million in the first quarter 2001.

But with $8.8 million in total revenues last quarter, officials felt the
pressure for more drastic steps. On pace to generate a little more than
$35 million this year, officials predict the measures to make them between
$45 and $50 million by year’s end.

Keith Markley, DSL.net president and chief operating officer, said its
latest efforts to cut costs actually brings his company within arm’s length
of cash-flow positive and will put it on par to meet its goals.

“The decision to reduce both workforce size and central offices was made to
substantially lower our cash burn rate,” Markely said. “In fact, the
majority of our remaining COs are already gross margin positive. Because
we are not overburdened with debt, the resizing of our operations has a
significant impact on cash burn.”

Officials said its withdrawal from 250 COs around the nation has little
affect on the 375 cities it currently serves, affecting less than five
percent of its customer base. They did not say if they would help those
affected find another provider.

DSL.Net will take a restructuring charge of $25-30 million in the second
quarter to pay for the cost-cutting measures, but officials expect to save
nearly $4 million a month by year’s end because of the changes.

The ISPs troubles highlight the problems faced by many DSL providers
throughout the U.S. In years past, some ISPs and data competitive local
exchanges (DLEC) financed their deployments on venture capital, not on a
solid business foundation.

At the time, the independent providers could get away with pricing that
kept them in competition with the Bells, who were charging bargain-basement
rates for DSL service. As the owners of the copper-based network, the
telephone companies figured they could afford to engage in a little price
gouging for its long-term good.

But once venture capital left, so did the financial crutch many of the
largest DLECs and ISPs were using to continue funding its operations and
deployment. It left them dependent on revenues generated by their customers.

Suddenly, the Bell competitors were taking a hard look at the way their
operations were running compared to the amount of money brought to the
coffers. No matter how much the numbers were moved around and they tried
to convince themselves otherwise, executives knew they were in
trouble. Debts soon mounted and so did the number of bankruptcy protection
cases.

National providers like NorthPoint Communications and Zyan Communications
were only the most famous of the many independent providers who went out of
business in the past 18 months. The ones remaining continue to look for
ways to cut costs, either through operational scale backs, as in the case
of DSL.net, or through bankruptcy restructuring.

Two of the largest remaining DLECs, Covad Communications and Rhythms
NetConnections, continue to operate but many in the industry consider them
on life support, close to dissolution. Monday, Covad announced it was shutting down operations at its BlueStar subsidiary, while rumors persist that
carrier Worldcom is after Rhythms to restructure its debt.

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