Did BT Subsidize Burlington with Cheap Internet Access?

There is so much to say about Burlington Telecom and its struggles that it cannot be covered in a single post. This is one of several posts that will discuss pieces of the situation. One of the questions that has been raised by the Larkin "audit" of BT is whether BT was losing money on the broadband it provided to City Departments.

Though the report prepared by Larkin for the State revealed a number of disturbing practices by Burlington Telecom, a number of them have been strongly disputed. The report clearly has a number of weaknesses, from an apparently lack of expertise on somewhat basic telecom economics to the fact that the "auditors" do not appear to have attempted to talk to anyone who knew anything about how BT operated.

That said, something surely went dramatically wrong with BT and the Larkin report may help shed light on it.

But when one reads articles in the local press about it, it is quickly evident that the writers have practically no understanding of what they write and harbor a strong hostility against Burlington Telecom. Consider this passage from the Burlington Free Press:

Auditors observed as well that the city, a prime user of BT services, was charged “below market rates” and “below BT’s cost of service. The low rates charged by BT ... to the city could be viewed as a form of cross-subsidization,” which, the audit notes, is a violation of a provision of BT’s state license. The building of the system in general, auditors said, was marked by a “lack of timely and accurate accounting information.”

While the quote does come from the Larkin report, it offers no foundation for the claim and later hedges against it (two paragraphs later -- all from page 26):

The fact that BT is providing services to various City departments at below- market rates that may be below BT’s cost of service, which could be viewed as a form of cross-subsidization, is a problem.

After stating without referencing any evidence that BT is providing services to Departments below the cost of provisioning, the conclusion two paragraphs below states BT may be providing services to departments at prices below BT's cost of service ... which could be viewed as a form of cross-subsidization. This is not credible (unless you are a local reporter trying to make the City look bad).

Sorting it out...

BT provides broadband to all the City Departments. BT says that it charges them the full cost of doing so (according to their statements as well as comments to me over the years). This rate is below prices charged by a private sector provider -- no one disputes that.

So we have two potential charges that are lumped together.

  1. BT is charging the Departments less than it costs to provide the service. If this was the case, BT would have been losing money on the deal to the great benefit of City Departments.

    The only footnote cited in the area of the charge by Larkin that BT was charging less than the cost of providing the service (which Larkin states once and hedge once) is a reference to where BT explains their formula for recovering the full cost of providing the service.

    This is one instance of several in which Larkin seems to overstep the available evidence and make conjectures unsupported by any facts.

  2. BT was charging less than the "market" for broadband services. This charge is more fascinating.
    • It is obvious that BT is charging less than what a private provider would because BT is charging the true cost with no markup. The private sector exists for the markup -- or margin.
    • The "market" for dedicated access consists of probably one or two providers who did not offer 1Gbps services at the time BT started (and may very well still not offer that service yet). There is no "market price" for those services. There are perhaps comparable prices of T.1 and T.3 services that undoubtedly reflect significant monopoly markups.
    • If BT were to charge a higher price closer to those boosted by monopoly power, the very same reporter would undoubtedly argue that the markup amounted to a "subsidy" to BT from the City Departments as the price was above the cost of providing the service. Damned if you do, damned if you don't.

Lesson Learned

So - for our purposes, what is a correct price for a community fiber network to charge City Departments?

This will vary depending on local custom and needs. But it seems foolish to charge only the cost of providing the service. It seems wise to charge some mark-up just as would any other entity - the net income can go toward paying down the debt. If done properly, a new publicly owned network will cut the prices paid by City Departments, increase the capacity of their connections, and have some margin for the provider. Everyone wins.

But if a new community network starts offering a connection at cost, expect a bloody war if the network wants to raise prices. Department heads become quickly accustomed to savings and will not react well to an increase even if they are still getting the best deal in town.

The interesting question is whether Burlington Telecom was subsidizing the City in other ways. This was the question we thought the Larkin report would answer. But it hasn't. Fortunately, City Council members are pushing for a forensic audit to understand exactly where all the money went. We hope they are successful and a proper audit is completed.