Palo Alto prepares for key decisions on fiber expansion

As Palo Alto embarks on its ambitious journey to build a citywide fiber network that delivers high-speed internet to every neighborhood, new survey results and financial projections for the proposed system are giving city leaders loads of reasons for both hope and anxiety.

On the bright side, there is the survey showing that about a third of the city’s internet customers are to some extent dissatisfied with their existing provider and would be good candidates to make the switch to Palo Alto Fiber. About 55% of the respondents have already “cut the cord” and are only getting internet service from their provider, while fewer — 28% — are also getting cable, and 25.8% are also getting telephone service, according to the survey, which was conducted by Magellan Advisors.

The trend suggests that Palo Alto will not need to worry about becoming a cable provider to make the fiber utility viable. Honker said that the trend of relying solely on internet streaming is much further along in Palo Alto than in other communities. A cable company typically provides internet service to about 75% to 80% of customers.

“Cord cutting is a big part of Palo Alto,” John Honker, founder of Magellan Advisors, told the Utilities Advisory Commission last week during its discussion of the survey results.

On the less sunny note, the costs for the proposed system have risen and it will likely require the city to take on debt that will take more than a decade to repay. And even though profit is not the primary motivator for the municipal utility, the city will need to find a way in the coming months of crafting a system that would be financially sustainable.

Because of growing costs of labor and supplies, the estimated price tag for the citywide system has increased from the prior estimate of $116.3 million to $128.3 million today, according to Magellan’s analysis. The city has about $42.5 million today in revenues that it can spend on the project from its fiber and electric utilities. The remaining $85.8 million would likely be financed through a bond and paid off over the next few decades, according to utilities staff.

Costs and staffing models will likely feature prominently when the City Council meets with the Utilities Advisory Commission on Sept. 12 to discuss a project that city officials have been contemplating for more than 20 years and that is finally starting to take shape. According to David Yuan, strategic business manager at City of Palo Alto Utilities, the city has completed about 90% of its work on engineering design for the expanded network, community engagement and business model.

One key question that the council will need to answer is whether the city go on a hiring spree to staff the expanded utility or whether it should hire consultants to provide most of the services. A model that banks entirely on city staff to run the expanded fiber utility would require about 23 new full-time positions, of which 19 would need to be hired within the first two years, well before the service has a wide customer base, Honker said. Between 2023 and 2032, the city would have to spend an estimated $54 million to operate the fiber network under this alternative.

The outsource model would provide the city with more flexibility but less control. The utility would be able to hire as many consultants as it needs to support the growing customer base at any given time. Over the first 10 years, the city would spend about $38.3 million if it outsources many of the key functions in the fiber operation.

“In an outsourced model, you’re paying more by the drink,” Honker said. “You’re paying as you go for the customers who are connected so you’re not managing all the upfront costs.”

While neither alternative is expected to generate net income over the first nine years of the system’s operation, Magellan estimated that under the outsourced model the city would climb out of the red and get a net income of $190,000 from the fiber system by 2032. Under the fully “insource” model, the utility would still be operating at a loss, with costs exceeding revenues by about $660,000.

What customers will get

Magellan also explored what Palo Alto Fiber could look like for customers. Under the proposed model, the basic package for fiber customers would cost between $40 and $60 per month and would provide them with a service level of 200 megabits per second (Mbps), which is considered sufficient for most households and which is well above the Federal Communications Commission standard definition of “broadband” as 25 Mbps.

Customers seeking higher speeds could purchase packages offering 1 gigabit per second for between $80 and $95 per month; 2 gigabits per second for $95 to $150 per month; or 10 gigabits per second for a rate to be determined in the future.

For commercial customers, the prices would range from a cost of $60 to $80 per month for the most basic package with a service level of 50 Mbps to between $500 and $1,000 per month for the premier package of 1 gigabit per second, according to the preliminary model. There are also options for 100 Mbps ($100 to $150 per month) and for 250 Mbps ($200 to $250 per month).

There are not a lot of applications around today that would warrant speeds of 2 or 10 gigabits per second, Honker said. But because the competition is already offering 2 gigabits per second and may offer 10 in the future, Palo Alto Fiber should be able to match that level of service.

“It’s important to get ahead of that and say that the network will be ready for next generation broadband and we can support those services natively if customers want them,” Honker said.

A critical question for Palo Alto as it plans for fiber is: If the city builds it, will the customers come? Honker stressed that the biggest factor that would determine the financial strength of Palo Alto Fiber is whether enough local residents and businesses make the switch to the municipal service. The Magellan model projects that the “take rate” for Palo Alto Fiber would climb to about 33% by 2028 and then stay at around that level.

“At the end of the day, more customers and higher take rates will offset the higher operational costs,” Honker said.

Several commissioners said they were heartened by the survey results, which were based on the 3,241 responses that the city had received prior to its Aug. 3 meeting. Commissioner Loren Smith was particularly pleased about the survey finding that more than half of the respondents won’t need a landline or cable service. He also emphasized that the utility doesn’t have to be a major profit generator to be successful.

“We’re not driven by a profit margin,” Smith said. “We’re driven by our ability to deliver the best quality service and the best marginal rate where we can maintain the service and maintain the business, just like we do with our electric. We don’t need to make a significant amount of profit to make it a viable business.”

Commission Chair A.C. Johnston also said he was optimistic, given the high number of people who have already “cut the cord.”

“It seems to me if we can provide faster speeds at a lower price, which we should be able to do since we don’t have to make a profit, we really have an opportunity to capture a significant share of the market,” Johnston said.

He acknowledged, however, that the greatly expanded fiber utility will face a challenge that traditional utilities such as gas, electric and water have not had to deal with: competition from the private sector.

“We have the advantage in that we’re not under some of the cost of service constraints that we’ve got under regulated utilities, but we also have competitors that we haven’t had to deal with before,” Johnston said.

For others, cost was a major concern. Commission Phil Metz observed that the net income is projected to be negative for about 10 years, as the city builds the system and gradually expands its customer base.

“This is a real loss. How do we pay for this loss or ideally eliminate it?” Metz said.

Council member Alison Cormack also took a more skeptical stance. She argued that the survey may not accurately represent the entire city population and suggested that the residents who responded may be those who are more inclined to support the fiber project. She also said the council has received correspondence from residents about the survey. Not all of it was not complimentary.

“I’ve gotten some emails from people who have been supportive of this problem in the last couple of years and are less so now,” Cormack said. “Personally, I’m going to be taking a much harder look at these numbers when we’re making this decision.”

One resident who expressed his disappointment was Paul Gregory, who wrote to the council last month and suggested that the survey is “designed to skew responses to get the desired outcome.” Gregory, a customer of Sonic, said that the survey did not include Sonic as one of the provider options, noting, “I’m very happy with my current internet provider and I intend to continue with them.”

He said that AT&T is already expanding its fiber network to some local neighborhoods and argued that there is no reason to have two sets of fiber.

“In other words, Palo Alto is late to the game,” Gregory wrote. “Palo Alto should instead concentrate on doing things that only they can do. For example, finally make some actual decisions about building grade separations at Caltrain crossings, and get construction underway.”

Whether or not the project ultimately succeeds, Palo Alto would need to commit to a long period of construction throughout the city to install fiber. Honker said construction of the citywide network will likely take about four years and will require strong coordination from city departments and good construction contractors.

“The underground construction is hard work,” Honker said. “It’s going to be difficult, we can’t sugarcoat it.”