Broadband Wars

Is ADSL Softbank's Waterloo? Broadband competitors have taken hatchets to their standard charges since Softbank's Yahoo! BB slashed prices in a bid for market share in June. The price war has thrilled consumers and shaken investors -- and broadband providers aren't done yet. When the smoke clears, who will be left standing? Only one thing is clear: Faster, cheaper access to the Internet is a reality now in Japan.

DESPITE THE SPUTTERING ECONOMY, the IT slowdown, and the sound of shutters rattling down on a thousand startups, at least one small corner of the business world is still firing on all engines -- Japanese broadband. Indeed, there has hardly been a dull moment since J@pan Inc looked at the subject in its June issue ("Mission Impossible? Do Japan's Broadband Upstarts Stand a Chance Against NTT?" page 48, June 2001).

Consider this: The number of broadband users in Japan -- defined loosely as anyone with high-speed, high-volume access to the Internet -- was expected to jump from about 700,000 in June to 2.6 million by the end of this year, and to grow to 3.5 million by the end of 2002, according to IDC Japan. The original starting lineup of cable companies and digital subscriber line (xDSL) providers has swollen with the addition of utility companies, television networks, and satellite content providers.

Back in June, we predicted a hard slog for the rash of broadband upstarts that have sprouted up since the end of 1999. The ink was barely dry before trailblazer Tokyo Metallic Commu-nications, with JPY4 billion in current liabilities, was swallowed up by Softbank.

Since then, NTT has forked out another JPY100 billion on its nationwide fiber-optic network, which it calls "the future of broadband."

But by far the biggest development since June has been Softbank's typically flamboyant entry into the market, when group company Yahoo! BB elbowed its way to the front with an ADSL (asymmetric digital subscriber line -- the domestic-use end of the xDSL spectrum) service for JPY2,280 per month, what Douglas Ramsey of Internet Business & Japan Affairs calls "the start of something special in Japan's Internet market."

At less than half the price of anything else in sight, the move sparked a price war and made what NTT technocrats dismiss as an "intermediate technology" the star of the broadband show. ADSL, says the Nikkei, has "graduated from venture to corporate business," and against all the odds, high-priced Japan now has the cheapest broadband services in the world.

Japan's long-suffering telecom users are of course delighted at this rare outbreak of cutthroat competition and have beaten a path to Yahoo! BB's door. The question is, can Yahoo -- or anyone -- make money from this technology? Like gawkers at a car wreck, nervous investors are trying to avert their eyes from the carnage in the US, where the major carriers are saddled with total debt of over $300 billion. "The top three startup ADSL companies in the US are all in bankruptcy court," says Thomas Rodes, a director at Nikko Salomon Smith Barney.

And what about Softbank itself? Is this expensive foray into broadband a smart, bold entrepreneurial ploy to corner a potentially lucrative market, or a desperate ploy by a group struggling to pull its rear out of the fire? Some observers believe it's the latter. "This is a very costly mistake that could pull down the whole group," claims Mark A. Berman, senior Japanese telecommunications analyst at Credit Suisse First Boston. Does Softbank know something we don't, or is it digging a hole for itself?

xDSL Takes Off

The cliche that the Japanese business world is slow to make decisions but catches up with lighting speed once it sets clear targets probably has some life left in it yet. Just two years ago the country was lagging at the back of the broadband pack, with limited and slow dialup ISDN services, a sluggish market, and some of the highest charges in the industrialized world.

Today, Japan still ranks well behind leaders like South Korea and Canada in the ratio of broadband connections to inhabitants (Nine in every 100 South Korean households have high-speed Internet access; Canada has just over four in 100; and Japan has less than one per 100). But there are a smorgasbord of sophisticated and inexpensive services being offered.

The choices are divided into a range of technologies: from ISDN, NTT's early expensive and -- at 64 Kbps -- decidedly pokey experiment, to cable radio company usen's 100-Mbps fiber-optic service, which the company rolled out in seven major cities in October following trials in Tokyo. In between, you can find up to two dozen xDSL providers offering speeds of between 1.5 and 52 Mbps (although the most common ADSL services operate at 1.5 Mbps).

Meanwhile, companies like usen, utilities such as Tokyo Electric Power (Tepco), and cable outfits led by Microsoft subsidiary Jupiter Telecommunications and Tokyu Cable are using their own networks of fiber-optic backbone and fat coaxial cables to bypass the chokehold NTT still has on the nationwide infrastructure. Add to this fixed-line universe wireless alternatives like wireless LAN by SpeedNet (78 percentDowned by Tepco) and NTT DoCoMo 3G cellular, which wobbled off its launch pad in September, and the phrase "spoiled for choice" comes to mind.

We gave the cable companies, with their own infrastructure and bundled multimedia services, the edge in this flush market against NTT in our June piece, although we thought usen, which raised JPY43.2 billion (about half its annual income) in an April IPO, had a shot, too. Because firms using xDSL -- a generic term for a range of technologies that soup up standard copper telephone wires to provide high-speed digital communications -- must fight and then pay NTT for access to their network, they are at the mercy of the telecom behemoth, which still controls 95 percent of the country's lines. Moreover, while 1.5 Mbps might be considered reasonably fast now, alternatives like fiber-to-the-home (FTTH) may make this look obsolete very quickly, reinforcing a common industry view that this is merely a bridging technology.

All this, however, was before Softbank's bombshell. The firm announced its fixed-charge, always-on ADSL service of 8 Mbps through subsidiary Yahoo! BB in late June, at almost the same time it took over Tokyo Metallic's ADSL infrastructure and its 22,000 subscribers. (Softbank also previously bought Korea Thrunet, a South Korean broadband provider). At JPY2,280 a month, the charge was cheaper even than NTT's creaking ISDN service (JPY3,300), and the effect was immediate.

While the total number of ADSL subscribers in Japan had already shot up from 34,000 in February to 300,000 in late June, Softbank's move sent the numbers rocketing to 650,800 by the end of September. Once rosy predictions of 1 million subscribers by the end of the year no longer looked so far-fetched, and ADSL, once the poor cousin of broadband, suddenly became the flavor of the month.

Broadband competitors, already struggling with massive investment costs, were forced to take an ax to their standard charges. First to chop was Sony Communication Network Corp's So-net service, followed by NTT East and NTT West, cutting rates from JPY4,050 to JPY3,800 on July 16. Next came Nifty, NEC, and Tokai Broadband Communications (T-com) in August, followed by another cut by NTT's regional units to JPY3,100, effective October 1. The 240-odd cable companies that provide Net access also had to respond, and market leader Jupiter lowered its connection fees on September 1 to JPY5,800 from JPY6,500. Japan Cablenet subsequently slashed its fees by about 40 percent.

Most competitors took all this on the chin, but there were some testy comments. "Jupiter has no intention of plunging into endless price warfare," grumbled chairman and CEO Tsunetoshi Ishibashi. NTT East vice president Tetsuo Koga said, "It was definitely the lowest fee we can offer."

As prices have tumbled, speeds seem to have increased. So-net, Asahi Net, and access service provider eAccess claim to have upgraded their ADSL services to 8 Mbps to compete with Yahoo! BB, although there is much skepticism about their ability to deliver. "There are a lot of wild claims being made about access speeds," says Lincoln Owens, manager of the digital product department of cableco Jupiter.

"Most of the time these companies are talking about the physical speed that modems can handle rather than what customers actually get. There's no way the DSL people are getting 8 Mbps. The best they can get is 4, and that's only for a couple of thousand customers."

Despite admitting that Yahoo's initiative had pushed cable subscriptions down and forced an unexpected price cut, Owens thinks the long-term fallout from Yahoo's move is good for the broadband industry. "The customer benefits, and it forces providers to focus on attractive content. In the long run, if the big telcos take this as a spur to start providing cheaper, better broadband services, that means a great boost for people on the edges of the industry, even if some of us have to take a short-term hit in revenue." Of course, the cable industry, still the country's leading provider of broadband services with its own networks and an estimated subscriber base of 970,000 users, has its own reasons for sitting back and watching the DSL companies slug it out. But many DSL providers are also putting on a brave face. So-net's Tatsuya Inada says it has had a tremendous impact on the public and "put ADSL on the map." Eric Gan, chief operating officer of eAccess, agrees. "A year ago the trade magazines were full of articles about cable and FTTH. Now every one has ADSL on the cover," he says. "People now take it seriously, and subscriptions are growing fast. So it has created a lot of excitement. It's the sort of creative destruction that's good for the industry as a whole."

Maybe so. But is creative destruction good for individual ADSL providers? Given the US broadband slump and the likely shakeout to follow in Japan, Gan seems oddly relaxed, saying what differentiates his company from competitors is the financial discipline of being a "real venture capital company." Some have suggested, however, that eAccess may already be in trouble. In September, Japan Telecom took a 15 percent stake in the company for JPY4 billion, making it eAccess' largest shareholder. Berman of CSFB calls it a "ridiculous investment that saved eAccess but threw good money after bad." He is deeply pessimistic about the chances of any DSL broadband startup. "No one is going to end up making money except NTT when they mop up the mess in one to two years' time. The only companies who will do well are the people who have networks, because everyone else has to pay NTT for the backbone network, and that's very expensive."

Nor is Berman alone in his assessment that ADSL rests on rickety foundations in an industry prone to seismic shifts, and that Yahoo Japan is diving into a "losing" business. "ADSL technology is probably already obsolete," says Andy Suzuki, executive vice-president of Internet products at Tomen Cyber-business Solutions. "In the long run, FTTH will win out, and I think Cable TV and wireless will be niche winners."

There have already been casualties. Apart from Tokyo Metallic, Mitsui & Co. abandoned plans to enter the ADSL business in June, a year after setting up a joint venture called Garnet Connec-tions Planning with Rhythms NetConnections, Sumitomo, Cable and Wireless IDC, and others. "Unless you are a telecommunications operator, it's nearly impossible to make the huge investments required to compete," said Garnet's director at the time, Yoshiyuki Izawa. Given the widespread doubt about the ability of ADSL to weather the coming storms, many are wondering what exactly Softbank is up to.

The Devil is in the Detail

The strategy sounds simple. Yahoo Japan must sign up 2-3 million households, and will start to turn a profit with 1 million paying customers early next year, according to Masayoshi Son, president of Yahoo's parent company Softbank.

There is certainly demand, and, as Japan's largest Web portal operator with some 23 million visitors, there is little doubt Yahoo can snag customers. Son claims that about 200,000 households applied on opening day, and a Softbank spokesperson said in early October there were then about 810,000 signed contracts. Indeed, Son blamed the decision to delay Yahoo! BB's launch by one month until September 1 partly on having to handle the deluge of applications.

The move to broadband seems to make sense. "The com-pany can leverage its brand name and provide richer and more expensive content services with broadband," says Ben Wedmore, software and Internet analyst at HSBC Securities, and the whole venture might help the firm sell more hardware. Moreover, with slumping revenues in the firm's core advertising business, the firm has little choice but to diversify income.

The devil, as always, is in the detail. Yahoo's strategy depends on quickly renting or selling modems to customers and rolling out a complicated service with many working parts, all the time paying NTT East and West for the use of their backbone network while keeping investors on board as the money dribbles in. Costs are racking up -- JPY4 billion for Tokyo Metallic, some JPY8 billion for the Yahoo! BB launch, and about JPY10 billion on hardware. Subscriptions are coming in quickly, but "turning 800,000 subscribers into paying customers is not going to be easy," says Kirk Boodry, senior telecom analyst at Dresdner Kleinwort Wasserstein.

The more Boodry and other analysts rummage around in the detail of Yahoo's costs and planning, the less they like what they see. Take the technology. The paper insulation on Japan's copper telephone wires means ADSL transmission requires special modems. Analysts say Yahoo balked at the cost and went for standard modems instead -- cheaper, yes, but storing up potential problems for later. The modems are either rented at JPY500 a month or bought for JPY22,800, and installation is free for the first 1 million subscribers. The danger is that customers will return the equipment after trying it out for free, leaving Yahoo stuck with a huge pile of outdated inventory. In addition, problems with reception might eat up revenue on servicing and maintenance. And all this is before giants like NTT and NEC start to really compete in the supply of possibly better, more reliable equipment and computers with built-in modems.

Berman of CSFB says the company's approach is not new. "Yahoo is trying to build up market share by using the old Internet model of building up its subscription base without considering cost. They are basically giving away equipment at about $130 to $150 each, and that doesn't include labor and servicing. Their revenue per month is only $19, and that includes the ISP charge."

Yahoo's internal accounting has also raised eyebrows. Softbank is buying the modems from Taiwanese manufacturer Ambit and selling them to Yahoo Japan, which then sells them on to Yahoo! BB. It's a costly bit of creative accounting that creates sales but leads to suspicions that Softbank is trying to sustain the image of Yahoo Japan as a high-growth company by giving Yahoo profits while pushing the costs elsewhere, according to HSBC's Wedmore. "Yahoo's profits are very open to question," he adds.

It is antics like this and what many see as the heavy hand of the parent behind Yahoo's recent activities that have made analysts suspicious. Nikko Salomon Smith Barney's Rodes says he only recently turned bearish on Yahoo stock. "Yahoo's problem now with the advertising slump is how to keep growth going, complicated by Softbank's ownership. Softbank has invested about $2.5 billion in 800 unlisted Internet companies, a large proportion in Japan. A lot of these businesses are tied up with online businesses, and many may not see the light of day if broadband does not go up. So I think Yahoo was called in by Masayoshi Son and told to get into this. Softbank is looked at as an investment firm. If Yahoo collapses, then Softbank collapses. Yahoo and Yahoo Japan are the jewels in the crown because they keep investors interested in the company while they wait for another hit somewhere."

CSFB's Berman agrees. "Not only are they not making any money in any other core business, but they are getting into this business which is losing. They are doomed to failure." Put all this together and it is clear how much is riding on the ADSL venture. If Yahoo can keep revenues flowing (it claimed 43 percent quarter-on-quarter growth in July-September) on the back of the Yahoo! BB income, while reducing its dependency on ads (down from about 95 percent in the first half of last year to 56.6 percent in the same period this year), the pack of cards might hold together. Certainly many are surprised by the interest shown so far in ADSL. But snags in technology, erosion of subscribers, or a trailing off in consumer interest could cause pain. And of course, once you start a price war, there's no telling where it will end. NTT Communications was set to introduce a JPY1,970 "debut price" on November 1, just edging out JPY1,980 offerings from KDDI and from telecommunications venture Wireless Internet Service. Without its own network, Yahoo has little room to maneuver and is forced to compete with ADSL rivals the only way it can -- on price.

Shareholders have not been encouraged. The price of Yahoo Japan stock dropped to its lowest level this year in September, 93 percent below the high of JPY167.9 million touched in February last year. Investors of course are only one side of the equation. Consumers are getting the deal of their lives, although it may be short-lived. After a couple of years of fierce price-cutting in the US, broadband costs have started to rise again. All it took was a shakeout and a slew of bankruptcies. @