The Future of Universal Service

The Universal Service Fund (USF) has been in the news over the past several months, and if your rural broadband business is heavily reliant upon it, there are some challenges ahead. This is not some “doom and gloom” post that everything will disappear, but there is a reasonable level of risks and uncertainty that it makes sense to have done some planning.

For those unfamiliar with the USF, this was a system set up in the Telecommunications Act of 1996 to ensure that all Americans had access to local and long-distance voice service at reasonable rates. It seems that trying to put telephone lines in rural areas was expensive…

It sounds a bit like broadband, doesn't it? Obviously, there were a lot of additional issues in the Act, but it set the stage for the industry going forward, especially rural telephone companies and cooperatives.

How does the fund work? The fund imposes a small fee on voice services across the United States and then distributes the fund to those areas where the economics of delivery are just too challenging.

As a result, telephone companies became either a "net payer" or a "net recipient." In other words, companies get USF dollars from customers and USF dollars from the government.?

Those who get more from the government are net recipients. Those who get more from customers and send it on to the government are net payers. Large telcos tend to be net payers, whereas small, rural telcos tend to be net recipients.

In rural areas of the country, this became a critical element to the business and allowed the buildout of copper telephone lines and the provision of service to nearly every person in the country.

The Universal Service Fund Of Today

A lot has changed since 1996. We have cell phones now, VoIP services have become available from cable companies, and, on top of it all, everyone wants fiber. The need for plain old telephone services (POTS) has changed.?

The Fund has also gradually evolved. The Federal Communications Commission (FCC), which oversees the USF, gathered industry input over time and realized that the Fund needed to shift to broadband from POTS.

There are four main areas of the Fund, but for this newsletter, I’ll only speak to one today: the High Cost Program. This program deals with support for the network in high-cost areas, meaning those places where it is really expensive to deploy and serve, i.e., rural areas.

The USF High Cost Program has become a critical component of the economics of rural broadband companies over the years, but it is seeing some of the following major challenges:

• There are ongoing court cases to determine if elements of the Fund are constitutional, specifically if the FCC has the authority to delegate collections and operations to the Universal Service Administration Company (USAC). If the court rules in favor of the claimants, the Fund will be in a major predicament.

• The Fund itself is struggling to stay solvent. Remember I said voice services support the Fund? To do this, each year, USAC has to establish a contribution factor that says how much of a fee will need to be charged based on the total base of voice services available (the “assessable revenue”).?
• That picture isn’t pretty, as noted in a recent blog from AT&T below, which shows that there is less and less assessable revenue causing a higher and higher level of contribution factor. This situation is unsustainable, and fixing this issue is non-trivial — congressional action will be required.

• There is an argument that given the amount of BEAD and other infrastructure dollars being put into rural, this is not needed anymore, especially when others, like cable, already compete in rural areas.?The argument is why taxpayer dollars should be used in this way.

As you can surmise, the picture is FAR more nuanced, and those arguments may make sense at face value in some instances but don’t always make sense in every area of the country. That said, Congress has a lot on its plate these days, and the appetite to put more money into this after putting nearly $100B over the past few years raises a question.

What Will Happen to the Universal Service Fund Over Time??

This is a critical question to many rural operators I speak with. The problem is it's difficult to forecast, but I think we can make a few assumptions as well as reflect some facts:

1. There will likely be some sort of funding mechanism to support areas, but it very likely will diminish in size over time as more competition reaches these regions.
2. The FCC started moving to performance and milestone-based funds nearly ten years ago. This means that an operator could receive funds if they voluntarily agreed to deliver a certain amount of broadband (originally 10 Mbps down/ 1 Mbps up) to all eligible locations in their territory. This was the Adjusted Connect America Model, or "ACAM." In return for moving to this model, operators forewent their old USF collections for fixed payments and certainty over a period of time. The money would end at a time in the future.
3. The FCC followed this with the "Connect America Fund" Phase II Auction, which distributed funding to other providers, again subject to milestone payments over a defined period. Again, the money would end in the future.
4. When broadband speeds increased, the FCC offered an adjustment to ACAM providers to make the target 25/3 in return for an extension of payments over time. You guessed it – there is a deadline.
5. In 2000, the FCC completed the Rural Digital Opportunity Fund, modeled after the CAF Phase II Auction, to distribute nearly $9B in funds to companies to build high-speed capabilities in rural areas, many of these at 1 gigabit per second (fiber-like speeds). These network builds had payments for ten years, and yes … they would then end.
6. Finally, we just passed another milestone when the FCC has once again gone back to all the USF-receiving companies (ACAM, ACAM II, and "legacy") to get an Enhanced ACAM offer that extends payment to 2038 in return for building to 100/20 Mbps capable networks to align with the BEAD program. Unfortunately, most providers had less than two months to make a 15-year decision with a high degree of complexity … and the money would run out eventually (admittedly, 2038 isn’t around the corner).?

Here's where I'm going with all of this. The FCC has continued to move to a model where the support eventually ends over time which helps control costs. In fact, if you look at data from USAC concerning the USF High Cost Program, you can see a very interesting trend.?

The fund has moved from an open-ended to a time-bound/milestone-based model over time. The latest iteration, the Enhanced ACAM, is partly trying to address a program called CAF BLS, which very small providers utilize (while at the same time providing more certainty to existing ACAM operators while bringing all items in line with BEAD).

Depending on how many opted into the Enhanced ACAM program, nearly 70% of the fund could have an expiration date!

USF High Cost Program, 2017-2022

Here's the point – USF WILL LIKELY DIMINISH OVER TIME. Let me be very clear – it won't be overnight and is likely far in the future, but by and large, companies that rely on USF should consider shifting over time to a traditional return on investment model vs. a “cost recovery” model. This brings you in line with most businesses today and how they are run.

If you are a recipient of USF, there is a path to create longer-term business sustainability. That path includes:

• Focusing on operational efficiencies
• Maximizing your market share
• Enhancing your ARPU
• Expansion, including via BEAD, into other geographies
• Addition of "up the stack" services
• Mergers and acquisitions
• Other services TBD

However, taking these steps will take time, and those who are dedicated to reducing their reliance on USF will not only sustain themselves when funds are no longer available, they will enjoy increased profitability as they are able to return more dollars to invest in the network or to their community and shareholders.

In short, whether or not you believe me on what could happen to USF, your best bet is to make a more efficient operating business that will create resiliency in your business.

If you'd like to hear more about the regulatory and strategic outlook for the rural broadband industry, I invite you to join me at the Ribbon Technology Forum in Plano, TX, on November 8 and 9. I'll be talking on this topic with my good friend, Dee Herman of Herman and Whiteaker.

We'll talk about USF, ACAM, BEAD, and competition, as well as how you can position your business for the long haul.

If you plan to attend, I'd love to talk to you while there, so please reach out directly or DM me through LinkedIn.

If you would like to attend, you can register here.?

How are you addressing the risks from USF changes?

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