Schaeffer Opines on the Act, RBOCs and Benefits of Being Big

With seven startups under his belt, it would be an understatement to say Dave Schaeffer is a prolific entrepreneur. Schaeffer in 1999 founded, and is CEO for, Cogent Communications Inc., North America’s largest ISP, which has grown, in part, through 13 acquisitions. The following is an excerpt of a recent conversation between Schaeffer and xchange Editor in Chief Paula Bernier.

Cogent's Dave Schaeffer

XC: 2006 is xchange magazine’s 10th anniversary and the 10-year anniversary of the Telecom Act. What are your thoughts on how the Telecom Act of ’96 played out and the status of the telecom environment today?

DS: In looking at the goals of the Telecom Act, by any objective standard you would have to say it has been a failure. It’s primary mission was to create competition in the industry, and it has not been successful. We’ve seen regulators focusing now on other issues, and it appears we’re headed back to either monopoly or duopoly reconvergence, let’s call it.

XC: On a more personal note, what were you doing ten years ago?

DS: I had just sold my SMR businesses to what became Nextel and had just started the company I started before Cogent. Cogent is my seventh startup. The previous company was a company called Pathnet. I was just founding that company at that point.

Pathnet’s mission was to aggregate excess telecommunication capacity from utilities into a nationwide network and then sell that access to other service providers. It actually grew to a pretty large size. We ended up growing the business, signing up 63 utilities and a number of service provider customers to buy our bandwidth. We were probably a victim of the boom, in the sense that we raised over $3 billion in capital, a large portion of that being in debt.

When I left the company, it was actually relatively healthy. I brought on the ex-CEO of Nynex; I began chairman for a while and then left to found Cogent. But about two years after I left, the company ultimately collapsed.

XC: What has happened in the industry over the past 10 years that helped lead you to where you are now?

DS: Three key drivers. First is the explosion in demand for bandwidth, primarily driven by the public Internet. While people hypothesized about very high growth rates, the reality is, in the 15 years that the Internet has been a commercial network – or network of networks – it’s consistently grown at about 100 percent a year, and that increase in demand for Internet bandwidth was the first reason.

The second reason was the ability to build out networks very different than they were built out previously, in the sense that to build a facilities-based communications network you no longer had to become a construction company, go out and secure rights-of-way and dig up streets, but rather you could buy facilities and focus on the delivery network layer as opposed to being a layer zero construction company.

The third trend has really been the explosive advances in the underlying technology, whether it be the maturity of wave division multiplexing in the transport layer or the advent of very high-capacity, optically interfaced routers that could actually deliver true wireline packet-processing speeds.

XC: What regulatory issues are front-of-mind for Cogent?

DS: In founding Cogent, one of the things I worked very hard on as I put the business plan together was to come up with a business model that was independent of any kind of regulatory oversight. We function entirely as an Internet service provider, therefore classified by the FCC as an ESP, or enhanced service provider, and are exempt from federal or state regulation. So we kind of sit outside of the regulatory milieu that the CLEC industry is so quagmired in.

XC: You say you’re unaffected by regulations, but what about net neutrality?

DS: Net neutrality I guess obliquely impacts us, but not directly. We at Cogent have focused on being a pure Internet service provider. We’re actually the second-largest carrier of Internet traffic in the world today, carrying about 12 percent of world’s traffic. So I guess we’re somewhat inoculated to those concerns because of the scale and amount of traffic that we carry. So it’s very difficult for a regional Bell company to take too hard of a stance, simply because of the breadth and size of our network. But for some smaller providers, which I think are the true core of this industry, net neutrality is a big issue. But even the definition of what that means is still ambiguous.

XC: Do you expect to see new federal telecom legislation this year?

DS: Probably not this year. I think over the next couple of years. It is important to remember the RBOCs are actually the largest political contributors in 49 of the 50 states. If you look at the top contributor in each state, except Alaska, every one of them is the local phone company. With that we’ll only see new telecom regulation when they totally figure out what they want.

Now what they’re trying to do is get into the video distribution business on the consumer side, and [they] are trying to get to the abandonment of franchise rules. So I think that will be included in new proposed legislation. But I think there’s still a lot of ambiguity in what all of the parties want. So while there is a lot of attention focused on telecom reform, I think it will probably be a couple of years away before we see new legislation. And, unfortunately, that legislation will probably be driven by the deep-pocketed monopoly.

XC: In a telecom environment that many believe is moving to a handful of megacarriers, how does Cogent fit in?

DS: I think there is a distinct bifurcation in the industry in two different dimensions. The first one is the dichotomy between companies that are primarily voice-revenue-supported and those that are data-supported. We clearly fall into the data camp. Most other large providers are really either video, if they’re an MSO, or telephony, voice telephony. So that doesn’t really impact us. The second thing is there, again, is a dichotomy between local distribution networks and backbone.

Our belief is that the world will probably consolidate down to 60 to 80 distribution networks globally that will control the vast majority, if not all, of the distribution facilities. We’re already seeing that here in the United States. We’re effectively down to six companies today, those being Verizon; AT&T, the old SBC; Time Warner; and Comcast. And then you’ve got BellSouth and Qwest as outliers that are much smaller that are likely to be absorbed at some point by one of the other four players.

And then on the core backbone, as prices continue to fall and there is continued pressure on operating margins, we’re seeing a lot of companies either abandon that space or get into significant financial trouble. Our belief is that that market, as prices continue to fall, is probably large enough to support somewhere between two and four global players. Today there’s probably only a dozen or less true global backbones, and that’s down from 50 or 60 a few years ago. When we started Cogent there were 13,000 facilities-based ISPs in the world. Today, there’s less than 1,000. So at the core we think the market continues to go to that dozen or so down to about three or so.

We are uniquely positioned to be one of those players because we are today the second-largest carrier of traffic, but we’re only utilizing about 4 percent of the lit capacity in our network. We selfishly were able to take advantage of some of the distress of others by acquiring 13 companies that, in total, had raised over $14 billion in capital to build their businesses.

Cogent Communications Inc. www.cogentco.com

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