Optimal BEAD grant theory

Bowling Green, Kentucky (February 1, 2023) - On November 15, 2021, U.S. Congress passed the Infrastructure Investment and Jobs Act (IIJA), which created, among other things, the Broadband Equity, Access and Deployment (BEAD) program. With $42.45 billion appropriated, the goal of this program is to deliver fast 100/20 Mbps internet access to every broadband serviceable location — every home or business — in America.

It’s a big job, and the agencies that have been assigned the key role in doing it — state broadband offices — have never done anything on this scale before. Some of them are just getting started. Before the pandemic, Congress channeled most broadband expansion funding through the Federal Communications Commission (FCC), with a supporting role for the U.S. Department of Agriculture (USDA).

The FCC’s last big program, the Rural Digital Opportunity Fund (RDOF), although it was very efficient at buying ambitious deployment commitments from internet service providers (ISPs) for relatively little public funds, turns out in retrospect to have made awards to a lot of unfit companies that defaulted on their promises. Congress is hoping the states will do better. They do have certain advantages, including more local knowledge and less bureaucratic protocol. But states have less technical expertise than the FCC. Will they rise to the challenge?

Connected Nation is here to help. In this series of blog posts, we hope to illuminate how states can run the BEAD program in a smart way. As in so many walks of life, a good conceptual model is critical to thinking clearly. So, as our explanatory touchstone, we will share a conceptual model of how BEAD grants administration can work to close the Digital Divide.

State broadband offices will need to think clearly in a complex area in order to make good use of the federal funding surge and close the Digital Divide once and for all.

BEAD grants: A conceptual model

Sometime in 2024 or 2025, states will start making BEAD grants to ISPs. What will happen then? Figure 1 present a handy, general way to think about the BEAD broadband grantmaking process. It involves seven quantities — capital expenditure or capex; PV or present value of revenue; PV of operating expenditures or opex; the grant; the match; and two conceptual quantities, the “willingness to invest” and the “required subsidy,” to which we’ll return later.

But first, let’s consider it chronologically. The steps are:

1. The state makes a grant.
2. The ISP raises its own capital, called the match.
3. Using the grant and the match, the ISP builds the network, spending capex to get the construction done.
4. With the network built, the ISP begins earning revenue from customers.
5. But in order to operate and maintain the network, the ISP must incur opex on an ongoing basis.

Figure 1:

But long before the grants start to flow, the state needs to plan the whole grantmaking process from beginning to end. It needs to do that both (a.) to enable ISPs to participate in an informed way, knowing in advance what obligations they are incurring, and (b.) to make grants to qualified companies, at affordable prices, that meets the state’s entire need for universal 100/20 broadband access. So, we’ll need to slow down.

Unpacking the model

Let’s take a closer look at each of the seven bars in the chart, starting with the five numbered bars that correspond to stages in the grantmaking and grant-performance process.

• Grant is what the state pays to launch the project. The ISP makes deployment commitments in return for receiving it.
• Capex (capital expenditure; blue) is what the ISP spends up front. It includes the cost of the fiber-optic cable, the towers, the labor to do trenching or make-ready work on polls, any environmental studies or permitting processes needed, electronics, and possibly the costs of initial advertising and onboarding customers. In short, everything you need to do to get a broadband network up and running.
• Match is what the ISP spends over and above the grant. It is equal to capex – grant.
• PV (present value) of revenue (green). Revenue is simple enough. It’s what ISPs collect from customers (or other sources like subsidies from universal service programs) after the network becomes operational. The tricky part is that the bar represents the present value of an ongoing cash flow. Future income is translated into present dollars using the finance concept of “present value,” which discounts future income using a “discount rate.” The present value of a future income stream shows what it would be worth paying today to secure that income stream.
• PV (present value) of opex, or operating expenditures (yellow). Like revenue, operating expenditures, including the energy to run networks and the labor to respond to customer service calls and roll trucks to implement repairs, are a flow extending into the indefinite future, which need to be translated into a present value to support business decision-making in the present.

The last two quantities, willingness to invest and required subsidy, are conceptual in nature. They will never be straightforwardly observed, but they are critical to understanding how to leverage BEAD funds to achieve the BEAD program’s policy goals.

Right-sizing grants and leveraging private capital: Two critical concepts

A lot of vague phrases get circulated when savvy people talk about broadband grantmaking. They might talk of “leveraging private capital,” of industry putting “skin in the game,” of getting “value for money,” and of “not leaving money on the table.” It’s time to give definition to these thoughts and make them logically clear. So, let’s turn to the last two quantities in the model in Figure 1.

First, willingness to invest (orange). This is a derived value, equal to PV of revenue – PV of opex. To understand it, think about the future and work backwards. Sometime in the future, if all goes well, an ISP that gets a BEAD grant will be a network operator in the project area, earning revenue and incurring opex. The difference between revenue and opex is profit. The present value of profit is what the ISP should, in principle, be willing to invest today. So, the orange bar represents the maximum amount that an ISP could invest and still earn an adequate ROI.

Of course, in Figure 1, willingness to invest is less than capex. This need not be the case as a matter of logic. Sometimes profits are enough to justify the costs of network construction. But if that were the case, the network probably would have been built already. In the areas where BEAD is relevant, it’s typically the case that what the ISP would rationally invest is less than what the network costs to build.

And that brings us to the last quantity: required subsidy (purple). This is another derived value, equal to capex – willingness to invest. In principle, this is the minimum amount the state could award as a grant in order to induce an ISP to build and operate the network. In practice, the state won’t know exactly what the minimum required subsidy is. The private ISP also might need an extra nudge, so a grant that is a little bit more than the minimum required subsidy should be considered pretty successful. A state that accomplishes this is “getting value for money,” “leveraging private capital” and making industry put “skin in the game,” not “leaving on the money of the table” for ISP shareholders in the form of an excessive profit windfall.

What success looks like

Figure 1, then, represents a success scenario for state broadband offices. Key points to celebrate:

• The network gets built and the residents get internet access.
• The ISP makes an adequate but not excessive profit.
• The network is commercially sustainable (revenue > opex) so the Digital Divide problem in the area should not reemerge.

If we’re lucky, there will be a lot of BEAD grantmaking scenarios like this in the next few years. Perhaps most remarkable is that, in this appealing scenario, a one-time expenditure permanently fixes the problem, with no need for ongoing subsidies.

Groping in the dark

Unfortunately, this conceptual model of optimal BEAD grantmaking comes with a huge disclaimer: it’s invisible.

All the quantities are real. There really is some capex that the ISP will spend before the network is operational. There really is some revenue that they’ll collect from customers if they build it. And so forth. But even the ISP doesn’t know exactly what the capex or the revenue will be. They’ll have to make decisions based on fallible projections and guesswork. And the state will almost always know less than the ISP.

Some of the quantities will never be exactly known, even if the grant project occurs and the network gets built. The ISP could calculate what it actually spent to build the network, but it might not do so. Some costs would be hard to categorize: for example, the wages of a worker learning on the job, or a piece of capital equipment with future-use value after the project is done.

Once the network is operational, the ISP will start to learn whether its forecasts of customer revenue were right or not, but there will be ongoing uncertainty about the future. If the ISP had to borrow to finance its matching investment, it will know what interest rate it paid, but questions will remain about the cost of capital. For example, what else might the ISP have done with the cash it spent building the network?

If the ISP is uncertain, even ex post, what its capex and PV of revenue and PV of opex are, the state can hardly insist ex ante that the ISP accurately report these things. There will be a lot of discretionary guesswork involved in any such projections. And if states design BEAD grant rules in a way that incentivizes ISPs to report their expected capex, revenue, and opex in a certain way, they should anticipate that ISPs will be strategic in the forecasts that they produce and share. The state could make a good, right-sized grant like that shown in Figure 1, and never know that it did. Or a savvy state broadband manager might know pretty well that she got the grant size right, yet never be able to prove it.

States need better information, and it’s a good thing that the NTIA is giving each state $5 million in planning funds that can be used, among other purposes, to collect better information. But even with a lot more data collection and information gathering, states will be, to a considerable extent, groping in the dark. Sometimes, the conceptual clarity of Figure 1 will be elusive to the point of unattainable for state broadband offices in the pell-mell of writing rules, reviewing applications, scrutinizing invoices, and conducting field validations of built networks in order to close out grant projects.

And yet the conceptual lessons of Figure 1 are valid and practical. Make the grant big enough but not too big. Don’t leave money on the table. Leverage private matching investment. That’s how to stretch the BEAD dollars, and turn a one-off grant into a permanent broadband access solution. That’s how to close the Digital Divide.

In the coming weeks, we’ll vary the quantities in Figure 1 to show a wide variety of scenarios that states are likely to find themselves in, and a wide variety of mistakes they might make, as they launch their own state-branded and somewhat distinctive implementations of the BEAD programs. There are different ways to do it right, but also a lot of ways to do it wrong.

As we write, state broadband offices are plunging into the few months of consulting and planning that will need to culminate, first in an action plan, due in the later part of this summer for most states, and an initial proposal, expected to be due near the end of 2023, which will have to fully specify a BEAD implementation for each state.

The clock is ticking. There’s no time to lose.

About the Author: Nathan Smith is the Connected Nation Director of Economics and Policy. Dr. Nathan Smith is a PhD economist with a Masters in Public Administration, who wrote his dissertation on the economics of technology. He is an extensively published writer on public policy, technology and economics. After leading the state broadband office in Arkansas during the 2020 pandemic, where he channeled CARES Act funds to broadband projects, he moved to Connected Nation to help other states wrestle with the rewarding but tricky business of efficiently subsidizing cutting-edge, sustainable broadband expansion. He also helps write proposals and develop digital equity plans.