Lately, some public-policy analysis has lacked an understanding of basic finance and simple math. If not bad, math then it is a demonstration of complete ignorance or willful deception. Some have argued that the cable industry reaps a 97-percent profit, a patently absurd claim. Others have cited various percentages and dollar figures, but most all fail to understand even the basics of business. At best, such claims take into account only the daily costs of running just a broadband network, ignoring the substantial fixed cost of building the entire network over decades.
 
To succeed, any industry must make a profit — that is, it must pay back what it spent plus a return on that investment. And to compensate the private investors for taking the risk, it must be a higher return than that money would have made parked in a money-market fund for all of those years.
 
The cable industry’s investments have been made over many years with the belief that the investment, plus a return on current program and operational costs, could be recouped, not just a marginal return on the marginal broadband product. The industry needs real profit to the “bottom line.” So what is the bottom line on the industry’s income statement? Below is one representative of the cable industry (sales = 100 percent of revenue).

Total sales 100.00
Cost of goods sold -32.00
Gross profit 68.00
General, selling and admin expenses -36.25
EBITDA 31.75
Interest, taxes, depreciation and amortization -22.00
NET INCOME (this is the profit) 9.75

From that net income — the 9.75-percent profit — a company must:

>> Pay for any new investment, such as the $13 billion the industry spends annually to expand and upgrade existing networks;

>> Save it in retained earnings; or

>> Pay out to the owners of the company as a return on their investments (or some mix of these).
 
Broadband providers have invested over $200 billion in private capital in the past decade to build our nation’s networks. A marginal cost analysis ignores this history and ignores financial reality. If companies were to operate as their critics would suggest — charging only enough to cover marginal costs — then debt taken on by companies to build the facilities in the first place would be abandoned, a massive debt default unhinging our economy. And investments in future upgrades would be abandoned, the end of innovation.
 
Perhaps these critics need to spend some time with a high-school finance text book before they opine further.

Bartlett D. Cleland is policy counsel with the Institute for Policy Innovation. Contact him at bcleland@ipi.org. This piece originally was published April 5 on the IPI Web site in its TechBytes section, and it is reproduced here with permission.

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