For Rural Ops, the Small-Town Life Isnt Easy

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With all the recent cable-industry consolidation in large
urban clusters, it's easy to overlook the competitive pressures facing smaller
companies in exurban and rural markets. And although hostile takeovers and overbuilders
may be less of an issue in small-town America, rural service providers face their own
challenges.

The cost of doing business in smaller markets is a primary
consideration for providers that cannot count on the same economies of scale or access to
capital that urban providers can.

"In the exurban markets with less density of homes per
mile, it's always more expensive to upgrade the [cable] plant," said SoftNet
Systems president Ian Aaron.

SoftNet serves small-market cable operators with its ISP
Channel high-speed Internet service.

So far, high-speed competition from digital-subscriber-line
service has been limited to larger market, said ISP senior vice president of marketing
Kevin Gavin. Today, ISP Channel's primary competition is from dial-up Internet
service providers.

Some companies that focus on the rural marketplace do so
because they see profit opportunities in areas where there is not yet much head-to-head
competition. Others see serving the hard-to-reach consumer as almost a morally mandated
mission.

"We have a social opportunity to serve the haves and
the have-nots," HSA Inc. chief operating officer Dan O'Brien said.
"We're becoming a society divided by those that have information and those who
don't. What we're about is being able to deliver Internet to homes in small
rural and exurban markets that might not otherwise be served."

Serving the unservables has been the mission of the
National Rural Telecommunications Cooperative for the past 65 years, according to
spokesman Harry Thibedeaux. The NRTC's work in providing satellite television to
rural subscribers dates back to the early days of C-band services.

While the NRTC continues to support the C-band business,
it's a strong proponent of DirecTV Inc.'s direct-broadcast-satellite service and
has the exclusive right to sell most DirecTV programming in designated rural territories
across the country.

"In certain rural markets, there is no other
option," NRTC executive liaison Chris Martin said. "It's satellite or
nothing. They can't get a signal off local off-air, and cable won't go
there."

The challenge of bringing television to households beyond
the immediate reach of a broadcast signal was the stimulus behind the creation of the
cable industry as well.

In this day of social, economic and geographic mobility, it
would be a mistake to write off small-town markets as uninterested in -- or unable to
afford -- robust video and data packages. As is the case in the nation's cities,
there is no typical exurban subscriber.

For example, ISP Channel serves a number of island vacation
retreats where high-speed cable penetration reached 10 percent within the first two months
of launch, Aaron said.

A number of ISP Channel's clients serve small-town
bedroom communities where residents commute to larger metropolitan areas and are
accustomed to using high-speed connections at work, Gavin added. In some of the more rural
markets, he said, demand for new technologies may lag behind that of larger markets by
about six months.

"Small cable companies are closing the digital
divide," American Cable Association president Matt Polka said. Some officials in
Washington, D.C., still can't get access to high-speed data services, but they are
available in rural towns in Nebraska -- thanks to operators who are upgrading their
plants, he added.

Thorn Landers, vice president of sales and marketing for
HSA, said demand for high-speed Internet access in small-town America has gone beyond the
early adopter stage. "We're starting to get to grandparents," he said.

Demand for local and network broadcast signals is strong in
rural America, judging from the calls, letters and electronic-mail messages that bombarded
Congress in the weeks and months leading to recent changes in legislation governing the
delivery of local broadcast signals via satellite.

Proposed language that would have authorized more than $1.2
billion in federal loan guarantees to companies that provide local broadcast signals to
DBS customers did not make it into the final bill last month, although Congress has
promised to revisit the issue next spring.

"Independent of the loan guarantees, just having a
clear statement from Congress and the FCC [Federal Communications Commission] that this is
a public interest priority" will help spark new efforts to provide local signals to
markets beyond those where DirecTV and EchoStar Communications Corp. plan to deliver,
Pegasus Communications Corp. chairman Mark Pagon said.

Congress already allows rural homes beyond the reach of
broadcast signals to receive distant network signals via satellite. But Pagon said the
existing standard for determining distant-signal eligibility is still flawed, and many
customers in exurban markets are unjustly denied access to a network feed.

The NRTC wants to be involved in delivering local signals
in 210 broadcast markets, according to Martin.

"Most of us take local signals for granted for their
entertainment value, but you can't discount the importance of local news, information
and weather," said Martin. "Regardless of where you live, all Americans should
have access to the information age."

DirecTV and EchoStar have not yet named all the markets
where they plan to deliver local-to-local service, but neither is expected to extend
beyond the top 40 or 50 cities, citing limited satellite capacity and economic
considerations.

But that doesn't mean that additional markets
can't served, according to Pagon.

"It's much simpler than people have convinced
themselves," he said. "The economics are better in New York or Los Angeles than
in Burlington, Vt., but that's true for anyone doing business there."

Already, 100,000 households in Burlington -- about
one-third of the market -- subscribes to satellite television, according to Pagon.
"That's an adequate market" for a local-to-local package, he said.

The presence or absence of loan guarantees won't by
itself determine whether Pegasus goes forward with a local-to-local service for rural
markets, Pagon said. But money could be a determining factor for others, especially for
those looking to serve the smallest areas.

"It would be very difficult to raise the money for
local to local without the loan guarantees," Martin said, because the volume of
subscribers in rural markets is not large enough to allow a sufficient return on
investment in a short time. "The loan guarantees give us time to pay back those
loans."

Polka believes that as long as his members are providing
local broadcast service, they should have access to the same loan guarantees.

"We'll come back in the springtime to talk about
a technology-neutral funding mechanism," Polka said. "Congress talks about
competition and rapid deployment of new services, and that's what our members have
been doing."

Small, privately owned cable companies don't have the
same access to Wall Street that DBS providers do, he added.

Other players likely to be interested in the loan
guarantees include Local TV on Satellite, a division of Capital Broadcasting, which would
likely use spot-beam satellites to deliver the signals, and Northpoint Technologies, which
has been testing a terrestrial-based system that shares the DBS spectrum.

Pagon said Pegasus supports loan-guarantee language
that's neutral when it comes to satellite versus terrestrial technology for
delivering local broadcast signals. However, "we draw the line that cable providers
should be permitted to avail themselves of those loan guarantees," he added.

Pegasus has also urged caution when it comes to the
secondary use of DBS downlink spectrum by services such as the one proposed by Northpoint.

Any third-party providers that decide to deliver local
broadcast signals to DBS subscribers in smaller markets will have to work directly with
EchoStar and DirecTV to make sure the DBS companies' receivers and programming guides
are compatible with local-signal delivery, Pagon said.

"Those are not simple issues, but it's not
economically prohibitive," he said.

Of course, some exurban markets will be within the DMA of
one of the top broadcast markets that DirecTV or EchoStar will serve, allowing subscribers
to get their major network signals seamlessly over satellite.

For NRTC affiliates such as Pegasus, a new wrinkle is that
DirecTV won't allow the NRTC to sell local broadcast packages for all the markets
DirecTV plans to serve.

Under its existing agreement, the NRTC only has rights to
sell programming from 27 of the 32 transponders DirecTV controls at its primary 101
degrees west longitude orbital slot, and none from DirecTV's new spectrum at 110 and
119 degrees.

Broadcast signals from San Francisco, Miami, and
Washington, D.C., for example, will be uplinked to the five transponders at 101, which the
NRTC cannot access. DirecTV senior vice president of new ventures Steve Cox said DirecTV
customers in nearby NRTC territories will still have access to their local signals;
they'll just have to buy them directly from DirecTV.

DirecTV also markets former U.S. Satellite
Broadcasting-distributed programming such as Home Box Office to customers in NRTC
territories, because it's also transmitted from the five transponders that the NRTC
has no access to. Consumers who buy programming from both DirecTV and the NRTC are billed
separately.

The NRTC and DirecTV are headed to court over the matter of
the former USSB programming, which some see as a part of a larger struggle over
renegotiating DirecTV's contract with the NRTC.

"The NRTC and DirecTV have some serious issues to work
out," Tellus Ventures Associates president Steve Blum said. "If the NRTC gets
the loan guarantees, it could use them for spot beam satellites. It could give the NRTC a
chance to extend the deadline on its agreement with DirecTV."

Martin said the NRTC and DirecTV are still working through
issues relating to which transponders the DBS provider will use to deliver its proposed
new services from TiVo Inc. and America Online.

"We're working to make sure our subscribers have
access to all DirecTV's services," he said.

Pagon said he does not expect to see a resolution announced
between the NRTC and DirecTV any time soon. "At this point in the litigation process,
it doesn't incent any part to get serious yet," he said.

Perhaps more so than in the urban markets, DBS providers
seem to be battling each other more than cable.

DirecTV, which had traditionally focused more attention on
larger markets and national retail accounts, has turned its attention to independent
dealers following its acquisition of the former PrimeStar Inc. customer base.

"EchoStar has historically focused on distribution in
rural America," DirecTV vice president of distribution and group sales Jim Arnold
said. "That's their strength; that's where they got their start. But
we're making real strides."

Arnold said DirecTV doubled the size of its sales
organization over the past summer in an effort to educate its independent dealer base.

Meanwhile, EchoStar does not appear content to let any of
its rural business go. The company launched an aggressive "bounty program,"
offering its dealers monetary incentives to steal former PrimeStar subscribers before
DirecTV had a chance to convert them to its high-power service.

"There are those companies who think it's all
right to focus their efforts on cannibalizing other customers," Arnold said. "We
take a dim view of that, and we're not interested in working with dealers who engage
in bounty activity."

EchoStar had run similar bounty programs targeting
large-dish C-band satellite subscribers. It recently struck a marketing alliance with TV
Guide, which agreed to promote EchoStar's Dish Network service to subscribers of its
Superstar/Netlink C-band programming packages.

The C-band satellite market has declined steadily over the
past year.

The rural satellite market could see further consolidation
in the future if Pegasus is successful in buying up other NRTC territories. Industry
insiders speculate that Golden Sky Systems is the next logical take-over target for
Pegasus.

"To the extent that Golden Sky represents half the
remaining NRTC territories, we'd be interested" in purchasing the company, Pagon
said. However, "we have not had any talks with them about this. They say they want to
be an independent company for the foreseeable future."

Pegasus plans to introduce two new services late next year:
TV-centric Internet access under the Pegasus brand, and a co-branded broadband service for
personal computers.

If implemented quickly enough, bundled service offers could
give small cable operators a competitive advantage against DBS.

"The future is pretty exciting," Polka said.
"Once operators get around digital [cable] and high-speed [data], the next step is
telephony."

HSA Inc. is already testing voice-over-IP telephony in
Smyrna, Ga., O'Brien said. The company is also testing Internet-over-television in
Colorado and Maryland.

Gavin said SoftNet's contracts with cable operators
include the ability to sell IP telephony and Internet over the television in the future,
along with the ISP Channel. The company plans to demonstrate both new technologies at the
upcoming Western Show.

Some of the new technologies require cable operators to
upgrade their plant to two-way digital, and many small operators cannot afford to do it on
their own. But in an effort to compete, many companies are finding a way to upgrade.

"Half our members this year told us they've
either already launched or plan to launch high-speed and digital by the end of year
2000," Polka said.

The upgrades are feasible thanks to vendors who provide
services and technology especially for small cable systems, Polka said. Among those
vendors: AT&T Broadband & Internet Services' Headend In The Sky (HITS) and
TVN Entertainment Corp. on the digital cable side, and HSA and ISP Channel on the data
side.

ISP Channel, for example, has a program called Upgrade
America, which gives operators $15 to $32.50 per subscriber to help upgrade the cable
plant to two-way.

"By going two-way, they can look at a new revenue
stream from new services," Gavin said.

By offering high-speed data service, small cable operators
not only get revenue from the new technology, O'Brien said, "but in many cases,
there's additional penetration in video, so there's another revenue
advantage."

Without a turnkey partner such as ISP Channel or HSA, the
cost to implement a high-speed data service could be prohibitive for small cable
operators.

"The smallest companies don't have the
technology, the time or the money to deliver Internet service," O'Brien said,
adding, "We take the burden off the cable operator with project planning, marketing
and revenue splits."

One challenge in providing Internet access in rural
America, Aaron said, is that headends are not always close enough to fiber to provide the
backbone connectivity. SoftNet bought a nationwide fiber network company, so it does not
need to use the local phone company's plant. ISP Channel uses satellite dishes at the
cable headend to tap into the network.

"The smaller and more remote the system, the more
likely we are to use satellite connectivity," Gavin said.

Vendor partners with turnkey operations can provide not
only technical, marketing, and financial support, but in some cases round-the-clock
customer service.

"There are the complexities of [dealing with] the
hardware in the customer's home," O'Brien said. "That's not
necessarily a skill set the cable company has."

HSA can help a small cable operator position itself as a
technology leader in its community by expanding its marketing to small offices as well as
residences, O'Brien said. When commercial buildings are not wired for cable, HSA can
deliver Internet access via digital subscriber line.

Small-town architects, for example, could benefit from
high-speed Internet access by sending changes to blueprints over a fast connection, rather
than wasting time with dial-up transfers or overnight shipping services.

Operators could also use local content to sell Internet
access in the same way they use access to local broadcasters to tie video customers to
their communities.

ISP Channel includes a default home page on its service,
called ISP Channel Neighborhood, which includes locally generated content such as soccer
game scores and school lunch menus. The company also partners with weekly and daily
newspapers to drive advertising and electronic commerce opportunities, sharing a cut of
those revenues with the local cable provider.

Educating potential subscribers about new technologies and
services can be a challenge in smaller markets because "your footprint isn't
large enough to do this with mass market advertising through television or
newspapers," Landers said. Instead, HSA uses direct mail and telemarketing.

A local presence goes a long way toward reaching customers
in small-town America. HSA puts its own city manager in the field in each market it
serves, Landers said.

Polka said personal service from a member of the community
is a main advantage separating small cable operators from DBS.

"Our members live and work with the customers they
serve," Polka said. "That's something you can't easily get around just
because you have some newfangled technology."

The independent satellite dealer base serving rural America
has remained fairly stable over the years, Arnold said. This makes dealers less vulnerable
to competition from national consumer electronics superstores because the big chains often
don't go into the smallest towns.

"They know their customers," Arnold said. "A
local presence is important.

"That's why we're embracing the independent
dealers. It would be very hard to serve rural America sitting in an ivory tower."

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