Major Internet Service Providers Are Fueling Their Own Disruption

Christopher Steiner co-founded Aisle50, YC S2011, which was acquired by Groupon in early 2015.

By lobbying the federal government to tear down privacy rules—and likely finding success, with a bill now having passed the House and Senate—the largest broadband and cable providers have provided more fodder for the startups that may one day depose them.

That these companies—Comcast, AT&T, Verizon—have been able to disregard consumers' interests for so long speaks to the inherent monopolistic advantages of their enterprises. These companies have grown into behemoths during the last two decades by providing what is now a crucial commodity to living in the modern world: internet access.

These major internet service providers seem to assume that their artificial monopolies will continue to hold. This is not only arrogant, but it will also prove to be bad for business.

Consumers, on a whole, have been slow to come around to the depth and detail with which their web activities are monitored. But the events of the last two years—uproar at the activities of the NSA, continual breaches of corporate databases—suggest that privacy is becoming a keystone issue to a larger number of people who pay for access to the web.

Speed and price will always be the No. 1 and No. 2 drivers for consumers of broadband, but privacy may well be No. 3. By flouting this fact, the major broadband providers give startup ISPs yet another benefit to extol.

FCC rules were put in place last year, scheduled to go into effect at the end of this year, to prevent ISPs from monitoring, gathering, and selling every little piece of data related to their users without first getting a user's permission. If the president, as expected, signs this bill, then these protections will never become active.

The large ISPs have been lobbying for exactly this. Don't regulate our business, they plead. The regulations wouldn't be necessary, however, if the ISPs battled for consumers based on the merits of their offerings. In many cases, however, households have access to only one source of high-speed internet.

The mistake these companies make is assuming that this will always be the case, that they will never face disruption from below.

That's a bad assumption, one that could end up the industry's undoing. There is no law of physics that says a fiber version of an Uber or Airbnb can't upend ISPs' business models by giving consumers more of what they want—speed and privacy—at a better price.

By so willingly turning back privacy protections for consumers, major ISPs give startups more toeholds to accomplish what is an admittedly tough mission. In some ways, however, the scene has been set for a classic tale of startup toppling Goliaths.

Legendary disregard for users

Even airlines are held in higher esteem by most consumers than are major broadband companies. Of course, that's because consumers can ultimately switch airlines in many cases. Switching ISPs is usually far harder, or impossible. The large providers know this and behave accordingly.

Cable and broadband companies have been dodging major regulation—the kind that could crack their near-monopoly status in some places—for decades. A New York Times article from 27 years ago details how hard some members of Congress tried to kindle consumer-friendly competition in the industry to no avail:

"But disputes over proposals aimed at fostering competition could derail the legislation and leave the industry a winner by default."

The landscape hasn't changed greatly, as most consumers are still left with one option for wired-up (dependable) internet service. What has changed, however, is the importance of the service carried by these owners of fiber and copper wires. The federal government was already wrestling with issues related to lack of competition for these companies three decades ago—and back then it was just about television. Now it's about literally everything: work, healthcare, education, communications and, yes, entertainment.

In the airline industry, bad service and disregard of the consumer gave rise to Southwest Airlines and JetBlue, both of which kept sailing as the incumbent class all succumbed to bankruptcies at one point or another during the last 15 years.

In the 1970s and 1980s, American carmakers, then perhaps the most powerful companies in the world, kept pumping out cars of inferior quality and in styles that consumers didn't seem to want. The rise of Toyota and Honda ensued.

In another similar arena, where infrastructure costs are high, T-Mobile has in the last several years pushed wireless carriers—most notably AT&T and Verizon—toward lower-priced plans that aren’t tethered to long-term contracts with punitive cancellation fees.

Why will the same fate not befall existing ISPs? Owning the pipes won't protect them forever. More pipes can and will be built, and despite the failure of WiMax, pipes may not always be required in the future.

Misaligned incentives, the startup advantage

Larger, older companies, like these ones, usually follow a critical path of maximizing revenue in any way possible. To be clear, this isn't inherently evil or otherwise amoral, but it leads to different decisions on product than would be made at a startup.

This is because the people in charge of these big companies, the CEO and other senior executives, are incentivized in far different ways than are startup founders. The average CEO of a Fortune 500 company spends a median of 4.9 years on the job. That's not a long time when compared with the tenure of founders.

So CEOs typically have a short stint. As it figures, most CEOs seek to earn as much money as possible during this time. And CEO pay, in general, is tied to the share price of the stock and to the company's earnings while the CEO is in charge. Unlike the situation for startup founders, a CEO’s compensation is not tied to how well the company has been set up for the next 10 or 15 years, or what growth and earnings look like in the five years following a CEO’s tenure.

So CEOs do what they can, in general, to make the company more efficient, and to squeeze more revenue out of the customers it already has. The latter requires a delicate balance, as a CEO doesn't want to drive consumers into the arms of competitors. But for the likes of Comcast, AT&T and Verizon, that danger isn't as real, as many consumers are simply unable to switch. That leads to all kinds of decisions, like those manifesting currently, of throwing consumers' better interests to the wind in favor of pursuing more near-term revenue.

ISP CEOs want to be able to sell consumers' data to anybody who shows up with enough money. They want to sell highly targeted ads, just as Facebook and Google do, but with the caveat that consumers can't turn off the monitoring carried out by their ISP—unlike that at Facebook and Google. Consumers also have the option of using different search engines or staying off of social media platforms altogether.

Finding another source of internet delivering speeds of 50 MB/s or faster, however, is often impossible.

Startups, on the other hand, often build their companies around the tenets of a better consumer experience. It's how they market themselves, it's how they grow, it's why they exist.

If startups simply offered another commoditized version of what was already on the market, nobody would use them.

Even Uber, whose in-house antics between employees and toward law enforcement have proven unsavory, has almost always done well by consumers, which is why most people won't be forgoing the convenience of the service anytime soon.

Building out an ISP is an infrastructure problem, which makes it unfriendly to the typical grind-it-out, bootstrapped startup. But that doesn't mean ISP's needn't worry about startups. Startup fiber ISPs, delivering a pipe of pure and fast access, have slowly spread across some communities. Google, of course, has rolled out its own fiber networks in select cities.

As startup ISPs are kindled or grow, their founders know they're signing on for a 10-year or 20-year build. Their incentives, therefore, are built around the long-term, around prying customers from incumbents and holding onto them for years. Startups need a better product.

Privacy could be the poignant kind of issue that kindles an ISP startup into being.

Culture gap - or no culture at all

Larger companies, in general, have poorer records for customer service and satisfaction. Some of that effect can be directly traced to the lack of culture, good or bad, in place at large companies. There's two reasons for this:

1. Culture starts with founders, and most big, old companies don't have founders around.  

Large companies' leaders and, for that matter, much of the employee base in general, are transient. Good culture and respect for the consumer flows down from above, an osmosis that often doesn't take place at large companies. There exists no grand mission, no great vision.

In the case of startups, founders often occupy the top positions at the company, and they continue to set an example. When startups become mega-companies, the founders are often still in charge or at least present—look at Google, Amazon, Facebook, Microsoft, Salesforce. At Apple, Steve Jobs, a founder, is the person who guided the company to its current status as a dominant force built around a maniacal focus on user experience.

At large companies, when leaders are only in place for several years and are just as likely to hop to another company as they are to stay, it's nearly impossible to cultivate a rich culture around the customer.

2. Their large size works against them. Controlling culture and maintaining message across an employee base of tens of thousands is hard. Starting it anew, trying to project an improved, customer-focused culture in a large company isn't impossible, but it's close.

Even if the CEO holds the consumer and her experience in the utmost regard, instilling that in a workforce of 30,000 employees takes enough time that the transition will likely never take place. The CEO will have moved on—or been pushed out—and most of the employees who were around for the effort will have changed jobs as well, leaving the large company back in the culture void in which it started.

The door is open for startup ISPs. We expect to see more in the future

FundersClub invests in all manners of startups, and maintains a focus on finding companies that can define—or redefine their space. The ISP space is one that has always interested us, as we think giant opportunity exists for the right startup and founders. When that company comes along, and it will, we hope to be part of it.