The devil in the NBN detail

NBN Co's annual report has attracted criticism about executive pay and bonuses but it's the activation rates that are the real worry.

Last week’s release of NBN Co’s 2012 annual report attracted a chorus of criticism about the organisation’s executive pay and bonuses. A closer reading of the report reveals that the real focus of any scrutiny needs to be on the complexity of the project and the big risks to the successful delivery of the National Broadband Network.

Despite the negative headlines, NBNCo met the revised targets of their 2012 business plan with the project passing 212,000 premises against the projected 213,000. That number however, is less than half the 495,000 premises expected in the original plan released in 2010.

Giving bonuses to senior staff after missing those original targets attracted the criticisms of excessive executive pay, however concerned taxpayers should keep in mind average senior management remuneration at NBN Co’ is $827,000, just over a third of the $2.3 million received by Telstra's leadership and about the same as Fairfax’s average of $850,000.

Executive pay at NBN Co doesn’t appear excessive by industry standards and what taxpayers probably should be more concerned about is that there are eleven senior managers listed in the annual report.

At Telstra there are six senior executives reporting to the board and at Fairfax seven, so NBN Co’s management structure appears somewhat more unwieldy with CEO Mike Quigley having nearly twice as many direct reports than Telstra’s David Thodey.

Too many bankers?

NBNCo’s large executive team and the board are notable for their lack of construction expertise. Chief Operations Officer Ralph Steffens is the only executive with network rollout experience and of NBN Co’s ten directors listed in the annual report, only Richard Turchini has experience in the construction sector. 

Opposition spokesman Malcolm Turnbull recently criticised NBN Co’s board for being overweight on bankers with half the board coming from a finance industry background. However, the number of bankers on the NBN Co board probably more reflects the financialisation of Australia’s boardrooms, government and society in general, rather than any specific issue with the company.

The board is also heavily overweight with management consultants with three of the directors listed in the annual report being alumni of the McKinsey & Co consulting firm. Further historical comparisons with Fairfax are probably not helpful after noting this.

A project of the scope, scale and complexity of the NBN requires some hard headed commercial construction nous. While there’s no doubt the bankers have vital negotiating skills, it’s difficult to see how they and the McKinsey consultants can anticipate and oversee the challenges of what is largely a diverse and complex civil engineering project. 

Fortunately for NBNCo, the company has an estimated 100 staff in various project management roles, something that will be needed if they are to achieve their target of passing 1.5 million premises in 2015.

There are different types of project managers and the skills required to run a building and civil engineering project in the suburbs – which is the bulk of the NBN rollout work – are very different to IT or telco project management skills. Hopefully NBN Co’s recruitment and internal management systems reflect this.

Despite running behind on installations, NBN Co did manage to spend $529 million in 2012, exactly the amount originally forecast in the 2010 plan. That NBN Co incurred the costs expected in the original cash flow while only completing half the work may not bode well given the bulk of the project still lies ahead.

Activation rates a real concern

The real immediate concerns in the annual report are the activation rates - the number of people connecting to the network – and the ARPU – Average Revenue Per User, or how much money NBN Co expects to make from each of those connections.

Activation rates in the original corporate plan were expected to be around the 30 per cent mark, however, to date the take up has been closer to 15 per cent in the areas where the NBN has been rolled out.

Making matters worse for NBN Co’s revenue stream, the estimated initial ARPU was reduced from $33 in the 2010 corporate plan down to $20 for the 2012 estimates.

These lower numbers have had a marked effect on the project’s cash flow. As of the end of June 2012, NBN Co’s gross revenue was $1.9 million, just short of the $2 million expected in the latest Corporate Plan and far less than the $42 million projected in the original 2010 plan.

Interestingly that $1.9 million income from 13,500 active connections gives an ARPU of $140, an extraordinarily high number as Telstra’s reported ARPUs max out at $65 for a post-paid mobile user and most of those NBN subscribers haven’t been connected for a full year. From this we should assume there are upfront payments included in those annual report numbers.

More of a concern raised by this shortfall is the revised business plan assumes reduced income early in the project will be offset by greater revenue in later years with the network still being profitably by the end of construction in 2021. Any misses in those targets will have a long term effect on already weakened federal budgets. For a federal government attempting to rein in spending, providing the capital contributions to cover these shortfalls may prove to be difficult. This is where the banking expertise on the board may turn out to be useful.

Keeping an eye on the metrics

Overall, NBN Co’s annual report offers hope to the project’s supporters that the task of rolling out high speed broadband across the country is now on track for the 2021 completion date. 

For critics of the NBN there will continue to be plenty more ammunition for snipers as a project which involves digging holes in thousands of suburban streets hits the usual unexpected gas mains and clumsy contractors inadvertently flattening carefully tended rose gardens.

Both critics and supporters of the project should however be watching the numbers – premises passed, activation rates and revenue per user are going to be the key metrics for the project’s financial success. If these targets are missed then there will serious financial pressures on the NBN.

While the NBNCo’s 2012 annual report claims things are going to plan the document doesn’t really indicate whether the project will run on time or budget. As we go into an election year, it’s clear the NBN will continue to provide plenty of headlines, which should leave both the NBN's supporters and its detractors with plenty to fight about.