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Cogent Communication's Ever-Falling Bandwidth Pricing

Cogent Communications, a tier 1 facilities-based internet service provider with operations in the United States, Europe, Canada and Mexico, announced in its fourth quarter earnings conference call that traffic on its network grew by 23% from the third quarter to the fourth quarter. Other than the somewhat slower 10%-15% growth in the second and third quarters, this rate of growth has not been atypical for Cogent.

However despite this 23% quarterly traffic growth, Cogent's revenues only inched ahead. Quarter over quarter, Cogent's revenues advanced only about 4%, and if you remove the currency gains then only 3%. The large increases in traffic are offset by significant drops in the prices Cogent charges for its bandwidth.

Cogent sells bandwidth in Megabits/second (Mb/s) at a monthly rate. Historically, Cogent had a set pricing of $10/Mb with discounts bringing the price down to as low as $7/Mb if the customers signed longer contracts. Cogent dramatically dropped these prices in Mid-2008 for users of large amounts of bandwidth, lowering the price it charges per Mb down to as low as $4 and in some cases even lower. Per Cogent's CEO, Dave Schaeffer, customers have been taking advantage of this new pricing structure. In fact, the current average new Mb sold by Cogent is at a price of $4.51/Mb. This reduced pricing has taken the average price paid per MB for Cogent's installed base from $7.55/Mb to $6.01 per Mb in the past three quarters. Cogent's installed base average pricing has also seen some erosion as current customers sign new contracts to take advantage of the new lower prices.

Cogent's drops in pricing may not be ending either. In the year-end conference call, Mr. Schaeffer mentioned that Cogent did a promotional offering late in the fourth quarter which resulted in the largest backlog in the company's history. A little research showed that Cogent was offering bandwidth and an unprecedented $1.5/Mb for a 1 gigabit connection, a total cost of $1,500 per month which is very cheap by anyone's standards. The promotion was in Mid-December and the bulk of those installations are destined to hit in the current quarter. In addition, Mr. Schaeffer noted that they signed up one major law and law services firm at the end of the fourth quarter which resulted in “literally hundreds of connections.” Traffic continues to grow while Cogent continues to drop the prices.

What is the strategy? CEO Dave Schaeffer's philosophy is that bandwidth is a commodity and should be treated as a commodity. Cogent sells the “pipes” rather than the bits going across the network.  As traffic increases, Cogent drops the prices.  Mr. Schaeffer notes that Cogent's competitors try to sell bandwidth based on the use of the bandwidth rather than straight pricing on the bandwidth itself and that doesn't make any sense. In the current environment, he says that Cogent's competitors are under significant pricing pressure for their higher prices where Cogent's own competitive environment has become benign. “We're in a great position. We're producing cash. We're growing our business. It's true our revenue scale may be smaller than others but our revenue is growing while theirs is shrinking. Those two will converge at some point in time,” says Mr. Schaeffer.

Disclosure: The author holds a long-term position in Cogent Communications (NASDAQ:CCOI).