When Bigger Isn't Better (From Forbes.com May 2008)

By Melanie Lindner (Read on Forbes Website)

Four years ago, Russ Hamm, a one-time production-studio engineer, dreamed of bringing fast, affordable Internet access to small businesses around the nation using something called WiMax technology. Armed with credit cards and angel capital, Hamm founded Rainbow Broadband in Manhattan to do just that.

The battle plan: First, get a foothold in New York's $1 billion market for speedy Internet service. Next, tackle Los Angeles, Chicago and Nashville--all homes to a cadre of small media companies increasingly hungry for bandwidth to transmit an avalanche of digital music and video files. Vast riches awaited.

But then something happened that every entrepreneur would be wise to note: When it came to making money, Hamm and company realized that bigger wasn't necessarily better.

By now even casual observers know that the landscape is littered with singed companies that over- reached for growth--from smaller tech outfits to giants like Merrill Lynch and Citigroup. And yet inevitably the same mistakes still get made.

While Rainbow's initial goal was to service 1,000 customers across the country, the company soon discovered that it could do the same amount of business right at home in New York City. More importantly, the founders managed to suppress the powerful urge among many aspiring entrepreneurs to take on too much too fast.

"We had to take our egos out of the boardroom," says Rainbow chairman Jacob Gold. "It would have been nice to have five cities on our business cards, but it didn't make sense for us at the time."

Taking on New York made a lot of sense. Until recently, Verizon had a virtual monopoly on the broadband market there. Time Warner, AT&T and RCN pay the big telco a fee to use its underground infrastructure (those so-called "last-mile" high-speed connections). WiMax networks, by contrast, transmit data via microwaves from local hubs to dishes mounted on customers' buildings--no digging up the streets required.

Until Rainbow and other Wi-Max players like Boston-based Towerstream came along, small companies might pay $600 per month to rent 1.5 megabits over a T1 line--a pipe big enough to transmit just one CD worth of music in two hours from New York to California. Or, if they wanted to splurge, they could spend

$4,500 per month for 45 megabits over a DS3 line, enough to zip that whole CD from point to point in just two minutes. (Verizon declined to discuss its prices.)

Rainbow offered a compelling alternative: a 10 megabit pipe (that's 10 minutes to send that same CD) for just $1,250 per month, enough capacity for many of Rainbow's small-business customers. (The company also competes on the high end, selling 45-megabit access for $4,000 a month.)

In early 2005, with three customers in hand and dreams of a national rollout still dancing in his head,

Hamm got a wake-up call. A financial firm with a fancy Park Avenue address wanted to sign up for Rainbow's service: "I was dumbstruck that they summoned us," says Hamm, now 64. "Then I realized our customer base here in New York was much broader than just small media firms."

Hamm estimates the number of New York City customers potentially interested in his service is about 60,000 (including all five boroughs and a sliver of New Jersey). Total estimated sales: about $500 million. Even 2% of that would mean sizable, and more easily managed, growth.

Sticking close to home has paid off so far. Last year, Rainbow pulled in just shy of $1 million in sales, and the top line cleared $300,000 in the first quarter of 2008. At current rates, the company expects to have signed up 250 customers by the end of the year. Better yet, Hamm claims Rainbow is already turning a profit.