BSkyB Archives

Introduction

The way in which audiences consume movies and television content appears to be changing. While ‘linear’ viewing of scheduled channels remains robust, the market for DVD has collapsed and new pricing and consumption models are opening up.

At the forefront of this is Netflix – with a total of 63M paying subscribers across 50 markets (it is present in a large number of locations in Latin America and the Caribbean) and a penetration of over 34% in the US, Netflix has created a new paradigm for on demand content.

How this model is going to impact other players in the market in the long term is as yet unclear. To date in the US, pay platform penetration has remained robust, premium channels such as HBO are also performing strongly, and for rights owners and producers a new player bidding for rights is hugely welcome.

So is Netflix a ‘win: win’ opportunity for all concerned? It may not be that straightforward.

For leading pay TV players, Netflix will be yet another component forcing them to invest in innovation to minimise customers churning from bundled packages, and reducing flexibility around price increases;
For TV channels Netflix could lead to programme rights inflation, as a new player with a distinct business model comes into bid for premium exclusive content rights
For both established TV platforms and premium channels there is the risk that in price sensitive markets or demographics Netflix offers may gain traction, particularly among younger consumers at the expense of traditional subscription models.
For telcos looking to compete with cable and satellite, while Netflix could offer a cost effective way to deliver attractive premium content, it also carries a risk of constraining the telcos into the position of a ‘dumb (or happy) pipe’, not sharing in upsides and not owning the consumer who deals directly with Netflix.

STL Partners has partnered with Prospero Strategy Consultants who work extensively with content and platform players on new market dynamics to prepare this Briefing. The work has drawn on interviews with key players and analysis of quantitative and qualitative market data, to determine the threats and opportunities emerging from this new content ecosystem and how these are likely to develop.

Overview of Netflix History

Netflix began as a postal DVD business in the US in 1997, launching its US subscription streaming service in 2007. Since 2011 it has focused on rapid expansion into international markets with the biggest growth now coming from international subscribers (67% growth between 2013 and 2014) while its US DVD business is now in decline.

Figure 4: Netflix subscribers 1999 – 2014(Q3) in 000s

Source: Netflix annual reports, STL Partners & Prospero analysis

Netflix changed its reporting methodology from Q1 2011

Consumer Proposition and USPs

The success of the Netflix proposition to consumers has been based on a number of components:

Low Price and refusal to tie users into long-term contracts
Volume and exclusivity of content
Effective User Interface, recommendation engine and multi-device access
Customer Data

Low Price
The low monthly price point of Netflix (USD7.99 per month in the US rising to USD8.99 for new subscribers in 2014) has been a key component of the company’s success. This price point is less than the cost of purchasing a single DVD and significantly less than monthly premium drama channels such as HBO (at ~USD15 per month). This price point (and that users are not tied into long term contracts) allows Netflix to attract distinct audience groups.

First, the high-end audience who are already pay subscribers. These customers have demonstrated that they are typically price inelastic and willing to pay for more, buying Netflix on top of existing services.
Second, the price constrained audiences, for whom traditional pay TV is out of reach but who are interested in expanded choice. These are often younger demographics for whom the concept of non-linear consumption is very familiar.
There is a third audience group, the price sensitive pay TV subscribers for whom Netflix could be an effective substitute and who could churn off traditional pay TV (either completely or partially) as a result. While the evidence around the impact on this group is as yet nascent, it is this segment that is making incumbent pay TV players nervous.

Figure 5: Reasons Netflix streamers subscribe to the Service

Source: Alphawise, 3rd Annual Streaming Video Survey – More Devices, More Consumption, March 2013

Volume and Exclusivity

As demonstrated in Figure 5 above a key to success has been offering both range and quality of content. However, over time the shape of the Netflix library has changed as it has used its customer insight and data to inform its rights strategy.

In February 2012 the Netflix US library consisted of ~15k titles (Source: SNL Kagan) of which nearly three quarters were movie titles.
Since 2012 the volume of library titles has declined by approximately 30% nearly all of which is accounted for by a decline in movie titles. Netflix has increased its focus on long run drama series which already have brand recognition and which are effective at attracting and keeping audiences.
Interestingly, the volume of content being offered in its international markets is significantly less than in the US (about one-third) as Netflix shifts its focus to quality (as opposed to quantity of content)

Netflix’s early content deals were typically library rights and non-exclusive. Over time that mix has shifted as Netflix increasingly looks to have a component of exclusivity with the aim of shifting from a “nice to have” to a “must have” service

Netflix is investing in original production of a limited number of high profile, high end drama series (such as House of Cards, Orange is the only Black and the recently announced Crouching Tiger Hidden Dragon sequel). For these Netflix can retain its exclusive rights indefinitely.
In addition, Netflix is bidding aggressively for exclusive windows for high end content (such as the recently announced deal for exclusive VOD rights in all territories for Gotham and first window rights in several territories for Penny Dreadful).

Figure 6: Netflix’s Evolving Content Proposition

Source: STL Partners & Prospero analysis

Effective consumer interface on multiple devices

Netflix has evolved a highly effective consumer interface, enabling personalisation by individual members in the household, with an easy to manage and visually effective selection mechanism.

Since 2008 Netflix has rolled out its proposition across multiple connected devices, with the most recent development being access on mobile devices and partnership with 4G operators such as Vodafone. Cross device functionality gives users a consistent experience.
The consumer is able to choose when and where to consume Netflix content – leading to a new dynamic of series “bingeing” analogous to box set consumption. In addition, Netflix’s deals with Smart TV providers gives consumers the ability to by-pass traditional pay TV gatekeepers.

Figure 7: Netflix’s user interface

Source: Netflix & SNL Kagan

Customer Data

Underlying a huge part of their success is Netflix’s control of its data. This includes knowledge of individuals within households (who will have their own profiles), detailed insight into viewing behaviour (not just what, but when and how much), knowledge that no linear channel can match.
In all markets (regardless of its distribution partners) Netflix retains its customer data and does not share it. This informs its rights negotiations and new programme investments.
Netflix continues to refine its customer understanding using sophisticated A/B testing where small sub groups are given slightly different user experiences to see how this changes behaviour

Executive Summary
Introduction
Overview of Netflix
History
Consumer Proposition and USPs
Netflix International Expansion
Netflix Financials
Attitude of the Financial Markets
Impact of Netflix on the Market
Impact on Rights Owners and Producers
Impact on Channels
Impact on Pay Platforms
Impact on Broadband Operators
Summary impacts on players along the value chain
Responses to Netflix
Case Study: HBO
Case Study: BSkyB
Case Study: Broadband Operators
Case Study: New Competitors

Figure 1: Selected Media Companies Market Capitalisation, 1st Sept. 2014 (left) & 1st Jan. 2015 (right), USD billion
Figure 2: Netflix’s subscriber targets for 2020 (announced launches only) in USD million
Figure 3: Summary of Netflix’s Impacts along the Value Chain
Figure 4: Netflix subscribers 1999 – 2014 in 000s
Figure 5: Reasons Netflix streamers subscribe to the Service
Figure 6: Netflix’s Evolving Content Proposition
Figure 7: Netflix’s user interface
Figure 8: Netflix geography and timeline
Figure 9: Netflix’s Market Penetration over time to Dec 2013 (% households)
Figure 10: Netflix revenue per service area, 1999 – 2014, USD million
Figure 11: Netflix’s revenues & costs per business line, 2011–2014, USD million
Figure 12: Netflix’s net income and free cash flow, 2009 – 2014, USD million
Figure 13: Netflix’s streaming content obligations, 2010 – 2013, USD million
Figure 14: Selected Media Companies Market Capitalisation, 1st Sept. 2014 (left) & 1st Jan. 2015 (right), USD billion
Table 1: Comparison of Key Value Ratios
Figure 15: Netflix’s share price (USD), Jan 2010 – Jan 2015
Figure 16: Players along the Value Chain
Figure 17: Subscribers to premium channels in the US (%of TV households)
Figure 18: Changes in US Pay TV Penetration
Figure 19: Percentage of Households that are “cord-cutters”
Figure 20: Real Time Entertainment Share of Downstream Traffic
Figure 21: Share of Traffic of Downstream Peak Time Applications
Figure 22: Summary of Impacts along the Value Chain
Figure 23: Overview of Sky Expanded Offering
Figure 24: Sky’s offering across All Windows
Figure 25: Vodafone / Spotify and Sky Sport deals – Impact on mobile broadband usage
Figure 26: Netflix Broadband Partners
Figure 27: Netflix Competitor Set

BSkyB is probably the most misunderstood publicly quoted company in the UK. Most analysts view them as a media company; our theory is that BSkyB is a platform company and comparisons to Apple, Microsoft or Google are more appropriate than UK media players such as the BBC, ITV or even potential new entrants such as BT.

Figure 1: Sky Delivery Platform

Rule #1 – You have to keep loading extra features onto your platform…

Microsoft historically were tops at this – Windows for some grew fatter and fatter release by release, but in reality every release contained new features that appealed to some. BSkyB have done the same – they moved from analogue to digital, introduced interactive TV, took PVRs to the mass-market, and now are doing the same with HD-TV. As soon as that is complete ,they will move onto the next thing – 3D TV or even true on-demand VOD.

BSkyB seem to be one step ahead of the competition all the time. The only exception to this is Virgin Media networked VOD service, which is far superior to the BSkyB limited caching of programmes to the Sky+ device – currently a big hole in the portfolio. Notice that BSkyB is totally agnostic whether the features are driven by hardware, software or network – their platform contains all three elements.

Rule #2 – You have to design your platform to be the easiest to use…

Apple are the kings of usability – they control both client hardware, software and in the networked world they are taking more control of delivery though not by ownership of underlying assets – think of the parallel with BSkyB using 3rd parties for satellite and broadband delivery.

Very little is thought of BSkyB’s innovation in design – the Sky remote control in its day was a huge advance from TV manufacturers’ efforts. Similarly, they have extended this advantage in the PVR world – still keeping with their own designs. This is just the start of BSkyB’s advantage in usability.

It is not by accident that BSkyB wins awards for customer service – they realise that excellence in usability also needs to consider every touch point with customer – from sales to installation and care. BSkyB have made huge investments here and it pays off – within a couple of years of entering the voice and broadband market, they seem to be winning almost every award on offer.

Rule #3 – You need the lowest cost platform…

This is all about the economics of scale and running a tight ship especially with regard to corporate overheads. Nearly every platform businesses involve huge upfront risks & investment with many years of losses, with a steady ascent to profitability as the platform gains volume & pricing power.

Organisational inefficiency is a disease that afflicts almost all large companies. Very little data comparative data is available here, but I suspect that Sky is far more efficient if costs were normalized and compared to other payTV (eg Virgin Media), fixed (eg BT) or even Mobile (eg Vodafone) competitors for the share of the consumer wallet.

Rule #4 – You need the best content on your platform…

This is probably the most misunderstood element of BSkyB’s business – people still think BSkyB’s advantage is all about exclusive rights to Premier League Football & Movies. The truth for most content owners is that the BSkyB platform is the most profitable mass market route. And the attractiveness grows year-by-year as subscribers and revenues increase compared to their competitors.

People tend to dismiss how flexible the BSkyB platform is to content owners: you can sell your individual rights to your preferred bidder on a particular Sky Channel, for example HBO selling rights to the “The Wire” to a minority channel, FoxFX; you can build your own channel(s), e.g. MTV and Discovery Channels, or get a particular Sky-owned channel to do the production, e.g. sports events.

Strangely, even the major public service broadcasters (BBC, ITV, C4 & Five) are not only happy to have their content attached to the BSkyB platform, but are willing to pay for the pleasure.

Rule #5 – You need to extend your platform into adjacent areas…

Currently the focus on BSkyB is the move into the home broadband and voice market, which is a much bigger market than pure TV. To date, despite the rapid gain in scale profitability is still an aspiration. The defensive qualities of the play are always underestimated, as is how it constrains the freedom of major competitors, especially Virgin Media and BT, to differentiate.

However, it should never be forgotten that moving into adjacent areas is nothing new to BSkyB: the early digital days featured BSkyB investing/losing money in “t-commerce”; a move into gambling via SkyBet has been more successful, but the retail focus of the service was dwarfed by the emergence of a gambling platform play, BetFair; and Sky has investing in online properties, especially football, but it is too early to access the success.

The BSkyB defensive investments pale into insignificance compared to those made by Microsoft in protecting their franchise against the growing encroachment from Google. These defensive investments are also crucial in negotiations with regulators – for every complaint that BT states about the lack of profitability in the payTV market; BSkyB can counter with allegations about the impossibility of making profits in the home broadband & voice market.

Following the Rules

Of course following the rules is extremely difficult – continual innovation and improvement is hard. But the end result is a platform with plenty of levers for growth to play with. Different levers can be used at different times – all of which make the platform more attractive to particular segments of consumers and thereby generate the growth. The underlying dynamic is that BSkyB needs to show customer growth for success – or more importantly the right type of customer growth, ones who’ll happily pay for the extra features. Building the platform, increasing eyeballs, and increasing diversity are crucial. Traditional TV metrics such as share of viewing for an overall channel is completely irrelevant.

Figure 2: Sky Customer Growth and major platform upgrades

Impact on Regulation

UK Regulators, especially OFCOM, have struggled with the BSkyB business model and tend to try to examine market share in very narrow vertical segments – eg the current ongoing PayTV consultation. These ways of looking at BSkyB are doomed to fail. OFCOM is not alone and the EU battles with Microsoft over its platform business are already legendary and still ongoing. We don’t yet have the answer of how to regulate in a platform world, but we do know that a different approach is required.

Most importantly, BSkyB’s platform shows a multi-sided business model in action, bringing value to both upstream and downstream customers and earning decent returns for shareholders.

Tag: BSkyB

Netflix: Threat or Opportunity?