Lessons from AT&T’s bruising entertainment experience

How AT&T entered and exited the media business

AT&T enters the satellite market at its peak

In 2014, AT&T announced it was buying DirecTV. By that time, AT&T was already bundling DirecTV with its phone and internet service and had approximately 5.9 million linear pay-TV (U-Verse) video subscribers. However, this pay-TV business was already experiencing decline, to the extent that when the DirecTV merger completed in mid-2015, U-Verse subscribers had fallen to 5.6 million by the end of that year.

With the acquisition of DirecTV, AT&T went from a small player in the media and entertainment industry to one of the largest media players in the world adding 39.1 million (US and Latin American) subscribers and paying $48.5bn ($67bn including debt) to acquire the business. The rationale for this acquisition (the satellite business) was to compete with cable operators by being able to offer broadband, increasing AT&T’s addressable market beyond its fibre-based U-Verse proposition which was only available in certain locations/states.

AT&T and DirecTV enjoyed an initial honeymoon, period recording growth up until the end of 2016 when DirecTV subscribers peaked at just over 21 million in the US.

From this point onwards however, AT&T’s satellite subscribers went into decline as customers switched to cheaper competitor offers as well as online streaming services. The popularity of streaming services was reflected by moves among traditional media players to develop their own streaming services such as Time Warner’s HBO GO and HBO NOW. In 2015, DirectTV’s satellite competitor Dish TV likewise launched its own streaming service Sling TV.

Even though it was one of the largest TV distributors on a satellite platform, AT&T also believed online streaming was its ultimate destination. Prior to the launch of its streaming service in late 2016, Bloomberg reported that AT&T envisioned DirecTV NOW as its primary video platform by 2020.

A softwarised platform delivered lowered costs as the service could be self-installed by customers and didn’t rely on expensive truck roll installation or launching satellites. The improved margins would enable AT&T to promote TV packages at attractive price points which would balance inflation demands from broadcasters for the cost of TV programming. AT&T could also more easily bundle the softwarised TV service with its broadband, fibre and wireless propositions and earn more lucrative advertising revenue based on its own network and viewer insights.

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The beginnings of a bumpy journey in TV

AT&T’s foray into satellite and streaming TV can be characterised by a series of confusing service propositions for both consumers and AT&T staff, expensive promotional activity and overall pricing/product design misjudgements as well as troubled relations with TV broadcasters resulting in channel blackouts and ultimately churn.

Promotion, pull back and decline of DirecTV NOW

DirectTV NOW launched in November 2016, as AT&T’s first over the top (OTT) low cost online streaming service. Starting at $35 per month for 60+ channels with no contract period, analysts called the skinny TV package as a loss leader given the cost of programming rights and high subscriber acquisition costs (SACs). The loss leader strategy was aimed at acquiring wireless and broadband customers and included initiatives such as:

  • Promotional discounts to its monthly $60 mid-tier 100+ channel package reduced to $35 per month for life (subject to programming costs).
  • Device promotions and monthly waivers. The service eventually became available on popular streaming devices (Roku, Xbox and PlayStation) and included promotions such as an Apple TV 4K with a four month subscription waiver, a Roku Streaming Stick with a one month waiver or a $25 discount on the first month.
  • Customers could also add HBO or Cinemax for an additional $5 per month, which again was seen as a costly subsidy for AT&T to offer.

The service didn’t include DirecTV satellite’s popular NFL Sunday Ticket programming as Verizon held the smartphone rights to live NFL games, nor did it come with other popular shows from programme channels such as CBS. Features such as cloud DVR (digital video recording) functionality were also initially missing, but would follow as AT&T’s TV propositions and functionalities iterated and improved over time.

The DirecTV NOW streaming service enjoyed continuous quarterly growth through 2017 but peaked in Q3 2018 with net additions turning immediately negative in the final quarter of 2018 as management pulled back on costly promotions and discounted pricing.

The proposition became unsustainable financially in terms of its ability to cover rising programming costs and was positioned comparatively as a much less expensive service to its larger DirecTV satellite pay-TV propositions.

The DirecTV satellite service sold some of the most expensive TV propositions on the market and reported higher pay-TV ARPU ($131) than peers such as Dish ($89) and Comcast ($86) in Q4 2019.

  • The launch of a $35 DirecTV NOW streaming service with no contract and with a similar sounding name to the full linear service confused both new and existing DirecTV satellite customers and some would have viewed their satellite package as expensive compared to the cheaper steaming option.

Rising programming costs

AT&T’s low-cost skinny TV packages brought them into direct confrontation with TV programmers in terms of negotiating fees for content. When the streaming service launched, analysts highlighted the channels within AT&T’s base package were expected to rise in price annually by around 10% each year and this would eventually require AT&T to eventually balance programming costs with rising monthly package pricing.

Confrontations with programmers included a three-week dispute with CBS and an eight week dispute with Nexstar in 2019, which resulted in a blackout of both CBS and Nexstar channels across AT&T’s TV platforms such as Direct TV, U-Verse, DirectTV NOW. Commenting on the blackouts in Q3 2019, Randall Stephenson noted there were “a couple of significant blackouts in terms of content, and those blackouts drove some sizable subscriber losses”.

AT&T’s confrontation with content owners may have been a contributory reason to consider acquiring a content creation platform of its own in the form of Time Warner.

In mid-2018, as AT&T withdrew promotions and discounts for DirecTV NOW (later rebranded it to AT&T TV NOW), customers began to drop the OTT TV service.

  • AT&T TV NOW went from a peak of 1.86 million subscribers in Q3 2018 to 656,000 at the end of 2020.

DirecTV NOW subscriptions

DirecTV-subs-AT-T-stlpartners

Source: STL Partners, AT&T Q2 Earnings 2021

Name changes and new propositions create more confusion

In 2019, DirecTV NOW was re-branded to AT&T TV NOW , and continued to be promoted as a skinny bundle operating alongside AT&T TV, a new full fat live TV streaming version of the DirecTV satellite TV proposition. AT&T TV  was first piloted in August 2019 and soft launched in November 2019. The AT&T TV service included an Android set-top box with cloud DVR functionality and supported other apps such as Netflix.
AT&T TV required a contract period and offered pricing (once promotional discount periods ended) resembling a linear pay-TV service, i.e. $90+. This was, in effect, the very type of pay-TV proposition customers were abandoning.
AT&T TV was seen as an ultimate replacement for the satellite business based on the advantages a softwarised platform provided and the ability to bundle it with AT&T broadband, fibre and wireless services.

Confusion amongst staff and customers

The new AT&T TV proposition confused not only customers but also AT&T staff, as they were found mixing up the AT&T TV proposition with the skinny AT&T TV NOW proposition. By 2019 the company diverted its attention away from AT&T TV NOW  pulling back on promotional activity in order to focus on its core AT&T TV live TV service.

According to Cord Cutters News, both services used the same app but remained separate services. AT&T’s app store marketing incorrectly communicated the DirectTV NOW service was now AT&T TV when in fact it was AT&T TV NOW. Similarly, technical support was also incorrectly labelled with online navigation sending customers to the wrong support channels.

AT&T’s own customer facing teams misunderstood the new propositions

DirecTV-Cordcutter-news

Source: Cord Cutters News

Withdrawal of AT&T TV NOW

By January 2021, AT&T TV NOW was no longer available to new customers but continued to be available to existing customers. The AT&T TV proposition, which was supposed to offer “more value and simplicity” was updated to include some features of the skinny bundle such as the option to go without an annual contract requirement. Customers were also not required to own the set-top box but could instead stream over Amazon Fire TV or Apple TV.  In terms of pricing, AT&T TV was twice the price of the originally launched DirecTV NOW proposition costing $70 to $95 per month.

The short life of AT&T Watch TV

In April 2018, while giving testimony for AT&T’s merger with Time Warner, AT&T’s then CEO Randall Stephenson positioned AT&T Watch TV as a potential new low-cost service that would benefit consumers if the merger was successful. Days following AT&T’s merger approval in the courts, the low cost $15 per month, ultra-skinny bundle launched as a suitable low-cost cord-cutter/cord-never option for cable, broadband and mobile customers from any network. The service was also free to select AT&T Unlimited mobile customers.

By the end of 2018, the operator claimed it had 500,000 AT&T Watch TV“established accounts”. By the end of 2019 the operator had updated its mobile tariffs removing Watch TV for new customers subscribing to its updated Unlimited mobile tariffs. Some believed the company didn’t fully commit to the service, referring to the lack of roll out support for streaming devices such as Roku. The operator was now committed to rolling out its new service HBO Max in 2020. AT&T has informed Watch TV subscribers the service will close 30 November 2021.

Timeline of AT&T entertainment propositions

AT-T-Timeline-Entertainment

Source: STL Partners

The decline of DirecTV

As the graphic belowshows, in June 2021 there were 74.3 million pay-TV households in the US, reflecting continued contraction of the traditional pay-TV market supplied by multichannel video programming distributor (MVPD) players such as cable, satellite, and telco operators. According to nScreenMedia, traditional pay-TV or MVPD market lost 6.3 and 6.2 million customers over 2019 and 2020, but not all were cord-cutters. Cord-shifters dropped their pay-TV but shifted across to virtual MVPD (vMVPD) propositions such as Hulu Live, Sling TV, YouTube TV, AT&T TV NOW, Fubo TV and Philo. Based on current 2021 cord-cutting levels, nScreenMedia predicts 2021 will be the highest year of cord-cutting yet.

Decline in traditional pay-TV households

pay-tv-decline-nscreenmedia

Source: nScreenMedia, STL Partners

Satellite subscribers to Dish and DirecTV 2015-2020

Satellite-pay-tvdish-nscreenmedia

Source: nScreenMedia, STL Partners

When considering AT&T’s management of DirecTV, nScreenMedia research shows the market number of MVPD subscribers declined by over 20 million between 2016 and 2020. In that time, DirecTV lost eight million subscribers. While it represented 20% of the MVPD market in 2016, DirecTV accounted for 40% of the pay-TV losses in the market (40% of 20 million equals ~8 million). AT&T’s satellite rival Dish weathered the decline in pay-TV slightly better over the period.

  • In Q4 2020 the operator wrote down $15.5bn on its premium TV business, which included DirecTV decline, to reflect the cord cutting trend as customers found cheaper streaming alternatives online. The graphic (below) shows a loss of 8.76 million Premium TV subscribers between 2017 and 2020 with large losses of 3.4 million and 2.9 million subscribers in 2019 and 2020.

AT&T’s communications business has also been enduring losses in legacy voice and data (DSL) subscriptions in recent years. AT&T has used a bundling strategy for both products. As customers switched to AT&T fibre or competitor broadband offerings this also impacted the video subscription.

Table of contents

  • Executive Summary
    • What can others learn from AT&T’s experience?
  • How AT&T entered and exited the media business
    • AT&T enters the satellite market at its peak
    • The beginnings of a bumpy journey in TV
    • Vertical integration strategy: The culture clash
    • AT&T’s telco mindset drives its video strategy
    • HBO MAX performance
  • The financial impact of AT&T’s investments
    • Reversing six years of strategic change in three months
  • Lessons from AT&T’s foray into media

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Gigabit Cable Attacks This Year

Introduction

Since at least May, 2014 and the Triple Play in the USA Executive Briefing, we have been warning that the cable industry’s continuous improvement of its DOCSIS 3 technology threatens fixed operators with a succession of relatively cheap (in terms of CAPEX) but dramatic speed jumps. Gigabit chipsets have been available for some time, with the actual timing of the roll-out being therefore set by cable operators’ commercial choices.

With the arrival of DOCSIS 3.1, multi-gigabit cable has also become available. As a result, cable operators have become the best value providers in the broadband mass markets: typically, we found in the Triple Play briefing, they were the cheapest in terms of price/megabit in the most common speed tiers, at the time between 50 and 100Mbps. They were sometimes also the leaders for outright speed, and this has had an effect. In Q3 2014, for the first time, Comcast had more high-speed Internet subscribers than it had TV subscribers, on a comparable basis. Furthermore, in Europe, cable industry revenues grew 4.6% in 2014 while the TV component grew 1.8%. In other words, cable operators are now broadband operators above all.

Figure 1: Comcast now has more broadband than TV customers

Source: STL Partners, Comcast Q1 2015 trending schedule 

In the December, 2014 Will AT&T shed copper, fibre-up, or buy more content – and what are the lessons? Executive Briefing, we covered the impact on AT&T’s consumer wireline business, and pointed out that its strategy of concentrating on content as opposed to broadband has not really delivered. In the context of ever more competition from streaming video, it was necessary to have an outstanding broadband product before trying to add content revenues. This was something which their DSL infrastructure couldn’t deliver in the context of cable or fibre competitors. The cable competition concentrated on winning whole households’ spending with broadband, with content as an upsell, and has undermined the wireline base to the point where AT&T might well exit a large proportion of it or perhaps sell off the division, refocusing on wireless, DirecTV satellite TV, and enterprise. At the moment, Comcast sees about 2 broadband net-adds for each triple-play net-add, although the increasing numbers of business ISP customers complicate the picture.

Figure 2: Sell the broadband and you get the whole bundle. About half Comcast’s broadband growth is associated with triple-play signups

Source: STL, Comcast Q1 trending schedule

Since Christmas, the trend has picked up speed. Comcast announced a 2Gbps deployment to 1.5 million homes in the Atlanta metropolitan area, with a national deployment to follow. Time Warner Cable has announced a wave of upgrades in Charlotte, North Carolina that ups their current 30Mbps tier to 200Mbps and their 50Mbps tier to 300Mbps, after Google Fiber announced plans to deploy in the area. In the UK, Virgin Media users have been reporting unusually high speeds, apparently because the operator is trialling a 300Mbps speed tier, not long after it upgraded 50Mbps users to 152Mbps.

It is very much worth noting that these deployments are at scale. The Comcast and TWC rollouts are in the millions of premises. When the Virgin Media one reaches production status, it will be multi-million too. Vodafone-owned KDG in Germany is currently deploying 200Mbps, and it will likely go further as soon as it feels the need from a tactical point of view. This is the advantage of an upgrade path that doesn’t require much trenching. Not only can the upgrades be incremental and continuous, they can also be deployed at scale without enormous disruption.

Technology is driving the cable surge

This year’s CES saw the announcement, by Broadcom, of a new system-on-a-chip (SoC) for cable modems/STBs that integrates the new DOCSIS 3.1 cable standard. This provides for even more speeds, theoretically up to 7Gbps downlink, while still providing a broadcast path for pure TV. The SoC also, however, includes a WLAN radio with the newest 802.11ac technology, including beamforming and 4×4 multiple-input and multiple-output (MIMO), which is rated for gigabit speeds in the local network.

Even taking into account the usual level of exaggeration, this is an impressive package, offering telco-hammering broadband speeds, support for broadcast TV, and in-home distribution at speeds that can keep up with 4K streaming video. These are the SoCs that Comcast will be using for its gigabit cable rollouts. STMicroelectronics demonstrated its own multigigabit solution at CES, and although Intel has yet to show a DOCSIS 3.1 SoC, the most recent version of its Puma platform offers up to 1.6Gbps in a DOCSIS 3 network. DOCSIS 3 and 3.1 are designed to be interoperable, so this product has a future even after the head-ends are upgraded.

Figure 3: This is your enemy. Broadcom’s DOCSIS3.1/802.11ac chipset

Source: RCRWireless 

With multiple chipset vendors shipping products, CableLabs running regular interoperability tests, and large regional deployments beginning, we conclude that the big cable upgrade is now here. Even if cable operators succeed in virtualising their set-top box software, you can’t provide the customer-end modem nor the WiFi router from the cloud. It’s important to realise that FTTH operators can upgrade in a similarly painless way by replacing their optical network terminals (ONTs), but DSL operators need to replace infrastructure. Also, ONTs are often independent from the WLAN router or other customer equipment , so the upgrade won’t necessarily improve the WiFi.

WiFi is also getting a major upgrade

The Broadcom device is so significant, though, because of the very strong WiFi support built in with the cable modem. Like the cable industry, the WiFi ecosystem has succeeded in keeping up a steady cycle of continuous improvements that are usually backwards compatible, from 802.11b through to 802.11ac, thanks to a major standards effort, the scale that Intel and Apple’s support gives us, and its relatively light intellectual property encumbrance.

802.11ac adds a number of advanced radio features, notably multiple-user MIMO, beamforming, and higher-density modulation, that are only expected to arrive in the cellular network as part of 5G some time after 2020, as well as some incremental improvements over 802.11n, like additional MIMO streams, wider channels, and 5GHz spectrum by default. As a result, the industry refers to it as “gigabit WiFi”, although the gigabit is a per-station rather than per-user throughput.

The standard has been settled since January 2014, and support is available in most flagship-class devices and laptop chipsets since then, so this is now a reality. The upgrade of the cable networks to 802.11ac WiFi backed with DOCSIS3.1 will have major strategic consequences for telcos, as it enables the cable operators and any strategic partners of theirs to go in even harder on the fixed broadband business and also launch a WiFi-plus-MVNO mobile service at the same time. The beamforming element of 802.11ac should help them to support higher user densities, as it makes use of the spatial diversity among different stations to reduce interference. Cablevision already launched a mobile service just before Christmas. We know Comcast is planning to launch one sometime this year, as they have been hiring a variety of mobile professionals quite aggressively. And, of course, the CableWiFi roaming alliance greatly facilitates scaling up such a service. The economics of a mini-carrier, as we pointed out in the Google MVNO: What’s Behind It and What Are the Implications? Executive Briefing, hinge on how much traffic can be offloaded to WiFi or small cells.

Figure 4: Modelling a mini-carrier shows that the WiFi is critical

Source: STL Partners

Traffic carried on WiFi costs nothing in terms of spectrum and much less in terms of CAPEX (due to the lower intellectual property tax and the very high production runs of WiFi equipment). In a cable context, it will often be backhauled in the spare capacity of the fixed access network, and therefore will account for very little additional cost on this score. As a result, the percentage of data traffic transferred to WiFi, or absorbed by it, is a crucial variable. KDDI, for example, carries 57% of its mobile data traffic on WiFi and hopes to reach 65% by the end of this year. Increasing the fraction from 30% to 57% roughly halved their CAPEX on LTE.

A major regulatory issue at the moment is the deployment of LTE-LAA (Licensed-Assisted Access), which aggregates unlicensed radio spectrum with a channel from licensed spectrum in order to increase the available bandwidth. The 5GHz WiFi band is the most likely candidate for this, as it is widely available, contains a lot of capacity, and is well-supported in hardware.

We should expect the cable industry to push back very hard against efforts to rush deployment of LTE-LAA cellular networks through the regulatory process, as they have a great deal to lose if the cellular networks start to take up a large proportion of the 5GHz band. From their point of view, a major purpose of LTE-LAA might be to occupy the 5GHz and deny it to their WiFi operations.

  • Executive Summary
  • Introduction
  • Technology is driving the cable surge
  • WiFi is also getting a major upgrade
  • Wholesale and enterprise markets are threatened as well
  • The Cable Surge Is Disrupting Wireline
  • Conclusions
  • STL Partners and Telco 2.0: Change the Game 
  • Figure 1: Comcast now has more broadband than TV customers
  • Figure 2: Sell the broadband and you get the whole bundle. About half Comcast’s broadband growth is associated with triple-play signups
  • Figure 3: This is your enemy. Broadcom’s DOCSIS3.1/802.11ac chipset
  • Figure 4: Modelling a mini-carrier shows that the WiFi is critical
  • Figure 5: Comcast’s growth is mostly driven by business services and broadband
  • Figure 6: Comcast Business is its growth start with a 27% CAGR
  • Figure 7: Major cablecos even outdo AT&T’s stellar performance in the enterprise
  • Figure 8: 3 major cable operators’ business services are now close to AT&T or Verizon’s scale
  • Figure 9: Summary of gigabit deployments
  • Figure 10: CAPEX as a % of revenue has been falling for some time…

 

Netflix: Threat or Opportunity?

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

Triple-Play in the USA: Infrastructure Pays Off

Introduction

In this note, we compare the recent performance of three US fixed operators who have adopted contrasting strategies and technology choices, AT&T, Verizon, and Comcast. We specifically focus on their NGA (Next-Generation Access) triple-play products, for the excellent reason that they themselves focus on these to the extent of increasingly abandoning the subscriber base outside their footprints. We characterise these strategies, attempt to estimate typical subscriber bundles, discuss their future options, and review the situation in the light of a “Deep Value” framework.

A Case Study in Deep Value: The Lessons from Apple and Samsung

Deep value strategies concentrate on developing assets that will be difficult for any plausible competitor to replicate, in as many layers of the value chain as possible. A current example is the way Apple and Samsung – rather than Nokia, HTC, or even Google – came to dominate the smartphone market.

It is now well known that Apple, despite its image as a design-focused company whose products are put together by outsourcers, has invested heavily in manufacturing throughout the iOS era. Although the first generation iPhone was largely assembled from proprietary parts, in many ways it should be considered as a large-scale pilot project. Starting with the iPhone 3GS, the proportion of Apple’s own content in the devices rose sharply, thanks to the acquisition of PA Semiconductor, but also to heavy investment in the supply chain.

Not only did Apple design and pilot-produce many of the components it wanted, it bought them from suppliers in advance to lock up the supply. It also bought machine tools the suppliers would need, often long in advance to lock up the supply. But this wasn’t just about a tactical effort to deny componentry to its competitors. It was also a strategic effort to create manufacturing capacity.

In pre-paying for large quantities of components, Apple provides its suppliers with the capital they need to build new facilities. In pre-paying for the machine tools that will go in them, they finance the machine tool manufacturers and enjoy a say in their development plans, thus ensuring the availability of the right machinery. They even invent tools themselves and then get them manufactured for the future use of their suppliers.

Samsung is of course both Apple’s biggest competitor and its biggest supplier. It combines these roles precisely because it is a huge manufacturer of electronic components. Concentrating on its manufacturing supply chain both enables it to produce excellent hardware, and also to hedge the success or failure of the devices by selling componentry to the competition. As with Apple, doing this is very expensive and demands skills that are both in short supply, and sometimes also hard to define. Much of the deep value embedded in Apple and Samsung’s supply chains will be the tacit knowledge gained from learning by doing that is now concentrated in their people.

The key insight for both companies is that industrial and user-experience design is highly replicable, and patent protection is relatively weak. The same is true of software. Apple had a deeply traumatic experience with the famous Look and Feel lawsuit against Microsoft, and some people have suggested that the supply-chain strategy was deliberately intended to prevent something similar happening again.

Certainly, the shift to this strategy coincides with the launch of Android, which Steve Jobs at least perceived as a “stolen product”. Arguably, Jobs repeated Apple’s response to Microsoft Windows, suing everyone in sight, with about as much success, whereas Tim Cook in his role as the hardware engineering and then supply-chain chief adopted a new strategy, developing an industrial capability that would be very hard to replicate, by design.

Three Operators, Three Strategies

AT&T

The biggest issue any fixed operator has faced since the great challenges of privatisation, divestment, and deregulation in the 1980s is that of managing the transition from a business that basically provides voice on a copper access network to one that basically provides Internet service on a co-ax, fibre, or possibly wireless access network. This, at least, has been clear for many years.

AT&T is the original telco – at least, AT&T likes to be seen that way, as shown by their decision to reclaim the iconic NYSE ticker symbol “T”. That obscures, however, how much has changed since the divestment and the extremely expensive process of mergers and acquisitions that patched the current version of the company together. The bit examined here is the AT&T Home Solutions division, which owns the fixed-line ex-incumbent business, also known as the merged BellSouth and SBC businesses.

AT&T, like all the world’s incumbents, deployed ADSL at the turn of the 2000s, thus getting into the ISP business. Unlike most world incumbents, in 2005 it got a huge regulatory boost in the form of the Martin FCC’s Comcast decision, which declared that broadband Internet service was not a telecommunications service for regulatory purposes. This permitted US fixed operators to take back the Internet business they had been losing to independent ISPs. As such, they were able to cope with the transition while concentrating on the big-glamour areas of M&A and wireless.

As the 2000s advanced, it became obvious that AT&T needed to look at the next move beyond DSL service. The option taken was what became U-Verse, a triple-play product which consists of:

  • Either ADSL, ADSL2+, or VDSL, depending on copper run length and line quality
  • Plus IPTV
  • And traditional telephony carried over IP.

This represents a minimal approach to the transition – the network upgrade requires new equipment in the local exchanges, or Central Offices in US terms, and in street cabinets, but it does not require the replacement of the access link, nor any trenching.

This minimisation of capital investment is especially important, as it was also decided that U-Verse would not deploy into areas where the copper might need investment to carry it. These networks would eventually, it was hoped, be either sold or closed and replaced by wireless service. U-Verse was therefore, for AT&T, in part a means of disposing of regulatory requirements.

It was also important that the system closely coupled the regulated domain of voice with the unregulated, or at least only potentially regulated, domain of Internet service and the either unregulated or differently regulated domain of content. In many ways, U-Verse can be seen as a content first strategy. It’s TV that is expected to be the primary replacement for the dwindling fixed voice revenues. Figure 1 shows the importance of content to AT&T vividly.

Figure 1: U-Verse TV sales account for the largest chunk of Telco 2.0 revenue at AT&T, although M2M is growing fast

Telco 2 UVerse TV sales account for the largest chunk of Telco 2 revenue at ATandT although M2M is growing fast.png

Source: Telco 2.0 Transformation Index

This sounds like one of the telecoms-as-media strategies of the late 1990s. However, it should be clearly distinguished from, say, BT’s drive to acquire exclusive sports content and to build up a brand identity as a “channel”. U-Verse does not market itself as a “TV channel” and does not buy exclusive content – rather, it is a channel in the literal sense, a distributor through which TV is sold. We will see why in the next section.

The US TV Market

It is well worth remembering that TV is a deeply national industry. Steve Jobs famously described it as “balkanised” and as a result didn’t want to take part. Most metrics vary dramatically across national borders, as do qualitative observations of structure. (Some countries have a big public sector broadcaster, like the BBC or indeed Al-Jazeera, to give a basic example.) Countries with low pay-TV penetration can be seen as ones that offer greater opportunities, it being usually easier to expand the customer base than to win share from the competition (a “blue ocean” versus a “red sea” strategy).

However, it is also true that pay-TV in general is an easier sell in a market where most TV viewers already pay for TV. It is very hard to convince people to pay for a product they can obtain free.

In the US, there is a long-standing culture of pay-TV, originally with cable operators and more recently with satellite (DISH and DirecTV), IPTV or telco-delivered TV (AT&T U-Verse and Verizon FiOS), and subscription OTT (Netflix and Hulu). It is also a market characterised by heavy TV usage (an average household has 2.8 TVs). Out of the 114.2 million homes (96.7% of all homes) receiving TV, according to Nielsen, there are some 97 million receiving pay-TV via cable, satellite, or IPTV, a penetration rate of 85%. This is the largest and richest pay-TV market in the world.

In this sense, it ought to be a good prospect for TV in general, with the caveat that a “Sky Sports” or “BT Sport” strategy based on content exclusive to a distributor is unlikely to work. This is because typically, US TV content is sold relatively openly in the wholesale market, and in many cases, there are regulatory requirements that it must be provided to any distributor (TV affiliate, cable operator, or telco) that asks for it, and even that distributors must carry certain channels.

Rightsholders have backed a strategy based on distribution over one based on exclusivity, on the principle that the customer should be given as many opportunities as possible to buy the content. This also serves the interests of advertisers, who by definition want access to as many consumers as possible. Hollywood has always aimed to open new releases on as many cinema screens as possible, and it is the movie industry’s skills, traditions, and prejudices that shaped this market.

As a result, it is relatively easy for distributors to acquire content, but difficult for them to generate differentiation by monopolising exclusive content. In this model, differentiation tends to accrue to rightsholders, not distributors. For example, although HBO maintains the status of being a premium provider of content, consumers can buy it from any of AT&T, Verizon, Comcast, any other cable operator, satellite, or direct from HBO via an OTT option.

However, pay-TV penetration is high enough that any new entrant (such as the two telcos) is committed to winning share from other providers, the hard way. It is worth pointing out that the US satellite operators DISH and DirecTV concentrated on rural customers who aren’t served by the cable MSOs. At the time, their TV needs weren’t served by the telcos either. As such, they were essentially greenfield deployments, the first pay-TV propositions in their markets.

The biggest change in US TV in recent times has been the emergence of major new distributors, the two RBOCs and a range of Web-based over-the-top independents. Figure 2 summarises the situation going into 2013.

Figure 2: OTT video providers beat telcos, cablecos, and satellite for subscriber growth, at scale

OTT video providers beat telcos cablecos and satellite for subscriber growth at scale

Source: Telco 2.0 Transformation Index

The two biggest classes of distributors saw either a marginal loss of subscribers (the cablecos) or a marginal gain (satellite). The two groups of (relatively) new entrants, as you’d expect, saw much more growth. However, the OTT players are both bigger and much faster growing than the two telco players. It is worth pointing out that this mostly represents additional TV consumption, typically, people who already buy pay-TV adding a Netflix subscription. “Cord cutting” – replacing a primary TV subscription entirely – remains rare. In some ways, U-Verse can be seen as an effort to do something similar, upselling content to existing subscribers.

Competing for the Whole Bundle – Comcast and the Cable Industry

So how is this option doing? The following chart, Figure 3, shows that in terms of overall service ARPU, AT&T’s fixed strategy is delivering inferior results than its main competitors.

Figure 3: Cable operators lead the way on ARPU. Verizon, with FiOS, is keeping up

Cable operators lead the way on ARPU. Verizon, with FiOS, is keeping up

Source: Telco 2.0 Transformation Index

The interesting point here is that Time Warner Cable is doing less well than some of its cable industry peers. Comcast, the biggest, claims a $159 monthly ARPU for triple-play customers, and it probably has a higher density of triple-players than the telcos. More representatively, they also quote a figure of $134 monthly average revenue per customer relationship, including single- and double-play customers. We have used this figure throughout this note. TWC, in general, is more content-focused and less broadband-focused than Comcast, having taken much longer to roll out DOCSIS 3.0. But is that important? After all, aren’t cable operators all about TV? Figure 4 shows clearly that broadband and voice are now just as important to cable operators as they are to telcos. The distinction is increasingly just a historical quirk.

Figure 4: Non-video revenues – i.e. Internet service and voice – are the driver of growth for US cable operators

Non video revenues ie Internet service and voice are the driver of growth for US cable operatorsSource: NCTA data, STL Partners

As we have seen, TV in the USA is not a differentiator because everyone’s got it. Further, it’s a product that doesn’t bring differentiation but does bring costs, as the rightsholders exact their share of the selling price. Broadband and voice are different – they are, in a sense, products the operator makes in-house. Most have to buy the tools (except Free.fr which has developed its own), but in any case the operator has to do that to carry the TV.

The differential growth rates in Figure 4 represent a substantial change in the ISP industry. Traditionally, the Internet engineering community tended to look down on cable operators as glorified TV distribution systems. This is no longer the case.

In the late 2000s, cable operators concentrated on improving their speeds and increasing their capacity. They also pressed their vendors and standardisation forums to practice continuous improvement, creating a regular upgrade cycle for DOCSIS firmware and silicon that lets them stay one (or more) jumps ahead of the DSL industry. Some of them also invested in their core IP networking and in providing a deeper and richer variety of connectivity products for SMB, enterprise, and wholesale customers.

Comcast is the classic example of this. It is a major supplier of mobile backhaul, high-speed Internet service (and also VoIP) for small businesses, and a major actor in the Internet peering ecosystem. An important metric of this change is that since 2009, it has transitioned from being a downlink-heavy eyeball network to being a balanced peer that serves about as much traffic outbound as it receives inbound.

The key insight here is that, especially in an environment like the US where xDSL unbundling isn’t available, if you win a customer for broadband, you generally also get the whole bundle. TV is a valuable bonus, but it’s not differentiating enough to win the whole of the subscriber’s fixed telecoms spend – or to retain it, in the presence of competitors with their own infrastructure. It’s also of relatively little interest to business customers, who tend to be high-value customers.

 

  • Executive Summary
  • Introduction
  • A Case Study in Deep Value: The Lessons from Apple and Samsung
  • Three Operators, Three Strategies
  • AT&T
  • The US TV Market
  • Competing for the Whole Bundle – Comcast and the Cable Industry
  • Competing for the Whole Bundle II: Verizon
  • Scoring the three strategies – who’s winning the whole bundles?
  • SMBs and the role of voice
  • Looking ahead
  • Planning for a Future: What’s Up Cable’s Sleeve?
  • Conclusions

 

  • Figure 1: U-Verse TV sales account for the largest chunk of Telco 2.0 revenue at AT&T, although M2M is growing fast
  • Figure 2: OTT video providers beat telcos, cablecos, and satellite for subscriber growth, at scale
  • Figure 3: Cable operators lead the way on ARPU. Verizon, with FiOS, is keeping up
  • Figure 4: Non-video revenues – i.e. Internet service and voice – are the driver of growth for US cable operators
  • Figure 5: Comcast has the best pricing per megabit at typical service levels
  • Figure 6: Verizon is ahead, but only marginally, on uplink pricing per megabit
  • Figure 7: FCC data shows that it’s the cablecos, and FiOS, who under-promise and over-deliver when it comes to broadband
  • Figure 7: Speed sells at Verizon
  • Figure 8: Comcast and Verizon at parity on price per megabit
  • Figure 9: Typical bundles for three operators. Verizon FiOS leads the way
  • Figure 12: The impact of learning by doing on FTTH deployment costs during the peak roll-out phase

Full Article: African Communications – a brewing storm

The outlook for the African Communications Industry is uncertain, at best. For sure, there is currently massive infrastructure investment across the continent. And this investment not only covers mobile technology, there are also major fibre and satellite projects working towards bringing the internet to the population. But a storm is brewing: major African players, such as MTN and Zain, are reassessing their corporate strategies; in-country consolidation in mobile looks inevitable in several countries as too many players have been licensed; and the business case for mass market internet services is unproven.

However, the lesson learnt from the mobile expansion through the continent is that innovation will flourish. This innovation is not only seen in products such as M-PESA, but also in business models. Africans are innovating their own business models for their own environment as well as adapting the tried and trusted business models which work in Western Europe. This article discusses some of the structural problems in some markets, examines some of major players and explores the new projects.

One Continent, Many Countries

Africa is a huge continent with a population close to 1bn and over 50 countries. Populations vary from Nigeria at 148m to Equatorial Guinea at 0.5m. GDP/head varies from the oil-fuelled Libya at US$8,300 to the war-ravaged Liberia at US$130. Importantly for Telco’s each country has a different regulatory framework, taxation regime and competitive intensity.

kmm-africa-table.png

It is hardly surprising, given all this diversity, that a wide range of strategies have been deployed by Telcos. There are a lot of nationally based local operators, however, a few key operators have been building a pan-African strategy.

Zain

Zain emerged from the Kuwaiti operator, MTC, and bought the original pan-African operator, Celtel, in 2005 for US$3.6bn. Since then, Zain has invested in Nigeria, Madagascar and Ghana. JPMorgan estimates in a recent note that including both acquisitions and capital expenditure,Zain has invested a total of US$8.9bn in Africa. Despite this historical commitment, Zain has been in the news recently after announcing that its African operations (excluding Sudan) are up-for-sale with a price tag of US$12bn.

In 2008, Zain Africa had a turnover of US$5bn (US$4.2bn ex. Sudan), EBITDA of US$1.8bn (US$1.4bn ex. Sudan) and net Income of US$401m (US$122m ex. Sudan). On these figures, it is hard to justify Zain Africa being worth US$12bn without complete faith in the potential of Africa. Obviously, the recent discussions between Vivendi and Zain have failed to reach a consensus on valuation.

In our opinion, Zain suffers from two major problems:

Zain-africa.JPG

  1. Their small subscriber base in many countries means that economies of scale are hard to achieve. Zain has tried with initiatives such as their One Network roaming product and the forthcoming pan-African payments system, Zap, yet have not solved the problem of operating in small, low income countries.
  2. Many of the larger countries in which Zain operates, especially Nigeria, Kenya and Tanzania, suffer from over-competition and Zain has a low market share. Furthermore, Zain is struggling to maintain margins as penetration grows.

MTN

MTN is a South African company which has expanded throughout Africa and the Middle East. MTN is currently present in 16 African countries and is particularly strong in the key markets of Nigeria, South Africa and Ghana. MTN has also been in the news recently with a complex merger transaction with Bharti Airtel of India in progress, under which the two companies will take blocks of stock in each other. In 2008, MTN had an approximate African turnover of US$10bn (ZAR86bn) and EBITDA of US$4.7bn (ZAR38bn). South Africa and Nigeria alone made up 74% of turnover.

MTN-Africa.JPG

Vodafone

Vodafone has been present on the African continent since 1993, being one of founders of Vodacom in South Africa. In 1998, Vodafone entered Egypt investing in the second operator, ClickGSM. In 2000, Vodafone entered Kenya with an investment in Safaricom. In 2008, Vodafone entered Ghana with an US$900m investment in Ghana Telecom.

This is a key differentiator for Vodafone from the Zain and MTN strategies – they expanded early, investing with strong local partners and in the largest African economies. The partnerships have not been trouble free, but today Vodafone is probably the strongest African operator in a relatively small number of countries.

vodafone-africa.JPG

In the 12 months to Mar-09, Vodacom alone had turnover of ZAR55bn (US$6.7bn) and EBITDA of ZAR18bn (US$2.2bn); Safaricom had a turnover of US$915m and EBITDA of US$363m; Vodafone Egypt and Ghana results aren’t published.

Unsurprisingly, Vodafone in Africa seems to be adopting a similar strategy to parent and transitioning itself to being a “Total Communications Provider” offering both fixed, mobile and internet services – with the exception of Egypt, where the local partner is the fixed incumbent. For instance, Vodacom has bought a pan-continent Satellite provider, Gateway, who offers services to carriers and businesses.

New Subsea Cables are arriving

The main Sub-Saharan cable connectivity is currently provided by the SAT3/SAFE cable which became operational in 2001. The SAT3/SAFE cable is not only limited to 120GB capacity, but access is controlled by predominately state-owned PTTs. East Africa is not currently served by a cable. Gigabit Ethernet circuits are currently available from London to New York at US$10/MB compared to approximately US$1,000/MB on African routes.

kmm-africa-cable.png

However, the Seacom and Teams cables will be operational this year and bring much needed connectivity to the East Coast of Africa. Prices are expected to drop to as low as US$33/MB over time. Main One and EASSY are expected to follow in 2010. WACS and ACE in 2011. Alternate routes and price competition are bound to follow over time.

Inland Long Distance Networks

Getting fibre to the shore is only one part of the equation; connecting the major cities is another. It appears that a vibrant set of altnets are starting to emerge: companies such as Neotel in South Africa and Jamii in Kenya. Companies such as Altech Stream East Africa are starting to build regional networks.

New Satellites are being launched

For most communications providers whether fixed, mobile or internet, the only option currently is slow and expensive satellite links. Slow as the current generation of geo-satellites have a latency of approximately 600ms and expensive as data is priced at approximately US$25k/MB. A next generation of 16 satellites are planned to be launched by O3b Networks (with Google as an investor) and due to be operational by late 2010.

kmm-africa-sat.png

Each of these satellites will orbit the earth providing coverage not only to Africa, but South America and Asia, and as they orbit much lower than the geo-stationary satellites are expected to have a latency of 120ms and approx. 10GB of capacity each. Cost will be around US$500/MB, which, whilst still expensive, makes the economics of rural Africa connecting within sight.

Chicken & Egg

The big question is whether all this investment will deliver a decent return to investors. The huge bubble investment in Western Markets in fibre, satellite and alternative networks in general at the turn of century ended with a lot of the original investors losing all their money. Demand is uncertain for advanced, or even basic, internet services in Africa. However, the infrastructure needs to be place before innovation and new services can flourish. The eggs are being laid and only time will tell whether the chicken will come home to roost.

With this second wave of investment, it becomes apparent why major operators such as MTN and Zain are reassessing their position and at a minimum are looking at spreading the risk through bringing in new partners. Vodafone is pushing ahead on a limited geographical footprint leveraging from a position of strength in mobile.