Can Netflix and Spotify make the leap to the top tier?

Introduction

This is the first of two reports analysing the market position and strategies of four global technology companies – Netflix, Spotify, Tesla and Uber – that might be able to make the leap to become a top tier consumer digital player, akin to Amazon, Apple, Facebook or Google. The two reports explore how improvements in digital technologies and consumer electronics are changing the entertainment and automotive markets, allowing the four companies to cause significant disruption in their sectors.

The first part of this report considers Netflix and Spotify, which are both trying to disrupt the entertainment market. For more on the increasing domination of online entertainment by the big Internet platforms, read the STL Partners report Amazon, Apple, Facebook, Google, Netflix: Whose digital content is king?

This report considers how well Netflix and Spotify are prepared for the likely technological changes in their markets. It also provides a high-level overview of the opportunities for telcos, including partnership strategies, and the implications for telcos if one of the companies were able to make the jump to become a tier one platform.

STL Partners is analysing the prospects of Netflix, Spotify, Tesla and Uber because all four have proven to be highly disruptive players in their relevant industries.

The four are defined by three key factors, which set them aside from their fellow challengers:

  • Rapid rise: They have become major mainstream players in a short space of time, building world-leading brands that rival those of much older and more established companies.
  • New thinking: Each of the four has challenged the conventions of the industries in which they operate, leading to major disruption and forcing incumbents to completely re-evaluate their business models.
  • Potential to challenge the dominance of Amazon, Apple, Facebook or Google: This rapid success has allowed the companies to gain dominant positions in their relative sectors, which they have used as a springboard to diversify their business models into parallel verticals. By pursuing these economies of scope, they are treading the path taken by the big four Internet companies (see Figure 1). Google, Apple, Facebook and Amazon have come from very diverse roots (ranging from an Internet search engine to a mobile device manufacturer), but are now directly competing with each other in a number of areas (communications, content, commerce and hardware).

Figure 1: How the leading Internet companies have diversified

Source: STL Partners

The evolution of online entertainment

As broadband networks proliferate and households are served by fatter pipes, telecoms networks are carrying more and more entertainment content. While there are major players in every country and region, there are essentially only six online entertainment platforms meeting this demand on a global scale – Amazon, Apple, Facebook, Google, Netflix and Spotify. These six companies are delivering increasingly sophisticated real-time entertainment services that are generating a growing proportion of Internet traffic, at the expense of traditional web browsing, file sharing, download services and physical retail entertainment.

The six are building global economies of scale that can’t be matched by national/regional media companies and telcos. Global distribution is becoming increasingly important in the media industry, given the prohibitive costs of sourcing content and then packaging it and distributing it across multiple different devices and networks.

Scale is also important for another reason. As the volume of digital content proliferates, consumers increasingly rely on recommendations. The platform capturing the most behavioural data (people who watched this, also watched this) should be able to offer the best recommendations.

Although the platforms with scale have a competitive advantage, they are still vulnerable to disruption because the online entertainment market is evolving rapidly with providers, including rights owners, experimenting with new formats and concepts.

As outlined in the STL Partners report Amazon, Apple, Facebook, Google, Netflix: Whose digital content is king?, most of this experimentation relates to the following six key trends, which are likely to shape the online entertainment market over the next decade.

  1. Greater investment in exclusive content: The major online platforms are increasingly looking to either source or develop their own exclusive content, both as a competitive differentiator and in response to the rising cost of licensing third parties’ content. Exclusive content may be anything from live sports programming to original drama series and even blockbuster movies. This is an area in which both Netflix and Amazon Video have heavily invested, making the two direct competitors for talent in this space.
  2. Growing support for live programming: People like to watch major sports events and dramatic breaking news live. Some of the online platforms are responding to this demand by creating live channels and giving celebrities and consumers the tools they need to peercast – broadcast their own live video streams.
  3. The changing face of user-generated content: Although YouTube, Facebook and other social networks have always relied on user-generated content, advances in digital technologies are making this content more compelling. If they are in the right place, at the right time, even an amateur equipped with a smartphone or a drone can produce engaging video pictures.
  4. Increasingly immersive games and interactive videos: As bandwidth, latency, graphics processing and rendering technology all improve, online games are becoming more photorealistic making them increasingly akin to an interactive movie. Furthermore, virtual reality will enable people to adopt different viewpoints within a 360-degree video stream, enabling them to choose the perspective from which to watch a movie or a live sports event. For more info, please see the STL Partners’ report: AR/VR: Won’t move the 5G needle.
  5. Rising use of ad blockers and mounting privacy concerns: Many consumers are looking for ways to avoid video advertising, which is more intrusive than a static banner ad and uses more bandwidth. At the same time, many national and regional regulators are becoming increasingly alarmed by the privacy implications of the data mining of consumer services and products, leading to clashes between the major online advertising platforms and regulators.
  6. Ongoing net neutrality uncertainty: In many jurisdictions, net neutrality regulation is either still under development or is vaguely worded as regulators struggle to balance the legitimate need to prioritise some online services with the equally important need to ensure that small content and app developers aren’t discriminated against.

To read on about Netflix and Spotify’s strategies and implications for telcos, please login and download the report, or contact us to subscribe.

Contents:

  • Executive Summary
  • Netflix: much loved, but too narrow
  • Spotify: leading a formidable pack
  • Lessons for telcos
  • Conclusions for telcos
  • Introduction
  • The evolution of online entertainment
  • Netflix: Keeping it original
  • Right time, right proposition
  • Competitive clouds gathering
  • Economies of scale, but not scope
  • Strengths
  • Weaknesses
  • Opportunities
  • Threats
  • Spotify: The power of the playlist
  • Smaller than Netflix, but more rounded
  • Strengths
  • Weaknesses
  • Opportunities
  • Threats
  • Takeaways for telcos
  • Lessons for telcos
  • Next steps for telcos

Figures:

  • Figure 1: How the leading Internet companies have diversified
  • Figure 2: Netflix revenue and paid subscriber growth, 2015-2017
  • Figure 3: Netflix has grown much faster than its rivals in the US
  • Figure 5: Netflix from a monolithic website to a flexible microservices architecture
  • Figure 6: Netflix: SWOT analysis
  • Figure 7: Tailoring movie artwork to the individual viewer
  • Figure 8: Netflix’s addressable market is growing steadily
  • Figure 9: The number of mobile broadband connections is rising rapidly
  • Figure 10: How studio films aim to make money using release windows
  • Figure 11: Hulu’s broad proposition is a challenge to Netflix
  • Figure 12: Growth in digital music is now offsetting declining sales of physical formats
  • Figure 13: Spotify’s rapid revenue and paid subscriber growth
  • Figure 14: Spotify’s fast-growing premium service is the profit engine
  • Figure 15: A SWOT analysis for Spotify
  • Figure 16: Spotify has significantly lower ARPU and costs than Netflix
  • Figure 17: Spotify’s losses continue to grow despite rapid revenue rises
  • Figure 18: Spotify’s costs are rising rapidly
  • Figure 19: YouTube is a major destination for music lovers

Full Report – Entertainment 2.0: New Sources of Revenue for Telcos?

Summary: Telco assets and capabilities could be used much more to help Film, TV and Gaming companies optimize their beleaguered business model. An extract from our new 38 page Executive Briefing report examining the opportunities for ‘Hollywood’ and telcos.

NB A PDF of this 38 page report can be downloaded here.

Executive Summary

Based on output from the Telco 2.0 Initiative’s 1st Hollywood-Telco International Executive Brainstorm held in Los Angeles in May 2010 and subsequent research and analysis, this Executive Briefing provides an introduction to new opportunities for strategic collaboration between content owners and telcos to address some of the fundamental challenges to their mutual business models caused by the growth of online and digital entertainment content.

To help frame our analysis, we have identified four new business approaches that are being adopted by media services providers. These both undermine traditional value chains and stimulate the creation of new business models. We characterise them as:

  1. “Content anywhere” – extending DSAT/MSO subscription services onto multiple devices eg SkyPlayer, TV Anywhere, Netflix/LoveFilm
  2. “Content storefront” – integrating shops onto specific devices and the web. eg Apple iTunes, Amazon, Tesco
  3. “Recreating TV channels through online portals” – controlling consumption with new online portals eg BBC iPlayer, Hulu, YouTube
  4. “Content storage” – providing digital lockers for storing & playback of personal content collections eg Tivo, UltraViolet (formerly DECE)/KeyChest

To thrive in this environment, and counter the continuing threat of piracy, content owners need to create new functionality, experiences and commercial models which are flexible and relevant to a fast moving market.

Our study shows that Telco assets are, theoretically at least, ideally suited to enable these requirements and that strategic collaboration between telcos and content owners could open up new markets for both parties:

  • New distribution channels for content: Telcos building online storefront propositions more easily, with reduced risk and lower costs, based on digital locker propositions like Keychest and UltraViolet;
  • Improved TV experiences: developing services for mobile screens that complement those on the primary viewing screen;
  • Direct-to-consumer engagement for content owners: studios taking advantage of unique telco enabling capabilities for payments, customer care, and customer data for marketing and CRM to engage with consumers in new ways;
  • Operational cost reduction for Studios and Broadcasters: Telco cloud-based services to optimise activities such as content storage, distribution and archive digitisation.

To realise these opportunities both parties – telcos and content owners – need to re-appraise their understanding of the value that each can offer the other.

For telcos, rather than just creating bespoke ‘enterprise ICT solutions’ for the media industry – which tends to be the current approach – long term, strategic value will come from creating interoperable platforms that provide content owners with ‘plug and play’ telco capabilities and enabling services.

For content owners, telcos should be seen as much more than just alternative sales channels to cable.

There is a finite window of opportunity for content owners and telcos to establish places in the new content ecosystems that are developing fast before major Internet players – Apple, Google – and new players use their skills and market positions to dominate online markets. Speedy collaborative action between telcos and studios is required.

In this Executive Briefing, we concentrate on the US market as it is both the largest in the world and the one that most influences the development of professional video content, and the UK, as the largest in Europe.

The developments in both are indicative of the types of changes that are facing all markets, although the exact opportunities and challenges are influenced by the existing make up of the video entertainment market in each country and the specific regulatory environment.

This report is part of an ongoing, integrated programme of research and events by the Telco 2.0 Initiative to foster productive collaboration on new business models in the global digital entertainment marketplace.

Sizing the opportunity

The online entertainment opportunity is often talked down by both telcos and media companies. It is, after all, just a small percentage of the current consumer and advertising spend. Examples are easily cited that diminish the value of the opportunity: global Mobile TV revenues (revenues not profits) don’t reach $1bn; on demand represents just 2% of total TV revenues; online film (rental and download) does slightly better but hasn’t yet reached 5% of filmed entertainment revenues.

Individually, these are not the sort of figures that are going to get telco execs bouncing with enthusiasm but collectively (as illustrated below) the annual digital entertainment market reached revenues of $55.4bn in 2009 and has a growth rate approaching 20%. And that figure is even better if you discount digital magazine and newspaper ad revenue. So, even today, digital entertainment is a market that equates to 83% of Vodafone Group’s 2009/10 revenue and it is experiencing the kind of growth that the mobile industry was once famed for. Realistically, the telco share will remain small for some time but as a growth market it cannot be ignored.

Table 1: Global Value of Digital Entertainment by Content Type 2009

Digital Content Type

Revenue (US$ bn)

% increase year-on-year

Video on Demand

4.09

11.6

Pay-per-view TV

4.56

-1.9

Mobile TV

0.99

7.2

Online and Mobile TV Ads

2.95

17.5

Digital Music Distribution

8.1

29.3

Online Film Rental

4.2

25.8

Digital Film Downloads

0.59

49.3

Online Games

11.63

21.3

Wireless Games

7.31

18.2

Online Game and in-game Ads

1.55

16.2

Consumer Magazine Digital  Ads

1.31

-0.2

Newspaper Digital Ads

5.48

-5.6

Electronic Book Publishing

1.79

50.4

Total

54.55

 

Average

 

18.39

Source: Telco 2.0 Initiative and PricewaterhouseCoopers Global Entertainment and Media Outlook: 2010-2014

An important factor to note here is the continued growth of digital music distribution revenue. Music can easily be discounted as a medium that has already moved online but it still has a huge amount of growth space as a year-on-year revenue increase of approaching 30% indicates. This is the key point, digital entertainment is a growth opportunity for the next decade and when you look at the size of the physical products that currently serve the markets targeted by these digital alternatives, it is high growth potential for a market that is already of a considerable size, as illustrated in the table below:

Segment

Revenue 2009 ($bn)

Television subscriptions and licence fees

185.9

TV Advertising

148.56

Recorded Music

26.37

Filmed Entertainment

85.14

Newspapers

154.88

Trade publishing

148.11

Book publishing

108.2

Total

857.16

Source: Telco 2.0 Initiative and PricewaterhouseCoopers Global Entertainment and Media Outlook: 2010-2014

Once you take out the existing on line spend and those elements, such as movie theatre revenues that won’t move online, the current addressable market is in the region of $700bn a year.

Again, to put that in context at our recent Best Practice Live! online conference and exposition, Anthony Hill from Nokia Siemens Networks valued the web services 2.0 market at $1 trillion.

What is more, there is evidence to suggest that as well as the substitution of digital online for physical and broadcast formats, the virtual world is also bringing additional viewers and potentially additional revenue with it. An extract from Nielsen’s A2/M2 Three Screen Report presented at our 1st Hollywood-Telco Executive Brainstorming, suggests that while online video viewing in the US grew 12% year-on-year and mobile viewing grew 57%, this was not at the cost of TV viewing in the home which also grew, if only very marginally by 0.5%.

It is not surprising therefore that content owners are looking to take advantage of the shifts in the market and move up the value chain to take a greater share of the revenues, and that telcos also want to play a part in a significant growth market. Indeed, the motivations pushing both groups towards digital and online entertainment are truly compelling.

In the next two sections we examine these in more detail.

Telcos: Let us entertain you

Telcos are keen to build a bigger role in online entertainment for four reasons:

  • Entertainment provides the kind of eye catching and compelling content that broadband networks, both fixed and mobile, were built for
  • Broadband networks will carry the traffic irrespective of the role of the telco, so it’s strategically important to play in a part of the business that accounts for a majority of their total data traffic
    (We estimate that online video makes up one-third of consumer internet traffic today and that this could grow more than ten times by 2013 to account for over 90% of consumer traffic overall. That makes it vitally important that telcos understand and maximise the opportunities associated with video and although not all video will be entertainment and not all entertainment is video, video entertainment is a major market driver. For more on broadband data trends, see our latest Broadband Strategy Report)
  • Entertainment is a growth market and the type of opportunity that can help build a Telco 2.0 business that, in conjunction with others, could re-ignite the interest of the financial markets in telecoms as a growth stock

  • It is a defensive play. Cable and DSAT providers are bundling communications services – broadband and telephony – into their service offering, eating into the customer bases of telcos. While telcos are still receiving revenue from these through wholesale, they are losing the direct link to customers and the associated customer information, both of which are integral to the ability of telcos to build effective two-sided business models

Downstream opportunity and challenges

Today, the vast majority of telcos are concentrating their activities in the entertainment arena in downstream activities – in IPTV and mobile TV, backed in some instances by a web TV offering as well. The primary success factors are, as might be expected, coverage/reach, quality of service and of course the appeal of the content. These are pre-requisites for success but there are no universally applicable targets by which we can judge success as so much depends on the competitive landscape within each market.

For example, mobile TV is bigger in China and India than in Western Europe and North America and this is despite the late entry of 3G systems in China and the very recent 3G spectrum auction in India which has kept connection speeds low. Furthermore, TV is far from ubiquitous, covering about 75% of the world’s population and Internet penetration sits around 25% and as low as 12% in developing markets, according to the ITU.

So why is mobile TV getting better take up on 2.5G in India than on 3G and 3.5G in mature markets? The simple answer can be found in the penetration levels of alternatives. Mobile simply has better reach than alternative transmission systems in emerging markets and the same factors influence mature markets with different results.
In developed markets, telcos are becoming part of the entertainment value chain as competitors to cable and DSAT but primarily with IPTV as opposed to mobile which, with a few exceptions, is coming more through content-specific apps than general services.

In the US, Comcast’s COO, Steve Burke recently cited telcos along with other cable providers and DSAT service providers as the company’s competition. Telcos have many options of how to enter the market but the default seems to be to think firstly, if not only, of full IPTV services or mobile TV, driven primarily by the desire to defend their communications markets.

Telcos are competing with TV cable and satellite companies for the home market on two fronts. Firstly to deliver high speed broadband connectivity and secondly to offer TV services. The problem for telcos is that IPTV, their TV service offering, has barely scratched the surface despite recent rapid growth.

According to the Broadband Forum, global IPTV subscribers grew 46% year on year for the first quarter of 2010. This equates to 11.4 million new IPTV subscribers, the most rapid growth in any 12 month period yet recorded and the global IPTV market totaled 36.3 million IPTV as at March 31st 2010. To put that number in some sort of context, according to Nielsen, there are 286 million TV viewers (not subscriptions) in the US alone.

The US IPTV broke the 6 million subscriber mark in the first quarter of 2010 and is growing fast but Europe is taking to the technology faster. France tops the IPTV charts, with just over 9 million users. This is perhaps no surprise given the weakness of its cable and satellite TV markets. Conversely, the UK which has decent broadband penetration, ranking 6th worldwide, doesn’t even register on the top ten for IPTV. Market entry is tough in the UK with BSkyB and Virgin Media dominating the pay TV market and in BSkyB’s case, tying up the premium content.

In many countries, telcos have also struggled to do the deals with studios and TV networks that will secure them the most compelling content and are therefore struggling to compete with cable and satellite services.

IPTV realities

In the US, AT&T’s U-verse and Verizon’s FiOS IPTV services have made some inroads. FiOS had 3 million subscribers at the end of Q1 2010, according to the company which also claims the service is available to 12.6 million premises or 28.8% of Verizon’s footprint. Its TV subscriber base had increased 46% to the end of 2009, while the major cable companies saw their shares drop by one or two percent but in absolute numbers cable remains dominant. Conversely, cable companies have seen their shares of broadband connectivity rise at the cost of the telcos.

Yet for telcos, the investments required for increasing speed and capacity through fibre is high. Fibre certainly represents the future for connectivity but its deployment is a long process and building complete end-2-end IPTV services will not make sense for every area in every country. Indeed, even within the US, Verizon is concentrating on core states and has sold its local wireline operations in 16 states to concentrate on building its fibre business where it is strongest. And fibre rollout is just the start.

Becoming a TV service provider is not straightforward and becoming a differentiated TV service provider is even more challenging. In addition to the technical connectivity, it requires deals to be made with networks to show their programming and, if real differentiation is to be made, deals also have to be brokered with studios, production companies and other owners of content, such as the governing bodies of sports, to secure broadcasting rights. Then it requires the development of an easy to use guide and the ability to at least keep up with the technical developments with which established TV providers are differentiating themselves – HD, 3D and integration with web features, such as social networking sites and delivery across multiple screens. This is a significant undertaking.

Many telcos are recognising that they cannot play every role in the video distribution value chain in every market. Indeed, even in France which we’ve established has receptive market conditions for IPTV, Orange has pulled out of competing in the sports and film genres that so often dictate the success of paid for TV services, and France is not alone.

At our 1st Hollywood-Telco Executive Brainstorm and at the 9th Telco 2.0 Executive Brainstorm, Telecom Italia’s representatives reiterated the company’s belief that IPTV was primarily a defensive play, designed to protect broadband revenues and that entertainment-related revenues would come instead from using telco assets and telco-powered capabilities to build new services around TV.

For Telecom Italia this is primarily about the upstream play based around QoE, CRM, billing and customer data and it also believes a business can be built around context and targeted advertising for free content on three screens. Building such functionality, linking consumer information and data about the environment to supplement TV services themselves and offer similar functionality to third parties is a core strategic decision being made by Telecom Italia, more about which can be seen on Antonio Pavolini’s presentation on our Best Practice Live! event site.

The upstream potential for telcos is something we shall return to later but we also believe that by working with, rather than in competition with studios and other content owners, telcos can become involved faster and more effectively in delivering entertainment services to their customers.

In addition, we believe an alternative and more accessible downstream opportunity exists based on digital rights lockers.

Digital Lockers: an alternative downstream option

Digital rights lockers are virtual content libraries hosted in the cloud that allow consumers to develop collections of content that are not tied to a physical format or device. There are a number of digital locker developments for online video, most notably Disney’s Keychest and UltraViolet, the new brand for the Digital Entertainment Content Ecosystem (DECE), a cross industry development.

These basically mean that a consumer can buy a piece of content once and then view it on any device at any time. For example, if a consumer buys Avatar on Blu-ray disc they would be able to register the disc into an UltraViolet-powered rights locker at the time of purchase or at a later date. Once registered, the digital proof of purchase is held in the cloud and then media service providers – cable companies, telcos etc., can access that information in my rights locker to know that they can deliver it to the consumer.

There are two important points here. The first is that from a consumer point of view it gives them what they want in the form of a one-time purchase for multiple formats; the second is that it breaks the tie between the device and the content. Content, in the form of rights, is held in the cloud, and is delivered in the appropriate form for any supported and registered device.

Ultraviolet works using a network-based authentication service and account management hub from Neustar that allows consumers log in and access digital entertainment they have rights to. The system authenticates rights to view content from multiple services, with multiple devices as well as manages the content and registration of devices in consumer accounts.

It means that content doesn’t keep a user locked with a particular device manufacturer as, for example, iTunes content does to the iPhone or iPad. Therefore if a consumer switches to a different device, assuming it is also supported, content will be viewable.

Furthermore, the fact that UltraViolet has multiple content owners committed, namely Fox Entertainment Group, NBC Universal, Paramount, Sony (which chairs UltraViolet) and Warner Brothers, makes it a strong proposition, as to try to compete with a proposition limited to one vendor, with one that was multi-device but limited to the content of a single owner is unlikely to succeed.

What this means for telcos is that an ecosystem is being built that they can simply tap into. A telco could use an UltraViolet-provided API to build access into its own customers offerings, whether that be IPTV, mobile TV or through a web-enabled storefront. They can access the rights locker in the cloud and see what a consumer is entitled to see and deliver it to them seamlessly. They make the enquiry, and deliver the video to the consumer which is in the right format for the device and complete with the necessary rights attached. An indication of how this flow works is illustrated in the diagram below.

Figure 1: Building the Digital Locker Proposition

Source: Telco 2.0 Initiative

The key point here for telcos is that such an approach overcomes the issues associated with scale and potentially with international distribution deals as well.

Both of these were uppermost in the minds of telco execs at the 1st Hollywood-Telco Executive Brainstorm, who constantly reiterated their frustrations at not being able to get the deals they need to give their customers the content they demand because of high ‘minimers’ and a mismatch between the internal operations and practices of telcos and studios. (See Telco 2.0 in Hollywood: There’s Gold in Them Thar Hills).

Collective activities such as UltraViolet are by definition more difficult to develop than those from an individual company as they require balancing of individual priorities and goals with those of the group. However, as we will discuss in more detail later, the desire of studios to compete with other groups to act as the retail and distribution point, makes working together more desirable.

It is also important to recognise that the strategic choices made by media companies have an impact on the options available to telcos. When media companies work together and create a new ecosystem, the value of upstream services from a single telco diminish, while their ability to enter as a downstream player increases as the open nature of an UltraViolet -like ecosystem allows them to grow incrementally. Should telcos want to play on the upstream side in such communities, then they too need to act collectively.

Telcos’ missed opportunity

Telcos have been notable by their absence in the development of UltraViolet which means many of the upstream capabilities they could have offered – authentication, billing, formatting for different devices – are being developed, at least in the first instance in different ways. However, there could be potential for these to develop over time based on building stronger relationships with the UltraViolet ecosystem, particularly around mobile device support. The formatting of data for specific devices is part of the basic operator function and this expertise could be highly valuable to the UltraViolet community but to be offered as an upstream service, rather than a downstream differentiator, it needs to be a collective proposition from the operator community, not piece meal.

However, if telcos are being challenged to develop new models to engage their customers, then content owners are even more so.

UltraViolet and other digital rights locker solutions open an alternative downstream opportunity for telcos and particularly for those that don’t have the market scale to compete with other Pay TV services. It is a middle ground that enables telcos to build an entertainment portfolio and overcome some of the challenges of building an entirely new business.

Content’s business model crunch

Once upon a time there were only two ways to get content to a large amount of people. Broadcast was one and the other was through a delivery chain made up of distributors, aggregators and retailers. The Internet changed that and high speed broadband access changes it again as even HD video can be accessed by individuals through the Internet, opening up new completion to those traditional channels.

All of these bring new challenges to the existing models of traditional media companies, which are both being challenged and pursuing new opportunities, as illustrated in the table below. The colour coding of the challengers reflects the severity of the challenge in the short to medium term (1-3 years).

Content Owner Category

Upstream Business Model

Downstream Business Model

Upstream Business Challengers

Downstream Business Challengers

New Business Opportunities

Film Studios

None

Revenue share from various sales windows – movie theatre, DVD sales, DVD rentals, Pay TV, Free-to-air TV – with the respective distributor/retailer

None

New online rental and sales channels eg Netflix, LoveFilm, iTunes, plus free and pirates

Downstream – sell direct to consumer getting all revenue and expand service offering with merchandising upsell etc

Upstream – create upstream advertising business

Free to Air TV Broadcasters

Selling advertising inventory

 

Public/government funding

 

Syndication

 

 

Fragmentation of peak audiences;

Google TV and online player services which undermine/destroy the value of advertising.

 

Upstream – greater distribution, lifespan delivering more ad value/opportunities; greater value to advertisers based on better measurement; greater targeting and personalisation; instant purchase opportunity.

Pay TV Broadcasters

Selling advertising inventory

 

Syndication

Pay TV services to consumers

Google TV and online player services which undermine/destroy the value of advertising.

New sellers of TV content – Netflix, iTunes,

New distributors of TV content – Hulu

New Connected TV propositions – particularly Google TV

Downstream – Maximise value of content with pre-broadcast promotion, post-broadcast access

Upstream – greater distribution, lifespan delivering more ad value/opportunities; greater value to advertisers based on better measurement; greater targeting and personalisation; instant purchase opportunity.

Games Publishers

Licensing of IP to third parties eg films, TV, books, comics etc

Ad-funded apps

Largest share of product sales revenue. Total shared with distributor, retailer + licence fee payable to platforms

In-play features

Piracy

Spiralling costs of production undermining profitability

Online distribution potential to open the market and reduce the power and value of the publisher role; Piracy

On line potential to break links between the platform and the game and gain larger share of ‘hit’ game revenues; growth and monetisation of casual and mobile games

Independent Games Developers

Commissions from Publishers, platforms and studios

Ad-funded apps

Revenue from product sales revenue shared with distributor, retailer + licence fee payable to platforms

Spiralling costs of production undermining profitability; Piracy

Spiralling costs of production undermining profitability

 

On line potential to break links between the platform and the game and gain larger share of ‘hit’ game revenues; growth and monetisation of casual and mobile games

Newspaper/Magazine Publishers

Sell advertising inventory

Revenue share with distributors and retailers

Proliferation of online publications hitting subs bases and diluting value to advertisers. Free is the dominant model

 

Online proliferation of publications; User-generated publications blogs etc;- readership dropping

Online provides opportunity for instant access to news, views – faster turn over and more inventory.

Potential to leverage back catalogue and increase life/value of old articles

Book Publishers

None

Revenue share with distributors and retailers

None

Online cutting the price of the product and therefore revenue to be shared

Potential to go direct to consumers and dramatically lower production costs

Music Labels

Licensing model to third party

Revenue share with artists, distributors and retailers

None

Piracy; Free and low cost online models taking too much revenue out of the value chain to sustain it

Have to reinvent business model as opportunity already missed

Source: Telco 2.0 Initiative

For some entertainment sectors, especially the music labels, a major battle if not the entire war has been lost and the fear of following in their footsteps keeps the minds of TV and film studios, as well as publishers focused on the possible threats to their own revenue streams.

For other content owners, such as game developers, the opportunities look to outweigh the threats, as their position in the value chain is currently limited by the strength of the platforms and publishers. Indeed, by examining the games market we can see some of the opportunities that are developing for content owners to usurp failing business models and engage more directly with their customers in many more ways.

Games search for better business model

The online games market is currently the most valuable of online video content businesses but this is predominantly made up from mass online games, such as World of Warcraft, as well as casual games and not from the blockbuster platform games that permeate the market. There has long been a feeling amongst developers and even some of the smaller publishers that the business model is broken, stacking the odds against developers.

Developers, whether in-house with publishers or independent, face burgeoning costs caused by the fragmentation of platforms and the increasing reliance on mega hit games. These cost more and more due to competitive pressure driving the complexity and sophistication of the game itself plus licensing fees paid for IP and to console manufacturers, which bizarrely are paid according to the number of games produced not sold. Currently, average development costs range from $15m for two SKUs (the unit attached to each hardware version) to $30 million for all SKUs and the figures keep on rising. For example, according to Blitz games, it cost $40 million to develop Red Dead Redemption, the current number one best-selling game.

It is not surprising therefore that casual and social games which typically have six month development cycles and cost between $30,000 and $300,000 and mobile games which cost even less, generally in the range of $5000 to $20,000 per title, are attracting more of the time and energies of independent developers. What have been missing in the past are effective routes to market for these but in social networking sites for casual games and app stores for mobile games, these are now reaching mass audiences with ease and both bring new business models to the games industry.

The mobile model is a simple storefront revenue share one, which typically delivers 70% of revenue back to the developer. The causal gaming and social networking tie up is following a freemium model, whereby the basic game is played for free and higher levels, additional features and tools can be purchased. Both of these represent potential channels for ‘hardcore’ games to follow, if and it’s a big if, the experience of the console can be replicated online.
OnLive has become one of the first to examine this potential, launching the first version of its cloud-based games service on June 17, 2010 and we will follow up on the development of this and the business model alternatives and opportunities in an Analyst Note later in the year.

However, while the games market faces up to its own business model challenge, it, like many other content areas, should not be viewed in isolation. Games consoles are providing more functionality than just playing games. They also offer Internet access, apps, voice and are also capable of playing DVDs. Meanwhile, games also have the potential to be accessed via other entertainment channels and this is indicative of the blurring boundaries that have emerged across the entire entertainment arena.

Blurring boundaries

Today, we have global media companies, such as News Corp, that owns Film and TV studios, book and newspaper publishers, TV networks, DSAT and cable service providers.

This convergence is a long-standing trend which has also thrown up some very notable failures, such as AOL TimeWarner. However, the synergies across vertical entertainment sectors mean that companies continue to try for the ultimate media company. Indeed, the online environment only encourages this as the content type is no longer tied to the delivery medium. Furthermore, other companies are moving up and down the value chain. In fact the landscape is more complicated with three distinct but sometimes related trends emerging:

  • The value chain is breaking up with existing players given the opportunity to collapse it down to fewer elements and take a larger share for themselves
  • New players are disrupting the ecosystem with new business models that challenge the value of the existing chain just as it is being reconfigured
  • New functionality, such as integrated apps or extension to the mobile screen, is providing further ways to differentiate services

Each of these alone would be considered an industry challenge; combined they set up a bloody battlefield. What is more, the battle is not limited to a single content type. The distinctions between platforms are also blurring. You can get TV through your games console, films on TV from your pay TV service and TV through the internet and all together these forces are totally disrupting the value chain.

These forces have also prompted the emergence of four different business approaches as follows:

  • “Content anywhere” – extending DSAT/MSO subscription services onto multiple devices eg SkyPlayer, TV Anywhere, Netflix/LoveFilm
  • “Content storefront” – integrating shops onto specific devices and the web. eg Apple iTunes, Amazon, Tesco
  • “Recreating TV channels through online portals” – controlling consumption with new online portals eg BBC iPlayer, Hulu, YouTube
  • “Content storage” – providing digital lockers for storing & playback of personal content collections eg Tivo, UltraViolet /KeyChest

These are not mutually exclusive but are providing new approaches that media service providers are using alone or in combination to create new business models that are disrupting the traditional value chain and building new ones.

Disrupting and rebuilding the value chain

Using the example of video distribution, we can see more clearly how things are changing. The traditional value chain for video distribution (illustrated below) sees a consumer purchase the video content from a retailer, who in turn was supplied via a wholesale distributor who bought from the content creators, and watches it on a device bought specifically for the purpose – TV, video/DVD/Blu-Ray player, games console, hifi, etc.

Figure 2: Video Content Value Chain

Each role has a distinct group of companies that serve it and that are highly competitive amongst themselves but as distribution and delivery moves online, the two end points are moving towards the middle to gain greater control over the market and a larger slice of the pie.

The online digital value chain has the same functions to deliver but which companies should provide these are anything but clear as each player has a shot at cutting some of the others out of the chain completely. The obvious point of collapse is between the distribution and retail elements and this is where the likes of Amazon’s on-demand service come in. However, it is not the only convergence point and content owners should be defining the online value chain to position themselves at the centre of it, not taking what they are given.

In the physical world, selling content straight to the consumer had been a logistical impossibility for content owners other than TV broadcasters but with digital a direct channel to the consumer becomes a distinct possibility. What we now have is the possibility to combine distribution and content creation. For content creators this means direct serving through on-demand services of the Internet.

All the major film studios have their own service on-demand services and provide early access to on-demand content through these. For example, Universal launches films on its site the same day they are offered for release on DVD. This demonstrates that although the sale of DVDs is the most lucrative of the second rights windows, a direct online sales channel is even better value for the studios.

However, while a direct sales channel is good for studios, the highly lucrative DVD/Blu-ray retail market is being threatened from all sides – from subscription rental, from VoD download and streaming and from pirates – all of whom are targeting the online opportunities offered up by physical windows. Therefore studios are attempting to both maximise their opportunity for the new channel and protect their traditional revenue streams. It is a decidedly difficult path to tread and the winners and losers will be inevitably be defined by their ability to pull on the vital parts of the value chain.

Taking each link in the chain in turn, we can see how the four new business approaches are being created and how telcos could contribute to their development.

Content Creation

The major studios have the professional content ownership in the bag, at least for the time being. There is little doubt that while user generated content (UGC) creates an interesting new dynamic, especially for news services, and cheaper and more accessible production and online distribution theoretically opens up greater opportunities for independent productions, neither is close to making a serious challenge in reality.

There have been a few examples of this in music where independent artists have used the internet to distribute and social networks to market their work and thus cut out the need for a music label. Given that the experience that music companies have had with online distribution is the one cited as the one to avoid by all content owners, it is worth watching.

Perhaps a stronger play is to draw on new interactive capabilities to supplement the content creation process, helping to define plot lines and characters. This is an area that has already seen some collaboration between telcos and studios, for example when Sprint worked with WPP’s Mindshare and NBC to create a new character for Heroes. This was in fact seen as a development for advertising, rather than creative content but it establishes a precedent for engagement with a show’s audience.

These are both developments that demand tracking but they’re not the most pressing issue at the moment. That comes from the convergence of the online distribution and retail elements of the video value chain.

Distribution and Retail

The distinguishing line between retailers and distributors is a fading one in the digital world as getting the content from content owner to retailer is a simple electronic process. As a result no distributor is required and the content owner can go directly to the retailer, which, if independent of the studios can also act as an aggregator. So a more likely structure is that content owners will become their own retailers and they will compete with independent aggregator retailers that provide a one-stop shop for content for multiple media companies.

This might appear nothing but positive but without the distributor or a requirement for a physical outlet, retailers have the ability to completely reset the pricing model according to their vastly reduced cost base. Content owners have little or no influence over the prices retailers choose to set one the retailer, or indeed the renter has purchased the selling rights. That has already set a challenge to content owners, as we have seen with Apple iTunes and music and increasingly with TV and film content. The $0.99 film may appear a good deal to the consumer but is it enough to maintain the investment in new film development and once price expectations are set, can they be increased?
Studios are, not surprisingly, anxious to avoid having pricing dictated to them by a single dominant online retailer but to compete effectively they need to differentiate their online stores through content of course but also through the ease of use and relevance of its service.

Unlike telcos, or even cable cos and DSAT service providers, content owners have access to the content to differentiate their online service from competitors. They are of course limited to their own content but with a limited number of top studios or content creators, consumers would be able to find their way to the content they liked the most – just as they find their way to the content they want on different TV channels. But content alone does not a service make and this is the steep learning curve that content owners are embarking on.

A full service requires effective content delivery, quick, easy and secure payment/billing facilities, a slick search and recommendation engine, easy links and access to additional services or more video content and efficient customer care. None of these are core competencies for film and TV studios, or even games developers and publishers. However, they are core assets of telcos, the same telcos that are struggling to get the right level of premium content from the studios. There is a natural synergy here, even more so when you take into consideration the motivations for telcos to get into the entertainment arena.

To this end we have identified core telco assets that could aid that differentiation. These are:

  • Interactive Marketing and CRM, whereby telcos are capable and willing to share the information they hold on customers and their behaviours. These leverage both personal and contextual data to create valuable information services
  • Customer Care – a core telco competency that is completely lacking from the skill set of media companies
  • Three Screen Delivery – telcos have vast experience in identifying devices, the OS and software platforms, detecting software configurations and radio connectivity and transcoding to deliver content in the right format for the device
  • Direct Payments – through the telco bill, one click secure and easy payments are possible, overcoming one of the major obstacles identified to put off prospective customers. Includes the ability to detect account status, billing and payments capabilities
  • Identity-based Content Delivery – the telco ability to identify customers and deliver across platforms provides another way to build a content anywhere business

(For more, see How to Out-Apple Apple).

It will also be important for studios to act quickly as hardware vendors have watched the Apple phenomenon and are looking to get a slice of the pie, meaning there are many more than one new entrant.

New roles – device vendors sell content

Entertainment device manufacturers rely on new formats and technologies linked to content to sell new hardware – eg Hi-resolution and 3D films, TV and games. That is how their business model works but online also gives them potential to move up the value chain and get into the retail sector, grabbing a share of the revenue as Apple has done. It is a process that has been exemplified in the mobile industry. With apps and app stores, manufacturers of devices can build communities and develop the potential for three revenue streams: hardware sales, revenue share on app sales and even software licensing to app developers.

There are two converging trends involved here. On the one hand, entertainment and communications devices are becoming one and the same thing, while on the other, devices are moving up the value chain and vendors are looking to gain revenue from outside of the highly competitive consumer electronics markets.

For example, Sony has built up an Internet community around the PS3, using it as the backbone for its connected TV network. It is looking to gain a recurring revenue stream to go alongside the one-off hardware revenues of the TVs themselves. TV replacement cycles are around 7-8 years and while the speed of innovation is increasing – 3D is coming relatively quickly on the heels of HD when compared to the move from colour to remote control to digital for instance – it is still a more uncertain business and one more influence by macro economical trends than pay TV services.

Sony is particularly interesting because its previously separate divisions serving the consumer electronics and entertainment markets are combining their assets to provide a significant challenger to the value chain. For example, in 2008, the Sony Pictures film Hancock was offered to those in the US who had its Bravia TV sets just a few days after the cinema launch and before the DVD went on sale, completely usurping the window release process that sees films follow a well-defined path from cinema to DVD/Blu-Ray sale, then to rental, followed by pay TV and finally free-to-air TV.

The Hancock experiment has not been repeated and instead Sony has done deals other online distributors for film on its Bravia sets, such as with LoveFilm in the UK, but it does show the potential if, like Sony, a company can control both ends of the value chain. However, the new competition does not end there.

New players – TV changing times

Continuing with the TV example, we can see that traditional TV broadcasters look at web distribution as an opportunity to:

  • Extend their reach beyond the limitations of the time-specific schedule
  • Diversify their offering by creating additional services and interactivity around broadcast services

On the flip side of this though, the web is also a threat as it takes away the broadcaster’s iron control over the distribution channel. YouTube has proved to be a key battle ground as broadcast TV programmes that were one posted for free within minutes now have a fee attached and a raft of country-specific as well a general providers of managed solutions have emerged as quality becomes a greater differentiator.

Taking this a stage further are the internet players, such as Apple and Google, which have both released TV specific services that extend their Internet expertise and services to the TV screen. Most significantly though, these also extend their respective business models to the TV screen. How these fit into and challenge the overall connected TV market is illustrated in the table below, which features a number of players from the US, the biggest market for video entertainment and the UK, Europe’s largest market, that are trying out new business models in attempts to gain a greater share of the market.

Table 4: Who’s Doing What in Connected TV

Consumer Proposition

Company

Product

Business Model

Strengths/Weaknesses

Pay to view TV services

 

Amazon

Online retail community – streaming and download

Retail model for sale and rental

New Business Approach: Content Storefront

Strengths -strong online retail brand and community. Cloud based storage and access

Weaknesses – Complex rights management; weak mobile/portable service.

Apple

Apple TV box plugs into any HD TV to provide the Apple interface to content through AppStore and iTunes and Mac-like computer navigation. Available now

Rumours persist about a $30 per month subscription service but Apple has not yet been able to secure the content deals to make this happen.

Hardware sales and 30% revenue share of all film and TV downloads

New Business Approach: Content Storefront & Content Anywhere

Strengths: Apple Brand; Leverages existing content environment; iPhone, iPad for mobile reach and ads

Weaknesses: On-demand service only, now schedule broadcast; Depends on content it can get – has held up sub-based monthly TV service

Google TV

Box from Logitech or embedded in new Sony TV. Leverages Google search capabilities and Android developer community

To launch Autumn 2010

Revenue share from Android market and extension of  AdWords from Internet to TV

New Business Approach: Content Channel & Content Anywhere

Strengths: Google brand; search engine; Android App Developer Community and mobile reach;

Weaknesses: Scale -hardware has to be bought; Access to content, currently blocked by 4 major broadcasters in US; Dependence on hardware vendors and content owners

IPTV Verizon FiOS

IPTV service with hundreds of channels, VoD and  PVR

Triple play service – bundled with broadband and telephony. Defensive activity to protect comms revenues

New Business Approach: Content Anywhere

Strengths: triple play – have control of both Internet and TV channels into the home; control over the delivery pipe

Weaknesses: Scale; Lack of exclusive access to premium content and content differentiation

Sky Player (UK)

Web TV player behind pay wall giving same service to subscribers as they get through satellite TV service

Watch anywhere value-add. Defensive play against web TV players

New Business Approach: Content Anywhere

Strengths: Leverage existing premium content deals and original content – especially sports; Extensive back catalogue

Weaknesses: Ability to control the quality of the experience

NetFlix/LoveFilm

Postal and online rental service

Subscription model for rental that breaks pay-per-view rental model

New Business Approach: Content Anywhere & Content Channel

Strengths: Subscription model attractive to consumers wanting set cost; model naturally migrates to online and gets stronger with lower distribution costs

Weaknesses: At the mercy of content owners wanting to protect revenue from other windows; No control over the pipe.

Cable TV Everywhere

In Beta testing on Comcast’s Fancast

Led by Comcast and Time Warner, this provides online access to their cable content behind a pay wall

Watch anywhere value-add to prop up premium subscription packages. Defensive play against web TV players such as Hulu

New Business Approach: Content Anywhere

Strengths: Leverage existing premium content deals and original content; Extensive back catalogue; Ability to control the quality of the experience

Weaknesses: Late to the game. Limited to those who already have cable subscription – no online only business model

Hybrid Pay and Free

Hulu Plus

Launched June 29, 2010

$10 a month subscription premium service for near real-time access to TV content, on all screens with handover pick up and play across all of them

Freemium model building value add on top of the free Hulu service adding subscription revenue to advertising

New Business Approach: Content Channel

Strengths: access to premium new and catalogued content from its parent companies; two-sided business model; three screen delivery

Weaknesses: access to content outside of that from founders;  no control of QoS of pipe – possible victim of throttling

 

YouTube

Free to view video upload for UGC, advertising supported professional content

Experimenting with paid for content

Ad-funded

New Business Approach: Content Anywhere

Strengths: Brand, scale and reach; Google technical and financial backing

Weaknesses: High costs of storage; lack of advertising placement

Free to view web TV services

Free to Air – Project Canvas (UK)

Extension of Freeview (all free to air digital channels)  to the web with full player capabilities

Ad-funded

New Business Approach: Content Anywhere

Strengths: reach – accessible by anyone with web access.

Weaknesses: player functions, such as fast forward, undermine value of advertising ; late to the game; no control over QoS of delivery – possible victim of blocking/throttling

Hulu

Free access to a range of Flash-based streamed TV and Internet video. Scheduling based on

Ad-funded, although the intention has been announced to introduce some paid services

New Business Approach: Content Anywhere

Strengths: free access limited only by internet connections; access to premium new and catalogued content from its parent companies

Weaknesses: no control over the quality of the connection – possible victim of throttling; access to premium content from other media companies; non-sustainable business model for most valuable content

Source: Telco 2.0 Initiative

Apple goes it alone

Apple TV is predominantly a pay-as-you-go model based on iTunes; it is a virtual retailer and has pioneered the content storefront model. Interestingly, TV is the first Apple business not to be built around hardware, suggesting that the company believes its online store is strong enough to carry its own business. However, Steve Jobs has referred to Apple TV as a project that will remain a hobby for some time to come. Despite this, Apple still has a strong role influence over the online video market. Its pricing policies for video on iTunes reset pricing levels and its stand on not supporting Flash is not just a technology decision based on the ‘buggy’ nature of Flash as described by Jobs.

Flash fire

Certainly Flash is quite heavy and would slow the iPhone down, so Apple is protecting its user experience but it is also protecting both its up and downstream business models for professionally created video content.

The vast majority of online video services from Hulu to Netflix, LoveFilm and TV network players are Flash based. This means that they can be viewed via a browser by any device that supports Flash. By taking Flash out of the equation, video consumers on the iPhone are left with two choices: get a different device that supports Flash or purchase video content through iTunes and that means more revenue for Apple. Apple talks about HTML5 as the natural replacement for Flash but this is still new technology and Apple will look to maximise its position for as long as possible.

Video service providers or content owners also have two choices: to build a second site that works on HTML5, as the BBC has for the iPlayer; or create apps for the devices as Netflix, LoveFilm and Hulu have. This later again works well for Apple as the apps strengthen the consumers tie to Apple hardware as should the consumer want to move to say an Android device, they’d lose the app, so it reinforces the company’s hardware business model. Furthermore, where applicable, Apple also gets its 30% of the app revenue and of course, SDK revenue.

The decision not to support Flash may have something to do with technology and protecting the user experience but it clearly also has everything to do with reinforcing the strength of Apple’s existing business models.

As with all other services, Apple and Google are taking fundamentally different approaches with Apple expanding its closed iTunes environment, while Google is all open. Apple is betting on taking a share or distribution/retail revenue; Google on turning TV into another and potentially huge extension to its advertising platform.

The big question here therefore is what this means for the broadcaster’s advertising model, as if Google’s version, which is performance-based and uses real rather than predicted data, is available on a TV screen, won’t the value of TV advertising decrease?

In the Apple case, it establishes the direct relationship with the customer, while Google’s play is purely upstream, extending its reach and delivering a new audience to its advertisers.
Apple also has another and for them, more significant objective, and that’s selling new hardware. While its famous Appstore brought in $1 billion dollars in its first complete year of activity, 30% of which went to Apple, that is put into perspective by the company’s total revenues of $13.50 billion and net quarterly profit of $3.07 billion for the second quarter, 2010.

Connected TVs could represent another diversification for the company that has been so successful at moving into the mobile device market and, just as with the mobile industry, Apple is looking to leverage the tight integration of its content marketplace to differentiate its hardware. This has been the primary driver of Apple’s business model but the expectation is that the relatively low retail price of the box and the lack of any real design differentiation means that for TV, Apple will be looking to create value from the service on the big and combine this with tight integration on the portable ones – the iPod, iPhone, and iPad.

Google on the other hand, is working in conjunction with hardware companies, most notably Sony for the Internet-enabled TV end product and Intel to get the Google functionality embedded in the chipsets. And Google’s objectives are not small, as a spokesman for the company have been quoted saying that it aims to have as big an impact on the TV industry as smartphones have had on the mobile world.

Differentiation options

In essence all the forces converging on TV are competing for the eyeballs of the consumer and the way they are doing this is to offer the consumer more choice: more content on more devices to be watched at more times. The consumer utopia it seems is to be able to pick exactly what they want to watch, when they want to watch it and on what screen; or in other words, the complete antithesis of broadcast TV when you get what your given, when its broadcast and always on the same type of screen.

There are however, problems with the utopia and the companies that solve these most effectively will run out the long term winners. As we are starting to establish there are four key points of competition:

  • The range of premium content
  • Integration of Internet apps to enhance the viewing experience
  • The user interface/ guide for finding the content

Extension to the mobile screen for true anywhere anytime viewing and enhancement of the big screen viewing experience

This is not to say that they are the only ways to compete, merely that they are the primary ones at the moment. Of these, only the appeal of content is proven; consumer demand for and willingness to commit dollars to the other three are, as yet, not.

Companies are however beginning to place their bets and while some are predictable, such as Google looking to leverage its search expertise for content discovery and its Android app development community to bring Internet-style services to TV programming; a lot more remain unclear. In particular, the ability of content owners that don’t have an established distribution channel to draw upon, to go directly to consumers is in question.

Interaction with Internet applications

For Google, key is a Software Development Kit (SDK) that will help independent content providers develop widgets to access their platform, content and participate in Google’s advertising revenue sharing program, similar to AdSense on desktop apps.

The Google TV proposition is Android based to draw on the rapidly-growing global developer community to create new and innovative ways for TV viewers to interact with their TVs. Facebook and Twitter widgets would provide easy to use chat facilities around key programming, for example. They are already used and by linking them in real time with the programme screen itself adds a further level of social networking. Beyond that, the possibilities are almost limitless but platform owners must understand what they are doing and the possible impact on existing revenue streams, particularly advertising as they could find their business model undermined.

For example, at a recent conference in London, an ITV representative speaking about Project Canvas stated that widgets and other apps would be uploaded onto the platform for free. Now imagine if an existing advertiser, say BetFair, which advertisers alongside sports events, launched a widget that enabled live betting on the event being broadcast. Why would they pay for advertising in a prime spot when they can launch the widget for free?

So the big Internet companies are coming to the TV party. They bring with them their own business models and these will compete with and impact on those of established TV studios, networks and distributors.

Free to air broadcasting is a simple one-sided upstream business selling advertising timeslots, whereas pay TV has a two-sided business model which adds consumer subscriptions to the revenue pot. A third pay-per-view element also exists for some pay TV services but revenues from these have declined over recent years. Following these developments through, we can see some major changes on the horizon.

Impact on advertising

TV accounts for the largest single proportion of advertising spend. Globally, it secures 36.6% of total ad revenues, according to PWC, and although spending has fallen on TV advertising over the last two it remains a default choice for buyers. It’s the IBM decision – the no one gets fired for making the obvious decision but if the TV world is changing isn’t advertising following suit?

Initially at least, research suggests that the answer is no. The $56 billion US TV advertising segment is expected to recover, growing by 9.8% during 2010 and thus erasing last year’s losses and returning the sector back to 2006 -2008 levels, according to the Magna Global Advertising Forecast, April 13, 2010.

At the 1st Telco-Hollywood Executive Brainstorm, executives were at pains to point out how TV still dominated viewing consumption patterns, delivers a better reaction to advertisements and are therefore seen as more pervasive than radio, print or online. According to the TVB, Nielsen Media Research Custom Survey 2008, cited by one of the speakers, 70% of adults believe that TV adverts are more persuasive than adverts on other mediums. It would seem that the TV/advertising love affair is set fair. However, we believe that the building trend towards on-demand viewing is challenging this particularly for free-to-air broadcast services.

If we take online advertising, we can see that it currently accounts for 12% of marketing budgets versus 34% of time users spend online. However, tying strategy to a delivery medium rather than a business model is a fundamental mistake. It’s not about online or cable or broadcast but live or on-demand. This is the change that undermines the very foundation of TV, broadcast and scheduling.

Scheduling, search and discovery

Of all the new functions that are hitting the market, it is on-demand that is making the greatest impact at this stage. At the 9th Executive Brainstorm, we asked the audience whether discovery would become the new search. The results were negative but it was the wrong question for entertainment and particularly for TV. The bigger question is whether discovery can become the new scheduling?

Broadband connectivity means that there is the potential for anyone to watch what they want, when they want it and where they want to. In theory therefore the individual can do the job of the schedulers of TV networks and channels and personalize it for themselves. This is especially true for the mass of archived material that is the mainstay of a host of cable DSAT pay TV channels. And the usage figures seem to back up the fact that the desire for consumers to control their own viewing is an irreversible trend and not just a short term fad.

A clear trend has developed around time-shifting whether through VoD, on-demand, or delayed TV; watching when the viewer wants and not when the scheduler says, is proving ever more popular. According to ComScore research on US viewing behaviour, 55% of viewers now watch original programming at a time other than when it’s scheduled. Furthermore, although it is a more pronounced feature in the younger demographic groups, it is also permeating the viewing habits of the over 50s and even over 60s, with 43% of the over 65s watching programmes after they had been aired. In short: everyone is time shifting.

However, a completely unstructured service where consumers search for the content they want relies on them knowing what that is. TV is generally regarded as a ‘learn back’ experience. It doesn’t require a huge amount of concentration, unlike say, video games and as such consumers don’t want to and won’t spend protracted periods of time searching for something, especially if they don’t know what they are searching for. Therefore the default becomes to stick with what you know. Just as many of us do with music, our viewing tastes could get stuck in time and we will miss out on new and different content.

We therefore have two contradictory user behaviours driving service requirements for on-demand video. On the one hand, consumers want to choose their viewing not have it thrust upon them, on the other they don’t want to have to make a huge effort to find their viewing.

The viewing guide is one of the most criticised parts of cable, DSAT and IPTV services. Often slow and clunky the guides, which list the schedules for each channel, struggle to deliver the large amount of information they have in a meaningful and useful way. If we then take out the timings and searching becomes even more difficult.
More sophisticated ways of discovering content are needed that encompass search, recommendation and some form of default scheduling and models for this are appearing.

Recommendation engines such as that used by Amazon or Apple Genius, which use observed tastes to make suggestions for future purchases are now well-established practice for online retail. However, there is potential to take this a stage further.

For example, the online radio service Last.fm offers playlists based on popularity of tracks as a default, as well as search and recommendation. This is interesting primarily because it is having the effect of increasing the amount and variety of music listened to by consumers. This may seem to be a nice, fluffy feature, but it is important for the discovery and support of new music talent and therefore the continued life of the industry.

Last.fm has flaws. It runs two business models, a free, ad-funded one in the US and UK and a subscription model in all other territories. This, the company says, is because it doesn’t have the sales capabilities necessary to run an effective ad sales campaign outside of its core territories and which will dominate in the long term is still uncertain but the value of an effective recommendation engine that acts as a scheduler, is.

As one speaker said at the 9th Telco 2.0 Executive Brainstorm in London, the opinions that influence his viewing habits are those of British actor/comedian, Stephen Fry and his mate Dave. No scheduler can do that but an effective mash up of recommendations perhaps through Facebook, Twitter and a purpose built recommendation engine such as Amazon uses, could.

Pay TV services increased choice dramatically over free-to-air alone and split the ad revenue. That took the number or channels from single figures to hundreds. Now imagine what happens when everyone has an individual channel.
The impact is already being felt on advertising revenue as these predictions for the US market from Magna Global reflect.

Table 5: US Ad Revenue According to Platform

PLATFORM

2009 ($$$) Est.

2010 ($$$) Est.

2011 ($$) Est.

% Difference

Digital Online

$22,843.7

$24,611.7

$26,792.0

 + 8.9%

Cable TV

$20,148.8

$21,491.7

$22,477.3

 + 4.6%

Broadcast TV

 $27,789.3

  $29,047.9

$27,384.0

 – 5.7%

Source: Magna Global data presented at 1st Hollywood-Telco Executive Brainstorm, May 2010

It does, however, mean that advertisers can target far more effectively and finally put to bed John Wanamaker’s infamous adage: “I know 50% of my advertising is wasted, I just don’t know which half.”
However, there are problems with this vision as well.

On the revenue side, it requires new ways to measure viewing of shows and ads, while in terms of the user experience, it is essential to find an effective way for users to find what they want and discover what they will like but don’t yet know about.

Basically this is a data crunching business. It requires personal data, usage information, content meta data, device preferences and more to be combined to create valuable information. Telcos with their knowledge of the customer, device and environment have high value. Even more valuable is the willingness of telcos to share this data with content owners, unlike many of the alternatives.

Extension to the mobile screen

Beyond time and place shifting, the other major area of competition and development is the ability to deliver content across multiple screens. In many ways it is a development of the same trend: consumers do not want to be restricted on where, when and how they view. The seamless shift from one screen to another would, for example, allow a consumer to move from TV to mobile and then to PC as the commute to work.

These pause and pick up services are of course already in existence. Netflix supports this and it is a central part of the cable industry’s TV Everywhere initiative. Meanwhile, the ability to buy once and view on any screen is the functionality at the heart of rights locker propositions such as Disney’s KeyChest or the UltraViolet initiative that we mentioned earlier.

However, we believe that this alone is only part of the story.

User behaviour suggests that consumers actually like to use more than one screen to interact with content. For example, it’s all very well getting detailed stats to accompany a baseball game through a multi-screen view on IPTV say, but this interferes with the primary viewing function. As ESPN has discovered, a more effective approach is to provide the stats to a mobile device through an app, giving the consumer the ability to choose when and how they look up the info. Add in a chat facility and watching the ball game at home becomes a social activity as it would be seeing it live.

Getting the right platform for the right content is not a trivial matter. It is often assumed that the more intense the experience, the more it consumes the viewer, the more valuable it is. Furthermore, the value is assumed to increase the faster the connection gets as this allows greater intensity. This is not necessarily the case.
Some ‘lean forward’ activities can benefit from greater speeds. For example, many online games will improve with faster response times and these are highly immersive activities. However, not all activities require and always benefit from greater immersion. 3D TV has provoked great debate along these lines as the most intense experience is seen to require greater engagement and brain activity, making it a more complete viewing experience but also a less social one.

Sociability is both a sought after and valuable feature and is not necessarily driven by high immersion, high speed experiences. It’s about getting the right device for the experience, related to the user’s activity. And that requires information about what screens the user has, how they use them, where and when. This is the kind of new user data that telcos can collect and use without drawing heavily on complicated legacy BSS and OSS systems.

So, in summary, we have a situation in which online video distribution is a reality and growing at a fearsome pace but the business models and value chain are far from clear. Indeed, the stress points in existing models for both studios and telcos are more obvious than revenue opportunities. Both of these are areas in which telcos are well placed to play an important part.

The next section therefore looks at how the assets and developments of the content and telco industries can be combined for the benefit of both.

Telco and Media Collaboration

The options for telcos are many and the approach taken is dependent on the structure of the entertainment industry in their country and their own set up. Amongst the considerations they must assess are their willingness to collaborate, the assets and skills available to them and the regulatory environment. As we’ve already established, for some IPTV is a viable option, for others mobile as a mainline channel is also worth pursuing as it is the most ubiquitous option.

In addition, a third downstream option is emerging for telcos to be an access provider to digital rights lockers.
On the upstream side, the opportunities are many but they are far less defined and their development seems to be stuck in an endless chicken and egg situation in which each side is waiting for the other to define the services required. To help move this discussion on and to define some near term opportunities we have honed down the list of possibilities by examining what media companies are looking for from telcos.

Where to Start

Surprisingly, combatting piracy which gains so many headlines is not uppermost in the list of priorities, according to our research.Instead the issues that dominate the thoughts of media executives are primarily those that we have outlined earlier, namely the ability to differentiate through delivering across any screen, enhancing the user experience and improving content discovery, as illustrated in the table below. Underlying that is the desire to re-define and build the value of the upstream side of the entertainment business ie advertising.

Table 6: Importance of addressing issues facing media companies rated 1-5*

*Where 1 is of no importance and 5 is critical           Source: 1st Hollywood-Telco Executive Brainstorm, Santa Monica 

However, along with piracy, the area in which telcos and entertainment distributors are most likely to interact is in conflict over the quality of the pipe they are receiving.

QoS, QoE and throttling back

Video is all about the viewing experience so anything that influences that experience is of vital importance to content owners and to the retailer/distributor if this is done by a third party such as Hulu, NetFlix or LoveFilm. As these media service providers have no ability to control pipe, they use adaptive rate video technology to sense the bandwidth available and deliver the quality of video the connection is capable of dealing with effectively.

Adaptive rate technology works to a point as it means that they can deliver the best possible video for the bandwidth at any given time. However, the underlying transmission speed and quality is still beyond the control of the media service provider, so though better connectivity may be possible it is not being delivered. Furthermore, within the confines of the thorny net neutrality debate, the throttling of service types and in some instances specific services is happening to the detriment of online video services. For example, in the UK, LoveFilm has examples of customers with 20MBit/s connections unable to get a satisfactory service even though other video streaming services including the BBC iPlayer work perfectly well.

Telcos want a share of the video revenue that is being generated over their networks, and in throttling, deliberately reducing the speed of connections, they have a stick to beat media service providers with, should they wish to and be allowed to use it. However, just like DRM, throttling is a negative activity and will serve no positive purpose as consumers are just as likely to move ISPs if their services don’t work as they are media service providers. If they want certain content, they will find a way to do and don’t be surprised if such throttling activities pushes more consumers to Pirate Bay and its like where an additional wait will be tolerated to download rather than stream and content comes free.

So is there a better relationship to be had?

Charging for QoS/QoE SLAs to media service providers would be the first choice of telcos and while our research suggests that telcos believe this to be more of a possibility now than a year ago, our view is that it is still a service that requires consistent failures in the market in order to prove its value before it could become a capability media service providers will pay for en masse. Therefore if telcos can’t charge upstream players for a guaranteed pipe, at least in the short term, they need to look at other what other telco assets can offer media companies.

In our analyst note, ‘How to Out-Apple Apple’, we identified a series of telco assets that could be valuable to media companies that are or are intending to sell their content directly to customers through online outlets. These and how they add up against competitors are summarised in the table below.

Table 7: Telcos Offer Unrivalled Asset Combination

 

 

Payments

Content Delivery

User Experience – 3screen

Interactive Marketing/ CRM

Customer Care

Apple

Yes

Yes

No

No*

No

Amazon

Yes

Yes

No

No*

No

Netflix

Yes

Yes

No

No

No

Cable Cos/Satellite

Yes

Yes

Partially

Partially

Yes

Other enablers

Banks, Credit Cards, PayPal

Eg Akamai, L3, Limelight

Marketing Ad Agencies

Outsource

Telcos

Yes

Yes

Yes (Converged telcos)

Yes

Yes

*Apple and Amazon have interactive marketing and CRM functions but do not pass data on to content owners.
Source: Telco 2.0 Initiative

At our first Telco-Hollywood Executive brainstorm the value of these telco assets and other capabilities were discussed and rated. All were recognised as offering possible value to studios in the development of their own services. As the graph below shows, it was the functions nearest to the consumer that rated the highest.

Table 8: Telco Capabilities Rated (1-5*) According to Their Perceived Value to Content Owners

*Where 1 is not valuable at all and 5 the most valuable
Source: 1st Hollywood-Telco Executive Brainstorm, Santa Monica

Again, the value of owning the network infrastructure is recognised as hosting content locally and ensuring its effective delivery are natural roles for telcos to take on. Usage and access distribution is the next highest rated capability and the expectation from studios and media companies is that telcos should enter the market as media service providers in some form or another and the downstream market should not be ignored. That said, those assets that are a stage further removed from consumers were also rated as valuable.

Identification and authentication, payments, decision support and data mining (listed under the heading of Interactive Marketing /CRM in table 7) and content protection are all rated as useful. However, there is a caveat here in that what media companies want is complete solutions not raw data or APIs that they then have to build services around.

Over the next 12 months, telcos need to develop complete solutions that can meet the needs of media companies. Simply saying that they have the assets and capabilities is not enough. Also the speed with which the market is changing means that solutions need to be developed fast as the window of opportunity for media companies to gain a more powerful position in the ecosystem will be relatively short. New and powerful players are entering the market and putting pressure of established price paradigms. Once changed these are difficult if not impossible to change back until serious failures in the market appear. The next 1-2 years are therefore vital.

From a telco point of view, this makes playing upstream difficult if they have not already begun to develop solutions that could be packaged for media companies. Downstream opportunities are in some ways less time sensitive but the current market flux offers up opportunities to establish a position that will be harder to reach when it is more stable.

Strategic choices

Telcos therefore have a series of strategic decisions to make about how and where they play in the entertainment market. We have developed a structure of generic strategy choices based on the willingness and ability of telcos to move on and off their own network and whether they intend to offer and end-to-end solution to consumers or play a specific and limited role in the ecosystem. The overall strategies these choices create are illustrated in figure 3 below.

Figure 3: Generic Two-Sided Business Model Strategies

Source: Telco 2.0 Initiative

Taking this a stage further, we can map this general theory onto the specific choices facing telcos in the entertainment market to create a framework with four different approaches to telco involvement in the entertainment ecosystem. As the market is developing, on-net activities are providing the greatest opportunities, as illustrated in figure 4 below.

Figure 4: Entertainment-specific Business Model Strategy Choices

Source: Telco 2.0 Initiative

Entertainment is an increasingly complicated market with collapsing value chains, new entrants and new technologies that are allowing established players to compete in different ways. Having a clear idea of where telcos fit into this dynamic market structure is important and there are roles for telcos to both support media companies in their attempts to go directly to consumers and to go directly to consumers themselves. A second phase, supporting multiple third party platforms and media service providers may emerge but this is a stage further removed as these are currently competing with what telcos and media companies are trying to do themselves.

Taking a look at the bottom left quadrant – enabling media companies to develop a direct sales channel – in more detail, it is possible to identify a range of way in which to do this. There are firstly a range of activities and assets that can be undertaken, as we have already outlined above, and secondly there is a range of ways in which to utilise those assets.

Using Telco 2.0’s established gold analogy, we can see that telcos have the opportunity to be more or less involved; to offer what they have in raw data to media companies and let them do as they wish with it at one end of the scale, right through to offering a complete end-2-end service.
Examples of what type of entertainment-orientated services can be offered at each stage by telcos are illustrated below.

Figure 5: Possible Telco Roles in Entertainment Industry

Telco 2.0 research suggests media companies put greatest value on telco assets that are packaged to them as services. As illustrated above, this means a managed one click payment capability, not an API on top of which they have to build their own payment service. What is more, they want things that have been proven to work, either for other industries or for the telcos itself. Eating your own dog food is not just a sound bite to be trotted out at conferences, it’s an essential tactic if telcos are going to gain credibility as upstream suppliers to the entertainment industry.

Fortunately this is something the telecoms industry is recognising, as a vote at the recent Telco 2 Executive Brainstorm in London where delegates demonstrated that to take full advantage of the customer data they have, they must first find ways to use it effectively themselves. During the session focused on the use and monetisation of customer data, the 180-strong group of executives were asked to rank 1 to 4, the importance of different strategies for beginning to use the customer data they hold in the short terms (next 12 months), using it for their own purposes ranked the highest.

Telco’s two-sided business model for entertainment

There is little doubt that telcos have a strong strategic interest in the entertainment industry both for its opportunity to grow and its impact on their existing businesses. However, they are entering a market that is itself in flux and the opportunities are neither well defined nor static. The market is constantly changing and so are the possible roles and activities open to telcos. Under such circumstances a two-sided approach to the business makes even more sense, giving more choice and opportunity to build revenue as illustrated below.

Figure 6: Telco two-sided business model for entertainment

 

Source: Telco 2.0 Initiative

However, the extent to which a specific telco gets involved in the up and downstream opportunities will depend on the specific market conditions, together with the skills and assets of the telco. These must also be mapped onto the needs of media companies as telcos must be aware of what the market is looking for.

Over the coming months we will look at each of the downstream models in detail, examining the conditions that make each play viable, together with the tactics that make each downstream strategy effective.

In addition to these we will develop use cases and identify case studies that help define realistic opportunities for upstream services.

Conclusions

  1. The transmission of entertainment online represents a significant growth market for at least the next decade. The addressable market is in the region of $700bn a year and growing, although it will take more than a decade if it ever happens to turn all entertainment into digital/online forms
  2. Content owners are being challenged by the changing patterns of distribution, retail and viewing and are looking to secure their place in new value chains that at least protect, if not increase their existing revenue streams
  3. Although the risks to content owners vary across genres, a major set of opportunities centre on the ability of content owners to go directly to consumers which requires a skill set outside of the core competencies of media companies. Telcos have many, if not all of these capabilities
  4. A second set of opportunities exist for media companies to work together to build ecosystems with their content at its heart that compete favourably with the offerings of new internet players. UltraViolet is an example of this which could compete with Apple iTunes. These approaches create new and better downstream opportunities for telco as they lower the barriers to telcos to enter the entertainment delivery business and allow them to build the business incrementally
  5. Complete end-2-end services in the form of IPTV require significant scale and huge investment. The success of these will be dependent on achieving these and they are heavily impacted by the maturity of competing solutions such as cable and DSAT. Therefore, while prospects look good in for telcos with large market shares that operate markets with weak pay TV markets, the majority of telcos will find differentiation through IPTV difficult and its deployment is therefore best seen as a defensive tactic against telephony and broadband service provision by TV service providers
  6. Other downstream plays are possible for telcos including:

    • Maximising the mobile opportunity by using it to enhance experiences on other screens and not just as another delivery channel. Telcos and content owners need to collaborate to develop value-added services that consumers will pay for
    • Operating as effective storefronts for entertainment content. Telcos have the customer scale, billing, customer information and CRM capabilities that make them ideal retailers but to be effective, telcos must offer content owners more than existing online retailers, such as Apple and Amazon. Of particular importance here is a willingness and ability of telcos to pass back to content owners on data about customer activity
    • The storefront proposition is strengthened further by developments such as UltraViolet which would enable telcos to build propositions while taking out the risk for both content owners and telcos
  7. Telcos have a range of core assets that could enhance the ability of content owners to move up the value chain and go directly to consumers and therefore gain a greater share of the entertainment revenue pie
  8. No other player has the range of enabling capabilities telcos have. However, the Telco USP is in combining these enablers and telcos must look at packaging them together as plug and play services for content owners. These need to apply across content categories (and possibly extend to other vertical markets) so that telcos can turn a niche vertical service into a broader and more valuable opportunity
  9. There is a finite window of opportunity for content owners and telcos to establish places in the new content ecosystems that are developing before major Internet players – Apple, Google – and new players use their skills and market positions to dominate those ecosystems. Speedy collaborative action between telcos and studios is required