For decades, cable operators have competed under a gentlemen’s agreement that persists even today: If you don’t steal my customers, I won’t steal yours.
Part of it was simply a case of local and federal laws. Cities awarded exclusive cable-TV franchises to a single winner of a competitive bidding process, in part to avoid a situation in which several companies would be tearing up streets to lay wire. Part of it, too, was simple physics: Cable operators could not compete in markets where they had laid no wire.
All of these forces kept companies from offering TV beyond their market borders. Until now.
The anticipated entry of socal led “virtual ” MSOs could set the stage for a video war marked by cable operators expanding beyond their traditional borders and invading the territories of fellow cable providers using an arsenal of services delivered over the top, via the Internet.
If such a scenario unfolds, it would quickly transform longtime cable-operator allies into bitter enemies, shave down margins and tear apart the economic fabric that has long held the industry together.
While such a war could destroy the way the cable industry conducts its business, at the very least it would create mutually assured disruption among its key players.
Cable operators are now trying to lock up the distribution rights necessary to offer services out of footprint, at least positioning themselves to react should the market suddenly shift into a virtual, over-the-top model of distribution.
But many in the industry consider executing on such rights and offering a full set of subscription video services out-of-region to be a desperate measure. Most MSOs would be reluctant to take the potential risks and invite similar attacks into their own markets.
Although these business hurdles could prevent incumbent MSOs from declaring war on one another, from a technology perspective, all of the pieces are in place for virtual operators to emerge and deliver video packages — live TV, video-on-demand and cloud-based DVR services — completely over the top.
“The environment today would facilitate a virtual MSO environment. From a technology perspective, it’s certainly doable,” one top cable-operator engineering executive said. “The network, the platform is there to do it.”
In fact, Sony plans to test such a service this year, heading up a batch of candidates that might develop and deploy a virtualized pay TV service of their own.
Today’s cable-modem services, which provide downstream bursts of 100 Megabits per second or more, deliver plenty of capacity and speed to serve up high-definition video. But the emergence of adaptive bit rate streaming, which allows video resolutions and streaming bit rates to fluctuate based on the available bandwidth, can keep the video flowing and avoid buffering even on unmanaged, “best-effort” broadband connections.
But technology is one piece of a complex puzzle. To enable a virtual service, all distributors, from traditional MSOs to newcomers like Sony, still need rights to sell and market a full-freight video offering nationwide.
OFF THE RESERVATION
The motivation to sell subscription video services beyond the footprint is an obvious one for incumbent MSOs: Most operators continue to shed video subs inside their footprints.
The top 13 multichannel video-programming distributors in the U.S., or about 94% of the market, lost about 25,000 net video subscribers in the third quarter of 2013, according to data from Leichtman Research Group. The top nine domestic MSOs lost about 600,000 video subs in that period, the group’s highest quarterly loss since the third quarter of 2010, LRG said.
Comcast bucked that longstanding trend, reporting last month that it added 46,000 video subscribers in the fourth quarter of 2013, halting 26 consecutive quarters of video losses.
That positive blip aside, invading new territory would provide operators with a way to turn the tide by riding someone else’s local broadband infrastructure to target more consumers in more markets.
“This could be one way to fill that hole,” an industry executive who handles programming rights for a large U.S.-based cable operator said. “I think, strategically, they will have to consider this type of [out-of-footprint] strategy. I believe there’s work going on in the background to figure out what it would take to do this.”
Distribution rights are clearly headed in that direction, with recent TV Everywhere deals that clear operators to offer live and on-demand programming to authenticated customers. “The next step is ultimate portability. Then a step beyond that is on a standalone basis to offer those kinds of capabilities,” the executive said.
“They’ve asked for the rights … to take our content outside their local franchise area and deliver it over the top,” an executive with a major programmer said. “They are reaching as far and broad as possible with those distribution rights.”
Although some smaller operators wonder if they’ll someday end up competing with an OTT service delivered by Verizon Communications or even a major cable operator such as Comcast, “it’s too early to worry about that, in my opinion,” Rich Fickle, CEO of the National Cable Television Cooperative, said. “I think the programmer rights aren’t accessible for a full offering. I don’t think that’s a near-term reality.”
So far, no pay TV provider has announced a plan to sell a full set of subscription video services out-of-footprint. But if one MSO launched an out-of-footprint video volley, there could be no turning back.
“I sincerely think these companies are obligated to look at it and reach a decision on what they want to do,” the MSO programming executive said. “But once you cross that line, it’s war.” Cable operators “will go from peers to competitors.”
MUTUALLY ASSURED DESTRUCTION
But just because you’ve hoarded those rights and that ammunition doesn’t necessarily mean that it’s good business to act on them. An OTT video product would have to be sold at a much lower margin, and may not be in the interest of incumbent pay TV service providers.
The acquisition costs for new customers would be extremely high, and Wall Street may frown at any publicly owned MVPD suddenly spending big on an OTT venture in an attempt to acquire new subscribers.
“It’s hard to see a scenario where an incumbent provider wins by going out of region,” Craig Moffett, principal and senior analyst at MoffettNathanson, said. “Such a tactic would “drive down the profitability of the industry … you suck a lot of the margin out.”
He added: “Everybody has been asking about this on every conference call going back to 2006. It’s not sensible for anybody to do.”
Still, some view Cox Communications’s brief flareWatch trial last year in Orange County, Calif., as a representative example of the operational challenges faced by a pure over-the-top TV service. Targeted to broadband-only customers within Cox’s footprint, flareWatch offered almost 100 channels and a cloud DVR service for $34.99 per month using IP set-tops and a fancy interface developed by Fanhattan, a startup based in San Mateo, Calif.
According to estimates by New York-based research firm IHS, flareWatch, which delivered a lineup “considered nearly on par with basic digital cable lineups,” operated on a financial margin of 22.1% — well below the 46.7% margins of MSOs’ traditional cable TV offerings. Cox didn’t vouch for IHS’s findings, stressing that flareWatch was a technology experiment and that it did not pull the plug for financial reasons.
Virtual MSO scenarios might not make dollars and sense for programmers, either. Trading a Comcast subscriber for a Cox Communications subscriber, for example, doesn’t exactly give programmers the proper incentives to grant out-of-footprint rights.
“They need to make a compelling case to the programmers that it’s additive to the existing revenue model,” Sean Riley, a former Fox Networks executive who is now the head of business development at 1 Mainstream, a startup that has developed a software platform that allows content providers and pay TV operators to create their own TV Everywhere apps for a variety of platforms, explained. “MVPDs would probably have to agree to packaging that more closely resembles other new competitive entrants, like telcos, if they want to convince programmers to grant them these rights,” he said.
It’s for that reason that Riley doesn’t believe MVPDs are hyper-focused on developing pure over-the-top TV products yet. “I’m not sure they [the programmers] are convinced there’s value, and I’m not sure MVPDs see tons of upside in linear OTT either. I believe it will be a while before we see a full OTT offering from a major MVPD.”
Based on recent history, there are also indications that MSOs might instead pursue a Netflix- or Hulu-type subscription VOD service that can be marketed and sold on a national basis.
Intel Media tried to pull off a full-fledged virtual MSO offering, eventually pulled back, and then punted on the whole idea, opting instead to sell the unit and its “OnCue” assets to Verizon Communications. Sources said Intel Media locked up enough distribution deals to get a virtual MVPD service off the ground, but Intel balked at signing them because it felt it could not achieve the scale required by those contracts.
With Intel Media out of the virtual MSO picture, Sony currently represents the only company that has announced plans to develop and launch a virtual MSO service in the U.S. Sony hasn’t revealed any content deals for the service it has in mind, but it’s likely if Sony is successful in securing those rights, it’s likely that programmers could be forced to extend them to traditional MVPDs, as well.
MAKE LICENSES, NOT WAR
If inciting an all-out-war with an OTT offering isn’t economically feasible because it would shrink margins and shake the foundation of the pay TV business, how else can incumbent cable operators grow a video subscriber base that’s been stuck in reverse?
One obvious path — a road Charter Communications is trying to take in its play for Time Warner Cable — is through acquisition.
But another way to extend an MSO’s video footprint could come through licensing and hosted services, which are proliferating as video services migrate to IP- and cloud-based delivery. Comcast already has plans underway to license its cloud-fed X1 platform, confirming last month that it is already discussing the idea with Cox Communications.
One industry source familiar with the X1 licensing model, which might use a revenue-sharing component, said Comcast could try to repackage Xfinity TV as a hosted, white-label service, enabling it to add more scale and, therefore, reduce costs of the X1 ecosystem without having to acquire more cable systems.
It’s too early to say how receptive the NCTC and its smaller, independent MSO constituents would be to an X1 licensing model, Fickle said, labeling such discussions as “informal.”
“Technically, the execution of it will take some time and work to make it friendly to other companies,” Fickle said. He’s been told that 2015 is a “realistic timetable” as to when Comcast might be ready to ramp up X1 licensing efforts, he said.
Fickle said a hybrid overlay approach that ties in X1 licensing with a repackaging of some cloud-based Xfinity services could strike the right balance.
If licensing X1 could help to “unify the customer experience across cable, I think that’s certainly a positive,” Joe Jensen, chief technology officer of Buckeye CableSystem, said.
“I think Comcast has made a valiant attempt to try to put the right features in place,” Jensen said. “We want to be the aggregator of choice, to be the place where our customers go to find and consumer entertainment.”
TAKEAWAY
The emergence of virtual, over-the-top MSOs could ultimately lead to a full-scale battle for subscribers beyond cable’s traditional franchise borders.
Virtual Competition
Media Giants Consider Virtual MVPD Services
Sony: Last month, Sony unveiled plans to test an over-the-top pay TV service in the U.S. this year that will include live TV, video-on-demand, and cloud DVR services. Details are still slim, but Sony has the advantage of having access to about 70 million Internet-connected devices in U.S. homes and about 25 million domestic PlayStation 3 users. Last August, reports surfaced that Sony had reached a preliminary deal to carry channels from the Viacom stable. Later, Viacom CEO Philppe Dauman predicted at an investor conference that there would be a “very strong chance” that virtual MVPDs would emerge in 2014. “But I’ll leave it to any such entity to make their own announcements.”
Verizon Communications: With its pending acquisition of Intel Media and its OnCue assets, the telco would seemingly be in position to move ahead on a virtual MVPD strategy that would allow it to sell services outside its FiOS TV footprint. However, people familiar with the deal’s rationale said Verizon’s near-term plan is not to take FiOS out of market, but instead to use OnCue to speed the development of an IP-based, next-generation version of the FiOS video platform. In the meantime, Verizon already has access to a more limited, subscription VOD/DVD service in the form of Redbox Instant by Verizon, a service that competes with Netflix.
Google: Rumors continue to swirl that Google has plans to develop a virtual MSO service that could ride high-speed broadband pipes. Google certainly has the infrastructure and the deep pockets to pull off a virtual MSO. Meanwhile, it’s gaining valuable experience as an MVPD via Google Fiber, the bundled broadband and TV provider that markets services in Kansas City and Provo, Utah, and is poised to launch in Austin, Texas, by mid-2014.
Amazon: Although Amazon denied reports it is exploring the development of a virtualized pay TV service, it has many of the ingredients needed to make a true go at such a service. It already owns a cloud-based video architecture (Amazon Web Services), a massive base of consumers to market to, and likely the stomach to launch and maintain a low-margin OTT service that can compete with traditional MVPDs.
— Jeff Baumgartner
First Strike: Non-Linear OTT
If MSOs are reluctant to launch full-freight pay TV services outside of their service footprints because it’s bad business and would cause industry-wide strife, there appears to be more interest in developing national, non-linear OTT offerings that more closely resemble services such as Hulu, Netflix and Amazon Prime Instant Video.
Comcast, for example, has already developed Streampix, a premium-level multiscreen VOD service that’s considered a Netflix competitor. John Malone, chairman of Liberty Media, has advocated that the cable industry come together and launch a nationally-branded, Netflix-like service that could be distributed over the Internet.
Charter Communications CEO Tom Rutledge suggested last November that distribution rights will allow for forms of video services to be delivered nationally. “We may sell video-on-demand everywhere,” he said on the MSO’s third-quarter earnings call. “We may sell subscriptions everywhere.”
DirecTV, meanwhile, was unsuccessful in its bid for Hulu last year, but the satellite-TV giant remains interested in developing subscription services that could be delivered over-the-top, though it has not yet identifi ed if the current plan is to mimic the Hulu model or to go beyond it.
“Over the next three years we are looking at electronic sell-through, SVOD, and over-the-top ideas,” Mike White, DirecTV CEO, said last December at the company’s investor day.
— Jeff Baumgartner
