Linear Dollars for On-Demand Pennies?

One enduring observation made by content business executives about the gross revenue or profit margin impact of digital content is that companies exchange analog dollars for digital pennies. That might also be true of the switch from linear to on-demand video entertainment.

Gross revenue for AT&T’s new DirecTV Now streaming service, for example, might generate an average of $118 a month. DirecTV Now will generate just $35 a month in subscription fees. So DirecTV Now represents gross revenue per account just 25 percent the size of a linear subscription, on average.

Profit margins suffer even more. Gross margin for the linear product might be as high as 45 percent, while gross margin for DirecTV Now might be as low as four percent, some predict.

Others think the profit margin will be even slimmer, as the “cost of goods”represents as much as 97 percent of revenue. Craig Moffett, MoffettNathanson equity analyst, estimates the  the cost of the channels expected to be included in DirecTV Now is likely around $34, which would leave just $1 a month before other expenses including overhead and marketing.

A reasonable observer might wonder why AT&T would offer such a service. There are several answers. AT&T is not alone in believing that the biggest opportunity to capture leadership in the on-demand video entertainment business is to focus on mobile video rather than the “direct to TV” model. So DirecTV Now, even if a “loss leader” at the moment, offers a chance to grab leadership of the business most expect will displace linear TV over time.

Also, subscription TV (linear or on-demand) is a clear “app,” offering a chance to escape the “commodity dumb pipe internet access” role. Simple internet access does not intrinsically drive incremental revenue for the access provider. Voice, messaging, video and other services, in contrast, boost revenue. And that will be a primary objective and necessity for all tier-one service providers, as legacy services approach “near-zero” pricing levels.

In that sense, entertainment video is among the likeliest candidates to drive significant application revenues, in addition to the internet access function. Also, content services--at least in principle--are more “sticky” than other services such as messaging and voice, allowing more chance for differentiation and loyalty.

To be sure, AT&T maintains the service will be aimed at households and customers who buy internet access, but not a subscription video service. Apparently, current DirecTV linear subscription customers will not be able to buy the DirecTV Now service. But at least some additional consumers are going to view the new offer as a viable choice.

That will be most true for consumers who might otherwise consider SlingTV or Hulu, less so for consumers of Netflix or Amazon Prime, both of which arguably compete more directly with HBO. DirecTV Now (as is SlingTV) is a better choice for consumers who want a broad selection of major network linear content.