FCC Releases Text of Net Neutrality Order

The Federal Communications Commission has published its Open Internet order. It is 400 pages long, so no, I haven't read it yet! (update: I'm trying to read it carefully and it is tough going. The actual text of the order is not so daunting, the footnotes and "how we got here" attempts to justify are what makes it slow reading)

It does seem clear that the rule is only the beginning of the process, as the use of terms such as "reasonable" means a continuing, case by case review of discrete actions. (In fact, now that I'm plowing through it, it reminds me of another book-length law recently passed where the actual implementation is where much of the actual rules will be developed)

The Commission also says it will launch a separate proceeding to bring mobile data roaming obligations into conformity with the new rules, and possibly apply common carrier obligations to data roaming.

Internet domain interconnection, long a voluntary set of agreements between the networks, now will be governed by common carrier rules. That is likely to have unexpected consequences.

In fact, much of the actual implementation seems to lie ahead, as the use of the test of "reasonableness" means a case by case method of ruling will be required.

Phablets Gain Share at Expense of Tablets

In the wake of the first ever year-over-year decline in global  tablet shipments in the fourth quarter of 2014, there seems little question but that “phablets” (smartphones with larger screens) have become a substitute product.

Tablet shipments are expected to reach 234.5 million units in 2015, a modest year-over-year increase of two percent  from 2014, according to International Data Corporation, which now also has scaled back its five year forecast for the product category.

Android will remain the platform leader, with close to two thirds of the market over the course of the forecast.

Apple  iOS share of the market to decline in 2015, reaching levels below that of the past three years.

Windows, despite modest adoption to date, is expected to gain significant share over the course of the forecast, growing from five percent in 2014 to 14 percent in 2019.

What, in Telecommunications, has Changed Over the Last Decade?

What has changed in telecommunications over the last decade? For Ofcom, the U.K. communications regulator, quite a lot.

Since 2005, broadband adoption increased 2.5 times, from 31 percent to 78 percent. High speed access at a minimum of 30 Mbps now is available to 78 percent of locations, while adoption has grown to 27 percent.

Mobile broadband availability has increased significantly, with 3G coverage increasing from

82 percent to 99 percent of premises, and 4G services available to 73 percent of premises.

More significantly, mobile broadband adoption now is 67 percent.  

Purchasing of bundled services has more than doubled from 29 percent to 63 percent.

About 44 percent of high speed access connections now are supplied by retailers using the wholesale approach, up from 17 percent in 2005.

Supplier consolidation also has been significant, including the formation of EE from

Orange and T-Mobile and acquisitions of smaller broadband ISPs (O2, Tiscali,

AOL, Be, Easynet).

The qualitative changes are just as significant.

A decade ago, the key issue was how to create a wholesale fixed network structure.

Now, Ofcom says, “a strategic review focussed on the market structure in fixed telecommunications risks being overly backward looking.” That means mobile and over the top apps and services must be a fundamental part of the examination.

“Increasingly, digital communications encompasses a combination of fixed, wireless

and mobile connectivity, and communications services provided over these networks,” Ofcom says.  

“For this review to be genuinely strategic, it needs to take account of digital communications infrastructure and competition more broadly,” Ofcom says.

The context includes increasing convergence between fixed and mobile communications, associated developments in wireless networks, and the ever increasing importance of “over the top” services, Ofcom notes.

Put another way, that means analysis and has to include fixed, mobile and untethered modes, plus over the top services that compete directly or substantially with carrier-offered services.

Policy, as a corollary, will likewise take into account the full range of access and services supply to ensure “competition, investment and innovation.” Ofcom suggests that, in addition to creating a climate for investment, while protecting consumers, it also will look at instances where deregulation is possible because competition (especially in voice and messaging) will discipline the market.

Lost Viewers Only the Start of Problems for TV Networks

In the third and fourth quarters of 2014, perhaps 40 percent of cable TV network ratings declines were caused by consumers who watched over the topp subscription video services instead of the linear channels, according to the Cabletelevision Advertising Bureau.

Total TV viewing fell 10 percent year over year in the third quarter and nine percent, year over year, in the fourth quarter, according to Todd Juenger, Sanford C. Bernstein analyst.

In the first quarter (through February), linear video network viewing was down about 12 percent.

“We believe the U.S. television industry is entering a period of prolonged structural decline,” said Juenger.

Should those rates of decline continue, at least some channels will face pressure to reconsider their business models. That will be a tough challenge. Linear distribution has one huge advantage: it creates huge potential audiences for advertising.

A la carte distribution will not carry such premiums. Most networks will find they simply cannot replace lost advertising revenues, in any switch to over the top distribution, by substitute subscriber fees.

The rough comparison is earnings of five cents to seven cents per viewer rather than 30 cents, on a much-smaller base of units, for the network.

The cumulative revenue shift would be catastrophic for most programming networks. Unbundling Analysts at Needham and Company have estimated that half of U.S. linear video ecosystem revenue would evaporate in any full shift to completely unbundled content access.

In other words, $70 billion in revenue would disappear. As a direct result, fewer than 20 channels would survive in an a la carte world where consumers are required to bear 100 percent of the cost of the content in the form of subscription or other fees, and advertising essentially disappears.

In 2012, the TV ecosystem generated total revenue of approximately $150 billion, about

$77 billion from advertising and $74 billion from subscription fees

paid to cable, telco and satellite distributors.

TBS, which historically was the second cable channel to be created, and the first ad-supported cable channel, generates about $1.5 billion of revenue from subscription fees plus $2 billion from advertising revenue, according to Needham.

Needham estimates that TBS charges distributors about $1.20 a month. Consumers might theoretically pay about $1.60 at retail, in a bundle. Nobody knows what TBS might cost as a stand-alone streamed channel, but something in the range of $5 to $10 is probable.

The reason is that TBS distribution costs would need to be covered, at the same time TBS loses much of its advertising and distributor revenue.

In a full a la carte regime, where channels are purchased as part of over the top Internet subscriptions, both revenue streams would be severely disrupted.

Networks would lose most of their subscribers and most of their ad revenue. The present TV ecosystem generally splits revenue 50-50 between content and distribution partners. The content provider generally earns 80 percent of all advertising revenue.

“Consumption of network and cable content is taking place in ways that allow viewers to circumvent high monthly cable bills, avoid watching commercials, or both. Every single one of

these changes represents a move to a revenue model that is less profitable than the one currently enjoyed by TV networks,” said analyst Gary Brode. “It is only a matter of time before the revenue and profitability of the networks begins to fall.”

Consumers Might Find Bundles A Good Deal, Eventually

Precisely what is happening in the linear video and over the top subscription businesses is unclear, even if most observers would agree the business clearly is in slow decline.

Paradoxically, consumers might eventually find that video bundles--even mostly linear--provide more value than a la carte streaming "channels" and services.

To be sure, strains in linear video are growing. In fact, by about 2020, smaller U.S. cable TV companies are going to experience zero profit margins on their linear video programming businesses, according to the American Cable Association.

Some would argue Verizon Communications likewise will have a hard time earning a profit on its own widespread investment in fiber to home networks, at least in part because revenue from new services has been less than anticipated.

Meanwhile, profit margins for linear video, in particular, have been rather low, Verizon now maintains, though in the past Verizon has claimed it earned good margins on video entertainment.

It would be going too far to argue video service providers are aggressively taking the bundle apart. It would be fair to say they are taking unprecedented steps to control costs, either by shrinking bundles or replacing expensive networks with cheaper apps.

Nor is the linear video business declining fast. 

The biggest U.S. linear video subscription providers lost about 125,000 subscribers in 2014, on a net basis. Within the category, AT&T and Verizon gained about a million customers, while cable TV operators lost about 1.2 million accounts, on a net basis.

On an installed base of 95 million accounts, that barely registers, a tenth of one percent over a year’s time.

Of course, it is worth noting, the number of accounts does not speak to average revenue per account, or account profit margin, higher retention and acquisition costs, or other measures of segment health.

Presumably, those metrics are under pressure.

With the upcoming launch of HBO Now and Sling TV, we might see some indication of whether the rate of change--in terms of abandonment of linear subscriptions for over the top subscriptions--is about to increase.

But we might eventually find that cord cutting has demand more limited than many suppose. The reason is that cord cutting might not save most consumers money, and that arguably is the key attraction.

Some consumers buy a linear video subscription, plus Amazon Prime and Netflix. In other words, monthly spending is at about the $100 a month level. By switching to Sling TV and HBO Now, and keeping the other services, a consumer might replace an $80 linear subscription with an alternative $20 Sling TV subscription plus $15 a month for HBO Now, a savings of possibly $45 a month.

But that assumes the buyer is content to lose lots of channels. And the thing about linear video consumers is that each of us tends to watch only about a dozen channels, and perhaps only about seven on a regular basis.

Each consumer will evaluate how many of those "most watched" seven are sacrificed, to get lower recurring prices. If not, the consumer has to calculate the cost of obtaining them on a streaming basis. At a hypothetical cost of $10 per channel, those seven represent $70 a month in costs.

For some consumers, Sling TV represents none of the most-viewed channels. For others, Sling TV will represent a few of the most-watched channels. In other words, it isn't clear that unbundled streaming costs less than bundled linear service.

True, the ability to watch your subscription content “on any Internet-connected device” is valuable. But that probably will stop being a “unique” value at some point, when most content is available from one or more online sources, on an on-demand or subscription basis.

At that the point, the issue is going to be “cost,” compared to value. And it remains exceedingly hard to envision how a full on-demand business case will lead most consumers to pay less. In fact, they almost certainly will face higher costs for an a la carte approach.

Are We Nearing an Inflection Point for Over the Top Video?

A study of North American linear subscription video customer churn suggests an uptick in churn rates since the earlier quarters of 2014. In the fourth quarter of 2014, quarterly churn was nearly nine percent, up about two percent compared to the same quarter of 2013.

That works out to about a three percent monthly churn rate, which perhaps is high by recent comparisons. The issue is whether that is a quarterly issue, or something representing a new trend.

Nor does the churn rate, by itself, tell us much. If most of the customers who churn then buy a similar service from another provider, that only speaks to the level of competition in the market, not to a change in end user demand for the product.

The worrisome trend, for service providers, is churn of a different type, where consumers simply stop buying the product from any current supplier. The study does not address that question, though it found about four percent of subscribers claimed they would end their subscriptions at some point in the next six months.

Another 2.6 percent claimed they would switch to an online app sometime in the next six months.

With the caveat that consumers quite frequently do not follow through, dissatisfaction ratings seem to be climbing. Comparing attitudes in 2014 compared to 2013, about four percent fewer respondents claimed they were satisfied with their linear service, while three percent more claimed they were dissatisfied. That is a net swing of about seven percentage points in a year.

The study found that 5.7 percent of subscribers switched service providers during the final three months of 2014.

That works out to a monthly churn rate of less than two percent, which is about in line with recent historical norms, and down dramatically from levels of several decades ago, when three percent churn rates would not have been unusual for any consumer communications or entertainment service.

The study suggests a potentially continuing incremental shift away from linear subscriptions and a growing use of over the top online services. But the change remains slow and incremental.

The coming launches of stand-alone streaming services from HBO, CBS and a comedy-focused service from NBCUniversal, plus the new Dish Network service, will provide more evidence about whether the rate of change finally is about to hit a knee of inflection.

Zero Profit Margins for Linear Video by 2020, Small Cable Ops Say

By about 2020, smaller U.S. cable TV companies are going to experience zero profit margins on their linear video programming businesses, according to the American Cable Association.

At least in part, rapidly-growing content costs are an issue, the ACA says.

To the extent that linear video constitutes a key part of the business case for fixed network operations, that collapse of the linear video model will imperil further investments in networks, the ACA also argues.

The broader point might be the growing importance of scale as a driver of the linear video business model, and a growing potential threat to the survival of the business model as over the top alternatives, costing less, become more available.

Should that happen, the business model even for the larger service providers will be challenged.

source: American Cable Association