CenturyLink Pondering OTT Video Service of Its Own: What are the Implications?

With the news that CenturyLink “is looking at offering an over the top video service, while AT&T has hinted it is certain to do so, we now have additional evidence not only of a fundamental shift in the video entertainment business model, but also an interesting twist on operating costs, with some possible implications for longer-term strategy as well.

To be sure, the main reason CenturyLink, AT&T and Verizon offer, or want to offer, streaming video is that the market is shifting in that direction. To remain relevant “triple play” providers, they need an OTT streaming option.

At a tactical level, there also are possibly-significant operating cost advantages, some incrementally helpful capital investment implications and at least a potential new opportunity to escape geographic limitations.

Consider the tactical considerations, which are important. Operationally, installing linear video now requires a truck roll that represents about 42 percent of the total cost of an install for a cable TV operator, for example.

Delivering an OTT video service does not. To the extent a truck roll costs  no less than $150 to $200, and could range much higher, the ability to turn up a service without a truck roll saves the provider money. Costs for cable TV providers are likely to range closer to $150, while telcos likely routinely spend closer to $200 for each install.

That is the cost of the truck roll for physical activation, not the cost of other hardware.  To turn up a video service requires one or more decoders, representing capital investment of perhaps $700 or more for set-top decoders. The investment varies with the number of decoders required at each location.

So, for starters, an OTT “install” can be done without a truck roll, and without the cost of a decoder, since the consumer likely uses their already-purchased Internet access modem and Wi-Fi (integrated into the modem, increasingly).

So OTT saves a great deal of money in the form of truck rolls, ancillary hardware and decoder costs, assuming the customer already has purchased fix network Internet access from any Internet service provider.

"As others are doing, we're also looking at an over the top product that we could deliver either some of or all the content we have today," said Stewart Ewing, CenturyLink CFO. "This is a product that we'll trial in 2016 that we believe we can get to the customer without a truck roll so it could help us decrease the cost of delivering the video to the customer."

CenturyLink logically would seek to use OTT video to reduce its capital and operating costs across the areas where it already operates fixed networks, and where, at a minimum, 10 Mbps downstream speeds routinely are available.

So far, only Verizon has intentionally structured an OTT service designed to work on “any mobile network.” But that is the final strategic angle.

Assuming advantage can be gotten, can a geographically-bound former telco create market-leading over the top services in other areas? Over the past decade, many tier-one fixed network telcos have pondered the value of providing OTT voice or messaging services, with relatively limited success.

More recently, mobile service providers have begun adding voice over Wi-Fi features that essentially make voice an OTT app.

The broader strategic issue is how much further OTT can grow, as a business strategy, for access providers and ISPs, and where the opportunities are greatest.

Verizon’s go90 can be viewed by any mobile phone with data access. Telefonica’s Tu Me was designed to be used globally, but was shut down, as the business model did not work.

The Internet access function, as it turns out, remains the sole area where a facilities-based approach (retail or wholesale) is required, and mandatory. All other “apps” are designed to run independently of the underlying physical layer, though they might be bundled with the physical layer access.

Still, any OTT service able to gain traction might not necessarily have to be limited to use “on my network only.” In fact, that would be non-sensical for any other app provider.

Service providers (retail fixed or mobile) have not yet seen major success operating over the top, out of region, with the exception of the MVNO business, perhaps.

So far, the pattern has been to expand by buying facilities outside of the historic core region.

Whether that “always” is the pattern is the larger question.

Smaller Cells or Additional Spectrum: Which Matters Most?

For decades, most mobile service providers have created new capacity more efficiently (at least cost) from adding spectrum than from changes in network architecture (smaller cells).

“For years spectrum was a much more efficient way to get capacity because of the price of it,” said Shammo. But “AWS-3 flipped that equation over.”

In other words, spectrum might now be getting so pricey that network architecture changes are more affordable ways of adding capacity.

“You need both (additional spectrum and network densification) but spending $10.4 billion and getting the top 48 markets out of the 50 with AWS-3, I walked away from New York and Chicago because of the price,” said Shammo. “ I'm building that through densification at almost 20 percent less cost than I would have in the spectrum.”

The majority of Verizon mobile capital investment now goes to “densification” of the network, mostly small cells in-building and distributed antenna systems. In other words, Verizon’s strategic need is for capacity, not coverage.

“This year alone we are seeing 50 percent to 75 percent increases in data usage on our network,” said Fran Shammo, Verizon CFO.

And lower prices for small cell infrastructure is helping Verizon maintain profit margin despite lower average revenue per device.

At least for the moment, Verizon continues to say it can add capacity more efficiently using small cells and densification, rather than adding 600-MHz spectrum.

Shammo claims Verizon now uses only about 40 percent of its LTE spectrum, carrying more than 87 percent of total data traffic.

So Shammo argues Verizon already has an additional 60 percent of spectrum-based capacity in reserve.

Some will see validation of the general rule that most of the capacity gains made in the mobile industry come from applying new network architectures, not deployment of new spectrum.

Others will see something different, namely a historic change in methods for bandwidth expansion. Where additional licensed spectrum historically has been key, use of small cell architectures (densification) might be more important--and more affordable than buying new spectrum--in the future.

Nor does Verizon necessarily agree that the number of leading providers in the mobile business will remain at four, over the long term. But the direction of change is the startling claim.

“Look, I think if we sat here and said it is only going to be the four carriers in the wireless industry I think that would be pretty stupid on our part,” said Shammo. “I think that if you look at the wireless world and you believe that the world is going to move to wireless, all wireless with no wires, eventually the pie is going to get much bigger for the industry.”

“And people are trying to figure out how they get a piece of that pie,” Shammo said.

Mobile Video Viewing Up 616% Since 2012; Now 45% of All Video Views Globally

There is a good reason why Verizon, AT&T and other tier-one mobile service providers believe mobile video is an attractive opportunity.

Mobile video views have increased 616 percent since the third quarter of 2012, and now make up 45 percent of all video views globally and more than half of all views in some regions, Ooyala reports.

For content less than 10 minutes in length, mobile gets 69 percent of views.

Despite mobile growth, consumers still trend toward larger screens for longer-form content.

For content longer than 30 minutes, connected TV share of time watched was 61 percent, almost doubling since the first quarter of 2015.

Over the past nine months, for video over 10 minutes long, the share of time watched on connected TVs (CTV) has increased from 43 percent to 71 percent.

The point is that consumers universally want to watch some forms of video on their mobile devices, devices increasingly make this possible, while faster networks make the experience pleasant.

Telecom Cost of Capital is a Big Issue, Especially for Some Fixed Network Operators

The telecom industry might be described as akin to the airline industry, in some key respects. Both industries are relatively highly regulated but also subject to lowish barriers to entry on the low end, capital intensive, unionized and subject to global competition.

The cost of capital is key for some providers, in some industries that have net profit margins as low as five percent. In the global airline industry, In 2015 the industry’s return on capital of 8.3 percent will exceed the cost of capital (debt and equity) of just below seven percent, for example.

What that essentially means is that airlines could have invested money in safer vehicles and earned just 1.3 percent less than assuming all the business risk of operating an airline.

Other studies suggest the cost of capital for U.S. airlines is lower, at about 5.64 percent, however, meaning telecom service providers arguably have more margin to work with.

On average airlines will still make less than $10 per passenger carried, according to the International Air Transport Association. That might remind some of you of the grocery business, where profit margins are closer to one percent to two percent, overall.

The industry’s profitability is better described as “fragile” than “sustainable,” said Tony Tyler, IATA Tony Tyler, IATA’s CEO. Some might, by way of analogy, suggest telecom company profitability likewise requires a great deal of work.

Cost of capital in the telecom business might represent between 10 percent and 25 percent of total operating costs.

Airline Industry Net Profit Margin
2015	Net Profit	Net Margin	Profit per Passenger
Global	$33.0b	4.6%	$9.31
North America	$19.4b	9.5%	$22.48
Europe	$6.9b	3.5%	$7.55
​Asia Pacific	​$5.8b	​2.9%	​$4.89
​Middle East	​$1.4b	​2.3%	​$7.19
​Latin America	​-$0.3b	​-0.9%	​-$1.05
​Africa	​-$0.3b	​-2.1%	​-$3.84

​​​​​​​ IATA Economic Performance of the Airline Industry

While U.S. mobile service providers have a 5.5 percent cost of capital, U.S. fixed network cost of capital is 6.31 percent, according to Aswath Damodaran of the NYU Stern of Business.

The big cost there is the cost of equity, at about 8.8 percent for mobile firms and 8.3 percent for fixed network firms. The cost of debt for mobile and fixed segments is 3.67 percent.

Some older studies have found the European after-tax cost of equity at 8.3 percent, for example.

So the search for replacement revenue sources is a major strategic objective for every fixed network services provider, indeed for every legacy communications or content service provider, especially given the high sunk cost of fixed networks and the obvious dwindling of legacy revenue sources.

Some have argued that the rate of return from FiOS has been negative, for Verizon, where cost of capital has been about five percent for fixed network assets, while returns have been as low as 1.2 percent.

source: Peter Klune

source: Peter Klune

Capital investment provides another illustration of business dynamics. Since about 2000, mobile capex has risen, while fixed network investment has declined.

It does not take much insight to note that expected returns from the fixed network business are perceived to be far lower than expected returns from the mobile business.

In fact, since about 2002, capital investment levels in U.S. fixed networks have been negative.

The caveat is that business models for tier-one providers and smaller upstarts--or contestants with different business models--could be significantly different, as many would note capital and operating costs are lower for cable TV companies, compared to their telco peers.

The upsurge of independent Intrernet service providers provides one example of different--and lower--capital and operating costs. Google Fiber provides an example of contestants with different business models.

source: Market Realist

source: CDC

Still Not at Inflection Point for Post-Linear Video Entertainment

In 2015, 4.9 million U.S. households will have dropped traditional linear TV subscription services, according to eMarketer. Perhaps the most-notable 2015 was the rapid deceleration of linear TV subscription service growth.

That is not yet a significant percentage of total U.S. homes, but the rate of abandonment is increasing. Cord cutting rates were higher by nearly 11 percent in 2015, year over year, and is projected to accelerate.

If the eMarketer figures prove correct, then we might still not be at an inflection point, where the rate of change goes non-linear, even by 2019.

Some 21 percent of U.S. consumers would prefer to spend less on their linear TV services, according to GfK MRI.

Those defectors represent 49 million potential lost accounts, according to GfK MRI study.

About 22 million people (nine percent) want to spend more.

One key difference between the two groups:  70 percent of consumers who want to spend more say “live” TV is “very important” or “important.” Of consumers who say they would prefer to spend less, 50 percent say live TV is very important or important.

The important observation, however, is the importance of the inflection point. When that point is reached, linear service abandonment rate will skyrocket, in a very short amount of time. 

Contestants not in position for the change will not survive, as there will be no time to build a next-generation offer from scratch, once the inflection point is reached.

At least for the moment, we remain in a period of quantitative changes that precede the inflection point. Then the market changes will be qualitative.

In other words, the winners are getting into position now. That is likely why AT&T soon will announce the creation of its own mobile video streaming service, and why Verizon already has done so.

While there is no guarantee of success, the market's eventual winners will emerge from the contenders ready to scale fast, when the moment for a change to a post-linear market arrives.

Will Video Streaming be the Initial Killer App for Verizon 5G?

Verizon has reconfirmed what it said in September 2015 about launching commercial 5G  (technically, pre-5G) service in the United States in 2017.

It seems likely that the initial use case will be mobile entertainment video, given Verizon’s belief that mobile video is the way it can win in the post-linear video entertainment business, its launch of go90, its new mobile streaming service, the acquisition of AOL and likely additional moves.

Using 5G to support mobile streaming makes sense in a targeted sense will make sense. Many would argue that 4G was different than 3G primarily because 4G made mobile streaming feasible, and an enjoyable experience,  for the first time.

Eventually, Internet of Things is expected to be the biggest likely important new app category enabled by 5G. But most consumers are going to encounter the clearest use case in streaming video.

A Verizon executive had said in September that  Verizon will begin field trials of 5G technology within the next year, with plans for start of commercial service, in some form, in 2017.

If you recall the introduction of Long Term Evolution (LTE) 4G, you remember that the first emphasis was on mobile data access, not phones, simply because suppliers had not yet produced LTE phones in mass quantities, and one initial early adopter segment were users who wanted much-faster access for their personal computers.

Since it is highly possible the full set of 5G standards will not be fully ratified by 2017, Verizon might be in a pre-5G mode, operating a commercial service that will appeal most to some user segments whose business cases are insensitive to use of a “pre-standard” but largely compliant deployment scenario. Video delivery is one such case.

Rapid adoption of what it believes to be a superior technology platform is very much part of Verizon’s understanding of its position in the U.S. market, and its basic strategy, which is to lead in the area of platforms and platform-based quality.

Roger Gurnani, chief information and technology architect for Verizon, earlier had said he  expects "some level of commercial deployment" to begin by 2017”. That's far earlier than the time frame of 2020 that many in the industry have pegged for the initial adoption of 5G technology. But the video streaming angle fits with that earlier comment.

Other mobile providers also have said they will launch commercial service as well.

South Korea hopes its wireless carriers can deploy a trial 5G network in 2018, in time for the Winter Olympics in Pyeongchang.

Japan hopes to have a 5G network running in time for the 2020 Summer Olympics in Tokyo. The Chinese government, meanwhile, has also pushed for the aggressive deployment of 5G technology.

If you use the rule of thumb that the mobile industry introduces a next generation network about every decade, that would suggest 2020 is the point at which Verizon would want to deploy 5G, nationwide, as it deployed 4G in 2010.  So 2017 might be an even-faster introduction than is typical.

“I showed my board the service in November,” said Lowell McAdam, Verizon CEO. “You don’t ever go to a board with something that’s not real.”

In Most Competitive Markets, The Low Cost Provider Wins

It has long been my contention that, in a competitive market, the low-cost provider wins. So average revenue per account, while important, arguably is not as important as operating cash flow, operating costs as a percentage of revenue, and therefore actual profit margin.

In that regard, consider subscriber acquisition costs, a figure that typically includes attributed marketing costs, including discounts and other promotions, per subscriber, for linear TV and mobile service.

Dish Network and AT&T’s DirecTV (prior to acquisition by AT&T) subscriber acquisition costs were about $868, on average. Comcast incurred SAC costs of $1980 per new account, while CenturyLink had $2352 per new account.

It has been estimated that some independent third party suppliers, such as Ting, spend only about $125 to acquire a new video customer.

That is not the only key long-term input, since Ting also pays high prices for its content, compared to Comcast, AT&T or Dish Network.

The important point, though, is the substantial gap in customer acquisition costs.

The same sort of disparity exists for mobile service provider subscriber acquisition costs. Verizon invests about $484 to get a new mobile account. AT&T invests about $583 to get a new mobile account, while T-Mobile US invests only about $169.

Sprint, on the other hand, has to spend a whopping $1440 to get a new account, while Ting spends perhaps $80.

There is, in other words, an order of magnitude difference between Ting SAC and costs for tier-one competitors.

In the mobile realm, Sprint spends an order of magnitude more money than its other tier-one competitors, and two orders of magnitude more than Ting.

To be sure, there are many more elements to full business models, so subscriber acquisition cost differentials are not directly indicative of overall business model advantages or disadvantages.

But they do suggest how much room might exist for competitors.

Non-facilities-based service providers in the U.S. competitive local exchange industry, formed in the wake of the Telecommunications Act of 1996, which deregulated U.S. voice services,  largely failed.

One key reason was a not-compelling cost structure, once mandatory wholesale discounts were revised from about a 60-percent level of retail prices to perhaps 20 percent from retail prices.

Up to this point, only U.S. cable TV operators, who already had network assets, marketing organizations and other assets, managed to become serious competitors in the voice and Internet access business.

What seems to be happening is that new independent competitors are discovering that, under some circumstances, they can afford to build fiber to home networks, and operate them efficiently enough, to make a business case work, where larger providers, with higher embedded costs, have not been able to do so, as well.

The issue now is the number of local markets where that is possible, especially now that tier-one providers are moving to boost delivered Internet access speeds up to a gigabit, albeit at low triple-digit prices, where many independents price price below that level, in high double-digits.

source: Seeking Alpha

source: Seeking Alpha

20% of U.S. Consumers Might Drop LInear TV in 2016, Survey Finds

About 20 percent of consumers could ditch their cable TV subscriptions in 2016, according to a survey by accounting firm PwC, which surveyed 1,200 U.S. consumers for its report.

According to PwC, 79 percent of U.S. consumers subscribe to some form of linear subscription TV, but 23 percent indicated they had reduced levels of service over the last year.

About 16 percent of respondents disconnected in the last 12 months, while five percent said they never had subscribed to a linear video service.

The study also found that while the average subscriber receives 194 channels, they regularly watch just 17 channels.

Some 77 percent of 18-to-24 year olds view “television” using the Internet.

In 2014, 91 percent of consumers said they could see themselves subscribing to cable in the following year. In 2015, that figure dropped to 79 percent, implying more than 20 percent of consumers could drop their cable subscriptions in the next year.