Here's How OTT Internet TV Will Transform Pay-TV
The Pay-TV industry has so far done a great job defending itself from the threat posed by OTT. But there’s a limit to what you can do with sticking plasters.
In a major report released last week, we projected that total service revenues earned by OTT internet television service providers worldwide will be USD 22.3 billion in 2015, rising to USD 49.7 billion by 2020. Beyond that, growth will continue for at least the next two decades.
While some of this spending will be incremental (because of the higher value placed on internet-based video, compared with traditional video) most will be because of reduced spending in each of the three existing television industries:
- Physical video (e.g. DVD and Blu-ray)
- Terrestrial broadcast television
Let’s look briefly at the impact on physical video and terrestrial broadcast television before diving into Pay-TV.
It is clear that the internet has severely cannibalized spending on physical video:
Looking ahead, we project that spending on physical video will fall from a worldwide high of USD 51.8 billion in 2005 to just USD 8.3 billion by 2020 and the main reason is that almost every dollar that consumers spend on OTT internet TV is a dollar that is not spent on DVD and Blu-ray.
But while the internet is decimating spending on physical video, it will be at least 10 years before it has any meaningful impact on terrestrial broadcast television.
Nevertheless, eventually, in all developed internet markets terrestrial broadcast television will be undone and redone as distribution shifts from terrestrial radio transmitters that broadcast TV programming out over the airwaves, to cloud-based media servers that deliver the same content over fibre optic cables, coaxial cables and copper lines to 100s of millions of broadband households worldwide.
In such markets, all the money that is now being spent on TV advertising will shift from linear broadcast content formats to non-linear multicast content formats (of which ‘broadcast’ is simply a special case, where a large number of viewers want to watch the same content at the same time – a baseball game, for instance).
If the TV broadcast industry manages this transition perfectly then the companies collecting the USD 178 billion that will be spent on TV advertising worldwide in 2015 will be the same as those who will do the revenue collection in the future. But even in this ‘best case’ scenario, total industry revenues will fall by about 30% - partly because of the lower costs associated with internet-based distribution and partly as a result of increased viewing on mobile devices, where ad rates are structurally lower.
The story for how OTT internet television will affect Pay-TV is more nuanced than that for physical video and terrestrial broadcast TV.
We should start by asking an important question:
If internet-based delivery will eventually make redundant most of the physical video market and - in countries that have mature internet infrastructure - the terrestrial broadcast TV market as well, then is it really credible that the Pay-TV industry will somehow escape unscathed?
Not only do I think the answer to this question is ‘definitely not’, my conclusion is that internet TV presents an existential threat to Pay-TV, although it will be some time before there is a substantive revenue impact and the type of impact will depend on the type of Pay-TV under consideration.
The impact so far has been small because:
- Changes to reporting policies mask what is really going on: Pay-TV operators are introducing their own OTT services and changing the way they report their video revenues so reporting measures like ‘video revenues’ and ‘video subscribers’ now include contributions from Pay-TV, pseudo-OTT TV and OTT TV and the relative contributions of these three are unfeasible to accurately separate;
- Bundling makes it hard to properly define the revenue contribution for the video element: Pay-TV operators have for years been adopting a bundling strategy and so it is in many cases impossible to accurately determine what percentage of a Pay-TV operator’s revenues are coming from video vs. voice vs. broadband internet and, in some cases, vs. mobile;
- Consumers are using OTT in addition to, not instead of their Pay-TV service: It is becoming clear to me that consumers presently see OTT internet TV services like Netflix and iTunes more as an additional category of expenditure and less of a direct replacement: this means that most internet TV users are at this point spending on internet TV in addition to their pay-TV subscription;
However, by definition, if a consumer is now paying to access a new video service – such as Netflix – then it is obvious that they will be spending less time watching their Pay-TV video packages – even though the spending on those video packages might not have decreased;
- Aggressive ‘do or die’ retention programmes: Pay-TV operators in developed internet markets are being extremely aggressive in their efforts to retain their existing subscription customers by, for example routinely offering heavy discounts rather than lose customers.
Existing customers are offered exclusive price deals and sometimes have to face very aggressive sales people who receive bonuses for each customer they convert from ‘wants to leave’ to ‘agrees to stay’
Taking all of these factors into account, rather than a direct cannibalisation of Pay-TV revenues, what I think is more likely to be happening now is that people are retaining their Pay-TV subscription, but they are using Internet-TV services in addition – with the money being spent on OTT services mainly coming from reduced spending on physical video.
Meanwhile, although the uptake of OTT services is causing total TV viewing time to increase (when all consumption devices are taken into account), the total viewing time for the Pay-TV provider’s video packages is falling.
We are beginning to see the effect of reduced viewing time as the advertising revenues of some leading Pay-TV operators (e.g. Comcast in the U.S. and Sky in the U.K. have shown signs of falling over the last few years).
However, further ahead, as the content and features offered by OTT providers become more compelling and as overall consumer awareness of OTT increases, then we are sure that we will see a much more tangible adverse impact on the video revenues of Pay-TV providers whose premium video content offers will increasingly have to compete with much lower-priced alternatives.
Remember that OTT internet TV will mainly only affect the video element of a Pay-TV providers’ offering
Internet TV will exert increasing downwards pressure only on the video element of the traditional Pay-TV packages.
Most Pay-TV operators will be able to make up some of the revenue shortfall by launching their own OTT services. However, the revenues they will earn from these OTT services will be insufficient to compensate for what they will lose from their core video business.
There will be two reasons for this:
Internet-based distribution means a structural reduction in the cost of delivering television programming
Because users pay for their own broadband service (which they need to access a range of internet content and services, in addition to video), they are in effect covering most of the cost of distribution themselves.
This is very different to how the cost of TV distribution has traditionally been recovered.
Because TV distribution networks could only used to distribute television programming the cost of building and operating those networks had to be incurred by Pay-TV operators and then recovered indirectly from subscribers.
Now, with OTT, the network that is being used to distribute television programming (i.e. the internet) is being used for a broad range of other services as well which means that the distribution costs are in effect being amortized over a number of bearer services (like search, online retail, social media, email, cloud storage, music etc.).
This severely disadvantages any Pay-TV operator who – by virtue of using a proprietary distribution network – has to incur the operating costs of that network (because these costs sit in the P&L account) unless the network can also be used to provide broadband internet access, which is the case with cable-based and IPTV-based Pay-TV offers. Satellite-based DTH operators can offer internet as well, but only by paying an extra cost to use a local access network owned by a third party.
Eventually, when OTT’s total viewing time reaches a critical threshold - which we estimate will be within the next 10 years - these 'extra' costs will need to be removed from the business models of all Pay-TV operators: basic economics mean that the internal human resources and tangible assets that Pay-TV operators have needed in order to operate their proprietary video distribution networks and network-specific OSS/BSS systems, will no longer be needed.
This will mean that a structural downsizing will need to take place because there is no way that any company can operate profitably in a competitive market environment, while carrying significant costs that rivals are avoiding by using a different strategy.
Indeed, part of the reason why the subscription fees of Pay-TV providers have been so high is that these companies have been spending a lot of money on operating proprietary distribution networks.
Clearly, when these costs are removed then service revenues will have to come down in proportion. The only exceptions would be in situations where the Pay-TV provider had secured a monopoly in the supply of certain types of ‘must watch’ content. However, the number of situations where this will be the case will fall as the market footprint of OTT players increases - because they will have achieved the market scale needed to place competitive bids for the same content.
It is one thing for a cable-TV operator to slug it out with a satellite-based rival when the battlefield is restricted to one country. But it is quite another thing for a Pay-TV operator to launch an OTT service and then face the prospect of competing with rival services that are being offered by large, well-funded, global players - like Apple, Netflix, Amazon and Google.
Not only do these global OTT players have lower marginal costs - which are simply the result of their scale - they have the detailed knowledge needed to compete in the OTT market on a global basis, which most Pay-TV operators lack. The world’s largest Pay-TV operator - Comcast - might like to think it is a big company but when it comes to the super-league, Comcast is a rather small player whose operations and market knowledge is limited to the U.S.
There is another reason why Pay-TV operators will find competing with large global OTT service brands very challenging: OTT services requires a platform approach which means developing:
- Apps for all types of connected devices (e.g. PCs, smartphones, tablets and connected TVs);
- Cloud-based delivery (e.g. the ability to manage multiple users accounts across multiple devices which could be located anywhere and when the device types are constantly changing);
- Advanced features such as voice search, content recommendations that use machine learning, plus some features that can only be offered by the large platforms, such as bundling with non-TV services.
Pay-TV operators used to be able to own and control all aspects of their service delivery infrastructure and all of the features offered to users.
But with OTT internet TV, Pay-TV operators will lose control of much of what they have previously done themselves. In effect this means that the proportion of the total value they will be delivering will fall because a significant part of the value proposition will be delivered by the large platform operators and device vendors.
Ultimately, because they will be delivering a lower percentage of the total value, this must mean that their addressable revenue will be less.
In summary, the impact of OTT on Pay-TV is a bit like a slow puncture: the nail first entered the tire 100s of miles ago but mile by mile, it slowly works its way through the rubber until it reached the inside – at which point the process of deflation is irreversible and the outcome is certain.
Pay-TV has the option to deploy a range of defensive strategies but running their video offers on a ‘business as usual’ basis isn't one of them.
For more detailed information of what Pay-TV providers can do to minimize the impact of OTT on their core businesses then see the detailed report we published last week: