Internet video needs sophisticated business models

Michael Kennedy, Network Strategy PartnersInternet traffic will continue growing at high double digit rates, primarily due to Internet video, but it does not necessarily follow that this growth can be converted to growing profits. A major problem for both wireless and wireline broadband providers is that Internet subscribers are accustomed to paying a fixed monthly rate for Internet broadband access tied to maximum download and upload data rates. In addition, the Internet access value-proposition is one dimensional.  Competitive differentiation has been almost exclusively on the basis of who has the fastest network.

This emphasis made competitive sense when the Internet was used primarily for web browsing and e-mail. The service was undifferentiated and speed was clearly a big issue as broadband replaced dialup access. It also made engineering sense. Downloads for web browser screens are short and independent events while e-mail messages are independent events, not too data intensive and response time indifferent. This made substantial bandwidth over-subscription both feasible and an effective means of leveraging access network resources. The short independent transactions also made it easy to build a robust network.

Over-The-Top (OTT) TV is an especially powerful driver for long-term Internet traffic growth. It seems likely that much traditional TV viewing will move to the Internet because it is much more accessible through mobile broadband, WiFi hot spots, and anywhere an Internet connection is available. OTT also is more affordable because many broadcast programs are available for free through media company web sites while a la carte viewing is offered by many content providers. For example, I can choose to watch only Major League Baseball or view a single movie. OTT also is much easier to use than it was even a year ago. Hundreds of new devices have been brought to market by the consumer electronics industry. Most of OTT's usage growth is ahead of it. The Nielsen Company estimated last year that while Americans watched 35 hours per week of traditional TV, they only watched 20 minutes per week of TV on the Internet.

OTT usage presents major financial problems for broadband service providers whether they provide a subscription TV service or not. It is obvious that viewers switching from subscription TV service to OTT hurt the profitability of triple play providers. OTT cuts out the subscription TV provider. Subscription TV accounts for about half of the cash flow needed to make the triple play business case.  Movement of subscription TV programming to flat-fee based high speed Internet service is very damaging.  This underlies the Comcast (Nasdaq: CMCSA)/Level 3 (Nasdaq: LVLT) dispute over delivery of Netflix OTT and is why AT&T (NYSE: T) and the National Cable and Telecommunications Association (NCTA) supported the Comcast position in a letter to the FCC.

OTT also is damaging to the business case of broadband service providers who do not offer subscription TV services.  Unicast (VoD) TV programs of an hour's duration and movies with 90 minute viewing times cannot be reliably delivered using the traffic engineering rules employed for web browsing and e-mail. Also, a dropped session can cause a catastrophic drop in service delivery for all long video sessions. Therefore, substantially more traffic capacity must be added to the network and policy-based routing must be deployed to assure reliable flow-based service delivery. Broadband service providers may feel that these additional costs should be passed through to Internet subscribers, but the subscribers do not. They have been taught that Internet usage is free and unrestricted, and strongly resist usage based fees and content discrimination. Recent wireless service provider behavior has reinforced that thinking. See Verizon Wireless' (NYSE: VZ) initial offer of the iPhone without a usage limit.

Broadband service providers need to retool their business models to adapt to OTT as well as many of the new cloud services. Two initiatives are essential.  First, move away from the flat-rate pricing model. One possible approach is to follow the lead of the airline industry that has added many extra fee options once the basic ticket has been purchased.  Second, develop an ecosystem-based value proposition where broadband service providers, content providers, financial services companies, consumer electronics companies, apps developers, and vertical industry segments develop richer service offerings and share in revenue based-upon their value added contributions. AT&T and Apple's (Nasdaq: AAPL) exclusive marketing of the iPhone is a very simple example of remaking the value proposition. Another simple example would be to guarantee video quality delivery through use of policy-based routing. In its best form the cost of the quality guarantee would be embedded in the content fee paid by the subscriber to the content provider and then passed through to the broadband service provider. The same thing could be accomplished technically via unilateral payments between the subscriber and service provider, but our research shows that this is much less palatable to subscribers.

The development of new value propositions by working within the OTT ecosystem is much more likely to produce a sustainable business case than going the legal, legislative, and regulatory route in an attempt to block and/or constrain OTT. Industry history has not been on the side of players who sought to halt progress.

Michael Kennedy is a regular FierceTelecom columnist and is the co-founder and Managing Partner of Network Strategy Partners, LLC (NSP), management consultants to the networking industry. He can be reached at [email protected]