Internet Everything: The Coming War for the Consumer
Paul Sagawa / Artur Pylak
203.901.1633 / 203.901.1634
sagawa@ / email@example.com
April 21, 2011
Internet Everything: The Coming War for the Consumer
- Consumer media, communications and commerce applications are being subsumed by the Internet. The simultaneous rise of smart devices, connected home electronics, fast wireless networks, content delivery networks and compelling cloud-based applications is fomenting a revolution in consumer internet use. No longer tied to the desktop or shackled by poor performance, consumers are shifting media consumption – e.g. video and audio streaming, on-line publishing, Twitter, etc. – communications – e.g. text, email, Facebook, Skype, FaceTime, etc. – and commerce – e.g. Amazon, eBay, Groupon, etc. – to the web at an accelerated pace
- This evolutionary shift creates the need for “home pages” that enable choice, navigation and payments. Explosive growth content on the internet raises a challenge for consumers – how to identify desirable, access and pay for it. We do not believe that a “one stop shop” can aggregate sufficient content, as the owners of valuable content are disparate, powerful and increasingly wary of the traditional aggregation model. Rather, we expect a wide array of independent content shops to arise, operated by or on the behalf of studios, sports organizations, branded channels, independent producers, etc., each with their own programming and payment mechanisms – i.e. subscription, pay-per-view, or advertising supported. This will create complexity for users, the impetus for “home page” services, or “meta-aggregators” that give users tools to find, view and pay for content
- The meta-aggregator role will be lucrative, monetized via advertising, transaction fees, and proprietary services. Rather than aggregating all content under one brand, meta-aggregators will link through to content owned by others. The meta-aggregator will have search and display advertising opportunities, may earn a portion of transaction fees for subscription or pay-per-view content, and will be able to offer services of their own to consumers – e.g. e-commerce, social networking, etc. – and to content owners – e.g. marketing services, hosting, transaction processing, consumer profiles. Like most on-line businesses, we expect the “home page” role to have natural economies of scale that will be substantial barriers to entry once leadership positions are established
- Key Success Factors: Brand, Navigation Tools, Content Delivery Infrastructure, Advertising Skills, Transaction Processing, User Profiles, Relationships with Content Owners. Successful meta-aggregators will need specific assets and skills. First, an on-line brand must be leveraged or established. Second, a successful meta-aggregator should have powerful and easy to use tools to find and select content – e.g. search and recommendation engines, expert curation, etc. Next, the content must be served to the consumer with high speed and reliability over an extensive CDN with cloud hosting capability, either owned or under contract. Furthermore, leading players will have the ability to design, sell and serve on-line advertising, across formats and geographies, and to profile users for advertisers and content owners. In addition, the ability to present, accept and process commercial transactions will be important. Finally, leaders will need to establish constructive working relationships with the most important owners of content
- Apple, Amazon, Google, and Facebook appear advantaged. Apple – Pros: unassailable retail brand, dominates music distribution, building navigation and advertising skills. Cons: reliance on commercial CDNs, distrust of content owners. Amazon – Pros: good on-line brand, existing transaction relationships and processing capability, recommendation engine tool, strong CDN and cloud hosting operation. Cons: behind in advertising. Google – Pros: dominant search and video brands, most advanced CDN/hosting capability, #1 Internet advertising player, strong user tracking. Cons: behind in transaction processing, distrust of content owners. Facebook – Pros: powerful, sticky and growing on-line brand, extensive user profiling, strong CDN/hosting capability. Cons: behind in advertising and navigation tools, no transaction processing or content relationships
- Traditional leaders in media, communications and computing are not well positioned to play this role. Others aspire to the meta-aggregator role, but we are not optimistic. Cable Operators – Pros: existing customer base, infrastructure “in territory”, transaction processing and advertising capabilities. Cons: terrible brand image, lacking on-line presence or navigation tools, must defend existing franchise, reticent to attack out of franchise, contentious relationships with content owners. Content Owners – Pros: control of a fragment of content, modest on-line brands, advertising skills. Cons: no CDN, no navigation tools, no transaction capabilities, competitive positioning vs. all other content owners makes consortium approach inherently unstable. Netflix – Pros: first mover brand advantage. Cons: poor navigation tools, no CDN/hosting or advertising, weak user profiling and transaction processing, one-stop subscription model relies on content contracts. Microsoft/Yahoo –deteriorating position vs. Apple, Amazon, Google and Facebook
- Some will “win” and some will “lose” – We like Google’s chances. While we expect the top four to all have a credible play as meta-aggregators, we see Google as the likely leader. The growing strength of Android and Chrome across fixed and mobile platforms ties an eco-system of hardware and software suppliers to Google’s ambitions as a meta-aggregator. This and the company’s breadth of excellence across the key success factors make it the best positioned company against the opportunity. As in smartphones, we believe Apple’s focus on margins and brand exclusivity will limit its eventual market share as a meta-aggregator. We are also concerned that reliance on partners for serving video could be an Achilles heel vs. CDN leader Google. Facebook and Amazon appear behind the top two, but have important assets and could surprise, particularly if Google and/or Apple misstep
It’s Too Late, Baby
We have written extensively about over-the-top video and cable cutting. In our view, the migration of consumer eyes to Internet-based programming has begun, enabled by the rise of video-friendly tablets and connected home electronics. In turn, advertisers have discovered the benefits of on-line delivery – e.g. precise audience targeting and measurement, interactivity, and impulse transactions – growing their spending at 15% while paying 11% higher rates per impression than for network television (Exhibit 1). Advertising draws content – studios are now financing content specifically for on-line. For example, Warner Brothers recently launched a nine-episode web series to relaunch its dormant Mortal Kombat franchise, with the first episode attracting more than 6 million viewers. Thus, buzz-worthy content draws more viewers, which draw more advertising, which attracts more content, and so on, and so on. The positive self-reinforcing cycle has begun.
Ah yes, but cable companies control broadband and broadband is necessary for over-the-top video. Can’t the cable companies either hike the price of broadband service to more than cover for the loss of channelized video or throttle network speeds to make high-quality video streaming nearly impossible? In the short run, yes – that is why the FCC has been so insistent on “net neutrality”. In the bigger picture, no – competition from 4G wireless and improved DSL is coming. Moreover, anti-competitive behavior would almost certainly erode the cable industry’s political air cover – cable operators are far from popular amongst the voting classes. We believe the genie is long gone from the bottle (Exhibit 2).
The same dynamic has played out across media and communications. E-books and e-zines are co-opting readers from traditional print publications (Exhibit 3). Digital downloads have destroyed the CD, and streaming audio threatens to do the same for radio (Exhibit 4). On-line multiplayer games are the fastest growing segment of the gaming industry (Exhibit 5). Internet-based telephony brought down the 130 year old circuit-switched Bell system in a little over a decade. Letter writing is an anachronism in the modern world of e-mail and texting. To believe that channelized cable television can hold off the Internet is, in our opinion, naïve.
Lost in the Cloud
As on-line video breaks into the living room on a wave of tablets and connected home electronics, it still faces inertia. The average American spends nearly 3 hours a day in front of the TV without very much demand for their participation (Exhibit 6). It’s easy – check the on screen guide to see what is on now, pick a program from the grid and click on it, done. In contrast, on-line video is not easy. There are thousands of content owners with archives of stored programs to download or stream, and innumerable live video feeds that can be tapped. The range of choices is overwhelming and there is no simple grid to check and click.
One improbable solution would be to stuff the genie back in the bottle. If enough content could is concentrated into a single source, be it Netflix, iTunes or TV Everywhere, perhaps users could be enticed to subscribe to a one-stop-shop. We are quite skeptical. First, the “walled garden” approach of controlling content has been uniformly unsuccessful over the history of the Internet. Second, the actual ownership of content is far more fragmented than most investors assume – most network content is bought on contract rather than created in-house. A look at 100 top non-sports entertainment programs reveals how little network programming is actually created in house (Exhibit 7). Combining a workable subset of this content into a single subscription service that is adequate as a one-stop entertainment source for more than a specialized corner of the market seems a fantasy. The big guns – major sports leagues, major production studios, 19Entertainment and Mark Burnett with their reality franchises, Oprah, etc. – will demand their due. As the market for on-line video expands, and with it, the flow of advertising dollars, content owners will rightly look to maximize the value of their own offerings and will explore offering their own packages. Indeed, even within the channelized model, owners of the most valuable content – from the NFL Channel to Oprah’s OWN – have looked to build their own branded distribution to cut out at least one middleman. This will be easier on-line, and thus, more prevalent.
In the midst of the content jail break, it is unlikely that a single revenue model will prevail. Advertising-supported programming will co-exist with pay-per-view, subscription and more experimental monetization schemes. This will add to the complexity for consumers, who will not only need to find and compare programming choices across a plethora of content providers, but also figure out how to pay for it. Clearly, users will need help.
The cornucopia of the Internet already requires powerful tools to navigate. Search engines, directories, content aggregators, social networks, e-tail shops – these are all tools to help users find content, products, resources, and people and for the providers of content, products and resources to find interested users. The need will be the same for video programming (Exhibit 8). Consumers will gravitate toward a familiar home base that will help them find what they want and facilitate payment.
We believe that these “home base” services will take the form of “meta-aggregators”, in that they will not actually aggregate the content into a single service, but rather look through into pools of content aggregated by others, connecting viewers with programming and facilitating transactions. Within this general construct, we see several important consumer functions for “meta-aggregators”. First, they will search for content, both live streams and archived files, fitting parameters expressed by users directly, and inferred from previous viewing. Beyond this, meta-aggregators will also offer suggestions. These could be based on user profile data, expert curators, recommendations from friends, or other sources. These sites will also handle payments to content providers, pre-approving credit and managing authentication to speed user access.
Meta-aggregators will also provide important services to content owners. They will be a forum for content advertising. They will deliver viewers and handle the messy business of authentication and payments. If desirable, meta-aggregators may act as content delivery networks, handling the streaming of video from geographically appropriate data centers. Taking it a step further, meta-aggregators could also serve as cloud hosts, entirely managing the technical aspects of an on-line service on behalf of a content owner. A meta-aggregator could also provide valuable user profile data back to content owners, and manage the targeting of advertising to appropriate audiences. A meta-aggregator could also sell advertising on behalf of a content owner, taking advantage of scale across content sources to deliver larger and more valuable audiences to advertisers at better rates.
Show Me the Money
Meta-aggregators will have many ways to monetize their position. They will be able to sell advertising – displays on the home page, paid search results, video insertions. They will be able to take fees for handling transactions – subscriptions, pay-per-view, etc. – that are generated by users of their site. They will also be able to sell content and services of their own, such as proprietary video programming, e-commerce, social networking, etc. Meta-aggregators will also be able to offer services to content owners for fee – hosting, CDN, site management, marketing services, user profile data, etc. Given that the on-line video opportunity targets the $130 B channelized television revenue stream, it is likely that the Internet meta-aggregator role will prove to be very lucrative indeed (Exhibit 9).
It is also likely to be a fairly concentrated business. The role abounds in economies of scale – content delivery and hosting infrastructure, transaction processing, advertising, and on-line branding. The history of web-based businesses bears this out, with major categories typically dominated by a small number of leaders. Google in search, Apple in music distribution, Amazon in many retail categories, Facebook in social networking, Yahoo, Google and Microsoft in e-mail – every one of these categories shows the economies of scale that drive toward market concentration. We do not believe that meta-aggregation will be any different.
What Do I Gotta Do?
The meta-aggregator role asks for skills and assets across several important dimensions (Exhibit 10). As in any consumer business, a successful meta-aggregator will have or build a powerful brand. Users need to know about the meta-aggregation site and trust it to give them give them the tools they need without undue costs. A part of this will be delivering a powerful set of navigation and recommendation tools in an easy to use format that enable the site to fulfill the basic requirements of the role. We believe that there are three aspects that will be important – the tool must deliver fast access to the most popular programs, enable comprehensive search for less obvious alternatives, and offer suggestions for programming likely to meet with a particular user’s approval. The first aspect is the easiest to deliver, and the second requires a fast and intuitive search engine that learns from a users search history. The third aspect offers several angles – Amazon’s recommendation engine steers buyers to products that are consistent with their profiles and enthusiastically supported by others with similar profiles. Apple’s iTunes offers curated lists of music recommended by experts and knowledgeable celebrities. Facebook allows a user to recommend items to others on their friend list. These are examples of the type of tools a meta-aggregator may provide to users, but we anticipate significant innovation to rule the day.
The next set of critical success factors is operational. A meta-aggregator should be able to serve video to customers with minimal delay or error. Each router that a video stream must traverse on its way to an end user adds delay and the potential for error, with the negative effects rising geometrically with the number of router hops. The difference between downloading a video file over a 100 mile distance vs. 1000 miles can be a factor of 100, making it imperative that video be served from as close as possible (Exhibit 11). The answer is a network distributed server architecture known as a content delivery network (CDN) that is either inherent in a meta-aggregator’s infrastructure or contracted from commercial partners. The more extensive and well designed the CDN, the better the quality of video streams delivered to consumers.
Along with the physical delivery network, a successful meta-aggregator must also be adept at selling, placing and serving advertising to specifically targeted audiences. Broad access to both advertisers and content providers, along with the institutional skills of designing on-line advertising, serving it to appropriate consumers and tracking impact are important. Associated with this is the ability to collect and analyze user data to tailor programming and advertising to a user’s interests. While the practice of tracking customer usage is at the center of on-going controversy over Internet privacy, it has become pervasive, with some players demonstrating real advantage from the breadth, depth and sophistication of their usage data mining. Those advantages will definitely be in play for meta-aggregator.
Finally, meta-aggregators will have to negotiate access to content. In the long run, we believe most content owners will offer similar terms to all meta-aggregators – access rights, transaction fees, etc. However, in the intermediate term terms will be fluid and content owners may be aggressive in trying to extract value from would-be meta-aggregators in the form of broader revenue sharing or direct content fees. While we believe that this approach would be counterproductive to the long term health of a content brand, the ability of meta-aggregators to manage the process could establish advantage with users who will be sensitive to the price, choice and delivered quality of programming. Television networks that take an aggressive tack risk limiting their audience, and thus, their ability to negotiate exclusive arrangements with original content producers for new shows.
The Fantastic Four
Handicapping potential rivals for leadership in the meta-aggregator role, four companies rise to the front of the list. In alphabetical order:
Amazon. Amazon’s greatest strength as a meta-aggregator may be its transaction processing ability – 81+ million US consumers have already established accounts with Amazon. It is also fairly far along in establishing relationships with content providers via its existing video and audio streaming services, along with its long-standing leadership in DVD distribution. Amazon also offers content players industry leading cloud hosting – it already acts as a host for NetFlix – and a modest capability in serving video to consumers. It has also developed a powerful content recommendation engine that lets it compare a user’s purchase pattern against other similar patterns to predict other items that may be of interest. This is obviously adaptable to the meta-aggregation role. On the downside, Amazon has no real advertising business today, and while its brand is widely recognized, it does not generate the daily traffic that sites like Google or Facebook do.
Apple. Apple’s retail brand is a juggernaut, but its premium price position and the narrowness of its Internet business make it less formidable than it might first appear. iTunes does give the company a strong platform from which to work, with the Genius feature combining with expert/celebrity playlists to offer strong navigation support to users and existing transaction relationships with the many millions of users. Apple has been investing to play catch up in advertising, but remains a niche player in on-line ads and in user profiling. Apple’s weakest attribute may be its centralized data processing approach. While the company may have invested hundreds of millions in its new North Carolina data center, Apple will still have to rely on Akamai and others to actually serve video to users. Apple has used its cachet to push a few early content deals, but we believe that much of the media industry remains wary of the company given its domination of the music download market.
Facebook. Facebook’s value derives from the extraordinary stickiness of its customers. Leaving Facebook means leaving ones friends, making the Facebook community unusually tolerant of the company’s extensive user profiling. This has also made Facebook one of the world’s most visited websites, both in total visits and unique visitors (Exhibit 12). As the youngest company on our list, Facebook has had less time to develop skills and assets, and so it trails on the strength of its navigation technology, its content delivery and hosting infrastructure, its transaction processing and its relationships with content owners. It has, however, made great strides in applying its user loyalty and extensive customer knowledge to the advertising market.
Google. Google is very good at many things. It is the dominant provider of Internet search and the leader in distributing and serving video via its YouTube business, both brand positions directly applicable to the nascent meta-aggregation role that we posit. Google is reputed to have more than 750,000 servers – if true, it would exceed the others on our short list by more than a factor of 10. Its distributed processing capability allows it to launch a separate search on each user key stroke, wasting untold CPU cycles to save a few seconds on each search. As such, its brand, navigation tool set and CDN infrastructure are second to none. It is also the world leader in Internet advertising, obviously dominating the search advertising category, but gulping market share in display ads and on-line video as well. Google also collects copious data on its users, although it has been more conservative in its willingness to use that data than has Facebook. If Google has weaknesses as a meta-aggregation candidate, it is in its subscale and untested transaction capabilities and in its strained relationships with content providers.
Why Not Cable?
Cable operators have made an aggressive move to forestall the progress of independent over-the-top video by creating their own on-line products available only to existing subscribers in their own homes. However, cracks in this business model have already appeared as channel owners demand additional compensation, and user uptake putters along. Moreover, cable operators’ dependence on sustaining the status quo for as long as possible almost assures that they will be late movers to a truly on-line model. This is a classic case of innovation as the attacker’s advantage, expounded by Dick Foster’s influential book from 1986, and reiterated and expanded by Clay Christensen’s work on disruptive innovation.
Considering cable operators against our seven key success factors reveals some substantial short comings, even if they were to break with the status quo. First, to say that cable companies are not well loved by their customers is an understatement. Comcast won the 2010 Golden Poo as the “Worst Company in America” as determined by a Consumerist on-line poll. The company made the final four in 2011, but was edged out in the semifinals by the much reviled BP in the wake of the gulf oil spill. Notably, BP also knocked out Time Warner Cable in the round of 16, keeping that company from its return visit to the final four. We also note that cable companies have no navigation tools beyond their channel grids, that their ability to serve video is strictly limited to their own franchise territories, and that they know very little about their customers. To their credit, cable operators have experience selling traditional local television advertising, but that may not translate particularly well to the on-line market. Finally, cable operators have familiar relationships with media companies, but familiarity can also breed contempt.
What About Big Media?
Media companies do not create most of the content that they air, they buy it. As content ages, and as contracts expire, media companies continually search for more content to fill their schedules. An all on-line model removes much of the leverage that comes from keeping the gate to the end viewer. Given that media companies offer little in the way of navigation tools, content delivery infrastructure, transaction processing or user profile data, media companies will depend on the strength of their content brands with consumers, their ability to sell advertising, and their ability to continue locking up the best programming. We are concerned that all three of these strengths could deteriorate as traditional networks are exposed to the internet. Given that fragmentation amongst creators and producers, and rivalry amongst media companies, make the one-stop-shop approach impossible, the network imprimatur becomes that of an expert curator. Some networks will be able to transition their brands and other will not. On-line advertising will be quite different than traditional television, with advertisers buying access to users rather than slots on programs. Some media companies will make the transition, others will not. Content creators will have far more options to shop their programming – some may choose to continue to co-brand with a network to gain marketing support, while others may go directly to the consumer. In balance, we believe television networks have more to lose from over-the-top than they have to gain.
In contrast, content owners, creators and producers have much to gain. The most valuable content – i.e. NFL football, Oprah, American Idol – will get leverage to demand and get more. New content creators will find fewer gate keepers between their programs and an audience. That said, we believe the field is far too fragmented for any content owner to have realistic aspirations of becoming an effective meta-aggregator.
Netflix has the early lead, but we do not believe that the one-price subscription model is likely to hold up for aggregators (Exhibit 13). Without sports and programming produced outside the major studios, Netflix will not be able to establish itself as a true one-stop-shop and we don’t believe it is well positioned to be a meta-aggregator either. Running it through our seven key success factors, we can give them credit for having established their brand and for having good relationships with content providers, but Netflix is a non-starter on the other five.
Microsoft and Yahoo may also aspire to the meta-aggregator role, but their position on the seven factors makes them decided underdogs against Amazon, Apple, Facebook and Google. Given that neither Yahoo nor Microsoft has exhibited real momentum in the internet space, it may be that the opportunity is already out of reach.
Winners and Losers
Handicapping the race, we see Google as the clear front runner on the breadth of its excellence and its clear differentiation on navigation tools, CDN and advertising, perhaps the most important and difficult to build success factors. Behind Google are Apple and Amazon (Exhibit 14). Apple is the show horse – it could lever its rabid device user base and too-cool-for-school brand image into a reasonable play, even if it weren’t also building strong advertising and transaction processing skills. Ultimately, we see Apple’s Achilles heel as its device-centered architectural mindset, which plays out in its late embrace of streaming and from its centralized data management approach, which forces it to rely on others for the performance of its streaming services. Amazon is the less glamorous, but perhaps more diligent cousin. Its customers do not relate to it with the same every day urgency that the other three have engendered, but it has a very strong brand presence and loyalty. It may not have the best navigation tools, CDN or user profiling, but it is competent. It was early out of the gate with both video and audio streaming products and has fostered positive relationships with many content owners. It may not have experience with advertising, but it is a clear leader in on-line transaction processing. Finally, Facebook is the new kid in town and hasn’t had the time to build the base of assets or experience that the others bring to the game. However, the genius of its friend-driven concept ties its users to it like unbreakable epoxy, driving them to accept aggressive user profiling and perhaps facilitating the consumption of video entertainment in a broader social context. It is the wild card in the game. As for losers, we remain convinced that cable operators and most television networks face a difficult future.