Posted by Chad | Posted in Data Science, Economics, Network Science | Posted on 06-08-2015
Below is a paper I wrote in April, so it may seem a bit anachronistic, but some of the things outlined here are starting to take shape. It was also my first foray into network theories of economics, so the whole topic was quite an eye opener for me.
On February 26, 2015, the Federal Communications Commission (FCC) decided that they would implement rules to protect the openness of the Internet. Its report, published on March 12, 2015 established what it calls, “clear, bright-line rules (F.C.C., p6.)” banning three practices that pose a threat to the openness of the Internet. In turn, the report cites bans on blocking of lawful destinations, throttling and degradation of traffic to and from lawful destinations, and paid prioritization of lawful traffic on the Internet (F.C.C., p6.).
This decision came on the heels of a lengthy public debate on the economic, sociological, and political effect of government regulation of Internet service providers (ISPs). Some arguments against the concept of Net Neutrality pointed to the economics of the Internet backbone and how removing the profit motive from network investment, the growth of the Internet backbone in the United States will stagnate (Hahn & Wallsten, 2006, p6) (Misra, n.d.) (Yglesias, n.d.).
There exists an economic reality that was always there, lurking beneath the crust of the conversation, but has come into full view and is having an immediate effect on the landscape of broadcast media. So-called over-the-top media providers are springing up from all corners of the broadcasting world, causing a fundamental shift in the way consumers buy content, how providers deliver it, and how advertisers are trying to worm their way in (Poggi, 2015).
Over-the-Top Services as Alternatives to Cable and FiOS
With broadband download speed capabilities reaching 35.7 megabits per second (mbps) in the United States and 23 mbps globally on average, and a global mobile platform download speed average of 12.1mbps (“Download Speed in United States | Net Index from Ookla,” n.d.), high definition video and audio streaming services have found a new market of consumers and delivery architecture for the lawful distribution of licensed media content.
Because of this access to bandwidth and content, coupled with a regulatory platform that ensures unfettered delivery of those services across backbone networks and into the home and mobile networks of broadband Internet customers, consumers are “cutting the cable,” canceling their cable service and relying entirely on streaming services for their content (Captain & Scharr, n.d.). This is also creating an economic climate for traditional television providers to offer a la carte services to their customers (Kang, 2015) much to the dismay of content providers who rely on fees collected from cable providers. Sports broadcasting company, ESPN, a subsidiary of media giant, Disney, is currently suing Verizon over their new bundling package, citing a breach of contract, but ostensibly rooted in the fear that they won’t collect fees for users who don’t watch their channels (Swanner, n.d.). One can understand ESPN’s frustration as it has positioned itself as a top price brand for cable companies, regardless of actual viewership, year on year. It sustains its popularity among sports enthusiasts by paying premium rates to carry sports events, but this comes at a cost. That cost is apparently $5.54 per month per subscriber (Ross & Maglio, n.d.).
Another driver for the growth of over-the-top services is a growing number of people who have never had cable and are instead skipping the cable rates and terrible service of the worst company in America (Matyszczyk, 2014) and going straight to the on-demand online media market. As many as one in four Millennials have never had cable and are using over-the-top services to access entertainment at home (Newman, n.d.). It is not a great stretch to see how those that never had cable are proving that it can be done and are cannibalizing the cable industry customer base, at least in part.
Poor service and availability of alternatives aren’t the only drivers of change. According to the U.S. Bureau of Labor Statistics, US consumers spent an average of $2,482 in entertainment categories in 2013 (B.L.S., 2015). This includes television services, with averages ranging from $360 per year for basic services to as much as $2,160 per year when bundled with other services such as home security and phone (Fottrell, n.d.).
Therein lies the rub. Analysts have long warned the cable industry that its model is inherently flawed (Diallo, n.d.) and that their pricing practices were just simply not in line with available discretionary spend (Eggerton, n.d.), so cable has had to turn to other services that are more important to consumers such as telephone service and security systems, but even this approach has a market cap that is constrained by price and non-price determinants of demand.
Convergence has rendered the home phone a relic of a bygone era, relegated to a device used for those who need a number on which they need to call the baby sitter and to those who have been sold on a discount for providing the phone service. A longer than expected recession has lowered the amount of household discretionary income, and prevalence of wireless telephone service has diminished the need for home telephone. This is a dangerous prospect for any company hinging their future on cross selling telephone service.
We are now at a stage of market development where the services provided by cable that aren’t television are necessary to justify the existence of television. In fact, the pricing model set up by Time Warner Cable has plans with television included equal to or less than plans without television (“Cable Deals and Internet Offers | Time Warner Cable,” n.d.) as if to say “Please just let us install television service in your home. We need you to say you want television for our shareholders’ sake.” It smacks of the desperation of a ponderous, lumbering behemoth gasping for air in an acrid economic climate.
The Real Cost of Cutting the Cable
The new regulatory environment has positioned the online streaming media market to grow very quickly. On its face, this relatively nascent market is an exciting place to be, and it is tempting for many to try to break in by providing their own licensed and original content over the Internet, on-demand, for a price. Any who would jump into these waters must do so with the knowledge that they are jumping into a space whose novelty will expire. The abundance of choices for the consumer are creating severe disequilibrium in the market, recklessly burdening the market with supply with little or no understanding of the demand.
As we’ve seen before, American consumers have a moderate budget for television services at just 4.45% of annual income, on average, and that this money has a nonlinear inversely proportional relationship at the consumer unit level (B.L.S., 2015). Even with consumers opting to shift their entertainment spend away from cable television services and to over-the-top services, there is still a dearth of spending relative to the ever-increasing supply of services. The problem with the model is if a consumer wants to take advantage of all the content provided by the prevailing leaders in the space, one could spend over $700 just to get content on par with a moderately priced (for some relative definition of “moderate”) cable service with much of the same content and on-demand capabilities.
Americans have proved resilient, if not apathetic, to content glut, tuning only 17 channels on average, despite an increase in available options (“Nielsen: Changing Channels: Americans View Just 17 Channels Despite Record Number to Choose From,” n.d.) (yet another failure of the cable marketing model by not understanding its customers wants). Even as more services emerge in the over-the-top media delivery space, consumers will settle into viewing patterns, and services that may provide quality content are likely to die on the vine or be subsumed by emerging leaders in the industry.
Over the Top Services and Emergence Economics
What we are going to see in the coming years is the concept of Emergence Economics in action. Whitt and Schultze define Emergence Economics as “an umbrella phrase” to describe the interaction between complexity economics and other competition theory and net-effect economic models (2009, p223). This model deviates from neoclassical economic models by acknowledging that there is far more than just an invisible hand driving the market toward equilibrium. Emergence economics, at their core, are a formula representing interactions between agents and networks and their evolution through network growth (Whitt & Schultze, 2009, p231).
Whitt & Schultze are purposefully vague on the concept of an agent, saying agents in emergence economics “consist of the full spectrum of economic actors (2009, p231)” In the case of our new model of over-the-top services, the agents of change in the network are many, but principally include consumers, the FCC, content creators, ISPs, the cable carriers, and the over-the-top services themselves.
Consumers are agents of the change exercising their options in media consumption expenditure, creating a demand, however amorphous, that the new services are trying to capture. The consumer role in the viability of the new market will have direct effect on the macro and micro aspects of the industry. As consumers react to changes in the network and from other agents in the sphere of influence, the network will fluctuate.
The FCC has emerged as the most visible single agent by establishing that the network infrastructure on which these services will work is free from artificial and purposeful hindrances. Now that the federal agency has dipped its gargantuan toe into the murky waters, it must be prepared to further smooth the regulatory and economic landscape they have helped shape.
Content creators will find their role in the plot to come as an important one by establishing the economy of licensing in the new delivery mechanism. The prevailing service providers are facing a problem with their licensing model by having to ask studios to produce or license exclusive content, a gamble in such an uneasy market being requested of an already uneasy industry (Rayburn, n.d.).
Despite being somewhat neutered by the FCC ruling, ISPs will play a significant role in the future of streaming media by changing their own consumer pricing models. At risk are the unlimited data streams in the current plans. It is likely that ISPs will evaluate, if not adopt, a pay-per-use model that has been the de facto model for mobile data carriers for some time. Such a model shifts the burden of cost to the consumer directly, rather than allowing the media providers to absorb the variable cost (or fixed, depending on how savvy their negotiations) into their own pricing structures.
The cable carriers do still have a role to play, as they are reacting already and can have a direct effect on the network by changing their model. Verizon FiOS is already marching down that road with their bundled services and, endangered though it may be, is but the first in many steps toward ensuring the survival of the industry and long-term viability of the service as a content delivery platform.
The over-the-top providers will certainly be the foci of the network as it evolves. The advantage these services have is that they are currently en vogue, the beneficiaries of the “endogenous novelty (Whitt & Schultze, 2009, p241)” in the model. They are also currently new and small enough to adapt to rapid change, which benefits them as they are the first in what looks to be the future of media consumption.
Given the regulatory, consumer, and organizational landscape spread out before us, we can make an educated guess to the track of the evolution of the market. Agents will find their role in the long-term model by differentiating themselves from other agents (in and out of their own classifications and networks), developing a core competency in which they will play. Those that do not differentiate will disappear or be subsumed by those that do.
We are already seeing evidence of this in the way Time Warner is offering its premium content network, HBO, via the online service, HBO Now (“HBO NOW. It’s HBO. All you need is the Internet.,” n.d.). Superficial views of this move would indicate that Time Warner is cannibalizing their cable television consumer base, and assuming HBO Now customers will retain their cable television accounts, but a closer look reveals a company shrewdly putting a physical distance between its media interests and its delivery infrastructure, decoupling a once tightly integrated vertical, and evolving to compete in a new economic landscape.
Over-the-top providers such as Netflix and Hulu are differentiating by providing exclusive content, often funded by the services at great expense in the assumption it will bring subscribers. If someone wants to watch House of Cards, they will have to carry a Netflix subscription. If that same person wants to watch episodes of popular cable or broadcast television shows such as The Walking Dead and not wait for Netflix to get the content, they will need an $8 Hulu subscription (“Watch TV and movies on Xbox, PS3, Apple TV, and more | Hulu Plus,” n.d.).
Consumers have been evolving for some time and have driven a lot of the change that led to the current landscape. Individuals will make their voices heard through their buying decisions. As they allocate their sparse discretionary income in a climate of increased options, they will define the leaders and will arbitrate at the scorers’ table for who adapts in the most effective ways.
ISPs will evolve through a tenuous process of managing pricing models, tempered by consumer fickleness and antitrust concerns. If they try to pass along too much cost, they will arouse the suspicions of the Department of Justice and could exacerbate already tense relationships with their customers who will clamor for alternatives.
The Shape of Things to Come
Given the stakeholders involved, we can posit many outcomes, but there are some factors on which we can rely to determine what shape the market will take. We will see a number of over-the-top streaming services emerge. As the market saturates, a few clear winners will emerge and will either push out their under performing competitors by leveraging customer bases and media licensing options, or acquire them and add their assets to their arsenals. These organizations will grow to become leaders in the industry and will have increasingly larger influence over the network. In two to five years, it will not be surprising to see three solid performers in the industry with a majority of the market shared among them, with niche players operating at much smaller volumes delivering premium content to narrower consumer markets.
ISPs will dance with their customers and ultimately find a compromise between controlling revenue growth while keeping prices within customer expectations. Customers that use data at rates at or beyond the 97.5th quantile will pay more than they do today, but net price to consumer will remain relatively flat for most users. In the next half-decade, ISPs will be charging for use, but customers will still be getting value for the spend.
Cable companies will continue to distance their media services from their delivery infrastructure. We will see a continued decoupling of once-vertical industries and these companies will start to look more like over-the-top services or ISPs. They may operate under the same shingle, but they will be subject to new shareholder expectations, and will overcome their identity crisis by acknowledging their role in the space.
The FCC and other regulatory agencies will spend the next five years monitoring the economic landscape, ensuring that everyone is playing fairly in the field. It is not unreasonable to assume that some other issue will come to the fore, and the FCC will have to determine in what capacity they will participate. Indeed, the FCC has struck a note in the symphony, and now it must be harmonious in its participation.
Consumers will have a direct and influential effect on how the next five years of this emergent market will progress. Through their spending choices, they will shape how the network evolves. In five years, broadband-connected households will stream their media from their favorite service directly to their televisions and computers (if one can still make such a distinction), adding premium content from smaller providers in an a la carte fashion, commensurate with their discretionary expenditures and television-watching proclivities.
In time, the market will evolve enough to expose new vertical industries, and larger conglomerations will emerge to dominate the landscape. As fewer and fewer companies control the market from content creation to delivery, the market will achieve its critical mass. A new agent, source or form yet unknown, will appear and create a new conversation about a new market and the cycle will begin anew.
The emerging market will be exciting to watch. In fact, with a story containing as much drama, as many diverse, multidimensional characters, and as unpredictable a plot as the new streaming media economy…
Who needs television?
B.L.S. (2015). Consumer Expenditures in 2013 (No. 1053). US Bureau of Labor Statistics. Retrieved from http://www.bls.gov/cex/csxann13.pdf
Cable Deals and Internet Offers | Time Warner Cable. (n.d.). Retrieved April 29, 2015, from http://www.timewarnercable.com/en/plans-packages/cable-internet.html
Captain, S., & Scharr, J. (n.d.). Cable TV Alternatives – A Guide to Cutting the Cord. Retrieved April 29, 2015, from http://www.tomsguide.com/us/cord-cutting-guide,news-17928.html
Diallo, A. (n.d.). Cable TV Model Not Just Unpopular But Unsustainable. Retrieved April 29, 2015, from http://www.forbes.com/sites/amadoudiallo/2013/10/14/cable-tv-price-hikes-unsustainable/
Download Speed in United States | Net Index from Ookla. (n.d.). Retrieved April 29, 2015, from http://www.netindex.com/download/2,1/United-States/
Eggerton, J. (n.d.). Moffett: Where Will Money Come From For Pay TV Price Increases? | Multichannel. Retrieved April 29, 2015, from http://www.multichannel.com/news/cable-operators/moffett-where-will-money-come-pay-tv-price-increases/328425
Ehrenfreund, M. (n.d.). This hilarious graph of Netflix speeds shows the importance of net neutrality. Retrieved April 29, 2015, from http://knowmore.washingtonpost.com/2014/04/25/this-hilarious-graph-of-netflix-speeds-shows-the-importance-of-net-neutrality/
F.C.C. (n.d.). Report and Order On Remand, Declaratory Ruling, and Order, GN Docket No. 14-28 (No. FCC 15 – 24).
Fottrell, Q. (n.d.). Why cable TV bills are only going up – MarketWatch. Retrieved April 29, 2015, from http://www.marketwatch.com/story/why-cable-tv-bills-are-only-going-up-2013-02-28
Hahn, R., & Wallsten, S. (2006, June). The Economics of Net Neutrality. Economists’ Voice, 1–7.
HBO NOW. It’s HBO. All you need is the Internet. (n.d.). Retrieved April 30, 2015, from https://order.hbonow.com/
Kang, C. (2015, April 17). Verizon breaks up its bundle to give consumers more choice – The Washington Post. Retrieved April 29, 2015, from http://www.washingtonpost.com/blogs/the-switch/wp/2015/04/17/verizon-breaks-up-its-bundle-to-give-consumers-more-choice/
Matyszczyk, C. (2014, April 10). Comcast wins! (Worst company in America) – CNET. Retrieved April 29, 2015, from http://www.cnet.com/news/comcast-wins-worst-company-in-america/
Misra, V. (n.d.). Net neutrality is all good and fine; the real problem is elsewhere | Dept. of Computer Science, Columbia University. Retrieved April 29, 2015, from http://www.cs.columbia.edu/2014/net-neutrality/
Newman, J. (n.d.). Nearly 1 in 4 millennials have cut the cord or never had cable | TechHive. Retrieved April 29, 2015, from http://www.techhive.com/article/2833829/nearly-1-in-4-millennials-have-cut-the-cord-or-never-had-cable.html
Nielsen: Changing Channels: Americans View Just 17 Channels Despite Record Number to Choose From. (n.d.). Retrieved April 29, 2015, from http://www.nielsen.com/us/en/insights/news/2014/changing-channels-americans-view-just-17-channels-despite-record-number-to-choose-from.html
Poggi, J. (2015, March 23). Apple, Sony, Dish Push OTT Viewing Over The Top | Media – Advertising Age. Retrieved April 29, 2015, from http://adage.com/article/media/apple-sony-dish-push-ott-viewing-top/297712/
Rayburn, D. (n.d.). Netflix’s Long-Term Business Model Flawed, Competitors Willing To Give Content Away – Dan Rayburn – StreamingMediaBlog.com. Retrieved April 30, 2015, from http://blog.streamingmedia.com/2011/11/netlfixs-long-term-business-model-flawed-competitors-willing-to-give-content-away.html
Ross, L. A., & Maglio, T. (n.d.). Your Unfair Cable Bill: Most Expensive Channels Aren’t the Most Watched – TheWrap. Retrieved April 29, 2015, from http://www.thewrap.com/cable-bill-battle-subscribers-providers-carriage-fees/
Swanner, N. (n.d.). ESPN sues Verizon over new FiOS bundling – SlashGear. Retrieved April 29, 2015, from http://www.slashgear.com/espn-sues-verizon-over-new-fios-bundling-27380933/
Watch TV and movies on Xbox, PS3, Apple TV, and more | Hulu Plus. (n.d.). Retrieved April 30, 2015, from http://www.hulu.com/
Whitt, R. S., & Schultze, S. J. (2009). The New “Emergence Economics” of Innovation and Growth, and What It Means for Communications Policy. Journal on Telecommunications & High Technology Law, 7(2), 217–315.
Yglesias, M. (n.d.). Net neutrality economics: The economic case against the broadband providers. Retrieved April 29, 2015, from http://www.slate.com/blogs/moneybox/2014/01/16/net_neutrality_economics_the_economic_case_against_the_broadband_providers.html