The Convergence Tipping Point
The media and technology world has reached a tipping point, one captured in some prosaic but infinitely powerful numbers. In the U.S., on a normal weeknight, video streaming on Netflix accounts for almost a third of all Internet traffic entering North American homes. The average U.S. household now has 5.7 Internet-connected devices, and according to ratings agency Nielsen, 41 million Americans watch video on a mobile phone for an average of five hours and 23 minutes per month. New market entrants, from Netflix to Apple, distribute both original and third-party content to a global audience on virtually any connected device via the Internet, and are rewriting the rules of global television distribution and consumption. As a symbol of the speed and scale of over-the-top distribution, Netflix itself just won its first Emmy — the first ever Emmy for Internet-distributed content — for best director of its ground–breaking drama “House of Cards.” To put this in context, HBO began creating original content in the early 1990s and only won its first Emmy in 2001. It took Netflix just one year to gain 14 Emmy nominations and win its first award. Netflix’s accomplishment highlights the reality that the convergence revolution has finally, and indisputably, arrived.
Convergence — the disruptive power of technology to transform the creation, distribution and consumption of media content — is creating game-changing opportunities and threats for almost all established media companies. In television, the incumbent cable, satellite and telecom multi-service operators are being forced to review and often revamp their traditional business models to compete with the OTT distributors who have now achieved material traction. In fact, Netflix now has nearly 30 million domestic subscribers, more than Comcast, the largest cable network.
With new OTT devices reportedly under development from blue-chip players such as Sony and perhaps even the ever-elusive but much anticipated integrated Apple TV on the horizon, the pace of consumer adoption of OTT will continue to increase. Consumers across the globe — empowered by technology to create their own personalized experience across every media genre — will expect and demand content distribution models that allow them to consume whatever, whenever and wherever they want.
Why has the convergence revolution now finally reached a tipping point? The answer lies in the maturation of three separate enablers.
First, the prevalence of high-speed broadband Internet enables rapid downloads and streaming of content globally. As nearly 40 percent of the global population is now connected to the Internet and broadband penetration and speeds continue to increase rapidly, OTT distributors will effectively have instant access to every consumer across the globe.
Second, convergence has been fueled and facilitated by the proliferation of both fixed and mobile connected devices, from Internet-connected televisions to smartphones and tablets. Even when viewers are still consuming content from their living rooms, Deloitte estimates that over 100 million televisions will have Internet connectivity by the end of 2013.
Third, a new content consumption paradigm has emerged, driven initially by a younger cohort of consumers, which analyst and investor Mary Meeker has characterized as the “asset light generation.” Essentially all of the media that this generation owns or rents is instantly accessible, either via a physical device or via the cloud. Physical media such as DVDs and CDs are rapidly becoming obsolete. Rather than remaining confined in the youth demographic, this generation’s content consumption habits have spread rapidly to their parents, many of whom have the same enabling connected devices and access to the Internet.
As a result of these three trends, almost all media genres are being transformed with accelerating velocity. For the second year in a row, digital music sales were larger than physical sales in 2012, and accounted for 55.9 percent of all U.S. music purchases. In movies, 2012 was the first year Americans watched more films delivered legally via the Internet than on physical formats such as Blu-ray and DVD. In publishing, e-books accounted for 23 percent of trade publishing revenue in 2012 and are predicted to account for 50 percent by 2016.
It is in television, however, where the convergence revolution is currently in its most disruptive phase. In the pre-OTT “old world,” content was distributed linearly and prescriptively, consumers were largely tethered to their living room couches and were charged for content regardless of consumption. That business model is rapidly fading. The OTT innovators such as Netflix, Hulu, Roku, Amazon, Apple and Microsoft have adopted diverse distribution and revenue models, some with their own hardware and others piggybacking on third party devices — but all providing global consumers with access to vast content libraries and often differentiated original programming, as well as the flexibility to create their own bespoke viewing experience on multiple devices, anywhere and at any time.
The one constant in the new OTT world is that content remains king. Television screens and tablets are worth little unless consumers can use their devices to access quality content. OTT players are now serious bidders for the best programming. For example,Sony and Viacom reportedly just reached a preliminary deal to offer Viacom’s television content, including MTV and Nickelodeon, on Sony’s OTT devices. Under the recently announced Netflix-DreamWorks animation deal, Netflix will reportedly receive 300 hours of original programming on an exclusive basis from Dreamworks. This content would traditionally have been distributed via a traditional pay-TV network, but will now come to the Web first.
Some OTT distributors are also investing heavily to develop their own original and differentiated content to attract and retain viewers. Adopting the same strategy pursued by scripted content-centric networks such as HBO or AMC, Netflix reportedly invested over $100 million to produce “House of Cards.” Netflix has subsequently developed and released several other original series, and reportedly has another dozen in the pipeline. In the words of Netflix’s chief content officer Ted Sarandos: “The goal is to become HBO quicker than HBO can become us.” Through these big content bets — as well as a willingness to experiment with television conventions and formats, such as releasing all of the episodes of “House of Cards” simultaneously to enable ‘binge’ viewing, or resurrecting and remaking a cult but discontinued television show such as “Arrested Development” — Netflix is changing the way television is both produced and consumed.
The OTT providers have also arguably created a new paradigm for global content distribution. In the old world, content owners had to establish separate distribution arrangements in each territory, while the local television distributors who acquired the content in turn needed a costly dedicated physical infrastructure to access each household. Now, thanks to the instant global distribution power of the World Wide Web, OTT content distributors can quickly reach the 750 million global Internet-connected households. Whereas previously it took months or even years for hit U.S. shows to syndicate internationally — and it was often difficult for international shows to achieve U.S. distribution — now Netflix and its OTT peers can distribute both American and international content instantly to huge audiences around the globe. In this new world, the hit show “Breaking Bad,” which won the prestigious award for best drama series at this year’s Emmys, aired on the cable network AMC on Sunday evenings, and was available via OTT the next day in the U.S. and internationally. Vince Gilligan, the show’s creator, even credited on-demand Internet streaming of past episodes as a primary driver for his show’s survival and ultimate success: “Netflix kept us on the air. … [without OTT distribution] I don’t think our show would have even lasted beyond season two.“
Despite the ascent of the OTT players, it would be a mistake to write off the incumbent operators just yet. Over one hundred million American households still subscribe to traditional pay TV from telecom, cable or satellite MSOs. These distributors not only power the Internet infrastructure on which the OTT players depend, but their television businesses also have huge advantages of scale. Time Warner Cable has over 300 separate distribution agreements already in place with content owners and spends $5 billion on its TV network each year.
The scale of old-world content budgets is fundamental to the economics of content owners and cannot be matched by the current business models of the new OTT players. For example, according to a recent Needham analysis, ESPN receives approximately $6 per month from 100 million pay TV homes, producing $7.2 billion of subscription revenue each year. OTT players either offering unlimited content at $7.99 per month (the Netflix model) or offering consumers a la carte, “pay by the drink” content selection (the Apple model), simply cannot come close to replicating these economics with their current business models.
Live sporting events remain the final frontier for the OTT distributors but also provide the incumbent MSOs with a significant content differentiation to attract and retain viewers. In fact, some incumbents are appropriating aspects of the OTT players’ distribution model.ESPN recently launched OTT access to live programming via its WatchESPN app on the Apple TV and, for the first time this season, NBC Sports will offer high-profile sporting events such as Sunday Night Football live on any Internet-connected device. The incumbent operators’ sustained distribution power and scale is reflected by the requirement for a pay-TV subscription authentication to access much of the content on both of these services.
Leveraging their inherent scale and current content advantages, particularly in sports, the incumbent operators are using technology to innovate and combat the OTT threat. On-demand, non-linear programming availability and “TV everywhere” have become pay-TV’s new mantras as the MSOs endeavor to provide their consumers with the same viewing flexibility as the OTT players. The cable provider Comcast, for example, is about to launch its X2 platform, which offers cloud-based program recording and Web-based content, an updated channel guide with individual recommendations drawn from program viewing history and the ability to watch recorded content on mobile devices. Comcast also now plans, for the first time, to offer on demand all episodes of some popular Fox shows to cater to the “binge” viewing phenomenon.
The ultimate beneficiary of media-tech convergence in television is undoubtedly the consumer, who is now receiving more and better media content, more personalization and more flexibility than ever before in history. The television content consumption experience is being fundamentally reinvented by technology. The so-called “golden age of TV” is going platinum.
The media-tech revolution has been a long time coming. It is a vision some predicted in the heady days of the dot-com boom, when convergence was first forecast and eagerly anticipated. At the time, however, the core enabling dynamics of convergence — robust broadband capacity, the proliferation of connected devices and strong consumer demand — had not matured sufficiently to make it a reality. Convergence was viewed, according to one academic writing in 2002, as “nothing more than an over-hyped illusion.” A decade later, the OTT players have now made the vision of convergence a reality. As a result, the media and technology world will never be the same.
Egon Durban and Stephen Evans are, respectively, Managing Partner and Director at Silver Lake, the global technology investment firm.