Would the big U.S. TV networks sell their stations?

Earlier today, TVNewsCheck ran a story about the positions of the Big 4 U.S. television networks (ABC, CBS, Fox and NBC) on ATSC 3.0. The Advanced Television Systems Committee (ATSC) administers the U.S. standard for digital terrestrial television broadcasting, and ATSC 1.0 is the system currently in use. ATSC 3.0 is intended to implement capabilities that are limited or missing in the current standard, including support for image resolutions beyond HD. Most importantly for many broadcasters, however, is that ATSC is intended to bring mobile TV reception to parity with the fixed HDTVs that we use today, The broadcasting industry realizes that an ever-increasing percentage of its audience is watching television outside the home on smartphones and tablets, but today, access to those devices is mediated by the mobile phone carriers (AT&T, T-Mobile, Sprint, Verizon, etc.). Broadcasters want direct access to those devices and viewers, and are hoping that ATSC 3.0 will give them that access.

The transition to ATSC 3.0 won't be without problems: Broadcasters spent many billions of dollars on new cameras, production equipment and transmitters to move from analog to digital television. Moving from ATSC 1.0 to 3.0 probably won't entail that level of investment, but it will still be expensive for broadcasters. In addition, smartphone manufacturers, mobile phone carriers and consumer electronics companies will have to be convinced (or required by law) to support the new features of ATSC 3.0 in their products. That will take time--potentially as long as ten years.

According to TVNewsCheck, both ABC and CBS have gone on the record as withholding their judgment on ATSC 3.0. Both NBC and Fox support ATSC 3.0 in principle, but both are waiting for more details of the standard to emerge before making a commitment. That led me to wonder whether the network broadcasters actually want or need to make the investments needed to support ATSC 3.0 in the television stations that they own.

All of the top four commercial television networks in the U.S. own and operate several television stations in major cities; in the industry, these are called O&Os (for Owned & Operated.) For example, all four networks own and operate stations in New York, Los Angeles, Chicago and Philadelphia. In Dallas-Fort Worth, all but ABC own and operate their own stations; in San Francisco-Oakland-San Jose, all but Fox own their own stations. The local stations are a big source of revenue and earnings for the networks; for example, in 2013, CBS's network had gross revenues of $8,645 billion and operating income of $1.593 billion, while its local Owned & Operated stations, both television and radio, gross revenues of $2.696 billion and operating income of $807 million. On a percentage basis, the local stations, while not the most profitable unit of CBS, made a much bigger profit than the network (30% vs. 18%.)

On the surface, it seems obvious that CBS, and the other big networks, should keep their stations. However, when you look further, the choice becomes less clear:

• The major networks could easily get $1 billion or more for each of their stations in the top U.S. markets, and those sales would be taxed as long-term capital gains, not ordinary income.
• The networks are already getting a significant amount of their income from retransmission fees charged to cable, satellite and IPTV video operators. They get those fees directly from the video operators in the markets where they own stations, and indirectly in other markets through the fees that they charge their affiliates for carrying their programs. If the networks sell some or all of their stations, they would get affiliate fees from those stations without any of the costs of operating the stations.
• If the networks no longer own over-the-air stations, they would no longer be directly subject to FCC rules. That means no more multi-million dollar fines for "fleeting expletives" or unplanned nipple slips. The networks would still have to abide by FCC content rules to protect their affiliates, however.
• Over 90% of U.S. households already get their television via cable, satellite or IPTV. Over-the-air reception is increasingly an anachronism.

As little as ten years ago, it would have been unthinkable for the Big 4 networks to sell their stations--if anything, they aggressively wanted to buy more. However, since then, we went through the 2008 Great Recession, which hammered local ad revenues. Network television viewership has been declining for several years, and ratings for many of today's successful network series would have guaranteed their cancellation just a few years ago. Now, many industry analysts are forecasting that digital will supplant broadcast television as the biggest recipient of advertising revenue within the next few years. If the Big 4 have the choice between spending billions of dollars to upgrade their stations to comply with ATSC 3.0, or making billions of dollars from the sale of their stations, it's looking increasing likely that sales, at least of their smaller-market stations, will make more sense.

Why the status quo in the U.S. cable business can't hold

The more that I look at the U.S. cable, satellite and IPTV business, the more I realize that "business as usual" is eventually doomed. Cable companies' core business for more than 50 years has been to sell access to bundles of broadcast and cable-only channels, which are accessed through the use of proprietary set-top boxes, to consumers. Starting in the late 1990s, cable operators started adding access to high-speed Internet services, which ride in and out of consumers' homes on available bandwidth not used for video. A few years later, cable operators added Voice over IP telephony services, which use the same bandwidth as high-speed Internet. IPTV companies offer the same service, but in the reverse order: First came analog voice telephony, more than 100 years ago. Then, DSL came in the 1990s for high-speed Internet service, and finally, AT&T, Verizon and others added broadcast and cable-only television channels, accessible through proprietary set-top boxes.

Today's cable and IPTV operators look very similar so far as consumers are concerned, and they both face the same business challenges: Retransmission and carriage fees. Retransmission fees are intended to compensate broadcasters for the use of their programming by video operators. Carriage fees provide compensation to cable network operators. It used to be that some cable networks would pay video operators to carry their programming, in order to sell advertising that would reach the widest possible audiences. Today, however, almost all cable networks charge video operators to supply their programming to consumers.

Until 2008's Great Recession, broadcasters and cable networks got most of their revenues from advertising. Broadcasters kept their retransmission fees low, or waived them altogether if video operators agreed to carry cable channels provided by the broadcasters' parent companies. Cable networks generally also kept their carriage fees relatively low, in order to get into the widest possible number of households. After 2008, however, all that changed. Broadcasters' advertising revenues dropped (in some cases, dramatically,) so they needed to make up for lost income. In addition, broadcast networks, which had been paying television stations to carry their programming, began charging stations for programming or demanded a portion of the stations' retransmission fees. Similarly, cable networks started increasing their carriage fees to replace lost advertising revenues.

Early on, video operators absorbed the price increases from content providers as best they could, knowing that they couldn't pass the increases on to customers in the form of higher rates during a recession. Now, however, not a week goes by where a video operator isn't threatening to drop a broadcast station or cable network because it's too expensive, or a broadcaster or cable network isn't threatening to cut off a video operator. Video operators are trying to disguise consumer rate increases as things like "concierge" services, where they charge for services that consumers used to get for free. And today, Cablevision filed an antitrust lawsuit against Viacom, charging the company with forcing cable operators to license a bundle of 14 unpopular cable networks in order to get access to popular ones such as Comedy Central and Nickelodeon.

This situation can't persist for much longer. In many markets, subscription prices have reached the maximum that consumers are willing to pay, and consumers have gotten wise to video operators' pricing tactics: Offer low "teaser" rates to get consumers to switch, and then start raising rates frequently, and often silently, once their introductory deals expire. Consumers respond by cancelling services, switching video operators, and in the worst case, dropping video services altogether and switching to over-the-air broadcasts and over-the-top Internet video.

Within a decade, I believe that most cable and IPTV companies will be well on the way to dropping their video services. Consumers will purchase their own set-top boxes, and similar functionality will be built directly into new televisions. Some set-top box vendors will also aggregate content. Rather than the plethora of formats for publishing video that work on set-top boxes from Apple, Google, Intel, Roku, etc., a single standard protocol will enable content providers to publish channels and on-demand video that will work with most set-top boxes, and will show up in the devices' program guides. Cable and IPTV companies are likely to partner with set-top box vendors and receive a portion of their revenue from consumer subscriptions.

Consumers would get the "a la carte" cable channel choices that they've been asking for--but at a price. For example, Disney's ESPN might make its primary ESPN channel available by itself to subscribers for $6.95/month--but price the entire ESPN channel lineup at $12.95/month, thus making it more attractive to pay more but get everything. This strategy would work for the rest of Disney, as well as Viacom, CBS, Discovery, Fox, NBC Universal and others.

The cable and IPTV operators would compete on other services and benefits--who offers the fastest and most reliable high-speed Internet service, the simplest and most useful home networking, the best home automation and security packages, etc. All of these would be services that the cable and IPTV operators would provide themselves--thus, they wouldn't be subject to ever-increasing financial demands from cable networks and broadcasters. By literally wiring their services deep into households, it would be much harder for consumers to switch from one service provider to another, which should decrease churn levels.

The war among video operators, broadcasters and cable networks, with consumers in the middle and paying the bills, can't go on for much longer. At some point, a critical mass of consumers will stop paying the bills, and video operators will have no choice but to spin off their video services.

Intel's "virtual cable" service: A "cable killer" one week, on life support the next

Two weeks ago, news about a new "virtual cable" service developed by Intel leaked to several outlets. The service was said to use Intel-designed set-top boxes and software to deliver broadcast and cable networks, along with video-on-demand, to televisions and mobile devices via consumers' existing high-speed Internet connections. It would also feature something called "perceptual computing," which would use face and voice recognition as part of the system's user interface. (One possibility is that the system would use a camera to identify the family members in front of the television or mobile device, and automatically select their favorite channels.) The Intel system was to be announced as early as next week's Consumer Electronics Show, and was to be rolled out on a city-by-city basis.

Blogs and websites published breathless stories about how Intel was going to "destroy the cable industry." However, the cablepocalypse lasted only until The Wall Street Journal reported that Intel is delaying the announcement of its virtual cable service for several months, if not indefinitely, because it can't get access to sufficient content. No one should be shocked or surprised that Intel can't get the content it needs; after all, it was widely reported last year that Apple was working on a very similar service, which it too had to rein back because it couldn't get enough content to make it a viable competitor to cable, satellite and IPTV services.

From one perspective, Intel's proposed system is very similar to satellite TV--it would eventually cover the entire country, and I assume that Intel plans to offer local broadcast stations, as Dish and DirecTV do in the U.S. However, there's no legal requirement that broadcasters, cable networks or movie studios do business with Intel. Comcast owns NBC, several cable networks and Universal Studios; it's required to offer its content on reasonable terms to other cable, satellite and IPTV operators, but it has no such requirement to do business with Intel. Cable and satellite operators have made equity investments in some other cable networks over the years; they can influence who the networks license their content to (or don't license it to, as the case may be.) The remaining cable networks and studios have to weigh the revenues they could get from Intel with how Intel might impact their revenues from other distributors. In addition, we don't know what financial terms Intel wants. For example, Intel may want to pay for content as it adds subscribers, while content providers may want Intel to pay a base fee covering millions of subscribers, even if the company might not be able get that many subscribers for years.

In any event, Intel's "cable killer" is apparently on life support, at least for now. Eventually, someone is going to figure out how to get enough content to make an over-the-top Internet video service competitive with cable and satellite. It might be Intel, Apple, Aereo, FilmOn, or a company that doesn't even exist yet. It might require Federal legislation. But, it will happen eventually.

The Internet video battle is the wrong fight in the wrong venue

Last week, over-the-top Internet video company Aereo faced the major U.S. television networks in a Federal court of appeals in New York. Last July, a Federal court denied the broadcasters an emergency injunction to stop Aereo from offering its service, which enables consumers in New York City to watch, record and replay live broadcast television over the Internet. Aereo assigns a tiny, thumbnail-sized antenna to each active user, specifically to circumvent objections that resulted in court injunctions against ivi and FilmOn, two similar services that preceded Aereo. The appeals court hasn't made its ruling as of this writing, but based on court arguments, it looks like the appellate court will be less sympathetic to Aereo's arguments than was U.S. District Judge Alison Nathan.

In my opinion, both sides are fighting over the wrong issue, in the wrong venue. Aereo, and both ivi and FilmOn before it, took the approaches that they did because broadcasters and cable operators either refused to negotiate with them for rights to their content, or demanded fees that they couldn't possibly pay. There are conflicts in current laws that bring into question whether broadcasters must license their content to cable operators under what's termed a compulsory license. However, as the laws are generally interpreted, broadcasters can either make their content available to cable operators for free (in which case the cable operators must assign the broadcasters a channel,) or the broadcasters can ask for compensation for their content, in the form of payment and/or an agreement to carry other content from the broadcasters' parent companies (for example, CBS could require a cable operator to offer Showtime, which it owns, in order to get the right to broadcast its local television station(s).) Broadcasters can withhold their content from any cable operator that doesn't agree to their terms.

The real issue is whether broadcasters, if not cable networks, should be required to license their content under fair, reasonable and non-discriminatory (FRAND) terms to all distributors. I think that it's time for such a requirement. The rules that define who can be considered a Multichannel Video Programming Distributor (MVPD) were written before the Internet became a viable medium for distributing live video. There's no technical reason why Internet video companies can't compete with cable, satellite and IPTV operators, but very few broadcasters, and even fewer cable networks, are willing to sell them their programming.

Here's an example of a FRAND compulsory licensing scheme that could work: Over-the-top Internet services could license content from broadcasters on a tiered pricing scheme based on each service's number of active subscribers--for example, companies with 1-249,000 subscribers would pay a given per-subscriber fee for each broadcast station, and additional tiers with higher fees would be established at 250,000-499,999, 500,000-749,999 and 750,000-999,999 subscribers. Once a video service reaches one million subscribers, it would be subject to the same rules as cable, satellite and IPTV companies. For their part, cable, satellite and IPTV operators would also be eligible for the same FRAND compulsory licenses, at the same rates, until they too reach the one million subscriber mark. According to the most recent statistics from the National Cable Television Association, that would make all but the top 12 MVPD companies in the U.S. eligible for compulsory licenses. Finally, broadcasters could make their programming available to Internet services for free, under the same "must-carry" rules that apply to cable, satellite and IPTV services.

This approach would enable innovative Internet video startups to gain a foothold and compete against larger cable, satellite and IPTV companies, and it would allow smaller legacy MVPDs to compete on a level playing field. I'd also propose that cable networks that are owned by MVPDs (such as NBCUniversal, which is owned by Comcast) be required to follow the same FRAND compulsory licensing rules. Other cable networks could choose to make their programming available to smaller MVPDs, including Internet companies, under FRAND licenses.

The courts can't implement a FRAND compulsory licensing scheme; it has to be done by the U.S. Congress, in conjunction with the U.S. Copyright Office. No court ruling in the Aereo case, even if it goes all the way to the U.S. Supreme Court, will fully resolve the case--if Aereo wins, broadcasters will push for legislation, and if the broadcasters win, Aereo and its allies will do the same. It's time to recognize that the public Internet works for live video distribution, that startups should be able to compete with existing cable, satellite and IPTV companies, and that content providers should get fair compensation, no matter how their content is distributed.

DRM: The product that (almost) nobody wants

A few years ago, I was an industry analyst covering the IPTV (Internet Protocol Television) industry--the video delivery technology used by Verizon (FiOS) and AT&T (U-Verse) in the U.S., and many other companies worldwide. One of the hardware segments of IPTV that I tracked was Digital Rights Management (DRM). When I came on-board, the retiring analyst whom I replaced warned me that the DRM vendors would probably cause me ten times as much grief as those in any other segment. He was right.

DRM is an unusual business: The companies that demand that DRM be used aren't the ones that pay for it. You can't distribute television shows or movies from any of the major television networks or studios unless you have an acceptable DRM system in place. The same is true if you want to distribute eBooks from most of the major publishers (O'Reilly is the biggest exception...in fact, O'Reilly demands that its eBooks be distributed without DRM.)

The movie studios, television networks and publishers often specify which DRM systems are acceptable, but they don't pay for them. That cost is borne by cable and IPTV operators, over-the-top video distributors (such as Netflix and Amazon) and eBook distributors. For their part, cable and IPTV operators have their own conditional access systems, and a nearly foolproof way of keeping unauthorized users from getting their content--in the worst case, they can send out a truck and disconnect the pirates from their network. However, that's not good enough for the movie studios and television networks, who want to make sure that their content can not only not be viewed by the wrong people, but that it also can't be copied.

Over-the-top video and eBook distributors are less concerned about piracy than they are about making their services extremely easy to use, in order to stimulate sales. They already require usernames and passwords in order to download content, which helps to insure that only those customers who are authorized to access their content can get it. They want DRM, but they don't want it to make their services hard for average consumers to use. The more hoops that consumers have to jump through in order to purchase, download and use content, the less likely it is that consumers will continue purchasing from those vendors.

Apple and Amazon developed their own DRM systems, which were designed to protect content while making access as easy as possible for consumers. Most other companies don't have the ability to develop their own DRM systems, and that's where third-party vendors come in. Content distributors want the cheapest DRM systems they can get that are acceptable to their content suppliers, because DRM adds no value for the consumer (it actually subtracts value), and it adds cost for distributors while offering little or no value. The only parties that it serves are the content providers, who don't pay for the DRM systems, implement them or deal with customer complaints.

This has created a field of third-party DRM vendors who are fairly paranoid. DRM vendors regularly compete on price, but some companies have chosen other approaches. Widevine, which was acquired in 2010 by Google, had several patents on its DRM technology and would threaten (and sometimes file) patent infringement lawsuits against competitors who were undercutting it on price. Widevine used the same tactics against market research and industry analyst companies that didn't report on the company the way that it wanted, or that put its competitors in a positive light. In the case of the company I worked for, Widevine demanded that we lower the installation counts that we had compiled for some of its competitors. When we refused to do so, it threatened to file suit against us. We easily could have prevailed in any litigation (simply going public with their threat would have been sufficient to destroy their credibility), but the owner of my company caved in and removed Widevine's name from our report, replacing it with "Anonymous". Shortly after, Widevine signed a consulting contract with us, hoping to have more influence over our reporting. When a subsequent report had installation counts for competitors that Widevine disagreed with, they again threatened to file suit, and my company's owner again caved into their demands. I demanded that the company take my name off the report and resigned shortly after, because I didn't want my reputation to be sullied. 

Another company, NDS (owned by News Corporation) refused to give us any numbers for its installed base, but after each report we issued, they would complain loudly that our numbers were inaccurate. When we said that we would be glad to adjust the numbers if they gave us installed base numbers that we could confirm, they said that they were under no obligation to give us any information. Given that they were unwilling to provide any evidence to support their complaints, we stuck with our numbers.

In short, DRM is a product that (almost) nobody wants, where the companies that want it don't pay for it, and most of the companies that are forced to pay for it don't really want it. That would be enough to make just about anyone a little paranoid.

Advertising is dead. Deal with it.

Have you ever had the feeling that you were a fly buzzing against a window, not knowing that you could escape if you just moved a few inches to one side? That's how I've felt recently, thinking about how to build an advertising-supported Internet site. I've come to the conclusion that, for all but a handful of sites, it's impossible to build a successful business by depending on advertising.

The classical advertising model was based on an economy with few media outlets and many media consumers. In the U.S., for decades there were three broadcast television networks and three commercial television stations in most markets. In most cities, there were one, or at most two, newspapers. The scarcity of media outlets meant that each outlet had a large audience, and that audience attracted advertisers, who were willing to pay enough to turn the outlets into viable businesses.

The Internet turned the classical model on its head: Instead of having a small number of media outlets, each with large audiences, we have a huge number of outlets, each with small audiences. Only a handful of sites and services on the Internet have been able to attract the audiences necessary to make an advertising-based revenue model work. The cost of setting up an Internet site is tending toward zero, especially if you can convince people to create content for you for free. Operators of these kinds of sites can run them profitably, or at least not at a large loss, right up to the point where they have to pay people for their content and services. That's why The Huffington Post has pushed back so hard against bloggers who want to be paid for the content that they provide to the site. If the HuffPo had to pay for all its content at market rates, it would go bust.

The problem goes beyond the Internet--cable television networks, in the aggregate, have a bigger audience than the broadcast networks, but few cable networks attract a big enough audience on their own to be viable without fees paid by cable, satellite and IPTV services. That's why cable networks and service providers fight so hard against "a la carte" pricing that would allow subscribers to pick and choose channels.

So, what should you do? If you're thinking about starting a business, pick a business and a business model that allows you to charge users. If you're running a business that is advertising-supported, or that you hope to run on advertising revenues in the future, pivot to a business and business model that can be profitable on user fees. If you're an investor and someone comes to you with a business plan that depends on advertising revenues, walk away. In short, if you can't get your users to pay for your service, you're in the wrong business.

U.S. cable subscribers continue to decline

SNL Kagan has released its Q4 2010 report on U.S. video service subscribers. The number of cable subscribers declined by 526,000 for the quarter, the third quarter in a row that cable's subscriber count has declined. Satellite operators added 133,000 subscribers, and IPTV service providers (primarily Verizon and AT&T) added 458,000 subscribers. Overall, the net number of multichannel video subscribers (cable, satellite and IPTV together) increased by 65,000.

The numbers don't add much evidence one way or the other for "cord-cutting", but they clearly suggest that the cable industry's subscriber losses are becoming a long-term trend. However, cable's competitors aren't doing themselves any favors. In particular, AT&T raised its rates considerably this year, and two days ago, the company announced that it will begin capping its DSL bandwidth starting May 2nd. Conventional DSL customers will be capped at 150GB, and U-Verse customers will be limited to 250GB. (The limits will not be imposed until a customer has exceeded their limits three times during the life of their AT&T account.)

The primary reason for customers to shift from cable operators to satellite and IPTV (as well as the primary motivator for cord-cutting) is saving money. If cable competitors raise rates and put limits on their services, they'll end up giving cable subscribers a reason not to switch. SNL Kagan reports that cable operators have almost 60% of the market, so it's their market to lose.

Internet TV will turn your next HDTV into a set-top box

Ryan Lawler of NewTeeVee has written an excellent post about how the just-concluded Consumer Electronics Show demonstrated that HDTV manufacturers have become the new consumer gatekeepers, and cable (as well as satellite and IPTV) operators are just another content option. This is thanks to the Internet TV functions built into almost all of the major-brand HDTVs introduced at the conference. Some manufacturers, such as Samsung, Vizio and Sony, have licensed Internet TV technology from Yahoo, Google and/or Boxee. Others, such as Panasonic, have developed their own Internet TV systems.

Lawler's argument is somewhat premature, in that only a small minority of installed HDTVs have Internet TV capabilities, and sales growth in the U.S. market has slowed to only 1% per year. Nevertheless, it points out a "blind spot" in many industry observers' thinking (including my own). The focus to date has been on set-top boxes from Apple, Boxee, Google, Roku, etc. The argument has been made that most consumers won't add another set-top box to the one they already have from their cable, satellite or IPTV provider.

Last year, the U.S. Federal Communications Commission proposed a new set-top box design called AllVid that would combine the functionality of service provider and over-the-top set-top boxes in a single device. However, Internet TVs don't require a separate set-top box for over-the-top Internet video, and as Lawler points out, consumers' incumbent multichannel video services show up as one of many content choices, including Netflix, Amazon on Demand, Twitter, Pandora and other services. These Internet TVs accomplish most of the goals of AllVid without requiring any changes to existing set-top boxes.

On the other hand, just as there's currently a lot of consumer confusion about how to choose among Apple TV, Boxee, Google TV, Roku, Vudu and other over-the-top set-top boxes, there will be confusion about the Internet TV services built into the new HDTVs. That's in addition to the existing confusion over HDTV resolutions, refresh rates, backlight technologies and 3D technologies/formats, all of which may be enough to stall consumer adoption. I don't think that there's a chance that we'll see any real standards, either de facto or imposed by the consumer electronics industry, to lessen the confusion. It will take several years for technologies and formats to shake out.

Sooner or later, however, most HDTVs will be Internet-enabled, and at that point, the third-party set-top box argument will be moot. The real challenge for the current set-top box vendors will be to get their systems integrated into HDTVs. Yahoo is in the lead today, but with strong competition from Google and Boxee, it's not likely to keep it over the long run.

Comcast out, AT&T's U-Verse in

Yesterday, after years of getting video and high-speed Internet service from Comcast in California and Illinois, I switched to AT&T's U-verse IPTV service. There were two big reasons for making the switch:

• Cost: Even with HD service to only a single television, no premium channels (HBO, Showtime, etc), moderate Internet speeds and domestic phone service, I was paying almost $200/month with my most recent price increase. This is the same service that I paid around $120/month for two years ago with "teaser" rates. The U-verse service is around $150/month, with more channels (including premium channels) and faster Internet speeds. I could have gotten an even better rate had I been willing to commit to 12 months of service.
• Quality: Some channels (for example, the local CBS station) were so compressed and filled with errors that audio would frequently drop out and video would freeze. I initially thought that the problem was with the television station itself, but watching the same station on U-Verse was a revelation: Not a single audio dropout or video freeze in hours.

AT&T gives the same three-hour "window" for installers to arrive as the cable operators, but it also advises customers to allow four hours for the installation. In my case, AT&T sent two installers, who called me 35 minutes before they arrived and showed up 5 minutes into the window. It took them just two hours to complete the installation (I needed a few hours more to get everything working on my network).

A few observations from very early use of U-verse:

• Even though I was supposed to be getting around 12mbps down from my Comcast service, I measured the speed before AT&T started its installation and only got around 8mbps down. The U-verse service measures a true 12mbps down.
• AT&T really, really wants you to use their 2Wire gateway for everything related to the Internet, but even though I got the very latest 2Wire model, it still only had 802.11 b/g wireless, not 802.11n.
• I received what appear to be Cisco's latest set-top boxes. Compared to the elderly behemoth Motorola box that Comcast used, they're much smaller and more modern, with a far more attractive user interface and electronic program guide.
• One thing I miss from the Comcast system is that the AT&T remotes lack a "Favorite" button to take me immediately to my list of favorite channels. Instead, I have to navigate the set-top box's menu tree to reach the favorite list.
• I don't at all miss the never-ending parade of commercials that Comcast runs on its own systems disparaging its competitors. If Comcast could sell that commercial inventory, they'd have enough money to buy NBC Universal twice over.

In hindsight, I should have dropped Comcast at least six months ago.

Pay more, get less

Two stories broke late last year that were seemingly unrelated, but in fact are closely related once you think about them. Last November, industry research company SNL Kagan announced that in Q3 2010, U.S. cable subscribers declined by their greatest amount, 741,000, since Kagan first started tracking the industry in 1980. Even with subscriber increases for IPTV and satellite television providers, the multichannel video provider industry as a whole lost 119,000 subscribers.

Cable prices have been going up for years, and IPTV prices, which had been kept lower than cable to provide an incentive for cable subscribers to switch, have also begun to rise. Plans by Time Warner Cable to increase its rates in 2011 first leaked in late November, and after a 2010 rate increase in most markets, Comcast announced late last year that it will raise rates again in 2011, by an average of 4.6%. On December 29th, AT&T announced that it would increase rates in 2011 for its U-Verse IPTV service from 2.4% to 10.2%, effective February 1, 2011.

Now, let's turn to another business--motion pictures. On December 29th, Hollywood.com projected that total theatrical ticket sales revenues would be slightly lower than last year, but that the number of tickets sold would be down by 5.36%, the second-biggest drop in the decade. The only reason that revenues were as good as they were was the inflated price of 3-D tickets. According to the Los Angeles Times, 8% of ticket revenues in 2010, or $850 million, came from the $3 to $4 premium charged for 3D tickets. Without that premium, revenues would also have been down more than 8% year-over-year. Like the cable industry, ticket prices have been going up for years, and attendance has been in a long-term decline.

So, in both the cable and theatrical motion picture businesses, we have prices going up and the number of actual customers going down. No one is arguing that subscribers or moviegoers are getting more for their money--they're simply being forced to pay more for the same content and service. Time Warner, Comcast and AT&T have all essentially said that they're fine with that, and they'll raise prices even more. The LA Times quotes Jeff Blake, vice chairman of Sony Pictures, as saying: "Focusing purely on headcount is nice if you don't want to accept money. But if money goes up while bodies go down, I'm not sure it's necessarily a bad thing." (Can you show me ONE Sony division that knows what it's doing?)

So, Mr. Blake and the executives at the cable and IPTV operators, here's the problem: Price elasticity of demand. There's now a significant body of evidence that demand for both multichannel video services and theatrical motion picture tickets has become elastic, which means that price changes have a disproportionate effect on demand. So, as prices go up, an even higher percentage of cable subscribers will switch to alternatives, and an even greater number of consumers will wait to see movies via Redbox, Netflix, Amazon, Apple, cable, satellite, IPTV, etc. HDTVs bring the big-screen experience into the living room, and 3D HDTVs will eventually eliminate 3D as a big reason to go to the theater.

One other thing that Mr. Blake doesn't seem to understand: Theaters make most of their money not from tickets, but from sales of food and drinks at their concession stands. If 5.36% fewer people go to the theaters, that's 5.36% fewer people buying food. If ticket prices are inflated, that's less money that consumers will be willing to spend on food. Mr. Blake might not care if he's making the same money from fewer people, but theaters care greatly, and if price increases cause further concentration of the theater business, it will give the remaining theaters much more negotiating power against the movie studios.

Both the cable operators and the movie studios seem to think of their services and products as essential goods without reasonable substitutes; in other words, consumers have to purchase them, no matter what the price. Even before the Great Recession, evidence was mounting that the "essential goods" designation was wrong. Consumers do have substitutes: They can replace cable with satellite or IPTV, or even with over-the-air broadcasts that are, in many cases, of significantly higher quality than the signals provided by the multichannel video operators. They can replace a $10 movie ticket with a $1 DVD rental at Redbox. They can replace both cable and movie theaters with streamed movies and television shows from Netflix, Amazon and Apple.

It's clear that both the cable and motion picture industries will stay on their present courses. They'll continue to raise prices and lose customers, until they reach the point where they're no longer profitable, and even then, they'll stay on course while they expect things to "go back to normal." The problem is that there's no more "normal" to go back to. The "new normal" may very well turn into the worst nightmare of the cable and motion picture industries.

Sezmi drops basic cable channels

Sezmi, the hybrid broadcast/over-the-top Internet service, announced last week that it will discontinue its $19.99/month bundle of 23 basic cable channels. The cable channel service was only launched in a portion of the Los Angeles market, and Sezmi claims that customers didn't want it, although it was the only thing differentiating the Sezmi service from a good over-the-air antenna.

Now, Sezmi is falling back to a package combining broadcast TV, video-on-demand and Web content for $4.99/month. However, in order to use the Sezmi service, subscribers need a high-speed Internet connection and Sezmi's $150 bundle of a broadcast antenna and 1 Terabyte DVR. By comparison, consumers could subscribe to the ivi TV service for $4.99, which only requires a high-speed Internet connection and runs on most personal computers.

I don't think that lack of customer interest was the only, or even the primary, reason why Sezmi dropped its cable package. However, Sezmi now has an additional problem--many customers in its 35 other markets bought the Sezmi system with the expectation that they would eventually get access to the cable channel package. Now that the cable channel option is dead, I expect many users to discontinue the service or demand refunds.

Sezmi has changed its focus to providing IPTV services for telecom providers in countries with minimal infrastructure, such as the company's recent deal with Malaysian service provider YTL Communications, using YTL's LTE wireless network. As a result, the eventual discontinuation of its U.S. service may not be a big problem. However, Sezmi's problems once again illustrate the difficulties for new players trying to break into the U.S. multichannel video business.

Episode 4 of the Feldman File videoblog is live!

It's Sunday night, and that means that I've posted a new episode of the Feldman File videoblog on YouTube! Here's the rundown for this week's edition:

• Apple's less-than-earthshaking announcement about adding the Beatles' music catalog to iTunes
• Sony follows up on its Super 35MM camcorder, the PMW-F3, with yet another Super 35MM camcorder, the 35MM NXCAM
• U.S. cable operators lose 741,000 subscribers in Q3--are consumers really cutting the cord?
• The Obama Adminsitration is looking for 500MHz of additional broadband bandwidth, and the National Telecommunications and Information Administration found 2.2GHz of bandwidth available within ten years. So, do we really have a bandwidth shortage?

U.S. pay TV subscribers fall for a second straight quarter

SNL Kagan is reporting that the number of pay TV subscribers in the U.S. has fallen for the second straight quarter, the first time that's happened since Kagan first started tracking the industry in 1980. Cable operators lost 741,000 cable-only subscribers, the largest quarterly loss for cable ever measured by SNL Kagan, while IPTV operators (primarily Verizon and AT&T) gained 476,000 subscribers. Together, satellite operators Dish and DirecTV gained 145,000 subscribers for the quarter. The net loss for all subscription television services was 119,000 subscribers.

Multichannel News points out one of the big reasons for cable's decline: When analog over-the-air broadcasts were phased out in the U.S., cable operators in particular offered very enticing offers to over-the-air households to get them to adopt cable. Those deals are expiring or have already expired, and former over-the-air television viewers are facing big increases in their cable rates. In addition, the price difference between the "basic cable" tier, which is closest to conventional over-the-air TV, and even the cheapest premium tier can be substantial. Multichannel News gives the example of a Comcast cable system that goes from $13.65/month for "lifeline" service to $62.60/month for its "Digital Starter" service.

IPTV and satellite operators have targeted price-sensitive cable subscribers with low-cost service and, in the case of IPTV, triple-play (video, high-speed Internet and telephone) packages priced below the "magic" $99/month number. That explains the gains by IPTV and satellite providers, but it doesn't explain the whole picture. Television Broadcast quotes SNL Kagan senior analyst Ian Olgeirson: "... it is becoming increasingly difficult to dismiss the impact of over-the-top [Internet] substitution on video subscriber performance, particularly after seeing declines during the period of the year that tends to produce the largest subscriber gains due to seasonal shifts back to television viewing and subscription packages."

Economic conditions may be driving the changes, but the changes are real, and they may not be temporary. Unless cable operators get a lot more competitive in how they price and package their services, they're going to be increasingly vulnerable to IPTV and satellite providers, as well as over-the-top Internet video.

Are cable and IPTV operators going to "back into" a la carte?

NewTeeVee ran an article last week about AT&T's decision to drop Crown Media Holding's Hallmark Channel and Hallmark Movie Channel from its 2.5 million U-verse IPTV households in the U.S., effective September 1st. As of this writing (September 9th,) the channels haven't been reinstated. NewTeeVee said that a JPMorgan research report from last April found that there are only 50 cable networks in the U.S. for which 10% or more of cable subscribers would switch service providers in order to watch them. The Hallmark channels aren't within that group of 50 essential networks.

Cable, satellite and IPTV systems have the capacity to carry hundreds of channels, and system operators have been racing each other to offer the most networks. New and small cable networks can get carriage on cable systems by giving their programming to cable operators at no cost or paying to have their programming carried (called "reverse compensation".) However, most of those networks get little viewership, and the service providers are essentially wasting bandwidth by carrying them.

Cable operators have successfully fought the FCC for years to prevent the imposition of rules that would require them to allow viewers to choose, and pay for, only the channels they want to watch (often called "a la carte".) However, as they begin to drop lesser-watched channels in order to save on retransmission fees, the operators of those networks will put political pressure on the FCC to protect them.

Cable and IPTV operators could turn this situation to their advantage (satellite operators have less flexibility, due to their technology.) As cable operators move to switched digital video and IP transport, they will have the ability to send any channel (or set of channels) to any subscriber. (IPTV operators like AT&T and Verizon can do this today.) These operators could offer to make small networks available on an a la carte basis in return for revenue sharing (for example, 70% of the fee would go to the cable operator and 30% to the network.) There would be some upfront costs to the network for making their content available to subscribers.

The "top 50" essential networks wouldn't be subject to a la carte, so those network operators would be unlikely to fight the move with the FCC or U.S. Congress. Some customers might actually save money by buying a few channels a la carte.  The cable and IPTV operators could position the move as sensitivity to consumer demand. They would also have more latitude to remove unpopular channels, giving them more flexibility to offer HD and 3D channels, and more bandwidth for high-speed Internet services.

In Cable TV, one quarter does not a trend make

Today, SNL Kagan reported that in the second quarter of this year, net pay TV subscriptions in the U.S. dropped for the first time in history. Cable systems lost 711,000 subscribers, and six of the eight largest cable operators reported their worst subscriber losses ever. So that means that consumers are dropping pay TV and moving to over-the-top Internet video services, right?

Not necessarily. Satellite (DirecTV and Dish) and IPTV services (Verizon FiOS and AT&T U-Verse) gained a total of 495,000 subscribers in the same quarter (414,000 for IPTV, 81,000 for satellite), and the satellite services don't even offer high-speed Internet. Why the big gain? You've probably seen the aggressive introductory price deals offered by the satellite and IPTV companies on television or in the mail, so people are switching to these services to save money.

Really? According to Steve Hawley, an IPTV industry analyst I used to work with, the monthly ARPU (Average Revenue per User, or subscriber) for the IPTV services is higher than that of any of the major cable operators. Only Cablevision comes close to Verizon and AT&T. That means that on average, the IPTV operators are charging more per month than the cable operators.

But pay television still lost a net of 216,000 subscribers in the quarter, so that still means that those subscribers went to Internet video, right? Perhaps, but Verizon and AT&T lost 515,000 subscribers to their DSL high-speed Internet services in the quarter, and you need high-speed Internet for Internet video.

So what does it all mean? We simply don't know yet. Over the next year or so, we can start sorting out what's really going on and identify the underlying causes. Are we seeing a temporary drop due to economic pressures (people losing or in fear of losing their jobs) that will be reversed when the economy improves? Are people experimenting with Internet video or committing to it as a replacement for pay TV? Is there a long-term shift from cable to IPTV and satellite, or in a saturated market, are people simply switching back and forth to get the best deal, just like they used to do with long distance services?

The key thing to remember is that one quarter does not a trend make.

Pace to acquire 2Wire for $475 million

On the heels of passing Motorola in the worldwide set-top box business, Pace will acquire 2Wire for $475 million. 2Wire supplies DSL routers for AT&T and other service providers, and also supplies media management software. Pace has recently been chosen to provide next-generation set-top boxes to Comcast, so the addition of 2Wire will give Pace an excellent position in both the U.S. Cable and IPTV markets.

FCC: Will AllVid be CableCARD Part Deux?

Last Wednesday, the U.S. Federal Communications Commission (FCC) issued a Notice of Inquiry concerning its plan for next-generation set-top boxes. The FCC's intention is to encourage a retail market for intelligent set-top boxes that can support just about any video service, including cable, satellite, IPTV and over-the-top Internet video content. The FCC tried to do the same thing several years ago with its CableCARD initiative, but even the Commission now recognizes that CableCARD has failed.

The original concept was to enable consumers to purchase cable set-top boxes from any of a variety of suppliers, and then rent a CableCARD that would be compatible with individual cable operators' conditional access, authentication and encryption systems. Somewhere between the original concept and actual implementation, the wheels fell off. CableCARDs could only handle one channel at a time and were one-way only, which meant that they couldn't be used for on-demand, pay-per-view or interactive applications. Two cards were required for DVRs in order to watch one program and simultaneously record a second program. The monthly lease price for CableCARDs wasn't all that much less than complete set-top boxes. Cable operators still required installers to come to customers' homes in order to set up CableCARDs, and few installers were trained on how to set them up properly. As a result, CableCARD was a bust.

In the FCC's new proposal, consumers would purchase a "smart video device" (set-top box) that would work for any "multichannel video programming distributor" (MVPD), including cable, satellite and IPTV operators, as well as Internet video providers. Then, each MPVD (except for the Internet video providers, who would connect via Ethernet or WiFi) would supply a "set-back" device, also called an "AllVid adapter", which would serve as a tuner and also perform conditional access, authentication and decryption functions. The FCC would like the AllVid adapters to connect to the smart video devices via Ethernet and to use standard IP protocol to send and receive audio, video and data, so technically, an AllVid adapter could be connected to a conventional network router and make video content available to any device on a home network.

The FCC's goal of "one box to rule them all" is laudable, but it's likely to have many of the same problems as CableCARD. First of all, despite the Commission's attempt to redefine terms, consumers would have to have at least two set-top boxes: The smart video device and one or more AllVid adapters. The AllVid adapters would be proprietary to each service provider, so for example, if a consumer moves from an area serviced by Comcast to one serviced by Cox Cable, they'll have to lease or buy a new AllVid adapter. AllVid adapters are likely to be even more expensive than CableCARDs, since they'll perform many more functions.

Two important goals of the new AllVid strategy are to make over-the-top Internet content an "equal partner" to video from service providers on television sets, and to prohibit service providers from limiting access to over-the-top content. However, service providers will fight hard against the new proposal in order to maintain content control in the living room. They're likely to argue that AllVid adapters will be set-top boxes in all but name, so why not allow them to continue to lease all-in-one set-top boxes to consumers? They'll also argue that they've just invested an enormous amount of money to implement the Commission's CableCARD mandate, and now the Commission wants them to throw out that investment and implement another unproven technology. Satellite and IPTV service providers, who were unaffected by the CableCARD situation, would be covered under the new plan, so it's likely that they'll oppose the FCC's recommendations as well.

If the FCC hadn't already tried and failed with CableCARD, I'd give AllVid a better-than-even chance of success, but in its present form and with CableCARD's experience behind it, I give AllVid very little chance of making it to market. AllVid would elevate over-the-top Internet video content from a bit player in the living room to an equal partner, and the incumbent service providers will do almost anything to keep that from happening.

The most important thing left out of the National Broadband Plan

The Executive Summary of the National Broadband Plan was released today by the FCC (PDF link), and what's been proposed is largely in line with what was leaked in the last few weeks. The FCC wants to get affordable broadband service with 100 Mbps download and 50 Mbps upload speeds into at least 100 million homes by the end of this decade. The Plan proposes lots of ways to get there, from subsidizing expansion of wired Internet connections in rural communities to reallocating 500MHz of wireless bandwidth to broadband service. However, for all the platitudes in the plan about lowering costs and making broadband service more affordable, there's precious little (at least in the executive summary) proposed to actually back up that intent.

A few years ago, when I was an industry analyst covering the IPTV market, I regularly traveled to Europe. My visits to France were particularly enlightening. There were multiple service providers offering IPTV, high-speed Internet and local & long distance phone service at the equivalent of around $30 a month; less than one-third the price of the $99 triple-play deals offered in the U.S., with similar or better channel selections and Internet speeds. As you can imagine, the French services were wildly popular.

So why was triple-play service so much less expensive in France (and so much better)? The French Government required France Telecom to make its lines available to competitors at wholesale prices. Far from slowing down the growth of broadband access, the French Government's decision caused usage of broadband services to explode for everyone, including France Telecom.

Telephone companies in the U.S. were once required to provide their lines available to competitors on a wholesale basis, and the U.S. had a healthy competitive market for DSL services. Cable operators, on the other hand, were never required to make their networks available to competitors. In the Clinton Administration, the same team that drafted the National Broadband Plan allowed telephone companies to stop making their networks available to competitors as part of the Telecommunications Act of 1996, ostensibly to encourage phone companies to make bigger investments in their networks and further the growth of broadband.

We saw what happened: Most of the phone companies that were originally part of AT&T got consolidated back into AT&T. As a practical matter, most U.S. households have a choice of broadband service from two suppliers--the incumbent telephone company and cable operator. There's no meaningful price competition. U.S. households pay much more for much slower Internet service than do households in many other countries.

I'm not saying that the National Broadband Plan doesn't have merit, or that it shouldn't be taken seriously. What I am saying is that the thing that's most likely to increase competition, lower costs and make more broadband access available is to open up the existing cable and telecom networks for wholesale availability. That idea is nowhere to be found in the National Broadband Plan, and there's no surprise why.

Update, March 22, 2010: The Berkman Center for Internet & Society at Harvard University did an extensive study of broadband in the U.S. and the rest of the world for the FCC, and released the report, "Next Generation Connectivity" in February, 2010. The report speaks to the points that I made in this blog post, plus much more. Click here to access the entire study, or visit this article at the New York Times for a summary of the relevant points.

Is there really a market for IPTV?

Late last week, Tilgin sold off its IPTV set-top box business to Amino in order to concentrate on the IP Residential Gateway business. The initial sale price was 30 million SEK, plus a potential bonus based on sales performance. Tilgin is just one of many second- and third-tier IPTV suppliers that have sold out to bigger competitors, and the list is only going to get longer as the worldwide recession drags on. The residential gateway business isn't exactly a bonanza, either; Pace is struggling to establish a business there, and the business argument for gateways isn't clear for a lot of operators.

The overarching question is whether or not there's really a market for IPTV services. IPTV is doing well in France, Spain and some other European markets, but in France in particular, consumers can get a complete triple-play bundle including IPTV for not much more than what U.S. customers pay for a single service. In Hong Kong, PCCW was the world leader in terms of subscriber count for a number of years, but now PCCW and China Netcom are merging, and the question is whether or not PCCW has finally saturated the market. In Japan, IPTV services have been all but stillborn, even with the country's largest telecommnuications companies (NTT, KDDI and Softbank) behind it.

In most of the first world, IPTV entered the market as the third or fourth choice for video services, after broadcast, cable and satellite. Where IPTV has been really successful, one or more of the following is true:

1) The IPTV services are offered at a dramatically lower price than competitive video services (that's certainly true in France.)
2) Local competitors let the IPTV services take hold with high prices, bad customer service, etc.
3) The IPTV provider offers non-video services that the local competitors couldn't match (in the U.S., Verizon's FiOS data service offered far faster speeds than cable operators, and Verizon used that advantage to sell FiOS TV into those same customers.)
4) The existing local video choices are rudimentary or nonexistent.

Where advanced cable services are available, it remains all but impossible to differentiate IPTV services from cable. The interactive features of IPTV are nice, but there's nothing that the cable industry can't match. Even satellite providers are getting into the interactivity game with Internet connections on their set-top boxes.

I do believe that there is, and will continue to be, a market for IPTV, but it's smaller than most of the analysts have been forecasting, and even smaller than I forecast when I was in that business. We'll continue to see tremendous pressure on second- and third-tier IPTV hardware and software suppliers to merge, discontinue their IPTV product lines or go out of business. We'll also see tremendous pressure on IPTV service providers to differentiate their offerings by price rather than functionality. Ultimately, IPTV will be just one of several video options for consumers.

AT&T's latest tactic for U-Verse: Free money!

AT&T is willing to buy U-Verse subscribers, at $200 a pop. Here's the deal, according to xchange Magazine: Sign up for a mid- or high-tier IPTV service package (starting at $59/month), keep it for at least a month, and get back $200. The most expensive of the three packages starts at $119/month, and in all three packages covered by this plan, subscribers get three set-top boxes, including one DVR, and additional set-top boxes are $5/month. Subscribers don't need to commit to any long-term contracts, or to bundles with phone or high-speed Internet. The program ends on January 31, 2009.

In other words, if you sign up for the lowest tier of service covered under this plan, you get a month of free service and $140 in your wallet. I don't think that AT&T expects everyone to throw out their current cable or satellite service in order to get the $200, but at least for a significant number of users, the $200 will cover their cable or satellite bills while they try AT&T's U-Verse service. Their hope is that a lot of those users will be sold on U-Verse, and will then drop their incumbent video service.

Given my suspicious nature, I've got to wonder why AT&T is offering this fairly incredible deal. I don't track subscriber counts anymore, but AT&T's subscriber growth must be slowing down dramatically. This plan will be an excellent way to boost the company's subscriber count by the end of the year. How many of those new subscribers will stick around after their first month is anyone's guess.

I can't see any of the major cable or satellite providers matching AT&T's deal, and I'm not sure that they have to. Comcast has for some time been running an unpublicized "hold at any cost" program to keep its subscribers from defecting to competitors, offering no-cost upgrades and free service. In the markets where Comcast and AT&T compete, I'd expect them to offer free service to those customers who ask to cancel in the face of AT&T's deal--"Keep your Comcast service for the next two months for free, and compare it with your AT&T service; we think that you'll prefer Comcast." Other operators are likely to do the same thing. The result will be lots of double-counted subscribers, but no one will really know how effective AT&T's promotion will be until well into next year, when we see how many of the subscribers bought by AT&T stay with them when the money runs out.