by Roger Bakos and John Kuykendall
(Reprinted from the March/April 2006 issue of the OPASTCO Roundtable magazine)
"Triple play" is taking rural telephone companies by storm. Surveys indicate that many rural telcos are adding video to their offerings or are seriously considering deploying it in the near future. This phenomenon has been created by several factors, including changes in consumer spending habits, increased competition from cable TV companies, and the availability of technologies that allow telephone companies to deliver video over their own facilities. However, offering video services in rural areas is a very different business and, to further complicate matters, the video market appears to be on the verge of some fundamental changes.
From a rural telco's perspective, developing a coherent, viable business plan can be daunting, especially if the company has little or no previous experience offering video services. Factors that JSI clients must consider include significant deployment costs (especially if purchasing a headend), the continued rise in programming costs and competition from cable TV and satellite providers, which rival each other in market share. To balance out these cost considerations, the business plan should consider not only traditional sources of revenue but also ways to utilize new technological advances to produce higher margins such as "on demand" type services.
Playing Offense or Defense?
Rural telcos are compelled to consider video either proactively for "offensive" reasons or reactively for "defensive" reasons. The "defensive" reasons are generally well understood-a competitor, often a cable company, has begun to offer competing voice services in the telco service area. However, the "offensive" rational for offering video actually may be more compelling.
When considering subscribers' spending habits for telecommunications and entertainment services, it shouldn't come as a shock to learn that most consumers spend significantly more on video services than they do for local, long distance or Internet services. TNS Telecoms estimates that for second quarter 2005, the average consumer spent $36.31 for local telephone service, $13.47 for long distance service, $32.79 for Internet service, and $57.12 for video service. For companies, this type of consumer spending information is sobering. By considering how consumers spend their money, they appear to value video services more than wireline voice or Internet access services. Accordingly, even if there is no threat of a cable company offering voice services in your area, rural telcos should seriously consider whether or not offering video services - in some form or another - is a viable option.
What Does the Video Business Case Look Like?
Offering video services entails much more than simply providing "big fat pipes" to subscribers like traditional telecommunications services. The video business is built around reselling someone else's content. More importantly, for most markets, even in the most rural areas, offering a basic set of video channels won't satisfy your subscribers' service expectations or your company's financial goals.
Rural telcos can learn quite a bit from looking at the financial statements reported by publicly traded, "pure-play" cable companies. Programming costs impose quite a burden on their business cases and programming-related expenses can range from 40-50 percent of revenue. In most cases, revenue attributed to their core channel lineups is profitable, but only meagerly so. As a result, many of the large cable companies have aggressively expanded their services offerings to include Internet access and voice services and have augmented their core video service margins by offering pay per view (PPV), video on demand (VoD), digital video recorders (DVRs), and high definition television (HDTV). Deploying these new types of video services also helps combat the competitive threat posed by satellite TV providers.
This insight has a significant effect on how rural telcos develop their business strategies. To be successful at the retail level and to achieve their financial goals, rural telcos should deploy a "fully featured" suite of video services. This imposes technical requirements on how the video services are delivered (i.e. bandwidth) and on the content and service capabilities that need to be provided.
Is Anyone Really Going To Buy This Stuff?
Rural telco managers commonly question the demand for these higher margin services in rural markets. To answer this question, current demand should be considered, but, more importantly, the answer lies in the future demand of these services. Market studies indicate that subscriptions to PPV and VoD service offerings are steadily increasing. One market research firm, the Gartner Group, estimates that since the introduction of PPV and VoD services, video revenue has changed from 100 percent fixed-rate subscription based to a mix of 70 percent fixed-rate subscription based and 30 percent PPV and VoD service based. Gartner predicts that this growth trend will continue to the point that the percentages of this revenue mix will reverse in five years.
There are similar encouraging forecasts for HDTV. The Yankee Group estimates that more than 40 percent of U.S. households will have HDTV-capable equipment by 2007 and that 90 percent of those households will subscribe to an HDTV service from either a cable, satellite or telco video provider.
What Do You Mean The Video Business Is Changing?
Further complicating matters, indications are that this industry could be very different five to 10 years from now. Industry players are forming new alliances and creating innovative new Internet-based video offerings. Some examples include Google's "Video Store" and the video iPod from Apple which allow consumers to purchase TV shows from the major networks. Cingular has partnered with MobiTV to allow consumers to access shows on wireless handsets, and Sprint Nextel and large cable companies have entered into a joint venture which will purportedly allow consumers to access streaming TV programming, video clips and prerecorded DVR programs over Sprint Nextel's wireless devices.
This movement towards a business model where programming can be obtained from multiple sources has the potential to decouple the content from the actual broadband pipe delivered to the customer. This creates both challenges and opportunities for telcos that are either currently providing video services or would like to begin offering video services in the near future. For example, access to programming over the Internet may provide consumers with new options to access video so they would be less likely to use your company's video services. On the other hand, such access to programming may provide more economical ways for rural telcos to obtain content. Also, video in the future could change to such an extent that the high costs associated with purchasing a headend would be minimized or even eliminated, thus making entry into the video market more economically feasible for many rural telcos.
Video Deployment Issues
Making the transition from simply providing connectivity and bandwidth to providing video services is complex, especially for rural telcos with little familiarity with video-related technologies. Simply creating the infrastructure to acquire, manage and market content is a difficult task. Because offering video services really boils down to re-selling and distributing someone else's content, one of the contractual requirements rural telcos will need to meet is to ensure that only paying subscribers have access to the broadcast or stored content.
Video data can be "conditioned" to reconcile any discrepancies in the video data format that need to be addressed between the time the video content is received and distributed to end users. Depending on the terms of the content deals, there may be requirements to protect content using encryption and/or digital rights management techniques. The compression and encoding schemes vary between different content owners, and this translates directly into higher costs for the video providers.
Rural telcos using DSL to deliver video are probably very aware of DSL's bandwidth limitations. Two relatively new compression schemes, MPEG-4 and Windows Media Video 9, reduce the video stream bitrates to approximately half. But not all content providers distribute their video signals using these new compression techniques. Most still use MPEG-2. In order to take advantage of the new compression techniques in their distribution network, a video service provider must incur the additional transcoding costs. However, for companies just getting into the video business, these costs can be minimized or avoided by "pre-engineering" their content acquisition and distribution processes.
Conditioning also is used to store content for VoD services. Some VoD content providers "pre-encrypt" content prior to being stored on a video server to protect the content. Content providers alternatively may require real-time encoding as subscribers view the material, giving the content owners the ability to change encryption algorithms. These conditioning and protection mechanisms translate into requirements throughout the entire distribution system, from the headend to set top box, and must be kept in mind while negotiating for content and designing the delivery network.
Fortunately, there are new content distribution methods entering the market that should make it easier and cheaper to appropriately distribute content. "Content aggregators" are distributing encrypted content that can be delivered directly to subscribers, thereby alleviating many of the current encryption and digital rights management issues.
Best-of-Breed or One-Stop-Shopping?
In addition to the obvious plant-related issues, rural telcos deploying video will require (or need to share) a head end, middleware, VoD servers, content management applications, content protection or digital rights management systems, and set top boxes. One of the more difficult, and overlooked, technical aspects of deploying video services is making everything work, especially if multiple vendors are involved. To address this problem, vendors and vendor partnerships offer "pre-integrated" solutions containing most or all of the video-related functions (excluding loop products) as a single integrated package.
At some point prior to implementation, the telco must determine if it prefers to acquire all the products from one vendor (a "one-stop-shop") or from various vendors ("best-of-breed" solution). The amount of time available for deployment is one of the major factors which must be considered when making this significant decision. For example, if a rural telco's video business plan requires strict time schedules and a tight budget, the "one-stop-shop" method would be preferable. If time is not as critical, the rural telco may want to deploy a "best-of-breed" solution since it may provide additional, avant garde capabilities but because of the integration complexity, introduces significant risk to schedules and budgets.
Impact that Changes May Have on Regulation of Video Services
Video and cable TV services currently must comply with a variety of federal, state and local regulations. These regulations, however, apply to one-way video services and not to "on demand" services. With the move to more "on demand" services and implementation of Internet-based video delivery services (IPTV), certain regulations could be relaxed, be strengthened, or eliminated altogether.
For example, SBC and other large telcos have made claims that IPTV services are not subject to local franchise authorities and should not be regulated in the same manner as conventional cable TV companies. These companies have been actively lobbying at the state level, at the FCC and before Congress for elimination of the local franchise requirement based on this argument. In response, some states have either passed legislation or have legislation pending to enact state-wide franchises. Additionally, the FCC has opened a proceeding regarding problems with obtaining franchises and bills are pending before Congress related to these issues. Pressure to make changes in how IPTV services are regulated is likely to increase as IPTV subscribership grows (one research firm, Multimedia Research Group, Inc., projects 36 million IPTV subscribers by 2009).
Copyright also becomes a concern. As more content becomes available by downloading from a variety of sources, will current copyright law provide adequate protection to copyright owners? Will it be necessary to modify the current process of video and cable companies pay copyright royalty fees?
Rather than wait for regulators to make these types of decisions, JSI clients should work diligently to encourage regulators to craft rules which would be in their favor. One such case would be the need to obtain programming on a non-discriminatory basis. Under current rules, rural telcos are at an unfair disadvantage in obtaining programming since they must compete with large national cable companies and telcos which have greater purchasing power and are able to obtain programming at significantly lower prices. In some instances, rural telcos have been denied access to certain programmers or have not been allowed to participate in cooperative purchasing groups. Without action on the part of regulators, the promise of access to multiple programming sources could be dashed as the larger nationwide industry players make deals that don't include rural telcos.
Conclusion
Rural telcos have provided outstanding voice service for decades, but in today's market, they are finding that it isn't enough. Developing a business case for video has historically been difficult due to the network costs and competition but with the availability of shared headend arrangments and new programming services like the NRTC IPTV offering, the cost of entry is becoming less formidable thus making the rural telco business case for video more feasible. America's thirst for entertainment choices is far from quenched. Accordingly, our clients are well-positioned in the marketplace if they are able to develop and successfully implement a viable business case for providing a full suite of services - voice, video and data - to their rural subscribers.
Roger Bakos is John Staurulakis Inc.'s manager of business development and John Kuykendall is JSI's staff director of regulatory services. Valerie Wimer, JSI's director of business development, also contributed to this article.
