Scenario - Viewers' Choice
TRANSCRIPT
Merrill Lehman – ET3: Entertainment, Telecom, Technology Trends 2010
Panel Session
Viewers’ Choice: Entertainment and Telco Transformation
Panelists:
- Jeffrey L. Bewkes – CEO, MSTV Entertainment Group (Nasdaq: MSFT)
- David Chance – Managing Director, BT Entertainment, Plc. (Nasdaq ADR: BTEY)
- Ivan G. Seidenberg – Chairman and CEO, Verizon Communications (NYSE: VZ)
Moderator: (applause) “Gentlemen, we’re delighted you’ve joined us here today. This is really one of the first gatherings where we have an opportunity to look back at the role of telecom in changing the video entertainment landscape. On this panel, I’d like to focus on what role telecom carriers have carved out in the video entertainment world, how they did it, and discuss it in the context of the overall transformation of telcos.
“Jeff, let’s start with you. You left an heir-apparent position at Time-Warner (NYSE: TWX), overseeing a portfolio of successful networks, including HBO where earlier you’d famously brought us a half-dozen or so ground-breaking series.
“Now you’ve defied the skeptics, overcome prior industry history, and helped drive Microsoft and US telcos to a strategic win in television, well beyond just the infrastructure. Can you start by talking about the underlying strategy and how telcos fit in?”
Jeff Bewkes: “Sure, I’d be happy to. You know, I’d been aware of US telco aspirations in television for a long time, and about five years ago when I saw another round of this brewing, I just shook my head, ‘there they go again…’ It conjured memories of these disasters from the early ‘90s like BellAtlantic studios – sorry Ivan, I know that wasn’t your fault (laughter) – or Americast, or TeleTV. But let me tell you a little history here, because I think it will help lay out both the vision and reality of what we’ve accomplished with our telco partners.
[Microsoft CEO] Steve Ballmer came to see me one day at the beginning of a recruiting campaign whose intensity I totally underestimated.
“From my point of view, that meeting went very badly. He went on and on about the whole history of Microsoft and TV, the cable investments, the set top boxes, the ‘Tiger’ or something-or-other servers, how IP television was going to be totally different. I either thought or might have even said out loud, ‘Steve, you’re putting me to sleep here with an endless litany of failure!’ (laughter).
“He goes away, and back comes Bill Gates to New York a couple of weeks later, under the guise of being in town with [former Microsoft CTO] Nathan Myhrvold who insisted they try dinner at ‘Per Se’, in fact why don’t I join them? So we meet that evening downstairs, and Bill casually lays out the vision. It was smart, big, and – this was a few years ago, remember – looked many moves ahead on the chessboard. Let me net it out in the simplified way I understood it.
“Now, I’d heard all kinds of technology companies, including people at Time-Warner, promoting the view that ‘rich’ media, video, etc. was going to be a central part of the whole IP communications user experience. Once everything ‘converged’, it was a short step to El Dorado, etc. You may remember there was once a great advocate for this view at our own company, a guy named Steve Case. (laughter) But I’d kept hearing it was just around the corner, always we were ‘just at the beginning’ of a limitless future, the usual Silicon Valley story of the last fifteen years or so. And as I think Bill was aware, the AOL aftertaste was still unpleasant.
”...most people … were reading the telco opportunity incorrectly… it represented an opportunity to change the nature of the internet experience and business model in ways that come about quite rarely…”
“Bill’s view was that most people, probably including the telcos themselves, were reading the telco TV opportunity incorrectly. He thought it represented an opportunity to change the nature of the internet experience and business model in ways that come about quite rarely, and that Microsoft had been patiently preparing for. He didn’t quite say it, but clearly in his mind, Microsoft’s role in cable was destined to be pretty limited, so this was their last major chance.
“In his heart, Bill knew that watching stuff via a PC, whether jazzed up as a ‘home media center’ or not, was probably destined to be a side show. Your infrastructure, your services, your content, need to get to the large screen in the family room without asking consumers to buy complicated boxes and do technical gymnastics inside the home. Otherwise it wasn’t going to be more than a niche.
“The telco TV initiatives were that opportunity for Microsoft… except the way things seemed to be going, if Microsoft didn’t step up to helping the telcos get a differentiated video service together, the whole thing might implode. Bill’s view was that clones of cable services – or even worse, watered down cable offers – would doom the telcos to a quagmire from which they’d never recover.
“So he would give me free reign to start a company built around alternative video offers for telcos, which would be a three-way win – two for Microsoft, and one for telcos. Microsoft would get its next-generation video infrastructure to really roll out in a big way and become a sustainable competitive platform.
“Secondly, Microsoft’s organization and packaging of content, while not profitable for a while, would have telcos as distribution partners as well as fuel Microsoft’s languishing internet services strategy. They’d stop the death of a thousand cuts they’d been experiencing from companies like Yahoo! (Nasdaq: YHOO), Google (Nasdaq: GOOG), Electronic Arts (Nasdaq: ERTS), Apple (Nasdaq: AAPL), Real Networks (Nasdaq: RNWK), etc., etc. Oh, and yes, the telcos, they’d actually get to succeed at what they were still stumbling around trying to do.
“Three things clicked in my head as he talked.
”...contrary to popular wisdom, the cable model was actually quite vulnerable in my opinion…”
“First: Totally contrary to popular wisdom, the cable model was actually quite vulnerable in my opinion. Cable kept trying to jam most of the emerging content diversity into the ‘more channels, fatter tiers’ model, and that was going to break.
“The answer to people’s appetite for narrow interest content isn’t to have the ‘Vegetarian Auto Repair channel’, or whatever. That’s not how you do personalization. And while I didn’t think the threatened à la carte regulations or legislation were likely, it was indicative of a problem in the industry. So was the proliferation of DVRs to skim out what you want to watch from these piles of channels. Typical of the media industry, at Time-Warner we saw DVRs basically as a threat to ad revenues, not as something to wake us up to doing things differently, despite the lip service we gave, or the number of boxes the cable division shipped.
“Second – big heresy here: Both the cable and satellite video-on-demand models were a bit of a dead end. Despite initial success, VoD – as implemented by cable as a closed, ‘we decide what’s in the library’ kind of model – had limited potential. In my mind it was still warmed-over pay-per-view, with a few giveaways thrown in, or analogous to the early AOL ‘walled garden’ approach.
“In the case of cable, they used a shotgun approach and built a whole ‘tier’ of VoD stuff nearly as complicated as the base packages themselves. But still, a lot of stuff subscribers would like to see and pay for on demand just wasn’t going to be made available to them. A cable company could compete against NetFlix (Nasdaq: NFLX) on impulse buying and speed of delivery only for a fraction of titles a subscriber might want. And that’s just NetFlix – itself a very limited library.
”... a very comfortable system…was all designed around big studio or broadcaster, big cable or satellite delivery, fat tiers of programming packages, artificial release windows, ..., etc.”
“This wasn’t an unfortunate limitation of network technology, it was part of the cable model itself. A very comfortable system existed between producers and distributors of video content. It was all designed around big studio or broadcaster, big cable or satellite delivery, fat tiers of programming packages, artificial release windows, and rich 60/40 splits of fairly expensively-priced movies, concerts, etc.
“Third: There were already signs that subscriber appetite for ‘value’ or simpler and more customizable video packages was probably quite high. While I didn’t say this over dinner, I was becoming a little unsettled by developments I saw in the UK, for which David [Chance] was already partly responsible, even before he went to BT (NYSE ADS: BT).
“Around the end of ’04 or so, the UK was already well down the path to digital television, something like 50% of TV households had already gone digital, in some form, by then. The UK was a market where you had free-to-air channels like the BBC and so on, BSkyB (NYSE ADS: BSY), David’s satellite alma mater, and NTL (Nasdaq: NTLI) for cable. The cable and satellite services were on the same course as the US, only more so – even fancier, as expensive or more.
“Along comes a service called ‘Freeview’, which is one of the main reasons the digital number was 50%. It was formed, in part for regulatory and public policy reasons as part of the digital transition. They offered something like 30 free digital channels and 20 music channels, the box cost around eighty pounds, or something. This is what consultants like to call ‘disruptive’. What interested me were the commercial opportunities it created, a bit analogous to the US initiatives with open CableCARD-enabled boxes and televisions.
“Clearly, this model prompted Sky to offer lower-tier services, as well as provided an up-sell path for them. David co-founded ‘Top Up TV’ which offered ten pay TV channels on the Freeview platform. The point is we saw big shifts and fragmentation to smaller, more value-focused television packages in a market that, according to textbooks, should have been pretty mature and well-penetrated.
“So put all this together—Bill’s concerned that the telco TV initiative might be the last catalyst in the US to get Microsoft on the video map in a big way and juice up their internet presence. I believe the cable model is getting bloated and vulnerable, that there’s a whole new approach to on-demand content, and that there’s appetite for value-priced, simpler video offers. By the end of the dinner, I started thinking seriously about the possibilities…”
Moderator: “How was the food?” (laughter)
Jeff Bewkes: “Nathan’s gourmet campaign failed. Bill would have been happier with a burger.”
Moderator: “This might be a perfect point to segue into the next chapter of the story. Ivan, maybe you can pick up on this and then bring us up to date on Verizon’s current success?”
Ivan Seidenberg: “Okay, let me give that a shot. At Verizon, we’d already selected Microsoft’s IP television solutions, the servers, set-top software, and so on for our FiOS-TV roll-out. The strategic question we were grappling with was ‘if we don’t go head-to-head as a full-service video alternative to cable or satellite, what exactly do we offer?’
“The cable industry started ganging up on us from the get go. They made sure broadcasters would seek unprecedented carriage fees from us, that we were forced to buy from the top of the rate card, especially in sports and movies, that we were unfairly accused of cream-skimming or red-lining in more lucrative neighborhoods, that we would have to compete for local franchise approval in an inapplicable cable regulation model, and so on. And they bought even more control of more channels and more movie libraries.
“Along comes Jeff to the new Microsoft venture. He came to us and laid out a different video model: attack cable’s vulnerabilities with an open, personalized on-demand model, a streamlined, value tier of programming, including local channels, and a good deal of à la carte flexibility. He’d already begun preparing programming package deals, and seemed very excited by the possibility of upending the studio/broadcaster to delivery network relationships.
“We had a session with Jeff, he sounded something like: ‘I mean, I could take an entire Sundance festival, on-demand monetize more than half the content in six months and get three times the lifetime theatrical release and DVD revenue of the festival winners alone and still have some syndication rights left over.’ At the time, we weren’t entirely sure… well, honestly, we had absolutely no idea what he was talking about … (laughter) but we knew it wasn’t the kind of thinking we knew how to do, and that this was exactly the track we were looking for.
”...people who thought we had to have a cable-equivalent video ARPU, so-called ‘full-service’ video in order to pay for the fiber network investment were entirely wrong…”
“I will tell you this – people who thought we had to have a cable-equivalent video ARPU [average revenue per unit/user], so-called ‘full-service’ video in order to pay for the fiber network investment were entirely wrong. Our financial models called for fairly modest video penetration and ARPU, we just weren’t sure what our offer was going to be yet. Video has always been meant to complement our broadband, IP-telephony, and wireless services revenues, not displace cable per se.
“What the MSTV programming service enabled us to tap – create, really – is a large, growing, alternative, value segment served with, as Jeff said, an offer that’s simultaneously richer and much more flexible than basic cable. Then there’s our on-demand service that brings orders of magnitude more content and personalization in all kinds of specialties than cable does. Our VoD buy rates are three times higher than cable as a result.
“I have to emphasize, the big breakthrough for us was figuring out how to avoid head-to-head video competition with cable, and being pragmatic about the likelihood of achieving success in video without substantial help on the programming side. You know, back when digital satellite started, DirecTV (NYSE: DTV)was a bunch of ex-aerospace engineers at Hughes who got taken to the cleaners early on by the media industry. But they learned, and it turned into a huge success. For us, there wasn’t room or time for that kind of on-the-job learning and risk any more.
“Having Microsoft as our infrastructure and programming partner all in one has been extremely fortunate. Obviously, Microsoft’s NBC Universal (NYSE: GE) relationship at MSNBC, and MSN itself on the internet, have also played into both content and broadband synergies for us, including in our wireless services. I think for Microsoft, those resources were sitting around largely untapped or in silos, until MSTV emerged as the flywheel for levering a lot of Microsoft assets in new combinations.
“So the net outcome of all this is that the economic advantage it created is both on our top line, and in cable’s shrinking EBITDA. By offering better value, we’ve hurt cable and their core video subscription business significantly. That’s the center of their business model. If that suffers, then ad revenues go down, fewer bundles of other services are sold. They’re very busy now working up ways to stop subscriber erosion. Also, I think clearly you’ve seen cable backpedaling very rapidly from positioning their phone service as an add-on to digital video only – i.e. you have to subscribe to pretty premium offers before phone service is part of the bundle. I’m wondering whether cable regrets getting into the phone business…” (laughter).
Moderator: “Thanks Ivan. Finally, let’s turn to David Chance from BT Entertainment. David, Jeff’s dinner-with-Bill story pointed rather far-sightedly to disruptive changes in consumer video services. You were on the scene in Scandinavia and the UK driving that early on. It seems you found a like-minded executive in [CEO] Ben Verwaayen at BT Group?”
David Chance: “Indeed. Ben’s mantra on video, as far back as ’04 was ‘innovation, not duplication’.
“Remember, at that time BT Group were just undertaking a major transformation of both the network architecture and business model. BT viewed video services as a significant part of the twenty-first century network, or ‘21CN’ direction. The strategy enabled by 21CN was, in a sense, ‘innovation, not duplication’ writ large. Ben rejected telecoms’ classic two-part strategy of regulatory squabbling plus ‘me too, but cheaper’, i.e. undifferentiated offers with discounting. As an outside director at [UK wireless carrier] mmO2, I began to better understand telecoms as an industry. It became apparent that BT’s strategy was quite radical.
Moderator: “In what ways, and how does that relate to your video business?”
David Chance: “Radical in three ways. First, there were no pre-conceptions about video other than it had to start with the customer and not be a carbon-copy of BSkyB or NTL. Second, BT were already learning from their environment quite early on– Jeff mentioned Freeview, and my prior company, Top Up TV. Third, we are a free-standing entity, enjoying wholesale relationships with multiple video distribution networks, but principally BT Group.”
Moderator: “Can you speak a little about the last point, and contrast it with Jeff’s group?”
Jeff Bewkes: “And leave out the wealth-creation comparisons…” (laughter)
David Chance: “Well, my understanding is that MSTV may yet become a listed company at some point as well…
“At BT Entertainment, we enjoy an arms-length, wholesale relationship with video distribution companies for both regulatory and business model reasons. BT Group and [UK regulator] Ofcom were getting on well, and Ben’s view was that applying the wholesale/retail design to BT’s video undertakings would be both good public policy, and a good business model, in line with the structural separation of BT and Openreach, the retail arm.”
Moderator: “And has it been?”
”...Freeview [created] a robust wholesale programming market in which [many] throughout Europe now participate.”
David Chance: “Absolutely. In several senses. One is that our example added to the wave kicked off by Freeview – the creation of a robust wholesale programming market in which BSkyB, or News Corp. (NYSE: NWS) generally, and others throughout Europe now participate.
“Secondly, and as a result, consumers’ cost of programming, especially sports, has declined, while choices have multiplied. This has been good for subscribers, and good for diversity and innovation of programming supply. So BT Group purchase programming from multiple sources, not just us, and at BT Entertainment we sell to NTL, and even some US satellite services.
“I’d add another point, and here I’d say we’re still a bit ahead of the US. The term ‘à la carte’ has acquired, for some reason, a pejorative connotation in the US market. In Europe, we took our cue very early on from music services. As you know, the album-oriented format of music retailing has been largely supplanted by individual song purchases. We studied the economics and the licensing, royalty and distribution elements of that business model quite closely in our implementation of on-demand video services.
“I think we can credit Jeff and MSTV for creating considerably greater on-demand programming supply than cable alone, but we’ve created royalty and rights-management processes which give us three times the number of titles that Jeff currently offers. Frankly, our view was that Microsoft’s ambitions for digital rights management software and standards were a hindrance rather than a help to MSTV’s library development.”
Moderator: “What have been the major disappointments, if any, as the video business has rolled out?”
David Chance: “I think both in Europe and the US, but especially Europe, the development of multi-room, multi-computer services has been very disappointing. Most of us expected a follow-on tranche of growth to be driven by subscribers adding the same services they had on their ‘main’ television or computer, to other parts of the house or flat where they live. This hasn’t materialized.
”In the UK, further video service penetration is restrained by the same consumer attitudes that existed towards the ‘telephone in the hallway’. Twenty-five years ago or so, the home telephone in Britain was, for many, just one handset permanently wired into a wall in a somewhat central place. The idea of ‘extensions’ and cordless phones was considered strange and unnecessarily lavish.
“Now we have a similar attitudes towards multi-room video, compounded by the fact that the condition of inside wiring in many UK homes corresponds roughly to the old stereotypes about our heating systems – clumsy and ineffective. Either the wires aren’t there, or they aren’t good enough. One can’t simply hook up more televisions in more rooms to a central set-top box without undertaking major inside wiring costs. These are generally too high to be underwritten by the network operator, and most households see this as intrusive and poor value for money.
“In the US, with larger homes, different viewing patterns, more pre-existing wiring, and so much new construction, the problem has been less pronounced, but nevertheless acts as a significant brake on additional ‘revenue generating units’, as they call them, per household.”
Moderator: “David, Thank you. And thanks to Jeff and Ivan for sharing their insights. (applause) We’ll open up the floor to Q&A now…”
* * * * *Disclaimer: This “transcript” is entirely fictitious, created to illustrate simulated strategic outcomes in telecom and other industries. We use the names of actual companies and publicly-known individuals in order to add a measure of realism, detail, and interest to discussions of industry strategy. We are entirely responsible for the views expressed in these simulated scenarios; they are not endorsed, sponsored, or in any way the responsibility of the entities or individuals named herein.
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11 October 05
