Internet Video: The Evolution From a Push to Pull Economic Model

After two posts last week on video and the internet, I thought I would take the time to summarize comments and provide some additional thoughts. Roger Ehrenberg had an interesting post a few days ago on video – but it was about two years too late. I was thinking about the evolution of on demand model in 2004 and if I was thinking about how the economic transaction model evolves in 2004, I know people smarter then me were thinking about it well before 2004. In short, this is the evolution from a push economic model to a pull economic model. For this post, I took some comments I received privately and combined them with some of the comments left by Scott Berry.

Private Emailer: “Anyone who lived through the optical meltdown ought to be skeptical about this supposed “tsunami” of video traffic, but it seems that few people are.”

WRK: I agree completely. If service providers provide data on the traffic flows and how it is impacting their infrastructure then I will believe video is causing something to happen. On March 6, 2000 Bernie Ebbers, then Worldcom CEO, stated at the New Economy Summit at Boston College that Worldcom was adding capacity of 800 percent annually to keep up with growth of the internet and that Worldcom’s CAPEX spending would exceed $100 billion a year by 2003. How did that work out?

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Scott Berry: “Video is *not* undermonetized from a transport perspective, just from a content perspective. P2P video is like people shipping diamonds via UPS, but cutting DeBeers out of the loop. UPS is making a good profit.

WRK: That is a humorous analogy.

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Scott Berry: Level 3 Communications (LVLT) originally positioned itself for commodity play in transport. But bandwidth is not a commodity, because it's not fungible. Last mile monopoly/duopoly prevents it. In light of this, they are embracing Cadence Design (CDN) and hoping their low-cost transport will raise revenue and let them gain share on a pricing basis. Not convinced it will.

WRK: Spot on. I agree completely. I think many people are confused and cannot separate a messaging for a marketing/positioning initiative from a technical network plan derived from real business drivers.

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Scott Berry: “Telcos/Cable are using duopoly to desperately hold onto vertical integration model because they are singularly *unsuited* to succeeding in a commodity market. To the extent their hold is broken, the model becomes horizontal. If they can't monetize the content as well as transport, they fail to achieve growth the Street demands.”

Private Emailer: “It makes me bristle every time [a RBOC CEO] says he doesn't want other service providers riding his pipes for free. If I pay him each month for the pipe into my house, then it is not free, and it is none of his business what I do with it. I am sure Google (GOOG) will make some money off YouTube from advertising. People who sell Internet access bandwidth to consumers may make some incremental revenue if YouTube convinces consumers to buy a higher bandwidth package from them. If not, then they don't make anything. So, from the service provider perspective, YouTube is under/non-monetized. The content owner (Google, in this case) doesn't see it that way.”

WRK: The long term effect of applications become services is not that they become free, it is they become lower margin, flat rate based services. Service providers are looking at a future of flat rate based bandwidth (i.e. data rate) with a variety of flat rate based services on top of the data rate: VoIP, Video and Mobile. This I why I believe premium content providers will leverage the infrastructure and derive high margins for in demand content. The question to be determined is who will provide localized ad insertion and how ill that revenue be split?

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Scott Berry: No tidal wave in VC activity because long haul (on per bit basis) is already relatively cheap. It has been metro/last mile that has prevented "natural" video tsunami and vertical decoupling. The problem is not technical, it is regulatory and business model driven.

Private Emailer: “The other issue that I think too many don’t get is that IP video and Internet video are not the same thing. Clearly, all the service providers are moving toward IP delivery of broadcast and on-demand video services, but that doesn’t mean that this traffic will traverse the Internet. These service providers are using their own IP backbones for video backhaul, not using the Internet. For example, Comcast (CMCSA) has already starting using IP multicast to distribute broadcast video via their backbone so they can start shutting off the satellite distribution network. It will take a while, but it is going to happen. Not one bit of this traffic will hit the Internet.”

WRK: I have no disagreement with either of these points. The fact that AT&T (T), Verizon (VZ), Qwest (Q) and Sprint (S) all own backbones is really hard to dismiss if you believe that video will kill the internet. Then there is the fact that Akamai (AKAM) runs a CDN without a backbone and Google, Amazon (AMZN) and eBay (EBAY) have huge distributed server clusters linked with leased pipes.

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Scott Berry: This has been true since the late 90s—every time someone predicts shortages in long haul bandwidth, they fail to materialize because the local access bandwidth never happens. I'm sure you know that US broadband penetration stats are equally a myth. Try comparing product of (actual) bandwidth and broadband penetration, and US is even farther behind world than official stats suggest. Even worse if you look at upstream bandwidth.

Private Emailer: “So, what exactly is this Internet video that is going to vastly increase bandwidth demand? Today, it is mostly YouTube (and calling that under-monetized is being kind). It remains to be seen whether Internet distribution of movies will become a dominant option for the average person. I have never even been tempted to download a movie over the Internet because it is still much too hard to view the movie on my television. I would never consider watching a movie on my computer, and I am not going to install an entertainment PC in my living room. The new Apple (AAPL) iTV and the new TiVo (TIVO) partnership with Amazon Unbox offer some hopes that it will become easier to use the Internet for movie download, but the jury is still out. I remain skeptical that a sea change is inevitable. Could happen, but surely not a lock. And I don’t think I will be betting any of my investment money on it. I would rather own the stock of the content providers. Any way you slice it, they will be good for a piece of the revenue that results from new content distribution models, while the intermediate service providers may get little to nothing out of it.”

WRK: The answer to why the dreams of the New Economy/Digital Revolution were unrealized in the 1990s has more do with local access speeds then backbones. Name a technical proof point from the 1990s bubble? Answer: Optical backbones can be built nationally and internationally faster and cheaper then anyone thought possible in early 1990s. I have extensively written on content in the past and I continue to believe that long term, I want to be in the position of content ownership rather then content distribution.

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Scott Berry: “1st fiber to the home "wins", and VZ knows it. But they are carefully restricting bandwidth (a "mere" 20 M or so). Otherwise, no one would use them for other than bit transport, and their service business would be dead. But they can't justify buildout costs without it, so they're stuck.”

Private Emailer: “I don't believe first fiber to the home wins, unless the service provider who provides that fiber really opens it up and resists the temptation to build a wall around the garden. If they open it up and provide a simple bandwidth/connectivity solution, then they win. It would be suicide for a second provider to build fiber to that home only to engage in a contest to see who to offer the lowest cost BW service. But if the first provider instead artificially limits bandwidth and/or tries to foist their own vertical service structure on the consumer, then there is an opening for one or more other service providers to run fiber and offer a bandwidth/connectivity service. Assuming that content is freely available (no exclusivity deals like NFL Sunday Ticket with DirecTV (DTV)), then the second fiber provider has a chance to compete and win business. Clearly, Verizon is intent on building a wall around the garden, so I do not concede that FiOS will make them the ultimate winner. That having been said, it would take plenty deep pockets to build a competing fiber access network. However, I am not convinced that fiber is required. With DOCSIS 3.0, I think that MSOs can provide sufficient BW to the home to compete.”

WRK: I have written that DOCSIS 3.0 and FTTH are going to collide, result in a war between really big companies and selling equipment to support these warring camps will be a good business. If I was a VC, I would be much more interested in this game then sprinkling $5-10-20M here and there to fund little companies to build boutonniere applications for mobile devices. If your objective is to build a big business, the game you choose to play in has to be big.

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Private Emailer: “Verizon Wireless is busily trying to figure out how to limit the ability of their customers to access competing services like P2P and SIP. The technology is there to allow them to do this, but it is not clear that the regulatory environment will allow it. The recent Skype suit filed with the FCC will be very telling.”

WRK: Do you want walled garden or open borders? From a social/historical perspective we have always sought to tear down walls and borders. We embrace freedom of movement and exchange of ideas. If we are a species that seeks to embrace openness, why do we close our systems and business to outsiders? The answer: to protect revenue!

Full Disclosure: I do not own shares of any of the companies mentioned in this post, with the exception of Google.