[IP] All Things IP: the Future of Communications in America
Above the Crowd
All Things IP: the Future of Communications in America
by J. William Gurley
"Gonna keep on tryin'
Till I reach the highest ground"
-Stevie Wonder, Higher Ground
Take a trip to Korea or Japan and you will immediately have a new
appreciation for the definition of broadband. There, it is not uncommon
for a consumer's Internet connection to breathe a blazingly fast 10 plus
megabits per second. In Japan, Yahoo BB goes a step further, trumpeting a
full 45 Mbps offering for a cool US$37 per month. Still not amazed? Korea
boasts a mind-boggling 80% broadband penetration rate, while the U.S. still
ambles around half that. That said, even the U.S.'s 42% penetration rate
is deceptive, as the U.S. version of broadband is a far cry from these
Asian fire hoses.
What is most striking about the notion of a 45 megabit IP connection is
the overwhelming universality of such an incredibly high-speed packet-based
conduit. Into it melt all forms of media and communications - voice, data,
video, and any other application or service you might imagine. There is no
need to consider bringing multiple connections or service providers into
your home, for this network can do everything you need and more. Early
signs in Japan are consistent with this notion. Yahoo BB announced a
stunning 80% attachment rate on its IP-based phone service. It is now
promoting an IP-based set-top box for the ultimate in personalized television.
One cannot help but wonder if we are headed for a similar fate in the
United Sates - a single super high-speed pipe into the home that carries
all media forms over a simple standard IP connection. It certainly seems
probable, although the path to such a reality is by no means a straight
line. The key constituents (the cable companies and the RBOCs) each will
make key business decisions over the next 5-10 years that will dictate the
likeliness of such an outcome, and in doing so could simultaneously ensure
their own leadership or obsolescence.
Here are seven key issues/questions that will shape the future of
communications in the U.S.
1) Who is the leader today?
Make no mistake about it; the cable companies rule the broadband world in
the U.S. While their networks are not currently "all-IP," their coax
cables are the only communications transport capable of carrying voice,
data, and video simultaneously. The satellite broadcasters are indeed
gaining steam on the video side, and they have improved their data
offerings, but voice is a real stretch due to latency. The RBOCs
unfortunately sit in the worst position. Not only are the current copper
wires quite feeble when compared to a coax cable, but the RBOCs are
simultaneously hamstrung by excessive regulations, including the
requirement that they share their networks. RBOC execs have claimed these
rules are a disincentive to investment, however, as we will discuss later,
it's the RBOCs that have everything to lose from under investment.
2) Will there be a long-term, stand-alone business for voice services?
It is a common macro-economic understanding that marginal pricing will
eventually approach marginal cost, assuming a competitive environment. As
long as there are "enough" providers of high-speed IP connections for each
home, and assuming that the government does not impose regulations that
hamper market forces, voice should one day be absolutely free. Already,
any two broadband users anywhere in the world can make wonderfully free
voice calls using the peer-to-peer client from Skype. Those that question
the quality of these calls have obviously not used the product.
Now, while voice should be free, that doesn't mean that it will be
free. The two conditions outlined above are nontrivial. First and
foremost, it is not at all clear that we have enough competition in the
U.S. broadband market. Innovations in the wireless market, particularly
recent innovations around mesh architectures, have the opportunity to
change this. As of right now, however, many users simply lack
choice. Additionally, the many state municipalities around the country are
eager to place their hands on VoIP. A poorly executed policy could in fact
"increase" the long term pricing on voice services for all users (for
example, would you really tax a free service?). The regulators are
supposedly looking after the best interest of consumers, but it is hard for
them not to look after their own longevity as well.
One huge irony in the marketplace is that the cable companies may
actually control the near-term fate of the RBOCs. It would be quite easy
for the cable companies to decide to make voice a free service over
broadband. The marginal costs are simply not that high, especially if you
assume an IP based phone solution such as Vonage or Skype. This type of
offering would likely lead to an attachment rate similar to Yahoo BB's in
Japan, which would in turn be devastating for the RBOCs. Yet there are two
reasons why the cable companies may choose not to do this. First, they may
have already fallen in love with the notion of charging for voice - they
may view it tactically rather than strategically. Alternatively, they may
view it as a strategic move to prolong frightening the RBOCs into fiber
deployment. The longer the RBOCs continue to believe there is a long-term
future in voice services, the better off the cable providers may be. More
on this later.
3) Was the offer for Disney driven by a vision of an all IP network?
It would be easy to dismiss the Comcast offer for Disney as just another
example of the standard media strategy of bridging content and
distribution. One could also point to the recent price hikes of cable
must-haves ESPN and MTV to see why Comcast might want a few aces in the
hole next time it has to barter. However, there may be one other reason
for such a move: a keen awareness that in an all-IP world the power of
distribution falls as all content providers can establish a direct
relationship with their customers. A similar move played out in the travel
industry last week when Hilton and many other hotels declared that in the
future, the best rates would be found on their own web sites, not on
Expedia or Travelocity.
Think about this. If you assume Brian Roberts and the team at Comcast
are rational, then they would only consider such an offer if they believed
that the market was overvaluing distribution relative to content. If they
felt the power of distribution would rise in the future relative to
content, it would be strategically inept to make such a move. The only
reasonable assumption is that, based on current information and valuations,
the company would love to trade distribution dollars for content
dollars. In an all-IP world, Disney would certainly have more choices and
alternatives than it does in a cable environment where its only negotiation
options are for channel placement and bundling inclusion - factors that are
both controlled by the cable company.
4) Will the cable providers "break" the IP network?
One of the most strategically interesting issues of the next ten years will
be the cable companies desire to "break" the IP network in an effort to
protect their video (and potentially voice) revenue streams. Make no
mistake about it, no cable company relishes a vision of the future whereby
it sells "X" megabits of IP connectivity and nothing more (i.e., a pure
commodity access provider). Cable companies are much too accustomed to
packaging, bundling, and upselling an array of offerings and
choices. Additionally, they are seeing early success with VOD (video on
demand) and believe it is their destiny to provide these services. An
all-IP (pure, traditional IP) network threatens these core business
assumptions.
So what's a cable company to do? It is quite easy for a cable company to
insert a half second delay in its IP network. This delay will go unnoticed
by standard web users but would quite negatively impact the quality of
after market VoIP clients like Skype and Vonage. This would allow the
cable company to "charge" for its own voice services. In other words,
customers would pay extra to have their IP network back. On the video
front, the cable companies have similar opportunities to offer priorities
to "sanctioned" IP-video streams, and intentionally reduce the quality of
streams to which the cable provider has no financial interest.
History would suggest these types of initiatives are continually being
considered. Cable broadband providers once charged for VPN services, a
similar "breaking" of the IP network to extract financial gain. What's
more, over the past twelve months, Comcast has terminated the accounts of
users who use more bandwidth than the company prefers. Lackluster support
of the "open cable" initiative over the years offers another proof point
that cable companies want as much control over the user experience as
possible. Again, it seems too improbable to assume that the cable
companies will quietly move towards a future as a commodity ISP.
The reality is, breaking the IP networks will elicit enormous waves of
negative feedback from core Internet users. Early actions like those
mentioned above have already been met with tremendous negative feedback
across the Web. That said, if there are no reasonable alternatives for
consumers for non-altered IP services, then the cable companies may very
well get away with such action.
5) How will the RBOCs respond?
The RBOCs are unfortunately in a difficult position. Their current IP
networks are simply too thin to provide the type of IP connection that can
realistically carry video. Additionally, they are burdened with excess
regulation, including one critical piece of regulation that requires they
allow competitors access to their physical assets. Lastly, cellular phones
and VoIP aggressively threaten their core revenue streams. While they
could theoretically make an offer for a satellite video company such as
DISH, this would require them to piece together an awkward multi-device
consumer experience.
The only real alternative is to immediately begin investing in a separate
high-speed all-IP network, either like those that have been built out in
Korea and Japan or one that leverages recent innovation in wireless. It
turns out that the RBOCs negotiated a regulatory carve-out whereby they are
not required to share new assets that are not part of the current
plant. More importantly, only by building a very high-speed IP network do
the RBOCs have any chance of slowing the onslaught of cable vis-á-vis
voice. While cable is busy puncturing the voice market, the RBOCs can make
an end run and puncture the traditional video market.
This will not be cheap, but waiting could be futile. While S&P has put
several of the RBOCs credit on a ratings watch, Wall Street has not fully
embraced the notion that wireline voice is under significant threat. As
such, the RBOCs market capitalizations are large enough that they might be
able to raise the capital necessary to upgrade their infrastructure. If
they wait until the cable voice attachment rate approaches that of Yahoo BB
in Japan (which really depends on the aggressiveness of cable VoIP
pricing), a pessimistic Wall Street may not be willing to provide the
capital needed to secure their future. Once more, that may be the scenario
that cable executives favor.
6) Who is underestimated in this market evolution?
Believe it or not, Microsoft is the company that may be most underestimated
in the all-IP network future. The company has done a magnificent job
developing its WM9 codec and corresponding DRM (digital rights management)
features and now appears to be the technology of choice for distributing
video over IP. WM9 has a strong presence in both Korea and
Japan. Hollywood appears to be satisfied with the DRM features and has
released many popular movie titles over such Internet sites at Movielink
and CinemaNow. Microsoft has also won a huge victory recently with respect
to the next generation DVD format, which will also include support for WM9.
Why does the codec matter? With strong execution, Microsoft can use its
position as a leader in codecs to back door its way into the operating
system and potentially into a position to control the UI for most consumer
electronics products. Until last summer, Microsoft only supported WM9
codecs on top of Windows operating systems. It has recently agreed to let
others build WM9 codecs for Linux, but rest assured it will focus its
support over time on Windows and WinCE. Controlling the UI (as it will
unquestionably do in PCs) is a very strong position from which to
aggregate, bundle, and extract rent from video over IP services.
7) Will there be a video over IP portal?
Who will make money from video over IP aggregation or distribution? As
just mentioned, Microsoft is in a very compelling position from which to
extract rent. You can already see a menu hierarchy within the media guide
on Windows Media Player. Just last week Microsoft agreed to pay $40MM to
roll access to Major League Baseball video underneath its premium MSN
services. That is direct proof that Microsoft sees itself as a key player
in video over IP aggregation.
The cable companies also warrant consideration, especially if they are
successful in altering the IP network to their benefit. Another key
advantage they bring to the table is a pre-existing billing relationship
with the customer. Any vendor that can authorize one-click ordering of
video content will have a huge advantage over someone that requires full
registration.
There are many others that will fight this battle over the next ten
years. Companies like Netflix and Movielink have strong early leadership
positions and have aggregated key content. The networks and the movie
studios likely fancy a vision whereby users will visit their sites directly
to purchase digital content. Based on Yahoo's original vision when they
purchased Broadcast.com, they might have an interest in this world, and
Amazon must certainly be thinking about the implications of fatter and
fatter IP pipes. Let's also not forget RealNetworks. If it is successful
in its litigation with Microsoft, RealNetworks will likely have a very
strong position in the market. Currently, it has major video distribution
deals with NASCAR, the NBA, and CNN.
While an all-IP world may not happen immediately, you can rest assured
that over the next ten years, our communications networks will very likely
follow the lead of the aggressive rollouts in Korea and Japan. As IP
engulfs everything else, many traditional industries and paradigms will be
challenged. For the companies involved, the time to prepare for these
challenges is today. Postponement will only increase the likelihood of
failure.
If you have any comments or feedback, please send them to
atc@xxxxxxxxxxxxxx The Above the Crowd archive is now available by
visiting <http://www.benchmark.com/about/bill.html>.
The Above the Crowd newsletter focuses on the evolution and economics of
high-technology business and strategy. The information contained herein
has been obtained from sources believed to be reliable but not necessarily
complete, and its accuracy cannot be guaranteed. Any opinions expressed
herein are subject to change without notice. The author is a General
Partner of Benchmark Capital and its affiliated companies and/or
individuals may have economic interests in the companies discussed
herein. J. William Gurley 2003. All rights reserved.
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