The Smart TV Transformation Is Under Way

For years, pay-TV services were the dominant means of delivering premium content to consumers. Today almost 900 million homes worldwide subscribe to pay-TV services, but new delivery technologies, with smartTVs at the forefront, have created new opportunities and new potential competition.

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The number of U.S. households with a smart TV increased to more than 18 million in 2011, and smartTVs will account for nearly one-half of all TVs shipping in 2012. Smart TVs allow consumers to connectdirectly to the Internet rather than via a separate device.

Further, most smart TVs ship with online video content services pre-installed. The smart TV app-based interface allows the number of potential content sources to grow and change over time. Thus, the smart TV helps to minimize barriers to entry into the consumer home for over-the-top (OTT) video providers.

Smart TVs also allow pay-TV providers to engage with consumers in new ways. Since 2010, pay-TVproviders and television original equipment manufacturers have discussed ways to bring managed content to smart TVs to lower capital expenditures (CAPEX) and satisfy consumers’ changing viewing habits.

However, operators also face challenges as to how they will defend their brands on devices that host content from multiple providers and have multiple interfaces, such as the OEM’s menu, a third-party interactive program guide, or an app store. Pay-TV providers do not want to lose potential subscriber revenues or potential advertising dollars to OTT video-on-demand services.

New Viewing Trends and Habits

Internet video viewing accounted for about 8 percent of all video consumption on the TV at the end of 2011, Parks Associates’ research found. New consumer viewing habits favor even greater adoption of online videoas OTT service providers, Internet service providers, telcos, consumer electronics manufacturers and others compete for a share of this growing market.

Online video generally offers lower-priced alternatives to traditional pay-TV subscriptions, making suchservices attractive to cash-strapped consumers and increasing the risks of cord-cutting and cord-shaving.Netflix now has a larger subscriber base than Comcast, the largest cable operator in the United States.

Consumers generally recognize that pay-TV services such as premiumVOD offer higher quality and greater selection than OTT options, Parks Associates research shows. However, services such as Netflix are easily the most affordable, stirring a cost-benefit analysis that affects consumers’ purchase decisions.

OTT providers have the opportunity to gain significant market share against pay-TV providers, both insubscriptions and transaction fees. (Why pay US$3 to see a new movie on VOD, for example, when you can watch reruns of a 1980s sitcom that come with a Netflix subscription?) To combat this loss, operators not only need to emphasize their inherent advantages in content and picture quality, but also need to develop alternative services that counter Netflix’s advantages in cost and flexibility.

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Smart TVs vs. Set-Top Box Deployments

Pay-TV providers can leverage smart TVs to their benefit to reduce costs. Providers are extremelyreluctant to replace legacy set-top boxes, because the process is expensive and requires hugeinvestments. Using the processing power of smart TVs or other TV-connected consumer electronics devices as set-top boxreplacements would substantially reduce the operator’s CAPEX.

There are also real opportunities to use connected devices to monetize rooms of the house where set-topboxes are not currently present. While operators appear reluctant to abandon set-top boxes entirely,this approach is feasible for second or third TVs within the subscriber’s home.

Of course, providers will lose the hardware rental fees that come with set-tops, and they will want tofind alternative revenues in order to maintain their ARPUs. In addition, operators want to be sure thatmoving set-top box functionality to a connected device does not simply replace CAPEX expenditureswith operating expenditures (OPEX) through increased support costs.

Thus, the operator’s interface application for these devices must be designed to guide consumers effectively so that pay-TV providers only receive support calls for issues related to the TV service, not for the CE device itself.

Smart TVs Capturing New Revenues

The smart TV app interface provides operators with the same opportunity to capture transactional orsubscription on-demand revenues that are available to online video services, but pay-TV services alsohave some distinct advantages over OTT services in this area. Because of their larger content deals, pay-TV providers can license content at a lower cost than OTT service providers. They can also bundle services such as TV Everywhere with other services to offer more premium content at a lower price to consumers.

Operators can also provide broadband subscribers with exceptions to broadband caps for contentprovided via their own service. By granting “free” broadband capacity for their own content, operatorsare able to use business models rather than traffic management to influence consumer content choice.

Smart TVs Increase Customer Satisfaction

Pay-TV providers view their ability to deliver premium content to smart TVs as an opportunity tolower CPE costs and expand the flexibility of consumer viewing methods. Smart TVs with motioncontrollers or voice recognition can also bring unique value to the user interface. All theseenhancements lead to higher customer satisfaction and a higher level of engagement, both withprogramming and advertising.

Smart TVs extend the whole-home DVR experience without additional set-top boxes.Whole-home DVRs allow consumers to access content that is recorded and stored on anetworked set-top box from peripheral set-top boxes in the home.

Several manufacturers arenow working with pay-TV providers to implement whole-home DVRs on their smart TVs so thatthe service is available to any room with a compatible smart TV. Consumers do not need tolease or buy extra boxes or install additional cables. Service providers gain additional viewingoptions without investing in expensive new hardware, all while increasing customer satisfactionand engagement.

Leveraging Content Through Virtual MSO Receivers

As pay-TV operators evaluate how best to monetize their TV Everywhere investments, anumber of global operators are considering expansion of their online delivery capabilities toconsumers who are not existing pay-TV subscribers.

For fixed-line operators, this decision mayinclude selling linear or on-demand services outside of the operator’s traditional footprint. As aresult, some TV service providers have become a type of virtual multichannel systems operator(virtual MSO), selling access to linear channels over the open Internet rather than through theirproprietary network.

Virtual MSOs have gained popularity at a faster rate among European andAsian service providers than in North America. As service providers in these regions contendwith much lower ARPUs (average revenue per user) on their primary services than do North American providers, they lookfor innovative ways to extend their potential customer bases.

Pay-TV providers can leverage their linear channels, VOD libraries, advertising sales teams,and existing relationships with content providers to become serious threats to OTT servicesand to expand their revenue opportunities beyond the constraints of their traditional landlinegeographies. Expansion is constrained only by content rights agreements and the amount andeffectiveness of the service’s advertising or promotion.

Opportunities and Risks

The smart TV opens several opportunities for innovative pay-TV providers, but it also presents a numberof risks to the core business for all operators, including increased competition, alternative interfaceoptions for the consumer, shifting delivery approaches, greater broadband network congestion, newand uncertain business models, and less control over the viewing experience.

However, consumer viewing trends and CE adoption show that the smart TV is becoming a fixture inhouseholds around the world. Operators will have to adapt their business models to accommodate thisnew device, which has a tremendous upside, provided they properly leverage its abilities.

Through thesmart TV, operators could even shift strategies from a defensive to an offensive mode. Right now, theyare developing and deploying services in their territories to counter the OTT threat. Through the smartTV, they could even expand into the OTT’s “borderless” territory with their own virtual services.

Pietro Macchiarella is a research analyst at Parks Associates

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