A.T. Kearney: Internet Value Chain Economics


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The internet ecosystem is a complex and involves multiple activities and players. Study breaks down the internet value chain into five main markets: Content Rights, Online Services, Enabling Technology/Services, Connectivity and User Interface (devices and applications).

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A.T. Kearney: Internet Value Chain Economics

  1. 1. Internet Value ChainEconomicsGaining a deeper understanding of the Internet economy
  2. 2. W hen considering the technological innovations of the past 50 years, the Internet is probably the one that has had the greatest impact on everyday life in developed economies.Nearly six out of 10 Americans now shop online and more than four outof 10 bank online. Twenty hours of video are uploaded to YouTube everyminute, while 5 percent of all time online is spent on the social net-working site, Facebook. The Internet has also changed the way in whichbusinesses operate—today, 64 percent of C-level executives conductsix or more searches per day to locate business information. The Internethas been a source of great good—as evidenced by the role played byInternet-based mapping and communications in the relief effort follow-ing the recent Haiti earthquake. The Internet also has shown a negativeside—more than 97 percent of all emails are spam, while more than 70percent of Americans fear online identity theft and 57 percent feel thattheir personal privacy has been greatly diminished by the Internet.1Behind these statistics and headlines, however, tions, a sound understanding of the Internetthere remains a low level of understanding of economy will be important for all stakeholders.how the Internet economy works. Who are the This includes the companies playing a role in thedifferent players involved in the Internet, beyond Internet economy, private and business consum-the flagship names? How is the industry struc- ers, and the regulators and policy-makers who aretured and how concentrated is it? How do players increasingly being asked to oversee or intervene inmake money and how do revenues flow across multiple aspects of the Internet.the value chain? Is the industry attractive in terms To help improve the understanding of theof growth and returns? Internet landscape, Vodafone commissioned As the Internet continues to grow and A.T. Kearney to conduct a review of the Internet’sdevelop, playing an increasingly important role in value chain and economics. This paper has beenthe lives and activities of people and organiza- produced independently and does not necessarily1 Data sources include Pew Internet & American Life Project survey, 2009; YouTube, May 2009; ComScore, April 2009; Google, Forbes, BtoB, June2009;“Social media get quake reports out fast,” Los Angeles Times, January 2010; Microsoft, 2009, quoted in http://news.bbc.co.uk/2/hi/technology/7988579.stm;ABC News/Washington Post, 2009, quoted in http://www.spendonlife.com/blog/new-poll-shows-increased-id-theft-fear. INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney 1
  3. 3. represent the views of Vodafone. Neither Vodafone Total Internet value chain revenues are esti- nor A.T. Kearney is responsible for the use that mated at US$1,930 billion in 2008, growing on might be made of this paper. average at 10 percent p.a. More than 60 percent This paper has a global scope but most exam- derives from business-to-business activities as ples and illustrations focus on North American many organisations have embraced the Internet to and European markets. Terminology has been market and sell their services and to manage rela- standardised and may differ from regional usage. tionships with suppliers and partners. On the The paper begins with a brief overview of the consumer side, the largest categories of spend are Internet’s growth and usage trends. Next, it lays for retail Internet access and end-user devices/ out the Internet value chain and describes each hardware. Between them, these enablers for part of the value chain in terms of key players and households to access the Internet account for 44 revenue models. Finally, it provides an assessment percent of total consumer value chain revenues. of the industry’s market size, growth trends, prof- Consumer Online Services, the most visible itability and competitive structure. part of the Internet economy, represent a US$242 It is not the purpose of this paper to offer rec- billion market, of which a substantial part relates ommendations, but rather to provide a consistent to e-Commerce. Search engines capture more framework and fact base to inform public debate. than one-third of remaining online service reve- With such a broad remit we may inevitably dis- nues and indeed 59 percent of online advertising appoint readers who would like more detail about revenues. individual markets or issues; for that reason we Revenues for consumer Online Services are have provided documentation of our sources and growing more than twice as fast as those for assumptions to assist further research. Internet access provision and more than five times faster than sales of hardware and software. Bandwidth growth has been even stronger, but 1. Summary of Findings online service revenues are for the most part disconnected from bandwidth consumption — in The number of Internet users has grown rapidly to 2008 file-sharing and video-on-demand accounted 1.7 billion in 2009, or a quarter of the world’s pop- for nearly three-quarters of bandwidth but only ulation. Consumers use the Internet for an increas- 8 percent of revenues. ing range of everyday activities, from shopping and Our analysis shows that the most concentrated banking to sharing photos and watching TV. As a markets in the value chain are the Online Services result, they spend a growing proportion of their of VoIP, gaming and search plus certain categories media consumption time and wallet on the Internet. of hardware/software, namely games consoles, A complex value chain has developed to deliver smart phones and operating systems. The online these services, comprising global and local players advertising network market is also highly concen- with assets as diverse as content rights, communi- trated. In all of these categories the top three play- cations and IT infrastructure, proprietary software ers account for more than 60 percent of revenues, and global brands. Businesses also use the Internet driven by strong network and/or scale effects. extensively to market and distribute their services We also analysed the profitability of the larg- as well as to procure and manage supply chains. est players in all categories. While many factors2 INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney
  4. 4. influence a company’s profitability in a given year, value chain to influence corporate strategic activity we found the most concentrated categories to be and regulatory decision-making in the years ahead. among those with the highest returns on capital employed (ROCE) in the value chain, at least 20 percent in all cases. Content Rights and 2. Growth of Internet Usage Connectivity, on the other hand, are less concen- trated markets when measured at a global level, The number of Internet users globally has grown although local differences apply. Both of these dramatically in the past 15 years (see figure 1). In markets also have lower ROCE (10 to 15 percent) 1995, there were only 16 million Internet users, and the market capitalisations of their largest equating to 0.4 percent of the world’s population. players have been stagnant for years. By 2009, this had risen to 1.7 billion users, corre- The Internet has a short history characterised sponding to more than a quarter of the world’s by rapid bursts of technological and economic population. In most West European and North development, often stimulated by the emergence of American markets, Internet usage penetration new entrants on a global scale. Whether it will con- now surpasses 75 percent of the population. tinue to be so dynamic or is now of such a size and In recent years the strongest growth has come relative maturity that it begins to resemble other from emerging markets. In China, the penetra- parts of the global economy, is beyond the scope of tion rate has jumped from 2 percent in 2000 to 27 this paper. Certainly one could expect such differ- percent by the end of 2009. With 360 million ences in economic performance across the Internet people online, China has more Internet users than Figure 1 Global Internet users and penetration rate (1995-2009) 25.6% 2,600 A quarter of the world’s population is online 26% 23.5% 2,400 24% 2,200 22% 20.0% World population penetration 2,000 20%Internet users (millions) 1,800 16.7% 1,734 18% 15.7% 1,574 1,600 16% 1,400 12.7% 1,319 14% 1,200 11.1% 12% 1,093 9.4% 1,018 1,000 8.6% 10% 817 800 719 8% 5.8% 587 600 513 6% 4.1% 3.6% 361 400 36 70 4% 16 248 1.7% 200 0.9% 147 2% 0.4% 0 0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Sources: Nielsen, ITU; A.T. Kearney analysis INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney 3
  5. 5. the whole of Western Europe, and 60 percent More recently, mobile devices have become more than the United States. Brazil already has a key means to access the Internet, driven by the more Internet users than any European country, availability and increasing affordability of smart- while the Middle East has gone from 3 million to phones as well as high-speed data modems and 57 million users between 2000 and 2009. USB “dongles” that provide Internet access for Most users access the Internet via fixed-line laptop computers. Total shipments for smart- broadband connections at home or at work. phones, for instance, are projected to grow from The take-up of broadband, delivered via multiple 54 million in 2005 to 289 million in 2013.2 technology options but primarily via DSL con- Time spent online is also growing substan- nections over the original copper telephone net- tially, to some extent at the expense of traditional works, has transformed the telecommunications media. A recent study conducted in Germany, for landscape in most countries. With plans to deploy instance, projected that the Internet’s share of fibre to deliver far greater bandwidth per connec- media consumption time would increase from 4 tion, the telecommunications sector faces a major percent in 2000 to 24 percent in 2015. This, how- investment wave in the next decade and is cur- ever, does not come solely at the expense of other rently engaged in extensive debate over the future media. Total media consumption time grew by regulatory framework and commercial model to nearly 50 percent between 2000 and 2009 to an support such investments. average of 10.3 hours per day. There is a growing Figure 2 Internet share of consumers’ time and wallet EXAMPLE: Germany Share of time by media1 (2000-2015e) Share of wallet by media (2000-2015e) (hours/day/person) (US$ billion) 7.2 8.3 9.6 10.3 71 75 99 134 20% 23% 23% 23% Others2 34% Others2 4% 40% 3% 2% 2% Magazines 47% 58% 24% 21% Radio 4% Magazines 37% 29% 4% Radio 5% 5% 17% TV 7% 6% 29% TV 8% 20% 30% 6% 34% 23% 36% 42% Internet3 23% 29% 21% 24% Internet 12% 16% 4% 5% 2000 2005 2010e 2015e 2000 2005 2010e 2015e Notes: 1Includes simultaneous media consumption Sources: PwC, SevenOne Media, ARD/ZDF online study; A.T. Kearney analysis 2 Books, films, newspapers, offline-video games and video 3 Internet advertising and access spending 2 Credit Suisse, June 20094 INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney
  6. 6. trend of consuming multiple media at the same Internet usage patterns have evolved rapidly,time—for instance, browsing the Internet while as illustrated by consumers’ preferred websites. Ofwatching TV. the top 15 websites in the United States in 1999, With increasing share of time, the Internet is measured by unique visitors, only four remainedinevitably also capturing an increasing share of in this league table by 2009 (see figure 3). Most ofconsumer and advertiser spend—from 5 percent the top 11 websites have been launched fairlyin 2000 to 42 percent of total by 2015 in Germany, recently and include sites such as Google,potentially twice as much as TV and Radio com- Facebook, eBay and Apple iTunes.bined. This trend is likely to be repeated for other Search and Social Networking are two exam-European markets (see figure 2). ples of services where market leadership has Internet usage is expanding to a broader range changed rapidly. In 1999, Google captured onlyof services and becoming central to everyday lives. 4 percent of global search revenues. Today GoogleIn the United States, 56 percent of people reported has two-thirds of the market, while 1999 leaderhaving bought a product online in 2009 com- Yahoo!’s share has shrunk from 29 percent to 7pared with just 27 percent in 2000; 42 percent percent. In social networking, Facebook did notbank online, compared to 10 percent in 2000; 28 exist in 2003. Five years later, it held 23 percent ofpercent use social networking sites, in contrast the market, while 2003 market leader Xanga is nowith only 5 percent in 2000. longer among the top five players.Figure 3Top 15 Internet websites (1999 versus 2009) U.S. top 15 sites 1999 U.S. top 15 sites 2009 Web property UVs (m) 2 Genre Web property UVs (m) Genre 1. AOL sites 46 Portal 1. Google sites 164 Search 2. Microsoft sites 32 Portal 2. Yahoo sites 158 Portal 3. Yahoo sites 31 Portal 3. Microsoft sites 133 Portal 4. Lycos 29 Search 4. AOL sites 99 Portal 5. Go Network 21 Portal 5. Facebook 97 Social network 6. GeoCities1 19 Web hosting 6. Ask Network 88 Search 7. The Excite Network 17 Portal 7. Fox Interactive Media 83 Media/social network 8. Time Warner Online 13 Media 8. Amazon 70 e-Commerce 9. Blue Mountain Arts 12 e-Cards 9. Wikimedia Foundation 69 Reference 10. AltaVista 11 Search 10. eBay 67 e-Commerce 11. Amazon 10 e-Commerce 11. Turner Network 63 Media 12. Xoom 9 Web hosting 12. CBS Interactive 59 Media 13. Snap 9 Search 13. Apple Inc. 58 Music 14. Real Networks 8 Media player 14. Glam Media 56 Lifestyle 15. CNET 8 Media 15. Answers.com 55 Reference = No longer operating Note: 1Now only available in Japan 2 The Unique Viewers (UV) metric enables a clearer comparison of different = No longer exists as an independent entity types of websites than the more commonly referenced Page Views metric Sources: ComScore, A.T. Kearney analysis INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney 5
  7. 7. 3. Overview of the Internet Content Rights owners are typically media Value Chain companies such as Warner Brothers, the BBC or Electronic Arts providing their content for a share The Internet ecosystem is complex and involves of revenues and/or license fees. Content Rights multiple activities and players. We break down owners typically retain 50 to 70 percent of the rev- the Internet value chain into five main markets: enues generated by the online service provider Content Rights, Online Services, Enabling Tech- that makes the content accessible to Internet nology/Services, Connectivity and User Interface users. For instance, iTunes shares approximately (devices and applications). Figure 4 shows the main 70 percent of revenues earned on each music pur- strategic segments within each market and the dif- chase with the music majors.3 In some cases, ferent service categories within those segments, Content Rights owners provide their own Online together with the logos of some of the larger players. Services, such as the BBC iPlayer service. Of course, A number of industry players operate in two there is still considerable illegal or unauthorised or more segments of the value chain. This can be use of content on the Internet for which there is powerful in terms of creating a seamless customer no payment made. experience but can also be used to take full advan- tage of assets such as technology, brands and Online Services customer relationships in order to strengthen Online Services correspond to the range of ser- competitive positioning. vices accessed by Internet users and are, as a result, very diverse. For simplification, we have grouped Online Services into five main segments:4 Description of the Key Markets in the Communications. Includes all forms of com- Internet Value Chain munications among Internet users, including voice (VoIP), social networking, email and instant Content Rights messaging. Leading providers of such services Much Internet content is user-generated, for include Skype (part of eBay), Facebook and example, an individual’s page on a social network- Hotmail (part of Microsoft). With the exception ing site or a “tweet” message on Twitter. Such con- of VoIP, these services are invariably provided free- tent typically does not involve remuneration to of-charge and funded by advertising revenues. content creators, although they may well retain General/vertical content destinations. This copyright or some degree of privacy protection segment includes general content portals (Yahoo!) over how their content is used by others. The and more targeted services such as dating web- Content Rights market quantified in our subse- sites, general news/consumer publishing or special quent analysis corresponds to the provisioning of interest content websites on a diverse range of content to online service providers on a commer- topics from wine to politics. Revenues are mostly cial basis. Examples of such content include generated through advertising, although some music, filmed entertainment, games, news or the websites charge for access to their services (for content of books and magazines. example, dating websites and FT.com). 3 Content Rights are often more complex than described here: an artist may own rights to different elements of a composition and receive royalties out of the revenues collected by the media company. 4 In subsequent analyses we also refer to the main categories of service within these segments where market characteristics are distinct.6 INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney
  8. 8. Figure 4Overview of the Internet value chain ILLUSTRATIVE Content rights1 Online services2 Enabling Connectivity User interface technology services3 Media rights owners Communications Support technology Core network Applications • Video Skype Vonage • Web-hosting • Software • Web-design/development AT&T NTT • Media players • Audio Hotmail Facebook • Content management • Internet browsers • Books NTT/Verio Rackspace British France Telecom Telecom • Gaming General/vertical content Limelight Akamai McAfee RealNetworks • Adult content Yahoo! Wikipedia Group • Editorial content Symantec Firefox Financial match.com Billing and payments Times Interchange • Online billing and TimeWarner EMI payment system Level 3 XO Search Communications Communications Harper providers Blizzard Collins Google Baidu PayPal First Data User BBC Devices Bing Ask.com Chase Google Retail Internet Paymentech Checkout access • PCs • Smart phones Entertainment Advertising • Game consoles YouTube Xbox Live • Online ad agencies AT&T Vodafone • Other internet access User-generated hardware content • Online ad networks/ SingTel Tiscali Last.fm iTunes exchanges • Operating systems • Text • Voice • Third party ad servers United Road Internet Runner Dell Nintendo • Images • Video Transactions • Ratings/analytics services NTT Free WPP Razorfish Microsoft Apple eBay Amazon Double Nielsen Nokia Expedia Boursorama ClickNotes: 1Content rights abbreviated to CR in subsequent value chains Source: A.T. Kearney analysis 2 See online services categories list in methodology for details 3 Enabling technology/services abbreviated to ETS in subsequent value chains Search. This segment consists primarily of products and services. The largest service catego-web search engines such as Google or Baidu, as ries include e-Retail (Amazon), e-Travel (Expedia)well as local/national directories such as Yell in and online brokerage (Boursorama.com). Boththe United Kingdom or Pages Jaunes in France. bricks-and-mortar and pure-play online players areRevenues are primarily generated from advertis- active in this segment. The e-Commerce site oper-ing, with sophisticated models such as auctioned ator will collect payment from the customer andkeyword references or pay-per-click having estab- retain a margin, with the remainder passed on tolished themselves in recent years. the manufacturer or service provider. Online costs Entertainment. This comprises websites are typically much lower than for traditional retail-focused on audio-visual entertainment, such as ing so that prices are often, although not always,downloads of digital content (iTunes), music and lower. This has triggered substantial growth andvideo streaming/online radio (YouTube, last.fm), a displacement of volumes from traditional retailIPTV, gaming (Xbox Live), gambling (Party- to e-Commerce for items such as books.Poker) or adult content. Revenues are generated Revenues generated by Online Services there-almost equally from advertising and payments fore originate from a combination of advertising,from end-users. paid-for access to content and services, and e-Commerce. Many websites sell non-digital e-Commerce transaction fees. INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney 7
  9. 9. Enabling Technology/Services provided by banks and payment processors such Enabling Technology/Services are generally invis- as First Data, there are also pure-play online pay- ible to the end-user, but are essential for the tech- ment service providers such as PayPal (part of nical delivery of web content and the generation eBay) and Google Check-Out. of revenues. Highly fragmented, these services fall Advertising services providers are funda- into three broad segments: support technology, mental to revenue generation for most online billing and payments and advertising services. service providers. This segment includes four Support technology refers to a set of technical categories: services provided to online service providers and • Advertising agencies that provide a range of ser- includes website design and development, web vices to their clients, including media campaign hosting and technical service platforms (such as planning, ad inventory acquisition for online content management platforms). Akamai, for advertising campaigns, and creative services to design and produce online adver- tising. They charge commissions based on the total volume of adver- tising spend and, in the case of Revenues for consumer Online large multi-service agencies such as Services are growing more than OMD and WPP, online advertis- ing is simply part of their portfolio twice as fast as Internet access of client services, albeit a growing part that requires specific skills. provision and more than five • Dedicated online advertising net- works and exchanges such as times faster than sales of hard- Doubleclick (part of Google). Ad networks are a technical and pay- ware and software. ment clearing house for adver- tising space. They both acquire advertising space on behalf of media buyers and advertisers and example, provides content delivery services sell ad inventory on behalf of Internet websites. through its network of servers that improve the They also provide the technical platforms that speed and reliability of the connection and manage facilitate the placement of display ads on web- the network load efficiently on behalf of online sites. In some cases, such as Advertising.com service providers. (owned by AOL), ad networks will acquire and Billing and payments comprise all payment resell ad inventory with a mark-up. platforms used to process monetary transactions • Third-party ad serving providers that host and made by consumers on the Internet—to pay for distribute online ads. This is also often per- accessing specific services (such as music down- formed by the advertising agency that provides loads) or to conduct online e-Commerce transac- the creative services. tions. Beyond payment processing services • Ratings and analytics service providers that pro-8 INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney
  10. 10. vide Internet user and usage metrics. Advertisers Assigned Names and Numbers (ICANN). Major have the option to buy advertising space either core network providers exchange traffic with each through ad networks, through their regular other on the basis of “peering,” whereby each advertising agency or directly from the website/ covers its own costs for installing and operating content publisher. equipment that interconnects with others. Many providers also procure interconnection on theConnectivity basis of IP transit, since this is more cost effectiveConnectivity refers to Internet access services pro- at lower traffic volumes.vided by telecommunications network operators, Both core network and interchange operatorswhether fixed or wireless. Telecommunications tend to be part of large, integrated telecoms oper-markets vary in their structure based on regula- ators such as Verizon or BT, but there are specialisttory and competitive dynamics, particularly with companies such as Level 3 or XO.regard to the “access layer,” colloquially known asthe “last mile.” User Interface Many customers will arrange their Internet The User Interface is an essential part of theaccess service via their home telecommunications Internet value chain, involving both devices (suchprovider, but cable TV companies, independent as PCs, game consoles and mobile phones) andresellers or service providers and wireless opera- the related software (such as operating systems,tors provide highly competitive offers in terms of web browsers, media players and games) used tonetwork speed and pricing. These services are render services to end-users. Key players includetypically provided on the basis of a monthly sub- hardware manufacturers such as Dell, Nintendo,scription fee, which in some instances can include Apple and Nokia, as well as software providersthe fixed-line subscription fee and bundled voice such Microsoft, Real Media and McAfee.calls and TV subscriptions. As usage volumes Revenues generated from the User Interfacegrow exponentially for some heavy users, there is mainly derive from the end-user’s acquisitiondebate on the future revenue model, with options of the device, which often includes pre-installedincluding volume-based pricing (benefitting occa- software. Subscription models are increasinglysional users) or models where the online service common for some applications, such as anti-virusprovider pays for the customer connectivity to security software. In some cases, software is pro-ensure a particular quality of service that matches vided free-of-charge (for example via Internetits content offering. browsers and media players) — as providers seek Also involved in providing connectivity are to maximize their user base and generate revenuescore network operators that provide the so-called from advertising. In wireless markets, it has been“highways” of Internet traffic transport. Core net- common for the connectivity provider to supplywork operators tend to be remunerated based on the device on a subsidised basis and recover thethe capacity they provide to the access providers. cost through ongoing subscription revenues. InThey connect the access network nodes to the some markets there have been trials with laptop“super-exchanges” of Internet traffic, which route computers provided on a similar basis.global Internet traffic based on technical stan- The replacement cycle for devices from PCsdards defined by the Internet Corporation for to wireless phones has been very short, with INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney 9
  11. 11. Figure 5 generated from consumer services, the main focus Revenues generated by the Internet industry of this paper, amounted to US$732 billion. Revenues from business services were sub- stantially higher at US$1,195 billion. Eighty per- Internet revenues by source/nature cent of these revenues derive from the Online (2008 in US$ billion) 1,927 Services market and by far the biggest category Content rights 34 here is B2B e-Commerce, accounting for 86 per- cent of the revenues for Online Services (see figure 6). The Internet has brought substantial efficiency Online services 1,198 1,195 gains to the way in which businesses deal com- 19 mercially with one another, through electronic data interchange (EDI) services, which offer 732 greater speed and traceability than offline trans- Enabling technology 956 16 and services 61 242 actions. This has resulted in the rapid replacement Connectivity 325 61 of offline transactions with web-based trans- 262 User interface 309 62 actions — in 2007 around half of e-Commerce 158 151 transaction volume between businesses in the Total Business Consumer United States was already taking place through Source: A.T. Kearney analysis the Internet.5 The analysis in Figures 5 and 6 omits the actual value of the goods and services a virtuous cycle from the perspective of the players and related fulfilment costs for B2B e-Commerce. in this segment, as new applications drove a need After e-Commerce, the next biggest service for stronger device functionality (for example, category in B2B Online Services is online infor- chip processing speeds) which encouraged cus- mation services, a US$71 billion market for the tomers to upgrade. In the economic downturn, provision of professional data on subjects such as however, many corporate customers sought to finance, healthcare and law. Providers include the slow down replacement cycles for their comput- likes of Thomson Reuters and Reed Elsevier. ing infrastructure. The subsidised model in wire- Other major Online Services categories are the less markets has also become increasingly strained provision of professional online e-Learning ser- as operators question the profitability of custom- vices and Internet communication services, the ers acquired on this basis. latter incorporating professional (or corporate) VoIP, email, instant messaging, video-conferenc- ing and machine-to-machine communications. 4. Market Size and Growth The Content Rights, Connectivity and User Interface B2B markets largely share the same cat- Internet Market Size egories as the consumer market. In the User Total revenues generated in the Internet value chain Interface market, however, it is worth noting that amounted to US$1,930 billion according to our user-paid software and other Internet hardware estimates for the year 2008 (see figure 5). Revenues categories are significantly larger for businesses 5 The United States Census website.10 INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney
  12. 12. Figure 6Revenues generated by the Internet — business-to-business (2008) # = market size in US$ billion1 Con- User CR Online services nec- interface tivity 8 SaaS/MFT4 19 Communications 27 Corporate e-Learning2 19 12 Applications 71 Information services 5 Oper. systems interchange Core network 14 Smart phones 19 49 OtherB2B content Internet hardware 43 831 e-Commerce Retail Internet access 78 PCs$19 $956 $62 $158 Total market = $1,195 billionNotes: 1All market sizes are based on gross revenues. Revenues generated from other companies in the value chain are Source: A.T. Kearney analysis not distinguished from those from companies outside the value chain; 2 Includes professional e-book sales 3 Includes VoIP, email, instant messaging, video conferencing, machine-to-machine communication 4 Software as a service, managed file transferthan for consumers. The B2B user-paid software Interface (US$151 billion) and e-Commercemarket was worth US$12 billion in 2008, com- (US$146 billion), which covers e-Retail, e-Travelpared to just US$2 billion for the parallel B2C and e-Brokerage services (see figure 7 on page 12).markets. This includes, for example, corporate In other words, a typical household will spendsecurity and networking applications. The Internet most of its “Internet budget” on the access devicehardware market was worth US$49 billion in (such as a PC with software) and the access con-2008, compared to US$7 billion for the parallel nection (such as a broadband subscription), asB2C market and incorporates the likes of enter- well as paying substantial sums per year as marginprise storage, Ethernet and enterprise routing on their e-Commerce purchases. As before, thishardware. The remainder of this paper focuses on analysis omits the actual value of the goods andthe B2C market. services and related fulfilment costs, so, for Revenues generated by consumers (B2C) are instance, the wholesale price of a book sold by afocused on Connectivity (US$262 billion), User publishing house to an e-Retailer such as Amazon INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney 11
  13. 13. Figure 7 Revenues generated by the Internet — consumer # = market size in US$ billion1 Enabling CR Online services3 technology/ Connectivity User interface services 3 4 Communication 2 Apps. 13 General/vertical content destinations 12 7 Oper. systems Editorial 80 13 Game consoles Support 34 tech. Core network/ interchange 2 Search 27 Adult 21 Smart phones 42 Entertainment Online 7 Other Internet hardware billing 4 and payments Games 182 Retail internet 95 7 78 49 19 16 12 access4 PCs Audio/video/books e-Retail e-Travel Online ad services2 Ad agencies e-Brokerage $16 $242 $61 $262 $151 Total market = $732 billion Notes: 1All market sizes are based on gross revenues. Revenues generated from other companies in the value chain are Source: A.T. Kearney analysis not distinguished from those from companies outside the value chain; 2 Includes ad networks/exchanges, 3rd party servers, ratings/analytics services 3 Online services includes $3 billion revenues for other website types not covered by the categories we have defined. This is excluded from subsequent analysis. 4 In determining the value of Retail Internet Access we have made assumptions about the directly attributable portion of monthly “bundled” subscription fees paid to connectivity providers —in some markets regulation makes specific distinctions on this point is excluded and only the gross margin earned by of the revenues from online advertising and user- Amazon is included.6 paid content and services are concentrated in Online Services represent perhaps the search and the largest entertainment categories, most visible part of the industry to the general namely gambling, gaming and adult. public, but of the US$242 billion in revenues Advertising (mainly Search-related) gener- most are related to e-Commerce while Search and ates over US$58 billion, or 60 percent of total Entertainment generates US$76 billion—10 per- online search revenues, while the remaining 40 cent of total value chain revenues. Even high- percent comes from payments by Internet users. profile players such as Skype, Facebook and The ratio of advertising revenue to end-user pay- YouTube generate less than a half a billion dollars ments in the Online Services market is similar to in revenues each, despite substantial user numbers. the ratio seen in more traditional media such as As Figure 8 illustrates, more than 75 percent consumer publishing. 6 Approach based on An Economic Map of the Internet (MIT 2002).12 INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney
  14. 14. Figure 8Breakdown of consumer online services revenues, 2008 (excluding e-Commerce)Internet B2C revenues by source Revenues breakdown2(2008 in US$ billion) (2008 in US$ billion) 732 96 58 Content rights 16 (2%) Others 3 4 (6%) Others Online services, 38 (5%) Communications 4 user-paid 58 2 2 (3%) Communications Online dating Online services, (8%) 7 advertiser-paid Consumer publishing 7 Consumer publishing Global portals 4 (13%) 146 Global portals e-Commerce1 2 (4%) (20%)Enabling technology 61 Search/directory 34 and services (8%) 34 Search/directory VoD/MoD 2 (59%) 262 Connectivity Gambling 6 (36%) IPTV 5 Music/video/book sales (digital) 6 Adult sites 11 151 2 (3%) VoD/MoD User interface (21%) 3 (6%) Adult sites Gaming 12 3 (5%) Gaming B2C revenues Online services, Online services, user- and advertiser-paid advertiser-paidNotes: 1Includes e-Retail, e-Travel, e-Brokerage 2 Excludes e-commerce (e-Retail, e-Travel, e-Brokerage) Source: A.T. Kearney analysis A comparison between global Internet traffic Internet Service Providers (ISPs, operating in thevolume (as measured in petabytes7) and the gen- Retail Internet Access segment of the market), aseration of Internet revenues suggests a significant traffic transportation costs account for more thandisconnect (see figure 9 on page 14). File sharing, 40 percent of their costs yet Internet traffic growthincluding both legal and illegal downloads and does not, under current pricing models, translateuploads, generates 54 percent of total Internet into incremental revenues.8traffic but only 2 percent of total revenues. Video-and music-on-demand services generated 18 per- Internet Growth Perspectivescent of traffic but only 6 percent of revenues. This A.T. Kearney has reviewed the growth trendsmight explain the concerns raised by a number of in each market, strategic segment and service7 One petabyte is equal to 1,000,000 gigabytes.8 This has led to a number of disputes between ISPs and providers of online services, particularly media services. For example, in 2009 the BBC voiced concern that BT was limiting Internet download speeds during peak times, and that this was affecting the user experience of the BBC’s iPlayer video-on-demand service. INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney 13
  15. 15. Figure 9 Online traffic versus online revenues in the consumer Internet value chain (2008) 6,100 PB $242 billion Gaming1/gambling 1% 2% Communications 7% Gaming1/gambling 1% Communications 7% General/vertical content sites Other online services2 22% 14% Search IPTV 3% VoD/MoD 18% File sharing and VoD • Generates 73% of all consumer traffic… • …but only 8% of consumer 60% e-Retail, e-Travel, e-Brokerage revenues File sharing/digital downloads 54% 2% IPTV 6% VoD/MoD3 2% Digital music/video/book sales Traffic Revenue Notes: 1Includes video and casual gaming Sources: Cisco, Gartner, IAB, IDC, eMarketer, Business Insights, 2 Includes all general/vertical content, search and e-Commerce online services JP Morgan, Natixis, PwC, A.T. Kearney analysis 3 Includes adult In October 2009 a report by Arbor Networks revealed more up-to-date Internet traffic analysis showing a relative decline in P2P file-sharing and significant growth in streaming video from sites such as Hulu.com or YouTube. The disconnect between traffic and revenues, however, remains constant. category in the Internet value chain and collated increased success in charging end-users for access growth forecasts from multiple sources (see to audio-visual entertainment services as opposed Appendix on page 22 for details). It is challenging to illegal downloading. Growth of Connectivity to make long-term forecasts, but for the next services is set to be moderate at approximately three years, we expect Internet revenues to grow 6 percent p.a., representing a mix of robust growth at 10 percent p.a. but with substantial differences in emerging markets and in wireless access but across the industry value chain. a major slow-down of broadband Internet access Figure 10 represents our growth estimates, penetration growth in developed countries and with the darker-shaded categories of the value intense pricing pressure. As discussed earlier, the chain being those with the strongest growth tra- User Interface market should experience the slow- jectory. Online Services is one of the most dynamic est growth at 3 percent p.a. following a period of markets in the Internet value chain, with a growth strong device penetration growth (for example, rate of 16 percent per annum—driven by migra- PCs and game consoles). New devices, such as tion of advertising spend to online formats and e-Books, may well provide new growth impetus.14 INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney
  16. 16. Figure 10Growth perspectives of the consumer Internet industry (2008-2013 in US$ billions) CAGR (2008-2013) <5% 5-10% 10-20% 20-30% >30% Enabling CR Online services technology/ Connectivity User interface services Social networking VoIP Applications Consumer Operating systems Content mgmt. Portals Dating Web publishing hosting, design and Game consoles Directory develop- Core network/ Web search ment interchange Smart phones Music/ VoD/MoD Gambling video/ IPTV Gaming Adult book sales Online (digital) billing and paymentsContent rights Retail internet e-Brokerage access PCs2 Online ad services1 e-Retail e-Travel Ad agencies 2008$16 $242 $61 $262 $151 market size24% 16% 13% 6% 3% 2008-2013 CAGR Total Internet value chain CAGR = 10%Notes: *Size of box indicates relative market size (2008) Source: A.T. Kearney analysis 1 Includes ad networks/exchanges, 3rd party servers, ratings/analytics services 2 Includes other Internet hardware5. Industry Structure and although some players might operate in multiple Economics countries (for example, eBay or Vodafone). Viewed at the global level, the Internet valueStructure and Concentration of the Internet chain seems highly fragmented, with a few nota-Value Chain ble exceptions. For categories such as operatingThe Internet value chain comprises some segments systems, smartphones, search, games consoles/and categories that are global and others that are services, music and video, the top three marketmore local in nature. PCs and operating systems players account for more than 40 percent of theare inherently global businesses, due to the stan- global market and, in some cases, more than 80dardised nature of these products and the very high percent. This is due to the inherently global natureeconomies of scale. Businesses such as e-Commerce of these activities and the high economies of scaleand Connectivity are much more local in nature— and/or network effects. INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney 15
  17. 17. Figure 11 provides a graphic representation of In Connectivity, concentration at a global the degree of concentration at a global level of the level for Network Access is low as this is a funda- Internet value chain categories; the darker-shaded mentally local business. Market concentration at a categories have higher concentration. e-Com- country level may be strong, given local econo- merce appears particularly fragmented at a global mies of scale and the legacy of monopoly infra- level. This is due to the local nature of these activ- structure providers. There are however significant ities and specialization of industry players by type differences across countries. In 2008, the five larg- of service. Although fragmented when considered est UK ISPs accounted for more than 91 percent at a global level across all retail types, e-Commerce of the Consumer market (following a wave of is highly concentrated in some specific areas, that consolidation) while the five biggest U.S. ISPs had is, at a national level and at a product category a combined market share of 56 percent. level. For example, Amazon has a 53 percent share of the U.S. online book market, which is pro- Profitability in the Internet Value Chain jected to grow at a CAGR of 44 percent between A.T. Kearney further attempted to calculate the 2008 and 2013.9 profitability of the larger players across the value Figure 11 Market concentration of the consumer Internet industry (2008) Cumulative market share of top 3 players (at global level) <10% 10-20% 20-40% 40-60% 60-80% >80% Enabling CR Online services technology/ Connectivity User interface services Social networking VoIP Applications Consumer Operating systems Content mgmt. Portals Dating Web publishing hosting, design and Game consoles Directory develop- Core network/ Web search ment interchange Smart phones Music/ VoD/MoD Gambling video/ IPTV Gaming Adult book sales Online (digital) billing and payments Content rights Retail internet e-Brokerage access PCs2 Online ad services1 e-Retail e-Travel Ad agencies Notes: *Size of box indicates relative market size (2008) Source: A.T. Kearney analysis 1 Includes ad networks/exchanges, 3rd party servers, ratings/analytics services 2 Includes other Internet hardware 9 Global Entertainment and Media Outlook: 2009-2013, PWC.16 INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney
  18. 18. chain. Figure 12 represents our estimates, with strates returns that are likely below the cost ofthe darker-shaded categories having the highest capital — the problems of this market in respond-returns (measured as Return on Capital Employed, ing to the challenge of “free” content have beenROCE). Higher ROCEs (20 percent+) can be well documented.observed in User Interface (such as operating sys- Beyond the mainstream market leaders,tems, PCs, smartphones and games consoles) and the Internet offers multiple niche positioningselected Online Services (such as e-Commerce, options — some of which appear particularlysearch, gaming, gambling and adult services). profitable. For instance, online nutrition com- Returns in Connectivity and Enabling pany Nutrisystem delivers a ROCE of nearly 80Technology/Services appear significantly lower percent; the company offers customized online(10 to15 percent). This is likely due to higher cap- nutrition programs and delivers ready-made mealsital intensity, more fragmented competition and that can be ordered online.in some cases specific regulation of prices and/ormargins, as in the case of telecoms services in Economics of the Internetmany countries. Consumer publishing demon- Economic theory would suggest that the highestFigure 12Returns on capital employed for market leaders in the consumer Internet industry (2008) Average ROCE3 <5% 5-10% 10-15% 15-20% 20-30% >30% Enabling CR Online services technology/ Connectivity User interface services Social networking VoIP Applications Consumer Operating systems Content mgmt. Portals Dating Web publishing hosting, design and Game consoles Directory develop- Core network/ Web search ment interchange Smart phones Music/ VoD/MoD Gambling video/ IPTV Gaming Adult book sales Online (digital) billing and payments Content rights Retail internet e-Brokerage access PCs2 Online ad services1 e-Retail e-Travel Ad agencies14% 21% 13% 11% 25% 2008 ROCENotes: *Size of box indicates relative market size (2008) Source: A.T. Kearney analysis 1 Includes ad networks/exchanges, 3rd party servers, ratings/analytics services 2 Includes other Internet hardware 3 ROCE is based on top 3 players by market share in each category INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney 17