Black Box Breach:  Solving The Living Room Riddle - Joseph Mathew
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Black Box Breach:  Solving The Living Room Riddle - Joseph Mathew Black Box Breach: Solving The Living Room Riddle - Joseph Mathew Document Transcript

  • BLACK BOX BREACHSOLVING THE LIVING ROOM RIDDLEMay 4, 2013By Joseph MathewSchool of Law | University of VirginiaJ.D. Candidate, Class of 2013Darden Graduate School of Business | University of VirginiaM.B.A., Class of 2010josephmathew10@gmail.com | 706-255-9793
  • Black Box BreachJoseph Mathew2 of 9EXECUTIVE SUMMARY .......................................................................................................... 3I. THE SETTING...................................................................................................................... 4a. Space Race To Where?...................................................................................................... 4b. The Establishment: Telecommunications Providers ..................................................... 4c. Overcoming Barriers To New Technology...................................................................... 4d. Emergently Influential Online Media Services ............................................................... 4e. Venture Capital Disorientation ........................................................................................ 5II. CONNECTING THE DOTS............................................................................................. 6a. The Question....................................................................................................................... 6b. Data Point 1: Internet Data Consumption Skyrockets.................................................. 6c. Data Point 2: Jet Speed Internet...................................................................................... 6d. Data Point 3: Troublesome Youth................................................................................... 7e. The Answer: Crown The Internet................................................................................... 7III. THE TAKE AWAYS......................................................................................................... 8a. To: The Technology, Media, & Telecommunications CEO.......................................... 8i. Evaluate Core Competency’s Validity ............................................................................. 8ii. Conservatively Value Low Growth Properties ................................................................ 8iii. Internet Impelled Acquisition Strategy............................................................................. 8b. To: The Average American.............................................................................................. 9OUTLINE
  • Black Box BreachJoseph Mathew3 of 9THESIS The contest over the future of your living room will be won, in the near future, indecisive fashion by hardware, content, and services infused with the internet throughouttheir DNARATIONALE As Millennials’ voracious appetite for streaming video steadily increases,telecommunications providers will eventually meet that need, creating a virtuous spiralfor online media servicesRAMIFICATIONS Technology, media, and telecommunications CEOs should candidly assess their strengthsand weaknesses in this new internet order of home entertainment, diverting capital fromrapidly decaying assets and into growth generating businesses within their corecompetenciesEXECUTIVE SUMMARY
  • Black Box BreachJoseph Mathew4 of 9I. THE SETTINGa. Space Race To Where?On a couch somewhere in suburbia the average American “Joe” is resting comfortably onhis favorite reclining couch, his flannel shirt not quite covering his well-deserved paunch,directly in front of a massive, flat screen television, with a jumbo size bag of Cheetos on hisstomach. Little does Joe realize, though, that his safe haven is on the verge of being engulfed ina war of epic proportions, being waged across executive suites spanning the continent from NewYork to Los Angeles to Seattle to the Silicon Valley. In the aftermath of this coming maelstrom,Joe’s living room will have encountered more disruptive innovation in a period of five years,than in the last two decades.In order to win this struggle, media and technology firms are investing billions of dollarsin their efforts. What makes this particular digital media pursuit so fascinating is that the playersdo not even agree, what defines “winning.” To put this analogy another way, if the current chasefor control of your living room were equivalent of the Cold War’s space race, the United Stateswould be shooting for the moon, while the Soviet Union would be aiming for the Earth’s core.b. The Establishment: Telecommunications ProvidersEver pervasive, laying in the background of this great race are the actualtelecommunications data providers, which include colossal companies such as Comcast, DishNetwork, Verizon, and AT&T on the domestic front, and behemoths such as China Mobile,Vodafone, America Movil, and Bharti Airtel, internationally. These firms tend to have naturalmonopolies or small oligopolies in the regions from which they operate, being the sole internet,cable, telephone or satellite provider. These players having been firmly entrenched in the livingroom for decades and are clinging to their stronghold in front of your couch with a vise like grip.This is one of the reasons satellite and cable operators tout their latest “black box” as beingintegral to your home entertainment experience.c. Overcoming Barriers To New TechnologyTelecom providers’ stronghold is the reason that state of the art technology firms havemet with limited success in the living room space, to date. Steve Jobs, in his last appearance atthe All Things Digital 8 Conference in 2010 noted this conundrum:The problem with innovation in the television industry is the go-to-marketstrategy. The television industry fundamentally has a subsidized businessmodel that gives everybody a set-top box for free or for 10 dollars a month. . .. There isn’t a cable operator that’s national. There’s a bunch of cableoperators. And then it’s not like there’s a GSM standard where you build aphone for the US and it also works for all these other countries. No, everysingle country has different standards, different government approvals. . . .It’s very balkanized.1Leading companies such as Apple and Google have, though, attempted to breach the shores ofthe market with their own supplemental boxes such as the Apple TV and the Google TV, whichallow consumers to connect to the internet as well as view their traditional television service.Smaller companies, seeking to disrupt the traditional system, have also entered the scene over thelast decade, ranging from the relatively well-known digital video recorder TiVo to theincreasingly popular online streaming player Roku.d. Emergently Influential Online Media Services1Steve Jobs, CEO, Apple Inc., D: All Things Digital 8 Conference (June 1, 2010) (emphasis added).
  • Black Box BreachJoseph Mathew5 of 9Avoiding the balkanization of today’s living room altogether are companies such asNetflix, the online streaming video service. Netflix is emerging as a major player in the homeentertainment space, investing $2.5 billion in 2012 alone on content licensing and originalprogramming, while Amazon reportedly spent hundreds of millions of dollars as well, on contentfor their Prime service.2Top tier media firms, for their part, are ecstatic about this new demandsource. The Walt Disney Company, for example, delightfully inked a deal granting exclusivedigital distribution rights, starting in 2016, for which Netflix is paying an estimated hundreds ofmillions of dollars annually.3e. Venture Capital DisorientationOn the other side of the technological divide, though, are elite venture capital firms suchas NEA, which invested seed stage capital in the television startup Tivli last year. The Tivliservice converts live feeds from satellite and cable distributors operating on college campusesinto online streams viewable on any gadget owned by students.4With Tivli, college studentswill presumably learn to be hooked onto cable television.5Meanwhile, a later stage startup Aereo, which has raised $63 million in venture capitalfinancing, is attacking the young urban professional market in New York.6Aereo captures livebroadcast television through a small antenna and then broadcasts the stream digitally to all yourpersonal devices, making the content available for viewing as well as recording. For theirefforts, the company has become embroiled in massive litigation pitting themselves against allthe major broadcast networks.Making their case in the 2ndCircuit, the networks, which include ABC, CBS, NBC, andFox, contend that Aereo is violating the Transmit Clause of the Copyright Act of 1976.7Byretransmitting broadcasts, the networks allege that Aero is basically infringing on theircopyrights. Aereo responds that they are merely providing the signal available to consumers,who set up their own antennas. Amidst the pending legal actions, News Corporation’s COOChase Carey and CBS’ CEO Leslie Moonves have both stated their intent go off the air andmorph into cable channels should the judicial decisions turn against them.8This aggressivestance is credible, since more than 85% of American homes are currently on a subscriptionservice, with Fox alone earning $472 million in affiliate and pay-TV payments.9The Tivli and Aero concepts sound revolutionary at first glance, until one takes a stepback, places oneself in the Reef flip flops of a Millennial, and thinks about the future. Afterwalking through a simple thought experiment, you should come to the following peculiar2Netflix, Annual Report (Form 10-K) (February 1, 2013); Peter Kafka, Netflix CEO: Amazon Losing Up to $1Billion a Year on Streaming Video, All Things Digital (May 1, 2013). http://allthingsd.com/20121116/netflix-ceo-amazon-losing-up-to-1-billion-a-year-on-streaming-video/.3Brooks Barnes, Netflix Reaches Deal to Show New Disney Films in 2016, The New York Times (May 1, 2013),http://mediadecoder.blogs.nytimes.com/2012/12/04/netflix-bests-starz-in-bid-for-disney-movies/.4Eric Markowitz, Harvards Go-To Venture Capital Firm, Inc. (May 1, 2013), http://www.inc.com/eric-markowitz/harvards-go-to-venture-capital-firm.html.5Brian Stelter, Start-Up Puts Streaming TV on Campus, The New York Times (May 1, 2013),http://www.nytimes.com/2013/01/28/business/media/tivli-puts-streaming-tv-on-campus.html.6Aereo, CrunchBase (May 1, 2013), http://www.crunchbase.com/company/aereo.7Tim Kenneally, Aereo Lawsuit: Networks Seek Re-Hearing After Appeals Court Setback, The Wrap (May 1, 2013),http://www.thewrap.com/tv/article/aereo-lawsuit-networks-seek-re-hearing-after-appeals-court-setback-86121.8Christopher Palmeri, CBS Could Switch to Cable If Aereo Wins Case, CEO says, Bloomberg (May 1, 2013),http://www.bloomberg.com/news/2013-04-30/cbs-could-switch-to-cable-if-aereo-wins-case-ceo-says.html.9Andy Fixmer, News Corp. to Take Fox Off Air If Courts Back Aereo, Bloomberg (May 1, 2013),http://www.bloomberg.com/news/2013-04-08/news-corp-says-it-will-take-fox-off-air-if-courts-ok-aereo-1-.html.
  • Black Box BreachJoseph Mathew6 of 9conclusion: what these supposedly bleeding edge startups are attempting is tantamount tohanding out Gordon Gekko 1980s style boxy cell phones to college students and hipsters today,expecting them to change their smartphone habits.II. CONNECTING THE DOTSa. The QuestionLet us conduct a thought experiment. What will the average American living room looklike a decade from now in 2023? Will a television still be at the center of most living rooms? Ifso, to what data stream will the television be connected to? Will some other device dominate thespace? Or will there be no piece of visible technology at all? Fortunately, there are some keydata points to take into account in answering these questions.b. Data Point 1: Internet Data Consumption SkyrocketsIf you have been wondering over recent years why your home internet connection slowsdown during prime time viewing, let me, as a Millennial, be the first to apologize.10In theperiod from 2011 to 2012, the average monthly data usage per fixed network subscriberincreased 120% to 51GB, which is equivalent to 81 hours of video.11Cisco Systems expects thisdata utilization to continue, with 6 million years’ worth of video traversing the internet monthlyby 2016.12Currently, Netflix accounts for 33% of peak period downstream traffic on fixed networksin North America, while YouTube eats up 20% of peak downstream mobile network traffic.Over in the Asia-Pacific region, BitTorrent, the popular peer to peer file sharing application,represents 36% of total internet traffic.13Netflix, alone has more than 36 million subscribersworldwide, while competitor Amazon’s Prime video streaming and package delivery service isestimated to have more than 10 million members.14c. Data Point 2: Jet Speed InternetWhile consumers have been steadily devouring more data, globally, Google has beenquietly testing their novel Fiber internet service in Kansas City, Kansas and recently announcedan expansion to Austin, Texas. Google Fiber offers Kansas City residents free basic internet fora one-time $300 set-up fee as well as a swift 1 gigabit-per-second for just $70 per month, with noset-up fee.15Unfortunately, Google Fiber will most likely not be coming to a city near you anytimesoon. Providing the Fiber service across the U.S. would cost Google an estimated $140 billion.16Google is using Fiber as a pressure point to spur traditional broadband providers into upgradingtheir own networks at a faster pace. This strategy has already has met some degree of success10Individuals born in the early 1980s through the early 2000s.11Sandvine Global Report: Internet Data Usage Up 120 Percent In North America, Sandvine (April 30, 2013),http://www.sandvine.com/news/pr_detail.asp?ID=394.12Bernhard Warner, Alcatel-Lucent Unveils Worlds Most Powerful Broadband Infrastructure, BloombergBusinessweek (April 30, 2013), http://www.businessweek.com/articles/2013-02-15/alcatel-lucent-unveils-worlds-most-powerful-broadband-infrastructure.13Sandvine Global Report: Internet Data Usage Up 120 Percent In North America, Sandvine (April 30, 2013),http://www.sandvine.com/news/pr_detail.asp?ID=394.14Netflix, Quarterly Report (Form 10-Q) (March 31, 2013); Owen Thomas, Amazon Has An Estimated 10 MillionMembers For Its Surprisingly Profitable Prime Club, Business Insider (April 30, 2013),http://www.businessinsider.com/amazon-prime-10-million-members-morningstar-2013-3.15Google fiber About, Google (April 30, 2013), https://fiber.google.com/about/.16Chris Marling, Google Fiber infographic: Will it take over the world?, Broadband Genie (April 30, 2013),http://www.broadbandgenie.co.uk/blog/20130425-google-fiber-infographic-will-take-over-world.
  • Black Box BreachJoseph Mathew7 of 9with TimeWarner Cable announced a free Wi-Fi service for subscribers in Austin.17Fiber is alsoproviding Google with a platform for testing out their new advertising technologies.While Google is at the forefront of broadband services stateside, across the pond, Alcatel-Lucent and France Télécom-Orange announced on February 6, 2013 the activation of the world’smost robust broadband infrastructure between Paris and Lyon, France, clocking speeds at asmoldering 400 gigabits-per-second. The service will initially be available only to scientists, butthe firms promise to unveil business and consumer plans in the future. These types of speedshint at the tantalizing possibility of downloading high definition movies in seconds rather thanhours.18The last piece connecting the internet speed puzzle comes in the form of wirelesstransmission technology. Qualcomm’s CEO Paul Jacobs predicts that data traffic will eventuallybe offloaded onto cellular base stations the size of a deck of cards. Base stations, whichhistorically have been large towers on mountaintops or on the sides of roads, will, according toJacobs, eventually be supplemented with mini stations plugged into home’s Ethernets, andprovide extremely fast download rates.19d. Data Point 3: Troublesome YouthThe final essential piece to understanding the future of home entertainment is theaudience of the future. As Baby Boomers retire, and GenX-ers grow older and wealthier,Millennials will continue to propel the elemental changes happening in media distribution,outnumbering non-Millennials by 22 million people by 2030.20This is important because Millennials consume media content in a unique manner. Only26% of Millennials watch more than 20 hours of television per week, while 49% of non-Millennials do so. Even more remarkable, is that 42% of Millennials prefer to consumetelevision content through their computer through services such as Netflix, Amazon Prime, andHulu, while only 18% of non-Millennials prefer the same. The Millennial generation represents,therefore, a truly existential threat to the traditional network and cable advertising model.If Millennials’ content consumption represent the future habits of the average American,their online video demands continues to unwaveringly ascend, and the internet backbonecatapults forward in bandwidth to meet their proclivity, does the television even need to beconnected to a cable or satellite provider? Wherever you stand on this new question, the answerto our original question should be clear.e. The Answer: Crown The InternetSynthesizing these three disparate data sources should lead you to a previouslyunimaginable conclusion. The future living room will revolve, in large part, around the internet,and the available apps, of which there will be hundreds, or even thousands. Each app on the17Stacey Higginbotham, Time Warner Cable sees the Google Fiber threat and offers Austin free Wi-Fi, GigaOM(April 30, 2013), http://gigaom.com/2013/04/25/time-warner-cable-sees-the-google-fiber-threat-and-offers-austin-free-wi-fi/.18Bernhard Warner, Alcatel-Lucent Unveils Worlds Most Powerful Broadband Infrastructure, BloombergBusinessweek (April 30, 2013), http://www.businessweek.com/articles/2013-02-15/alcatel-lucent-unveils-worlds-most-powerful-broadband-infrastructure.19Don Clark, Qualcomm CEO Envisions Cell Base Stations in Your Home, The Wall Street Journal (May 2, 2013),http://online.wsj.com/article/SB10001424127887324339204578173332194107300.html.20Christine Barton, Chris Egan, Jeff Fromm, The Millennial Consumer Debunking Stereotypes, The BostonConsulting Group (April 30, 2013),http://www.brandchannel.com/images/papers/536_BCG_The_Millennial_Consumer_Apr_2012%20(3)_tcm80-103894.pdf.
  • Black Box BreachJoseph Mathew8 of 9future “smart” television will be comparable to channels and services that are presently found viayour computer, mobile device, and television. The device may come in the form of a massiveflat screen that perhaps covers an entire wall, or in the shape of glasses, projecting your ownpersonal display, or some combination of the two.21The key insight from this exercise, though,is that the internet is king in the new regime of home entertainment.III. THE TAKE AWAYSa. To: The Technology, Media, & Telecommunications CEOi. Evaluate Core Competency’s ValidityFor the average tech, media, or telecom mogul, the results of our thought experimenthave some fairly clear repercussions for your corporate development and merger and acquisitionstrategy. First, take a deep breath and remember that some of the most powerful states in theworld, such as China, are pouring billions of dollars into their economic systems in a furiousattempt to replicate your success.22Then, sit down with your top management, discern your corecompetencies and assess whether they still apply in the internet dominion of television.Disney, for example, owns the computer graphics animation space, multiple epicfranchises, and the unique ability to monetize intellectual property across a wide variety ofbusinesses. In preparation for the internet connected living room, Disney should ensure that theirstory generating machines (ABC, Disney Channel, ESPN, Marvel, Pixar, and Lucasfilm, to namea few) have a coherent online distribution strategy that meets the vagaries of the Millennialconsumer. Could ESPN, for example, increase their financial footprint even further by offering a$10 stand-alone online subscription? (ESPN currently sits at the top of the cable mountain,extracting $5.13 in affiliate fees from distributors per month per more than 100 millionhouseholds.)23ii. Conservatively Value Low Growth PropertiesSecond, internal valuations should depreciate soon to be antiquated distribution channelsto zero over the next two decades. Assets headed for obsolescence in the ten to twenty yearperiod include distribution methods such as television broadcast stations. Serious analysesshould be done on the feasibility of satellite and cable pay-TV services beyond two decades.Valuing the viability of the long term primary cash flow generator in your firm could be acontroversial exercise but far safer than being competed into extinction, if your firm lacks theability to provide internet services.iii. Internet Impelled Acquisition StrategyThird, potential acquisitions for driving inorganic growth should focus on media contentdelivered via the internet. On this front, two firms have recently followed the right strategy, one,for the wrong reasons. News Corp.’s phone hacking scandal, which erupted in 2011, forced thefirm to drop a $12 billion bid for the outstanding share of British Sky Broadcasting (BSkyB), a21Tom Warren, Microsofts Xbox chief predicts well all be wearing 10 sensors in the next decade, The Verge (May1, 2013), http://www.theverge.com/2013/3/7/4075196/microsoft-don-mattrick-sensor-predicitions.22David Barboza, China Yearns to Form Its Own Media Empires, The New York Times (May 2, 2013),http://www.nytimes.com/2009/10/05/business/global/05yuan.html?_r=0.23Kurt Badenhausen, Why ESPN Is Worth $40 Billion As The Worlds Most Valuable Media Property, Forbes (May2, 2013), http://www.forbes.com/sites/kurtbadenhausen/2012/11/09/why-espn-is-the-worlds-most-valuable-media-property-and-worth-40-billion/.
  • Black Box BreachJoseph Mathew9 of 9pay-TV provider.24Based on our living room model, News Corp. will be happy to have avoidedthe acquisition ten years from now.On another front, Dish Network entered the bidding contest for Sprint, against SoftbankCorp., with an unsolicited $25.5 billion offer. Dish Network’s CEO, Charles Ergen, has publiclyremarked that four of his five children have stopped paying for TV. Sprint offers Dish theopportunity to provide both wireless internet as well as satellite television nationally.25GivenQualcomm’s vision for the future, if Dish will most likely be in a stronger strategic position post-acquisition, if their bid is successful, and they refrain from overpaying.b. To: The Average AmericanFor the average American, your home entertainment options are about to become farsuperior in the next few years. You will have very real substitutes to traditional cable andsatellite subscription services, and should, eventually, be able to shift to a completely à la cartepay television model, online or off.26With the most content available in history coming to aliving room near you, your biggest issue will not be finding which show you want to watch, butdeciding what show you want to watch the most, or, perhaps more importantly, when to stopwatching. Stay entertained America.24Felix Gillette, Rupert Murdoch, News Corp. Dodge Phone-Hacking Ruin, Bloomberg Businessweek (May 2,2013), http://www.businessweek.com/articles/2013-04-18/rupert-murdoch-news-corp-dot-dodge-phone-hacking-ruin#p1.25Shalini Ramachandran, Sharon Terlep, Anton Troianovski, Billionaires Duke It Out for Control of Sprint, TheWall Street Journal (May 2, 2013),http://online.wsj.com/article/SB10001424127887324030704578424200831745578.html.26Roberto Baldwin, Intel Will Lead Us to à la Carte Pay TV, Wired (May 2, 2013),http://www.wired.com/gadgetlab/2013/02/intel-a-la-carte/.