OTT's early impact: 6 rules for monetizing next-gen pay-TV business models

By Daniel Frankel

Executives in both the music and newspaper industries have compared their digital transformations to trying to push their businesses through a garden hose--they have struggled mightily to sustain their businesses as they learned to monetize IP-based distribution of content.

And there is a belief, finally reinforced by real-world business models like Pandora and Spotify, that there is, in fact, a spigot on the other side. Revenue growth will once again be realized in these media sectors disrupted and transformed beyond all recognition by the Internet. We may never see margins get anywhere near where they used to be, but there will be real monetization, nonetheless.

For TV video, "I still feel like we're in the early, early days," notes Joel Espelien, senior analyst for boutique research firm The Diffusion Group.

Indeed, pay-TV hasn't officially entered the garden hose phase yet. Research company Strategy Analytics reported a 101,000-subscriber rise in U.S. pay-TV customers for 2014, bringing the total to 96.1 million cable, satellite and IPTV homes in the U.S.  Still, while the fundamental indicators might not have shifted yet, the industry is wisely dipping its toes into the over-the-top world with the sudden emergence of new services like Dish Network's Sling TV and Sony's PlayStation Vue.

The U.S. pay-TV industry is wisely learning how to monetize OTT services before they must be relied upon as core revenue-producing products.

"My experience is, some of our theories will be right, and some will be wrong," noted Dish Network (NASDAQ: DISH) chairman and CEO Charlie Ergen, a few months before the February launch of Sling TV, summing up the experimental mindset that the pay-TV industry and its partners seem to hold toward OTT right now.

Here are some of the early basic rules--or "learnings," as Ergen calls them--we already know about OTT distribution:

Rule 1: The line between keeping content costs low and the user experience high is razor-thin: While operators like Dish and Sony have to keep price points low to attract a next-generation digital consumer, content makers can't--and won't--discount the price of their products, at least not straight away.

"I don't think ESPN is discounting its service for these guys," says Espelien, noting that Sling TV probably pays the same $6-per-subscriber for cable TV's top channel as every other pay-TV service.

Pricing, he notes, can be trimmed at the margins. Sling TV's basic service, for example, offers 20 channels for a millennial-friendly $20 a month, but most of the channels don't support VOD and none support DVR functionality--a major drawback.

"I think Sling TV is penny wise, pound foolish if they try to save money on content by not paying for the features users actually want," Espelien says.

Conversely, not only does Sony's PlayStation Vue feature more basic channels, it includes a robust cloud-based DVR. However, the $50-a-month base price skirts the line in which the consumer asks, "Why don't I just get a traditional cable package."

Being at the outer edge of price elasticity also limits Sony from adding ESPN down the road. The absence of the leading live-sports platform for a service targeting predominantly young-male PlayStation users has led Espelien to label Vue "dead on arrival."

Rule 2: Understand that content companies still control growth: The major programming conglomerates have come a long way in regard to their attitudes toward OTT distribution, and feel they have to do something to sate the burgeoning consumer demand for a la carte multi-screen services.

But they're still being careful in regard to possible cannibalization of core pay-TV products.

Several conglomerates, for example, licensed their channels to Sling TV on the condition that the service grows no larger than 2 million subscribers.

"They want it to be a complementary product and not a competing product that cannibalizes their core business," says Bloomberg Intelligence analyst Geetha Ranganathan. "They don't want it to become too popular."

Rule 3: Operators will, in fact, be in the media business: In a world that is increasingly OTT-dominated, and in which MSOs are ever more reliant on their broadband businesses, "cable operators should be thought of as infrastructure providers, not media companies," analyst Craig Moffett argues.

But in order to effectively monetize their OTT businesses, pay-TV operators will have to get directly involved with the selling of advertising on their platforms. Luckily, being IP-based, these next-generation services will have inherent advantages.

"I think online advertising delivered programatically is ultimately a superior product to traditional linear TV advertising," says Espelien, noting that brands can stream personalized, targeted commercials in a way they never could on linear platforms.

Ergen, for example, has said that targeted advertising will become a major monetization feature for Sling TV as the product evolves.

Rule 4: A lot of channels are going to go away: The age of "media networks" being ubiquitous for pretty much every programming conglomerate could very well become a thing of the past.

For one, the early OTT pay-TV models are fairly "skinny," with programmers seeming to understand that they can't cram their marginal, low-rated networks into the core bundle.

Meanwhile, the launches of products like HBO Now and CBS All Access further perpetuate an a la carte landscape, where smaller, niche programmers are squeezed out.

"I think future profitability will be less evenly distributed than it was under the pay-TV paradigm," Espelien says. "The days of everyone getting fat at the same trough are over."

Rule 5: The digital customer pays differently: Basic pay-TV transaction theory requires a contractual bond between operator and subscriber. And it's justified, for a model that mandates the deployment of pricy truck rolls and the leasing of expensive equipment.

Delivering OTT services, where the customer is providing all the hardware, and has paid for the use of the network infrastructure, is a different story. Thanks to Netflix (NASDAQ: NFLX), the online video customer expects a 30-day free trial and to be able to cancel service at any time.

"You spend so much driving them to the page and getting them interested. You don't want them to finally get there and go, 'What?'" explains Gene Hoffman, founder and CEO of Vindicia, a company that has designed online payment systems for DirecTV's Latino-targeted SVOD service, Yaveo, NFL Sunday Ticket, and many other streaming video services.

Hoffman says that converting 45 percent of free-trial participants into credit-card-tapped members is a good batting average. And once they are signed up, he says, customers of online video services should be given a little more rope.

Take his example of a millennial-aged consumer with a $500 limit on a starter Visa card, who rents a car to go on vacation. The automatic hold placed on that Visa by Avis or Enterprise will result in the next transaction being declined.

And if that next transaction comes from a traditional video and broadband service provider, this customer might find his TV and video service suspended or cancelled when he comes home.

Operators of online service companies must be smarter, Hoffman says. "You can often infer from the data what's going, and whether it's simply a large hold on an account," he explains. "You don't want to lose those customers."

Rule 6: There aren't a lot of rules right now: It was just reported by Re/code that Apple (NASDAQ: AAPL) wants the programmers participating in its upcoming OTT pay-TV service to provide their own streams. If proven true, this would relieve Apple of a significant technological cost burden.

Due to the proliferation of the Apple TV streaming device, a lot of OTT industry watchers think the tech giant can get away with it.

"They were rumored to be building their own CDN, just like Netflix, but they appear to be using their market clout to put the onus back on content providers," said Alan Hoff, VP of strategic marketing for multi-screen technology company SeaChange.

Apple's creative solution to the issue of distribution infrastructure--make someone else provide it--is just one of novel monetization strategies we'll see as the paradigm more fully evolves over the next few years.

OTT's early impact: 6 rules for monetizing next-gen pay-TV business models
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