Why the once-great pay-TV set-top box market is now in retreat

By Daniel Frankel

If you're a Mediacom pay-TV subscriber, there's a very good chance you have a new Pace MG1 multi-tuner media gateway with TiVo's advanced user interface in your living room.

It's a robust set-top, featuring a removable hard drive of up to 1 terabyte in size, a 3000+ DMIPS processor supported by 256 MB of flash memory and 1GB of SDRAM. It also features a CableCard conditional access system that provides for decryption of up to six QAM streams.

pace mediacom mg1
Pace's MG1

"We're really focused in on high-functioning boxes that marry traditional set-top access to online content," said Mediacom spokesman Thomas Larsen. Mediacom's set-top strategy is similar to that of other Tier 2 MSOs in the U.S., like Atlantic Broadband, Bright House Networks and Suddenlink, that also use advanced set-tops and TiVo user interfaces. None of these video services has migrated operations to the cloud.

But outside the American Heartland, where Tier 2 MVPDs still proliferate, the once fast-growing pay-TV set-top market is changing fast. And for set-top manufacturers, it's not for the better, as the forces of operator consolidation and pay-TV market maturity, as well as the emergence of cloud-based video distribution systems, begin to take their toll on the businesses of industry leaders such as Arris/Pace, Cisco, Technicolor, EchoStar and others.

An industry that grew explosively over the last decade, driven by the proliferation of video tech including HD, DVRs and digital cable, is now in recession.

Set-tops now obscured by clouds

The emergence of the cloud is one reason why the global pay-TV set-top market receded in 2014 for the first time since 2002, dropping 4 percent to $15.3 billion in global revenue, according to IHS. Global shipments of pay-TV set tops reached just $15.3 billion in 2014, down nearly 4 percent from the $15.9 billion in sales reported in 2013, according to IHS. Shipments grew slightly in 2014 to 204.7 million units, an increase of just under 1 percent. Such modest shipment growth, IHS said, failed to compensate for the effects of price erosion in this highly competitive market.

ihs set top boxes

The research firm predicts that global set-top revenue will decline to $13.2 billion by 2018 before leveling off. Blame the cloud.

"Once you start to substitute hardware functionality from the STB with something in the network or cloud, then the impact on the STB market is greater because you're reducing the complexity and therefore the price of the STB and potentially the need for an STB," said Daniel Simmons, director and head of connected home for IHS Technology.

Charter Communication's (NASDAQ: CHTR) Spectrum Guide is primary example of this dynamic. Demonstrating its new cloud-based video interface at CES in January alongside its technology partner, Cisco, Charter showed how the Spectrum Guide IP interface could work on an 11-year-old Scientific Atlantic set-top.

charter spectrum guide
Charter's Spectrum Guide

From a financial perspective, that's good news for Charter investors. The company's legacy set-tops could remain in place in customer homes until they short out and die. Replacements--as well as set-tops for new Charter customers--will be built around Cisco's Worldbox open downloadable security architecture. These boxes will be relatively inexpensive and simple in nature, thereby saving Charter money.

Other large MSOs are moving their video infrastructures to the cloud. Liberty Global deploys in Europe the same cloud-based video infrastructure Charter does. Comcast is almost done launching its cloud-based DVR across its U.S. footprint.

"I think you're going to see lighter, cheaper devices being deployed to homes," said Jim Denney, VP of product marketing for TiVo.

Even in a cloud-based video operating environment, Denney doesn't envision the set-top going away. "Having control over that end point is still beneficial for operators, as opposed to running apps for smart TVs," he said. But pay-TV set-top makers are lapsing into a "grey area," whereby premium features like terabyte-sized hard drives are going to be relegated to the cloud.

"Many customers are going to be put into the cheapest, lightest boxes operators can put them in," Denney adds.

Cable consolidation compounded

For set-top makers, migration of video service functions to the cloud complicates an already vexing M&A environment among operators. For example, for the past few years, Bright House has been deploying 500 GB Cisco and Samsung DVRs to its Southeastern footprint, while Time Warner Cable (NYSE: TWC) Maxx customers have access to Arris' six-tuner DCX 3600 enhanced DVR.

If its deal to acquire both MSOs gets regulatory approval, Charter has said that the video customers of both cable companies will start receiving its cloud-based Spectrum Guide service, along with its minimalist set-top requirements.

Already, set-top suppliers are dealing with basic M&A physics--consolidation means fewer customers to sell boxes to.

"With the market looking set to decline, scale will be a big driver," Simmons said. "It's going to get harder to grow market share organically and so vendors will need to grow through acquisition."

Already, No. 1 set-top supplier Arris has agreed to buy No. 2 vendor Pace for $2.1 billion. In order of market position, Arris and Pace are followed by Cisco, Technicolor, Humax, Samsung and Echostar. All of these companies refused FierceCable's invitation to speak for this story.

"Pure-play set-top vendors could also look to broaden their product lines to achieve growth, by acquiring broadband modem and gateway vendors and/or video software companies that supply TV Everywhere solutions and advanced user experiences," Simmons added. "It's also not impossible that we could see companies that don't currently offer STBs but do offer cloud TV solutions, such as Alcatel-Lucent, Nokia or Ericsson, buy into the space to help them compete with the likes of Arris and Cisco, which can offer both."

For the moribund set-top market, other gravitational forces are having a negative impact. Digital pay-TV growth had been the primary growth driver across North America and Europe, but those pay-TV markets are largely saturated now, and even declining. Other growth drivers, such as HD DVRs, are also largely at the saturation point.

"Most pay-TV operators in these markets have completed these transitions and so demand for STBs in these regions will fall to 2019," Simmons said. "STB growth in North America and Western Europe is dependent a new technology arriving that can drive service providers to deploy new type of boxes."

Bottoming out

Ultra HD is one of those technologies that could spur revenue growth, Simmons said, noting that Comcast, DirecTV (NASDAQ: DTV) and Dish Network (NASDAQ: DISH) are expected to announce new DVR set-tops specially designed to decode Ultra HD later this year. "If operators in mature pay-TV markets were to be more aggressive with their Ultra HD rollouts, we may even see the STB market return to growth," he noted.

comcast ultra hd set top
Comcast plans to launch an Ultra HD set-top box.

Meanwhile, TiVo's Denney said cloud-based delivery and the associated virtualization of set-top functions is harder for satellite operators to pull off. But as satellite pay-TV services proliferate across emerging markets like Africa, the Middle East and South America, new vendor opportunities for growth will be created.

For example, Simmons said that Arris will benefit from its acquisition of Pace in South America, where the latter is well-positioned. He added that other vendors that are strong in satellite set-tops and emerging markets, such as Altech Multimedia, Humax, Sagemcom and Technicolor, could also be acquisition targets.

"The set-top isn't going to go away," Denney said. "There's going to be a need for a receiver at the end point for a very long time."

Why the once-great pay-TV set-top box market is now in retreat