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The Broadband-driven transformation of consumer markets

By Dr. Martyn F. Roetter, North American Project Leader, “Making Broadband Profitable”, Arthur D. Little

Executive Summary
As of early 2003, broadband access had only achieved around 16% penetration of US households, well behind the South Korean penetration level of more than 70%. Nevertheless, the arrival of broadband is already acting as a major force in US consumer markets and competitive landscapes for both “connectivity” and media services and equipment. It is widely expected that broadband access will have become a mainstream facility by 2007-2008, with a penetration level at that time of close to 60% of households (Table 1).

Table 1: US Broadband Households

Year-End Broadband
Penetration of Households, %
Broadband Households(millions) % Cable Modems % DSL % Other (fiber, satellite, fixed wireless)
2001 9.2 10.8 66.0 32.3 1.7
2002 15.9 17.2 65.4 31.7 2.9
2003 22.4 24.3 65.0 32.0 3.0
2004 29.8 32.4 64.0 33.0 3.0
2005 38.5 41.9 63.0 33.9 3.1
2006 46.8 51.0 62.0 34.8 3.2
2007 53.6 58.5 61.0 35.7 3.3
2008 58.5 64.0 60.0 36.5 3.5
Source: Arthur D. Little estimates

Broadband represents a decisive point of inflection for consumer markets. By virtue of the new user experiences that broadband access enables, exploiting humans’ senses in regard to rich audio and moving video content, it is evidently much more than simply a faster substitute for dial-up access. The next few years promise to be the period during which market positions and shares will have to be firmly established by participants who do not wish to miss new broadband-related opportunities, and/or are trying to avoid the threats that broadband may pose to their existing businesses.

The US will be a source of much innovation in broadband-related markets, despite its current relatively low broadband penetration levels, as a result of:

  • The sheer size of the US market, even at relatively low penetration levels
  • US leadership in the areas of Internet- or web-based content and services, and
  • The impact of competition between diverse major connectivity providers, - telephone companies, cable MSOs (multiple system operators) and satellite providers – that is much more intense than in many other markets.
The broadband-related value or supply chain is complex and involves a very wide variety of participants (Figure 1), from components and equipment makers to the providers of connectivity and content services, as well as content creators and distributors. Their fates and fortunes will depend on their ability to participate in the creation of “ecosystems” of companies that can deliver compelling and pleasing experiences to consumers.

A key competitive dynamic in the broadband era is that consumers are becoming increasingly attracted to “bundles” of connectivity and media and entertainment services that are facilitated by broadband access. These “bundles” are initially offered as, and are tempting for their associated price incentives (discounts), but in the long run they will be constructed and differentiated on the basis of the experiences they enable.

Legal and regulatory decisions will continue to influence the relative strengths of competing participants in broadband markets as in all telecommunications market segments. However, the influence of traditional telecommunications and broadcasting regulations on opportunities in broadband markets for participants will be secondary to their skills in tackling basic business challenges in areas such as sales, marketing, and partnerships. Furthermore, the development and implementation of robust digital rights management systems and associated legal and operational frameworks will have a greater impact on the market potential for paid content and content services than will regulations on the rights and conditions of access to networks.

Dynamics of Broadband Markets
Broadband access allied with the Internet can deliver digital content of all types from music and video to interactive games and of course data and information. As a direct consequence, two changes have already become noticeable in consumer behavior:

  • Consumers are spending more time with media-capable PCs, game consoles, and web browsers (+27% in 2001) and less time consuming “traditional” media such as TV (-6%). Several indicators of the media business have declined, such as advertising and music revenues (e.g. audio CD sales).
  • Consumers have begun to show a propensity to buy “bundled” services for connectivity and media and entertainment, instead of discrete connectivity services. However, these “converged” packages are emerging from partnerships between two or more enterprises rather than from companies that have brought all the components together under one corporate umbrella through acquisitions.
Thus far the attraction of “bundles” has been essentially one of price (discounts for buying two or more services) and convenience of single point billing. In the longer run, however, the winning packages will be those that offer compelling user experiences, with consumers enjoying considerable flexibility to tailor these experiences to their specific desires. Therein lie both the opportunity and the challenge for broadband participants, namely how to offer enticing combinations of rich content and pleasurable and convenient user experiences.

The development of broadband access is affecting the overall development of the market for consumer connectivity, in which it is one of the key drivers, but far from the only one. The future landscape of consumer communications is being shaped by several interacting, but distinct, forces in the market arenas of (a) Connectivity; (b) Content Distribution; (c) Content Services, and (d) User Devices. The dies are by no means cast yet, and they may well turn out differently in geographies outside the US, where the relative competitive starting positions and assets of the various players, and the institutions and social and cultural tastes of consumer populations vary widely. The technical and economic forces of “globalization” are far from sufficient to guarantee homogeneous outcomes.

Connectivity:

  • Competition in consumer connectivity services is becoming increasingly difficult. Declines in the core voice revenues of telephone companies, that will be exacerbated by broadband access that removes the need for additional telephone lines for dial-up access, means that telephone companies will need to redefine their consumer markets – to include participation in the consumer media and entertainment markets while protecting their share of the consumer communications market; they are however very unfamiliar with the dynamics of content distribution
  • Powerful initiatives from large, consolidated cable MSOs that have been investing heavily (some $70 billion over the past 7 years) in higher bandwidth digital cable networks that can support new high speed interactive and one-way digital content distribution services. Some cable MSOs also offer telephone service to their customers. However, cable MSOs have yet to come fully to grips with the broadband data market and with the potential of some new digital content distribution channels – for the former they will have to go head-to-head successfully with AOL, MSN and other portals and content services providers or build effective partnerships with them. Cable MSOs will also have to take care that their existing content distribution relationships are not bypassed or reduced in value by telephone companies’ negotiation with content owners of mutually attractive rights to digital content distribution over new digital channels.
  • Satellite providers (DirecTV and Echostar) have made inroads in capturing customers for video entertainment not only in rural regions where there is no cable infrastructure but also in some areas where they compete directly with cable. They exploited their now largely eliminated advantage of being able to offer a larger number of channels by using digital signals while cable was still employing analog technology. The most powerful competitor could emerge in News Corporation, which recently arranged to acquire control of the 11.2 million subscriber satellite provider DirecTV - it will have to to exploit its rare combination of this satellite distribution and its extensive programming content in a mutually reinforcing manner, as it has so far succeeded in doing with its satellite property B Sky B in the U.K. It must also hope that the deficiencies of satellite compared to cable in supporting high-speed interactive services are not decisive limitations for the purchasing decisions of many consumers.
  • Continuing regulatory disparities between cable MSOs and telephone companies, especially in regard to their obligations to make their network facilities available for use by competitors, which are required of telephone companies but not of cable MSOs (although some of the latter are doing so anyway). While regulatory disputes make for good press and revenues for lobbyists, in this broadband context they are becoming less important than the business issues outlined above participants would do well to focus on the respective threats and opportunities that success or failure in the broadband access market will pose to their longevity, rather then act as if regulatory or legal decisions will have a decisive influence on their competitiveness and future prosperity.

Content Distribution

  • There is increased interest from content creators and owners in accessing new distribution channels in the era of digitized content (e.g. video-on-demand to replace and/or supplement the purchase or rental of DVDs and videotapes) - however, the business models for the distribution of original and repurposed digital content to consumers are still unproven. There is considerable tension about the digital distribution model and how to develop a digital rights management system that will be acceptable to all stakeholders. Sony - both a content owner and a major device manufacturer- faces an internal dilemma. On the one hand it has a strong incentive to develop terminals to be user-friendly, making it easy for users to transfer and reuse the same content on different devices. On the other hand as a seller of content Sony wants to make sure that it receives all payments to which it is entitled from all the uses and users of its content.
Content Services
  • There is growing evidence of the financial potential of providing services instead of, or in addition to, stand-alone content. Consumers do seem to be willing to pay for services that enable them to access information, and tools for enhancing information for their purposes, in a convenient way at a convenient time, even when that content is basically available for free. Examples of content services range from location-based access to content, to hosting and web site-building tools, and a wide range of niche offerings, such as special interest online personal ads, which allow consumers to post content about themselves that other users pay to access.
User Devices
  • Technology is spurring thed evelopment of a wide range of new and more powerful user devices with increasing communications, storage, processing, and input/output capabilities and a variety of user interfaces. Several battles are looming whose outcome will determine the relative market shares and importance of competing user devices for example, will Sony’s “CoCoon” product line built around Linux and MIPS RISC processors threaten the “Wintel” dominance of mass market hardware for access to the Internet?

The development of all of the above markets is fundamentally subject both to consumers’ ability to pay in relation to the prices of the equipment and services offered, and to the strengths of their desires for the associated services and content. These offerings are competing with other demands upon consumers’ wallets, from travel to health care to education.

Broadband value chain suppliers can influence consumers’ choices in their favor by enhancing the effectiveness and price/performance of their offerings in satisfying or arousing desires for communications and content. However, consumers are being bombarded with confusing choices of communications and other services. Absent compelling customer experiences, and assuming essentially comparable levels of quality in the services themselves, the only enticement to which consumers can respond is price. Mainstream consumers do not care about comparisons or the relative merits of DSL versus cable modem or satellite, they are driven primarily by their wants and desires with respect to:

  • Availability and access on-demand to a range of entertainment and other choices (music, games, video, learning programs etc.) at all times
  • Ability to control their entertainment and other (e.g. hobby) experiences themselves
  • Easy distribution of their entertainment, information, and communications content to the device or devices of their choice physically located throughout the household, and according to the preferences of different members of the household.

Customer focus and understanding are critical to the success of the broadband value chain or ecosystem, disciplined by the need to create sustainable business models founded on realistic sources of revenue and profit.

Requirements for Success
Companies in the broadband ecosystem are making key choices about how to participate in areas that are not their traditional strengths, considering:

  • Internal growth of new capabilities
  • Acquisition
  • Partnering.

Every firm will have to find its own way, since there are no universally “right” ways to achieve desired business goals. Nevertheless, there are three principles or guidelines that all companies would be well advised to keep constantly and prominently in mind as they make and implement their decisions:

1. SHOW ME THE MONEY!: The revenues from and associated with residential broadband customers will come from several identifiable sources:

  • Entertainment expenditures by households (games, movies and videos, audio etc.)
  • Communications expenditures by households (telephone, messaging, information retrieval etc.)
  • Advertising and other marketing expenditures by businesses and institutions directed at consumers
Opportunities for broadband revenue growth can come from broadband-based substitutes for existing expenditures in these categories, and from decisions by consumers to spend more discretionary income on broadband as they shift expenditure patterns, for example spending less on dining out.

Analysis of government data indicates that for the quarter century up to the end of the 1980s the average US household spent about 6% of its disposable income on “information and entertainment”, including everything from newspapers and movies to telephone service and radios and TV sets. This percentage grew throughout the 1990s, and may now have reached 10%. Whether this percentage can continue to grow or is bound to fall as consumer spending may be shifted in a morose economic environment towards health care, more home improvement, and debt payments is very difficult to predict.

2. FIND A FULCRUM - NO PARTICIPATION WITHOUT NEGOTIATION: Independently of the strategy a company chooses to pursue, its ability to negotiate effectively, creatively, and flexibly with companies in different sectors and with very different cultures and histories than its own will be a critical success factor. Companies from all backgrounds will be striving to establish themselves as a fulcrum within the overall value chain of broadband-related services, so that they can enjoy strong negotiating positions with their suppliers and their customers (whether the latter are the consumers themselves and/or other businesses). The famous Microsoft/Intel “Wintel” combination is of course just such a fulcrum in the PC world. Google, the leading search engine, is showing many signs of becoming a fulcrum because of its emergence as a powerful new marketing medium on the Internet. Its new advertising programs made available to businesses include software that makes the ads relevant to Web surfers’ search requests. Depending on popularity, advertisers pay anywhere from cents to dollars when a searcher clicks on the ad. This approach to marketing and hence Google’s positioning, that is not confined to but is being reinforced by the advent of broadband access, could be strengthened by the serious barrier to entry that is posed by the immense size of Google’s computing resources. Major portals such as MSN and Yahoo! (Yahoo! has long relied on Google’s search technology) are trying to overcome this barrier with their own initiatives. Their interest is sparked by the fact that revenues from search-related advertising in the US grew to $1 billion in 2002 from $400 million in 2001, and rapid growth is continuing, aided by the irritation of consumers with indiscriminate “pop-up” and video ads.

3. UNDERSTAND THE CONSUMER: The companies or alliances of companies (or “ecosystems”) that will succeed in the broadband arena are those that create and help consumers create for themselves enticing and compelling user experiences, from combinations of connectivity services, content, and content services. Consumers will decide how much and how they spend their money on communications, entertainment, and personal and even professional content. The telecommunications industry in particular should pay attention to this principle, to avoid falling into the trap of competing only on price, as has happened in several segments of its traditional consumer business.


Martyn F. Roetter, Ph.D.
Dr. Martyn F. Roetter is a Vice President, Communications and Information Technology at the management consulting company Arthur D. Little. He is based in Lexington, Massachusetts, USA. He has over 25 years of experience in consulting on business and technology issues for companies in the telecommunications, information systems, and electronics industries, both equipment and service providers, as well as investors in these sectors. His activities have had extensive international and global components, covering markets and competitors in the three principal regions of North America, Europe, and Asia/Pacific, as well as in Latin America. Dr. Roetter’s earlier positions included co-managing Arthur D. Little's global communications and information technology consulting practice, and founding the European arm of this practice from a base in Paris. He was also responsible for developing the international business of the UK- based software and services company PA Computers and Telecommunications. He was a Vice President at Decision Resources, Inc., a spin-off of ADL, where he managed its consulting and advisory publication services for the telecommunications and information systems industries. Dr. Roetter was educated in England, Germany, and the United States and holds a doctorate in theoretical nuclear physics from the University of Oxford. He has lived in the United States and several European countries, and speaks English, French, and German. He speaks and publishes regularly, is widely quoted in the business and trade press on issues affecting the communications and information industries, and has co-authored several books on the uses of information technology. He is a member of the IEEE and the IEEE Communications Society, and of the Board of Directors of Allen Telecom, Inc., where he is Chairman of the Compensation Committee.


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