Digital Television

Exploring Opportunities for Broadcasters

by Scott Kosch

Montgomery & Associates

Note: It will be useful for the reader to also see three other articles in this issue of 21st that all have a bearing in one way or another on the issues raised by Scott Kosch. See the "SpeedChoice Corporate Profile", Matthew Oristano's "Data Over Wireless" piece, and last but not least, Vale 's "Dolo" column.-- Ed.

 

Digital technology has swiftly and radically transformed most media and communications businesses. Now broadcast television's time has arrived. Although the public may not be fully aware of the changes at hand, many industries are actively involved in the rollout of digital television including broadcast, cable, satellite, consumer electronics, computer, and entertainment. The driver of this change in the United States is the Federal Communications Commission, which has taken an active role by requiring broadcasters to convert to digital. Commercial network affiliates (i.e., ABC, CBS, NBC, and Fox) in the top 10 markets must begin broadcasting a digital signal by May 1999, and affiliates in the top 11 through 30 markets must follow suit by November. All remaining commercial stations must file construction permits with the FCC by November and be on-the-air by May 2002. How broadcasters use this digital spectrum beyond broadcasting a digital version of the conventional NTSC signal with a 4:3 aspect ratio remains unclear. On the other hand, satellite broadcasters have pioneered digital broadcasting and the cable industry is rapidly building an advanced digital infrastructure to support both broadband connectivity and digital television.

 The public, nonetheless, has already begun to demand digital entertainment and content from a more interactive medium, the Internet. Today nearly 80 million Americans are online either from home or at work, and more than half of 16 to 34 year olds use the Internet. Moreover, recent surveys report that people in homes with Internet access watch 15 percent less television. The cable and satellite broadcast industries are betting heavily on the convergence between the PC and television by investing and establishing partnerships within the technology, Internet, and consumer electronics industries. The key threat to broadcasters, therefore, is the growing control of the viewer by the cable and DBS operators as they integrate program guides, Internet access, enhanced TV, and VCR-like control platforms into the viewing experience. The gauntlet has been thrown down, and the broadcast industry must respond with conviction.

 As of February 1999, 51 television stations in the United States are now delivering digital signals. By November network affiliates in the top 30 markets will have to broadcast digitally, reaching over 60 percent of all households. The FCC has granted this digital spectrum to incumbent broadcast companies without a competitive auction process; however, as broadcasters are well aware, the conversion to digital broadcasting is not without significant costs. CBS, for example, has allocated $100 million to upgrade its 14 stations for digital broadcasts. Similarly, ABC has already spent over $55 million to acquire digital equipment. Most local stations and network affiliates, however, are expected to swallow the majority of the capital costs for new digital transmitters, tower upgrades or replacements, production equipment, and post-production facilities. These costs, which can exceed the market value of many small stations, will total $2 to $14 million per station. In sum, the current fragmentation of the broadcast industry the aggressive, industry-wide investment that is necessary to mount a robust competitive response to cable and satellite operators and the Internet.

 Nevertheless, where will the additional revenue come from to justify these costs? Broadcasters are beginning to explore new business models; yet, without a critical mass of consumer demand, assessing which opportunities are the most robust requires thoughtful analysis. Broadcasters who are unprepared for the digital television revolution may find themselves giving way to new entrants; whereas, those with sound digital strategies will find the opportunities to expand market share, dominate new markets, and enhance profitability.
 

Demand for Digital Television

Market penetration of digital TV sets and set-top boxes will largely determine consumer demand for digital television. Of course, most people would prefer high definition television (HDTV) for sporting events and movies, and many would find interactivity within a television environment compelling. Notwithstanding consumer service preferences, the market for TV sets that cost more than $5,000 is limited. In fact, CEMA conservatively estimates that sales of digital TV sets will be limited to 150,000 units for 1999 and 600,000 units for 2000.

 As prices begin to fall the market will expand. There are 18 million households ? from a total of 100 million television households ? who have already purchased TV sets priced at $2,000 or more. Furthermore, CEMA projects digital TV set penetration will reach a minimum of 30 percent of households by 2006 with annual unit sales exceeding 10.8 million. In addition to digital TV sets, many more consumers will purchase digital set-top boxes, which can capture and convert a digital signal for display on current analog TV sets. For a few hundred dollars, set-top boxes will bridge the gap between consumer demand for digital television services and the average household budget for consumer electronics. The combined installed base of digital TV sets and set-top boxes should grow to over 60 million units by the end of 2003 and then explode to 330 million units by the end of 2010 according to a recently published market study by International Data Corporation. Although these numbers include some double counting ? for example, a DBS set-top box connected to a HDTV set or more than one digital cable set-top in the home ? these projections clearly indicate that digital television will reach a critical mass of consumers by 2001 and ubiquity sometime within the decade.

 With these numbers in mind, broadcasters need to assess their strategic options today. Now is the right time to explore the opportunity for new service models within digital television.
 

New Service Models

Widespread reception of digital television signals will make it possible for broadcasters to provide a broad range of new services. Each of these new business models must be assessed on a case-by-case basis in order to pursue a wise course of action. Without taking into consideration consumer demand, box deployment, unique broadcaster assets and capabilities, enabling technology requirements, and competitive response, a broadcaster will have little information with which to make an informed decision. Representative digital television service models include:

• TV Internet Portal - Aggregating excess spectrum to provide a continuously updated, personalized, local and national portal service including news, weather, sports, financial, city guides, and other subjects.
• Enhanced Interactive Broadcasts - Simultaneous television and data or direct links from broadcast television to related interactive content.
• Transaction Channels - Programmed channels with streaming content and interactivity dedicated to direct marketing and e-commerce (e.g., finance, travel, automotive, video games).
• Internet over the TV - Selected Web sites streaming to the television screen (cached on a set-top hard drive in future years).
• Subscription Channels - Gated pay-per-view and subscription channels for proprietary video and data.
• Multicast Channels - Multiple channel programming of enhanced HDTV and SDTV provided by major networks for network affiliates.
• Datacasting - Surplus spectrum utilized for video and data transmissions to corporate and mobile customers

Although each of these models is distinct, some share related features. For instance, targeted advertising, e-commerce, and direct marketing revenue streams can be explored with many of these service models. Moreover, with a data rate of 19.44 Mbps for a digital broadcast signal as well as improvements in data compression technology, broadcasters may choose to develop a hybrid model that includes a synthesis of service models. Some service models will also require a response back channel and strategic alliances with other companies in broadcasting, entertainment, consumer electronics, and the Internet. Nevertheless, broadcasters should carefully consider the abundance of new opportunities made available by the transition to digital television.

Making the Right Choice

Some broadcasters are wary of taking a decisive posture regarding market entry into digital broadcasting. They either are not comfortable with the role of early market entrant or hold the belief that decisions they make today will have a profound and irreversible effect on their business for the next 50 years. Despite these justified reservations, broadcasters must also consider the possible negative consequences of inaction. The broadcast industry has long been familiar with the experimentation that takes place in the content programming world. New show pilots are developed and tested, and many do not succeed. Nevertheless, without developing and testing new content, broadcasters would be at a competitive disadvantage in the battle for viewers. Even in the face of new sources of competition and falling ratings, the value of television spectrum has appreciated exponentially over time as a result of effectively managing media value. For broadcasters, experimenting with and exploiting new opportunities in digital television will be a good long-term value play, as the television platform remains the premier medium for advertisers.

 The challenge for broadcasters, thus, is to build media value ? the nexus of broadcast spectrum, compelling content, and an attractive viewer base ? through the transition to digital service models. For example, a broadcaster might conduct trials of the multicast channels service model by offering distinct channel programming to niche audiences. Targeted advertising consistently garners higher CPM rates than mass market ads; therefore, multicasting could both augment the broadcaster's ad inventory and raise CPMs. Similarly, interactive/response advertising, pioneered by Internet advertising agencies, is highly valued by consumer focused advertisers. Other forms of advertising ? such as yellow pages, classifieds, newspaper retail ads, direct mail and consumer promotion ? can also be explored within new digital television service models; this $200 billion market for non-electronic, localized ad spending represents a previously untapped pool of revenue for digital broadcasters.

 In addition to these new and incremental sources for advertising revenue, broadcasters can consider how to profit from transaction and subscription based service opportunities. For broadcasters willing to experiment with a robust transactional back channel over the phone lines, the opportunity to capture a share of the retail e-commerce market is waiting. This market is expected to grow from $5 billion to more than $24 billion by 2002. Moreover, consumers are now spending more than $40 billion annually for video programming, video software, computer software, and subscriptions to online services. Digital service models that look to gain market share within these large and growing markets can also be explored. Finally, broadcasters can even forge new service models that aggregate digital spectrum in a local market to compete for the $30 billion a year that consumers spend on subscription television.
 

Hypothetical Business Case

To illustrate the opportunities that broadcasters can explore, the Personal Finance Channel provides one representative business case for a transaction driven digital television service. This digital broadcast channel would be offered within a multicast digital signal, providing financial market news and analysis during and after market hours. For example, e-commerce applications and interactivity ? enabled by a secure back channel and provided in partnership with an online brokerage or news service ? would allow consumers to research market news and manage their investment portfolio from home. Real time market activity could be monitored during market hours, and consumers would explore more in-depth analysis and request further information in the evening. Some examples of potential online partners would include services such as E*Trade, ESchwab, Bloomberg, and Raging Bull. In addition complimentary, consumer-oriented, financial content could include local postings of homes, instruction regarding home finance, retirement planning, and insurance education. Correspondingly, this Personal Finance Channel will be a valuable advertising and transactional platform for other online brokerages such as Realtor.com, E-Loan, and InsWeb.

 Our analysis suggests that over 7.5 million online brokerage accounts are generating 340,000 trades per day, or roughly $175 million in monthly commissions in early 1999, and this valuable market space is projected to double by 2002. Similarly, online mortgage origination is expected to reach $250 billion in 2003 (still less than 18% of the whole market today), and annual premiums for insurance products currently total $670 billion. The challenge, therefore, is to promote the digital broadcast spectrum as a valuable medium for these new online industries to utilize the broad reach of television. Considering that current transaction focused television properties like QVC and the Home Shopping Network reach as much as 70 percent of U.S. households, the digital broadcast spectrum can bring many new services into the homes of consumers. By contrast, popular e-commerce properties such as Amazon and Etoys reach only 16.1 percent and 6.8 percent respectively of all domestic Internet users, according to Media Metrix.

 The penetration of digital television should outpace the residential online market and reach near ubiquity as widespread consumer adoption accelerates. Our financial models consistently indicate that this medium will be a valuable source for both advertising and e-commerce, if broadcasters develop robust service models to support these revenue streams.

Summary

For broadcasters to build media value, exploit new Internet content, and prevent losing ground to competitors, they must begin to explore new service models in earnest. It is important to note, however, that decisions cannot be made hastily or without sufficient examination of service model options. To explore these new digital business opportunities, broadcasters need to assess their options against an analytical framework of consumer demand, box deployment, unique broadcaster assets and capabilities, enabling technology requirements, and competitive response.

 Digital spectrum enables broadcasters to explore market opportunities that were previously inaccessible within the traditional analog broadcast paradigm. Some players will emerge victorious and others will fall short. Nevertheless, broadcasters must resolve to view the transition to digital television with optimism as they devise distinct strategies to profit from new opportunities.

  Copyright 1999, Scott Kosch, Montgomery & Associates, All Rights Reserved

Scott Kosch is a Senior Associate at Montgomery & Associates in Santa Monica, California. Montgomery & Associates is a leading strategy consulting firm providing counsel to clients in the media, communications, cable, information technology, and convergence industries. Mr. Kosch can be reached at 310.260.6957 or send e-mail: skosch@monty.com. Montgomery & Associates is located at 100 Wilshire Boulevard, Suite 400, Santa Monica, CA 90401. Please refer to the company's Web site, http://www.monty.com, for additional information.