Hulu’s New Business Model is Bad Industry Juju

AT&T’s report on earnings reinforced some structural changes in the industry that Verizon’s report had already suggested.  One basic truth is that mobile services are more profitable and more fertile areas for growth than wireline.  Another is that mobile service gains and ARPU both depend substantially on broadband and smartphones rather than on voice services.  Finally, both carriers’ numbers show that you can’t even support a wireline business model on voice any more, and you can’t support it on broadband Internet either.  You either make money with TV or you don’t make money on wireline.

That’s an interesting counterpoint to the reports by the WSJ that Hulu is looking at becoming a kind of online cable operator, offering a premium service only and requiring payment for the service.  This has resulted in some suggesting that maybe it’s time for the whole cable TV industry to be subsumed into a broadband delivery/Internet model.  But if TV is the only profitable wireline service, where does that lead?  We all know the answer to that one, but that doesn’t address the question of whether an attempted shift to a pay-TV model for Hulu, coming after the significant growth Netflix has enjoyed, couldn’t create some serious stabilization issues for ISPs.

Democrats, you will recall, have proposed legislation that would not only codify the FCC’s framework for net neutrality but apply its terms to wireless and explicitly bar any paid prioritization of traffic or “fast lane” other than that paid by the customer.  As I noted earlier, this kind of bill stands no chance with the Republican House so strongly against even the current neutrality rules, but it does show that the political winds are at least blowing somewhat in the direction of accentuating a kind of “Internet-must-carry” principle that could have major impact on future services.

Buried in the details of the AT&T report is the fact that the company has fallen far short of its target for fiber feeds to its cell sites—less than half its goal for 2010 was met.  Now let’s be serious here, gang, nobody doubts that AT&T understands how to deploy fiber; the problem isn’t one of skill or technology.  It’s ROI.  The financial industry has noted that there’s a surprise boost to vendors who offer inexpensive digital-over-copper to buttress AT&T’s tower bandwidth; clearly the fiber shortfall is cost-driven.

The ROI shortfall shouldn’t come as a surprise because it’s caused by the same forces that have marginalized wireline—bit commoditization.  Customers want more applications online, but they don’t want to pay more for the capacity to deliver them.  High-end services at 50 Mbps or more undersell unless there’s virtually no price premium for them.  4G isn’t something people want to pay for; they just want to get it.  The public doesn’t understand how the business model of online services depends on the simple launch point of being online with capacity to access the service, and nobody in the media is interested in offending them with the truth.

I’ve been told that with the current trends in both wireline and wireless, and with no additional revenue streams, broadband Internet would be an unprofitable service for US operators by 2013 and that mobile broadband would be unprofitable by 2015.  Carriers like Verizon and AT&T who are gaining customers in the traditional postpay market can only gain so much market share because there’s only so many customers.  The “Hulu model” of broadband TV would exacerbate the problem by driving up traffic in both wireless and wireline networks, and worse it would compete with the traditional video services of operators—services that are making wireline at least somewhat profitable and that aren’t contributing to wireless traffic growth.

But it gets worse.  Online ad revenue per user from a Hulu model would be about 4% of what TV commercials now bring on a per-user basis.  If we saw migration to an online model, we’d either lose 96% of the money available to fund content development or we’d have to presume that somehow advertisers would agree to pay 20 times or more as much for each online eyeball, which sure seems unlikely to me.

What this adds up to is simple; we’re heading for a usage-priced model of broadband foreverything and if regulators try to stem the tide they’ll simply drive the operators out of investing in infrastructure.  One way or the other, the Internet isn’t going to be the “over the air” of the future, with no marginal cost to deter usage.

Cable’s business model works not because of voice or broadband but because of TV.  Fiddling with that golden goose could cook a lot of the players in the industry—and the vendors who support them, and the viewers who depend on them.  We’re facing a major disruption here, and the question now is whether we can, as an industry, come up with some logical way to save the health of the system that the whole of the Internet depends on.

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