The Future Role of Cable in Shaping the Digital Home in Europe

POLICY SERIES

Liberty Global Policy Series The Future Role of Cable in Shaping the Digital Home in Europe by Booz Allen Hamilton

CONTENT

I. Executive Summary 1

II. Creating the Digital Home 2010 in Europe 7 1. Vision of the Future: The Digital Home 2010 7 2. High Acceptance Expected: Consumers Want It, Once They See It 9 3. A Cause for Action: Europe Is Lagging Behind the United States and Asia 10

III. Evolving Competitive Landscape for the Digital Home Market 15 1. Industry Convergence Has Become a Business Reality 15 2. The Rules Are Changing: Emerging Patterns of the New Competitive Landscape 17 3. Premium Content Is Key for Success: Competition Will Further Intensify 24

IV. Challenges for Regulators in Supporting the Digital Home 2010 28

V. “Digital Dividends” of the Digital Home Market 31 1. Scenarios for the Development of the Digital Home 2010 31 2. The Uptake of Digital Homes 2010 Promises Significant “Digital Dividends” in Regard to Growth, Investment, and Employment 33 3. Delaying the Digital Home Greatly Affects the “Digital Dividends“—Regulation Being the Key Enabler or Barrier 41 3.1. Failing to Adapt the Regulatory Framework Fast Enough Will Have Significant Impact 41 3.2. Imbalanced Industry Structures Will Slow Down the Development Towards the Digital Home 41

VI. Recommendations 42 1. Recommendations for Policy Makers and Regulators 42 1.1. Refocus Attention from Broadband to Convergence/DTV 42 1.2. Ensure a Balanced Market Structure and Competition in a Convergent Digital World 42 1.3. Balance Consumer Protection with Long-term Investment and Employment Objectives 44 1.4. Rebalance Regulation in Favor of Infrastructure-Based Competition 45 2. Recommendations for the Cable Industry 45

I. EXECUTIVE SUMMARY

Shaping the Digital Home in Europe—Key Takeaways

After broadband and Telephony, TV distribution is the next market being hit by the digital revolution and being challenged by new competitors such as telco operators

Digital TV can be expected to overtake broadband within the next five years in terms of household penetrations in Europe—becoming the driving force of the development towards the Digital Home and an inclusive digital society

The development of the Digital Home brings significant benefits to the consumer: More choice, more control and better entertainment value—advanced markets show: Consumers adopt the new services fast once they understand their benefits

The competition will be increasingly based on multiproduct bundles (TV, Internet, Telephony) that cover all household needs leading to one unified Digital Home market

Scale will be increasingly important in the convergent competitive landscape as it allows to sustain the necessary upfront investments to build a competitive edge

Telco incumbents will be in a good position to dominate the Digital Home market since they are by far the largest players in this space dominating cable TV competitors by a factor of 1:10 or more

Nevertheless, in many markets cable TV operators will be the only credible contender to challenge telecommunication incumbents

The upside of an accelerated path towards the digital home is significant: Cumulative investments of up to € 100 billion until 2010 would lead to the creation of 100,000 new jobs

Thus the development of the Digital Home—largely driven by the DTV development—will prove to be a key enabler to implement the EU i2010 agenda

Cable TV operators would become the most important job engine accounting for over a third of all jobs created by infrastructure providers

Delaying the digital home market bears significant downside risks—cumulated investments of € 39 billion and close to 90,000 jobs could be lost or delayed

To secure an accelerated path towards the Digital Homes in Europe policy makers need focus on four key areas:

1. Refocus attention from broadband to convergence/DTV 2. Ensure a balanced market structure and competition 3. Balance consumer protection with long-term investment and employment objectives 4. Rebalance regulation in favor of infrastructure-based competition

Page 1 Creating the Digital Home in Europe markets with sophisticated economic forecasting mod- els, we developed a robust midterm vision for what The digital revolution is progressing at an ever- we call the “Digital Home 2010”. This outlook of the increasing pace despite a somewhat slow start in future development is meant to support the thinking most European countries. Consumers are shifting of decision makers in the industry and in regulatory their time and spending budgets in favor of new, digital bodies. media. Driven by a steadily increasing base of PCs and broadband connections, the way consumers retrieve In the next five years most European households can information, receive entertainment, and do their be connected to advanced communication services, shopping has changed dramatically in most Western including both broadband internet and Digital TV. In economies: Consumers spend more time online than fact, we expect that by 2010, Digital TV will already have reading newspapers or magazines; close to 50 percent outgrown broadband internet. Consumers will benefit of consumer hard- and software is already bought from this development in many dimensions: Increased online in the United States; and in the United Kingdom choice and quality and better control and interactivity and Germany one out of five music CDs will be ordered will revolutionize the TV experience of tomorrow. The via the PC this year. majority of European consumers will have access to a diversity of programming unheard of today in most Now the next important segment of everyday life is parts of Europe. Since 2000 the number of available being radically transformed by the digital revolution: TV channels available in Europe has doubled to a Television. Although certain European countries such staggering 1,600 channels—in the most advanced as the United Kingdom, and to a lesser extent, France, TV market in Europe, the United Kingdom, consumers are making significant progress in terms of digital can choose between more than 400 TV programs. television penetration, international market comparison But it is not just about quantity. Consumers also have shows that the EU as a whole is lagging significantly access to higher quality content: From premium sports behind other regions, most notably the United States or movies to leading documentaries and European and some Asian countries, in terms of penetration and local content programs. In addition, higher-quality rates and service availability. content will increasingly be offered in better picture quality based on High Definition TV (HDTV) technology. More than 50 percent of U.S. households already Steadily increasing HDTV adoption rates in the United receive digital TV services, with no slow-down in growth States and Japan as well as an increasing demand for on the horizon. This compares to a European average HDTV sets in Europe underline the consumer interest of only 20 percent. Our analysis of the developments in for these services. Moreover, consumers will be in more advanced markets as well as in Europe suggests better control of their viewing experience. Interactive that the development towards Digital TV (DTV) will Program Guides (IPG) will help them to navigate be one of the most important drivers of innovation through the plethora of available content. In addition, and growth in the information and communication a lot of content will be offered “on demand” or can be technology (ICT) sector: (1) DTV per se will soon be easily recorded on a Personal Video Recorder (PVR) one of the largest growth segments in the ICT market. and retrieved at a time convenient for consumers. (2) DTV will provide a platform for growth for the local content industry leading to a diversity in pro- Again, market experience in the United States suggests gramming never witnessed before and (3) DTV as the that consumers will readily adopt the new services, pre-eminent mass media and technology will prove to once they become available: Gemstar, the leading IPG be the key for digital inclusion, opening the full potential provider—available to 12 million homes in the United of interactive services to parts of society that otherwise States—reports usage numbers that match the total may remain excluded from a purely PC-based digital usage of private internet users in the United States. world. (4) Last, but not least important, DTV will act Comcast, the leading U.S. cable TV (CATV) provider, as a catalyst for convergence reshaping the competitive expects to see more than 1 billion on-demand sessions landscape for communication and entertainment on its network this year—more than 20 sessions per services enabling significant economic growth and active subscriber per month. Last, not least, TV will employment. become interactive allowing consumers to react and interact directly using buttons on their remote controls. Our Midterm Vision: The “Digital Home 2010” Apart from purely commercial and entertainment services, the interactive development also provides Despite the ever-increasing pace of change, clear sign- an opportunity for T-government and other information posts of the future landscape are emerging: Connect- services to reach out to a much greater number of ing the data points from our research in more advanced homes. Since August 2004, interactive TV allows

Page 2 Community Channel viewers in the United Kingdom to Experience from other markets shows that consumers donate money to a number of different charities via the are quite willing to source all services (i.e., TV, set-top box on their televisions. One of the greatest broadband internet, and telephony) from one supplier successes was the Tsunami earthquake appeal in if the bundle on offer is attractive. The implications December 2004, which has managed to raise in excess for the evolving competitive landscape are twofold: of 1.25 million pounds so far. Similar developments First, it will become increasingly difficult to compete can also be seen in some Asian countries and in the for the Digital Home unless a provider is able to offer United States, where for example, material from the the full suite of services. In the midterm that leaves Democratic and the Republican National Conventions CATV operators as the only credible contenders to as well as presidential debates was available on Video telco incumbents. All other players are competing on a on Demand (VoD) to 20 million homes. technology basis (e.g., DTH and DTT—digital satellite and digital terrestrial distribution technologies) that Evolving Competitive Landscape for the Digital Home is not (yet) capable of delivering triple play services. Market Second, size will become increasingly important as a competitive factor, as digital services provide significant Not only will the services on offer change, but the way economies of scale. To put it simply: the larger the they are marketed and delivered to the consumer will subscriber base served, the higher the margins to be change as well. The majority of Digital Homes will be gained—and this increases the capability to reinvest in able to receive the video and TV services described upgrading networks, building alternative platforms, and above together with broadband internet and advanced bidding for high-quality content to further improve the telephony services from one single provider. In advanced competitive advantage. Reaching scale is also vital in markets that lead the development, consumers will becoming an attractive partner for other players in the have a choice of providers to buy the services from—in Digital Home value chain (like content providers) and most cases telecommunication providers and CATV is fundamental to foster confidence in new business operators—and with that also a choice of technologies models. The vital role of sheer size and scale clearly puts (Hybrid coax/Fibre vs. Digital Subscriber Line DSL). the former telecommunication incumbents in the pole The infrastructure providers will take a very important position in the race for the Digital Home market. In most and proactive role in shaping this new convergent markets incumbents such as Deutsche Telekom, France market environment. The development in broadband in Telecom, BT, or KPN outsize their largest infrastructure- Europe has already shown that countries with strong, based CATV competitor in terms of revenues infrastructure-based competition frequently take the generated or subscribers served by at least a factor of lead in terms of overall household penetration of 10 to 1. these services. And as in other infrastructure-based businesses, their investments will pave the way for other Challenges for Regulators in Supporting the Digital market participants, such as technology, equipment, Home 2010 and content providers, to prosper. Technological developments, competitive moves, and All providers of telecommunication infrastructure, consumer preferences are changing many underlying including the former telecommunication monopolists, are assumptions of the current regulatory regime at an jockeying for position to serve the Digital Home market. ever-increasing speed. For example, distribution was That means they are investing to provide so-called triple traditionally regarded as a bottleneck, resulting in play services (telephony, internet, and TV services)— regulators taking a protective stance towards content adding whatever part is missing to their portfolios. The providers to distribute their content. This has changed main motivation differs substantially, however. Whereas in the Digital Home environment: spectrum availability CATV operators and alternative telco providers look at and bandwidth is less of an issue. In fact, there might the Digital Home market primarily as a way to grow their well be an oversupply of distribution capacity and an business, typically, for telecommunication incumbents, undersupply of content. To protect consumers, price defensive considerations prevail: With their fixed levels have frequently been regulated, and consolidation telephony business already under attack from mobile in distribution has often been prevented. In the services, unbundled local loop (ULL) providers, and Digital Home era, however, consumers can choose the digital telephony services (VoIP) offers from cable between different media distributors, and prices will operators, they see video services including TV not only increasingly be regulated by market forces. Continuing as a potential growth avenue, but as an effective means with the existing regulatory frameworks of the to defend their customer base by preventing alternative past may significantly hinder the advancement of the players with alternative infrastructures to capture their Digital Home, ultimately putting industry growth and customer relationship. consumer satisfaction at risk.

Page 3 Regulators on the national and EU level have started making Digital TV the main enabler of an inclusive to acknowledge that competition will increasingly take digital society place in a convergent market environment and are trying to understand the implications for the regulative regime. Cumulative investments of Euro 100 billion would be On the EU level, important public policy and regulatory deployed by the industry to enable the Digital Home initiatives have been introduced to address the environment until 2010 converging market environment, such as the introduction of the i2010 agenda, policy initiatives to bridge the digital Close to 100,000 jobs will be generated, with CATV divide, the communication on accelerating the transition being the strongest job engine from analogue to digital (terrestrial) broadcasting, and the application of competition policy principles on access Local content could expect significant growth, with to (and exploitation of) content (rights) for different Euro 35 billion being spent on programming until distribution platforms. Going forward, the forthcoming 2010, driven by DTV proliferation revision of the Television without Frontiers directive (TVWF) and the review of the regulatory framework There is certainly a lot to be gained by enabling this for electronic communications networks and services favorable environment, but there are some barriers to (NRF) in view of “next generation networks” as well as be overcome. A lot of different players along the value the review of the list of relevant product and services chain need to align their strategies and business markets as recommended by the Commission under models to ensure that all players will be rewarded the NRF will further reshape the regulative framework according to the economic risk. But our analysis clearly at the EU level. shows that the most important enabler will be a balanced regulative regime ensuring a level playing Yet, most policy makers and regulators at national level field for all players willing to invest against this oppor- are struggling to implement coherent midterm public tunity. Almost two-thirds of the total investment needs policies and regulatory instruments to keep pace with to be carried by network operators. These investments the technological and market developments ensuring are going to trigger significant knock-on effects, for a fair and level playing field for all companies willing example, in the area of content development and to invest in that area. The EU Commission has already home equipment innovations. Therefore, ensuring fair taken a first step in the right direction by entrusting one competition on the infrastructure level rewards special Commissioner with the responsibility for both Information attention. Looking at the broadband development across Society and Media. As such this Commissioner is Europe as well as at the development in more advanced effectively the Commissioner for convergence. However, DTV markets like the United States, a clear lesson can most European countries continue to regulate media be learned: Only a balanced and infrastructure-based and telecommunications without much coordination competition will secure a fast and sustainable market among authorities, which often makes regulation and development. Countries with significant infrastructure- policy making in the convergent world extremely based competition for broadband connections, for challenging, and vulnerable to wrong decision example, from CATV, enjoy faster overall penetration making. rates and typically give better value to consumers for their money. The same can be expected when the “Digital Dividends” of the Digital Home Market competition for the Digital Home unfolds: Only if more than one competitor will be able to offer comparable triple play Booz Allen Hamilton has undertaken extensive research offers to the consumer, market dynamics similar to what and analyzed the future market development of Digital can be seen in the most advanced broadband markets, Homes across Europe applying state-of-the art scenario such as Belgium or the UK, will be unleashed. techniques. The results are encouraging, but also reveal an urgent cause for action. Assuming a favorable This also implies a significant risk for regulators. If economic climate as well as supportive regulative infrastructure investments are not being encouraged regime, the gains (“Digital Dividends”) to be achieved and—to a reasonable degree—also protected by the from the development towards the Digital Home are regulative regime, significant delays can be expected. very significant: Almost half of the cumulative investment—close to Euro 40 billion—would be delayed or lost altogether in More than 60 percent of European households can Europe if significant regulative barriers remain in place be served by Digital TV services until 2010 or additional ones are created. The impact on the job market would be even more severe: 90,000 out of By then Digital TV can be expected to overtake the 100,000 jobs to be generated in the convergent broadband in terms of household penetration— industries could be delayed or lost.

Page 4 Recommendations for Policy Makers and Regulators different authorities (e.g., one regulatory body for telecommunications, another one for media) under The stakes are high to get it right—both policy makers different policy objectives. However, the convergence and industry players need to act decisively. On the basis of TV, broadband, and telephony will require much of our analysis, we see four key themes for regulators to closer coordination—if not even a merger—between focus their attention on. different regulatory bodies and the definition of new strategic industrial policy objectives supported by a 1. Refocus attention from broadband to convergence/ broader set of coherent public policies. Digital TV The shift from analogue to digital TV is a risky To date policy makers and regulators have by and challenge for all industry players; any unequal support large focused on broadband to drive their digital of technologies and/or platforms may lead to an economy objectives. Our analysis shows that Digital imbalance in industry structure and a slowdown of TV becomes increasingly important and can be overall market development. Hence, policy makers expected to overtake broadband penetration by should therefore support rapid consumer migration 2010. As Digital TV becomes the main enabler of to the Digital Home regardless of the technology of an inclusive digital society, a more balanced policy the distribution platform, for example, through pub- perspective on broadband and Digital TV is justified. licity campaigns or clear analogue switch-off dates. Policy makers and national governments need to As such, support for digital switchover should be realize the importance of the analogue to digital technology neutral. migration and, hence, should support migration efforts initiated by industry players. 3. Balance consumer protection with long-term investment and employment objectives 2. Ensure a balanced market structure and competition in a convergent digital world Policy makers face the challenge of balancing short- term consumer interests (e.g., low prices) with To ensure a balanced market structure, policy makers midterm objectives concerning economic growth need to reflect the convergence of TV, broadband, and employment. For the regulator, the need to and TV markets. The relationship between different support this balance drives the need for a coherent horizontal markets (e.g., TV distribution and regulative framework across services (TV, broadband, broadband), including the increasingly stronger telephony), distribution infrastructures (cable, DSL, interdependencies, needs to be taken into account. satellite, terrestrial), as well as along the value What seems to be a position of significant market chain (content versus distribution). When making power (SMP) in one market today can be easily dwarfed decisions on positions of significant market power tomorrow by the entry of a competitor 10 times the or on consumer protection, policy makers need to size and economic weight. Also, the interplay across make a trade-off of short-term gains against positive the value chain, in particular between infrastructure long-term effects on investments, jobs, and industry operators and content providers, needs to be brought structure. They need to ensure that short-term (or kept) in balance. Traditionally, near monopolistic remedies (e.g., price regulation, network access) do market structures in distribution put the platforms not prevent investments in long-term growth, which into an advantaged position, and they were thus would lead to significant distortion of fair market prevented from entering the content market. But it is competition. time to rethink this dependency in the convergence space because distribution will no longer constitute 4. Rebalance regulation in favor of infrastructure-based a bottleneck. Today’s changing reality paves the way competition for a new relationship and integration of content and distribution with only extreme cases of unfair Policy makers should stimulate infrastructure blocking of platforms or unfair treatment of own competition rather than focusing too strongly on versus other content required to be regulated. service-based competition to foster consumer Thus, regulatory decisions concerning vertical and choice because infrastructure-based competition horizontal consolidation need to bear these new leads to the best results in terms of investments market realities in mind. Consolidation in the industry and technological innovation as well as in-country will be required in most European countries to enable job creation. Increasing service competition on fair competition. As such, the convergent market distributors’ infrastructure will deter them from poses a particular challenge to regulators because making significant upfront infrastructure investments frequently the Digital Home market is regulated by because they may not be able to earn an adequate

Page 5 return on those investments. As infrastructure the mass market quickly, and (3) Changing investment is reduced, so too will be the overall revenue streams. To address these challenges and penetration of the Digital Home. Because the Digital to take a lead in driving the Digital Home, Home is far more than just another entertainment cable operators should act on six strategic impera- fad, the impact of a slow penetration is immense: tives: substantial investments in digital content and new businesses are delayed, small and medium-sized 1. Understand the Customer: Develop Consumer-Driven enterprises are deprived of up-to-date communication End-to-End Entertainment Offers features, and the digital inclusion is not realized to the extent possible. In addition, regulators need to 2. Serve the Entire Digital Home: Offer Compelling be aware that service competition on a network may Bundles lead to degradation in quality of service both to the service provider’s customers and to the infrastructure 3. Convince Consumers: Build Marketing and Sales provider’s customers. Opening up networks to third- Capabilities party service providers may also limit the effective protection of content rights. 4. Give Consumers What They Want: Proactively Migrate the Customer Base to Digital Recommendations for the Cable Industry 5. Size Matters: Build In-Country Scale In turn, industry players need to adapt to the new re- alities to drive the development of the Digital Home. 6. It’s a Team Play: Build New Business Models and Today, the cable industry finds itself in a consumer prod- Partnerships for Superior Digital Services uct market in which companies have to cater for diverse and fast-changing consumer needs. And for every one Regulators are challenged to secure a level playing of these products, several credible competitors try to field and investment security for all players willing secure their part of the market. To successfully to invest to make the Digital Home a reality. Once drive the development of the Digital Home, this is granted and all players take advantage of cable operators thus face three key challenges: this market opportunity, Europe will look at a (1) Making large upfront investments, (2) Capturing very exciting decade of moving into the digital age.

Page 6 II. CREATING THE DIGITAL HOME 2010 IN EUROPE

1. Vision of the Future: The Digital Home 2010 over a single, high-speed distribution infrastructure (Exhibit 1). Consumers will consequently have the Digitalization and convergence are no longer buzzwords choice between different distribution platform providers, but have become business reality: communication and such as cable, telecommunications, satellite, or media industries continue to experience rapid techno- terrestrial distribution players, who will aim at providing logical innovations in digital services, digital distribution a suite of comparable entertainment, communication, networks, and end user equipment; television distribu- and information services to the Digital Home, thereby tion technology is increasingly shifting from analogue threading into each other’s former core markets. What to digital; and industry players are introducing more the industry has been discussing for the past 10 years and more services expanding their traditional offering is fi nally becoming a market reality. Consumers in Bel- into the domains of different competitors. All these de- gium can already choose a complete TV, broadband, velopments support a fundamental trend: the digital and telephony package (triple play) from their cable convergence of en- operator (e.g., Telenet) or from the telecommunications The digital convergence of tertainment, com- incumbent Belgacom. Similarly, French consumers can TV, broadband, and telephony munications, and subscribe to triple play service offers from cable op- infrastructures is the basis of computing into a erators (e.g., UPC Noos) or France Telecom. To bring a the development of the Digital feature which we series of new digital services, such as interactive TV, Home 2010 call the “Digital VoD, or interactive gaming to the home, strong digitized Home”. distribution infrastructures are required.

Convergence will predominantly have the effect of The provisioning of millions of homes with converging boosting infrastructure competition by allowing multi- services implies huge upfront investments in ple distribution platforms to enter the market for the infrastructure upgrades and in building alternative delivery of digital TV, broadband, and telephony serv- infrastructures. To recoup these fi xed costs, network ices. These services, which were previously provided operators will push very hard to market their offerings as distinct services via different distribution networks, and achieve high penetration rates. This operator are increasingly becoming available to digital homes in push is important for overall market uptake. Reaching Europe in the form of multiplay bundles, delivered a suffi cient scale fast to offer multiplay services over

Exhibit 1: Convergence of the Digital Home

Today: Silos into the Home Tomorrow: Triple Play Services for the Digital Home

Television DTH Terrestrial

Cable Television Digital Home

Broadband Cable, DSL, DTH, DTT Telephony Internet Triple Play

Broadband Telephony Television Sources: Forrester Research, Booz Allen analysis Internet

Page 7 state-of-the-art distribution platforms to as many The range and diversity of premium content will also subscribers as possible is the only feasible strategy in increase signifi cantly. Viewers will be able to take more this fi xed-cost-driven infrastructure business in which a conscious decisions about what to watch. In order to large part of the total cost base basically remains the cater for these fragmented customer preferences, same irrespective of the number of customers. In view investment in programming will rise. of the huge investments in infrastructure and content that are already being made by many market players At the same time, innovative services will become and new market entrants, convergence to the Digital available with the introduction of greater interactivity Home is an irreversible trend. over state-of-the-art networks. Advanced digital services are increasingly putting the control of media directly into The potential consumer the hands of consumers—allowing them to benefi ts of developing the access what they want, when they want it Digital Home in Europe are The development of the Digital (IPG, PVR, VoD). Furthermore, Digital Homes signifi cant. Consumers will Home brings signifi cant benefi ts to can expect having access to improved have the choice between the consumer picture and sound quality for traditional a number of state-of-the- broadcast entertainment offers with higher art interactive distribution distribution quality becoming available, platforms, all equally equipped to act as a one-stop- for example, HDTV as well as audio. Subscribers to shop for the provision of triple play services. Each digital services in the United States already have these distribution platform will deliver a multitude of the choices today (Exhibit 3)—and make intensive use of currently available free-to-air programming, containing them. Consumers will ultimately also control on which a signifi cant amount of European, national, and local device they retrieve and enjoy the content of their choice content: Both entertainment, cultural and educational in their home. Digital Homes will further gain access to in nature. In recent years, digitalization has already led interactive services beyond audiovisual services. Digital to a signifi cant increase in new channel launches. Since telephony services (VoIP) will become as common as 2003, more than 200 new channels have been launched a range of broadband internet access speed levels to per year in Europe (Exhibit 2). Together with the then- choose from (symmetric or asymmetric), tailored to possible targeting of content to individual viewers, this consumers’ specifi c needs. development also promises the emergence of more niche content, fostering cultural diversity (e.g., minority Finally, the Digital Home will enable greater participation content, special language content). This specialized in society. Every Digital Home will have interactive access content refl ects the fragmentation of the audiences. to public interest content and services (e.g., local

Exhibit 2: Development of European TV Channels (1995-2005)

Channels #

1,800

1,600

1,400

1,200

1,000

800

600

400

200

0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Existing TV channels Launches

Source: Screen Digest

Page 8 Exhibit 3: Digital TV Services in the United States Example Comcast (examples)

EPG Mini-Guide Digital Cinema premium movies and other electronic on-screen information programs in HDTV (8-15 channels) program guide while watching

On-Demand pay and free packages

Dedicated Movie channels Interactive Gateway Email Weather Games Entertainment with broadband internet access at 6 Mbps speed Digital TV Foreign Language Packages with more than e.g., Latino, Chinese 150 channels

Sources: comcast.com, Booz Allen analysis government services, medical services, government of Apple’s total revenues. In October 2005, Apple and parliament channels) and the option to interact with announced the video iPod, which could shake up the public bodies/administrations as well as to proactively (portable) digital video industry in a similar way. participate in a democratic society (by e-voting, for Consumers understand the benefi ts of digital services example). In Italy, consumers can already access local and have expressed their interest. Consumers, however, information via their TV set. Useful numbers and opening express signifi cantly more interest in new digital services hours of government agencies are on display as well as and features after they have had the opportunity to all the employment offers of the local job center. experience them (Exhibit 5). The industry needs to be aware of the passive nature of the consumer demand 2. High Acceptance Expected: Consumers Want It, and proactively offer new digital services with low Once They See It barriers for consumers and then actively market these services. A good example of the nature of the consumer Despite some consumer inertia, spending trends is the reaction to “TiVo”, the PVR service in the United indicate that European consumers are investing in new States. Initially, the company found it diffi cult to technologies that enhance their TV experience, such as persuade consumers of the value added of the service. widescreen liquid crystal display (LCD) and plasma TVs After the company started to provide the service at no (Exhibit 4). Consumers’ interest in charge during the fi rst test months, it and spending on digital services found that the subscription was rarely are stunning—once an attractive Consumers are ready to adapt cancelled. Now 93 percent of TiVo’s offering is available. In music, to new equipment for interactive customers fi nd the service amazing, Apple managed to provide such an services or enhanced media citing in particular the superior TiVo attractive consumer offering with consumption—and they are ready user interface that makes the product its iPod and iTunes, changing the to pay for it so easy to use. music industry almost overnight. Overall downloads exceed 500 High-defi nition television (HDTV) million songs to date. Apple turned digital music provides theater quality pictures and CD-quality sound downloads into a staggering commercial success. In to consumers– bringing cinema experience to the home. the second quarter of 2005, Apple realized revenues The 2006 soccer world championship in Germany, of $U.S.1.2 billion with the iPod—more than one-third which will be broadcasted in HDTV, is expected to boost

Page 9 for the consumer due to VoD’s proximity to existing Exhibit 4: EU Consumer Uptake of “Next video/DVD rental services—just with more convenience. Generation” TV Equipment As such, VoD is thus regarded to be one of the fi rst interactive services with real mass market appeal. Uptake of Widescreen LCD and Plasma TVs In the U.S., (Western Europe) Units (000s) industry leader Enhanced TV services: CAGR 83% Comcast is of- 3,000 Consumers want them . . . but fering an ex- seeing is believing tensive library of both paid

2,000 and free on-demand content. Of all Comcast VoD- enabled households, more than 65 percent are active users and new Comcast VoD customers typically place CAGR 88% 23 orders per month. LCD 1,000 3. A Cause for Action: Europe Is Lagging Behind the Plasma TV United States and Asia

0 Although Europe is clearly moving towards the Digital 2003 2004 2005e Home, an international market comparison shows that other regions are far ahead in terms of penetration Sources: IDC 2004, Booz Allen analysis rates and service availability.

Many European countries are now seriously lagging consumer interest in the service signifi cantly. Japan and behind the United States in penetration rate of Digital the US are currently leading the fi eld in HDTV. At the end TV (Exhibit 6). Europe’s average penetration rate of of 2004, HDTV was available to more than 90 percent roughly 20 percent in Digital TV compares poorly with of US households. that of the United States, where half of all households subscribe to Digital TV services. The U.S. market is not On-demand services will further drive adoption and usage only larger but also growing more rapidly. As a result, of Digital TV. The benefi ts of VoD are easy to understand there is strong growth in the United States in digital

Exhibit 5: Consumer Assessment of New Digital and EExxa Interactive Services ammppllee N Neetthheerl rlaannddss

Very attractive 9

8 Superior Image 7

6 PVR EPG 5 SVoD 4

Attractiveness 3

2

1

Very unattractive 0 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Awareness Analogue only users Digital TV users

Sources: SKIM Research 2004, Booz Allen analysis

Page 10 services and content development, whereas in Europe Korea’s government is leading by example to stimulate enhanced services such as electronic program guide e-business. Early on, the government adopted an e-com- (EPG), VoD, and PVR are only just being introduced in merce-based public procurement service. In 2001 more most markets. than 80 percent of all procurements in the public sector were carried out online. The adoption of e-commerce In broadband service, Europe signifi cantly lags behind has had a spillover effect on the business community Asia. With a roughly 24 percent average penetration because not only do rate, Europe overall is closely behind the United States, businesses bid on- but lags far behind leading Asian countries such as line for government Korea exemplifi es the benefi ts Japan, Taiwan, Hong Kong, and most notably Korea contracts, but the of Digital Home technologies: (Exhibit 6). government also broadband is a catalyst for uses B2B sites to education, innovation, economic With a household procure goods and growth, and job creation Europe lags behind the United penetration rate of services. States in Digital TV penetration almost 80 percent, and behind Asia in broadband Korea offers a good These examples from an advanced broadband economy services example of how denote the importance of broadband as a catalyst for broadband can po- education, innovation, economic growth, and job creation. sitively infl uence Flourishing around the broadband access providers is society. Online shopping already makes up near- an entire ecosystem of companies that capitalize on ly 12 percent of all retail sales in the country. As the broadband infrastructure. This environment, in Korea approaches its penetration ceiling, opera- turn, results in economic growth, which generates new tors such as Korea Telecom respond and are now employment opportunities. aiming to become a “broadband communication provider” and to serve customers with high-speed, For Digital TV, high penetration rates and proliferation high-quality broadband communication services such of new digital services are evident in more ad- as fi le transfer, video services, and peer-to-peer com- vanced markets such as the United States munication. (Exhibit 7).

Exhibit 6: Digital TV and Broadband Penetration in 2004

Digital TV Penetration in 2004 Broadband Penetration in 2004 – Maturity Curve – – Maturity Curve – Digital TV Penetration Broadband Penetration (% of TV Households) (% of Households) 100% 100% Czech Republic 2.1% Finland 26.6% Hungary 4.0% Hong Kong 32.0% Korea 79.2% Greece 5.2% New Zealand: 36.0% Portugal 25.6% Sweden 25.8% 80% Netherlands 5.8% Malaysia 36.0% 80% China 4.0% Austria 7.0% Sweden 37.8% Czech Republic 4.1% France 26.5% Poland 7.4% Malaysia 4.6% USA 27.4% Belgium 9.5% Poland 6.9% Denmark 34.9% Germany 11.4% Hungary 9.6% Belgium 37.1% 60% Japan 13.7% 60% Ireland 9.8% Switzerland 14.7% Portugal 15.2% Spain 17.1% Canada: 42.0% Slovenia 16.3 Italy 18.3% Ireland 1) 45.3% Germany 19.1% Switzerland 41.4% 40% Denmark 19.2% USA 47.0% 40% UK 23.1% Netherlands 44.3% France 21.5% UK 1) 57.2% Spain 23.9% Singapore 42.2% Austria 24.1% Japan 43.0% Taiwan 56.1% Hong Kong 65.5% 20% 20%

0% 0% emerging growing mature emerging growing mature Digital TV Development Stages Broadband Development Stages

European Countries Non-European Countries

(1) Digitalization mainly driven by DTH in UK and Ireland Sources: Informa 2004, ADL Broadband Update 2005, Forrester European Residential Broadband Forecast 2005, Screen Digest 2005, JP Morgan 2005, Booz Allen analysis

Page 11 Initial Digital TV growth was driven by more channel variety rather than on the PC. For example, Cablevision, a and improved picture and sound quality, allowing con- cable operator with a strong presence in New York, offers sumers to benefi t from their private investments in interactive services wide-screen TVs and enhanced home entertainment via its Interactive The United States has systems. The number of digital channels increased sig- Optimum (iO) dig- proved the benefi ts and nifi cantly, mainly as a result of the consolidation in the ital platform such as consumer acceptance of cable industry after 1996. The cable industry’s invest- “Metro Weather Inter- enhanced Digital TV services: ments have led to the creation of an increasing number active” with localized More consumer choice, more of cable networks, that is, broadcasters affi liated with forecasts; “Metro consumer control, higher cable operators. According to National Cable and Tele- Traffi c Interactive”, entertainment value, and industry communications Association (NCTA) estimates and data which includes live growth—Digital TV becomes from the U.S. Federal Communications Commission camera shots of con- an important means for digital (FCC), the number of national cable networks providing gested road-ways; inclusion content for cable operators has risen from 145 in 1996 and the “iO Dash- to 390 by year-end 2004—a 269 percent increase during board”, which lets 8 years (Exhibit 8). Programming has become ever more users access news, sports, weather, and horoscope diverse over the years. A signifi cant number of program information. choices for ethnic and minority audiences have been added, such as “Black Family Channel”, “Black Starz!” The basis of competition is thus shifting from the or “Discovery en Espanol”. Also, local and regional con- number of channels to breadth and quality of advanced tent has proliferated during the past 19 years: 25 state digital services, allowing for more participation and public affairs networks and 30 regional cable networks interactivity.

Exhibit 7: Uptake of PVR and VoD in the United States compared with Europe

17.9% PVR Penetration VoD Penetration % of Households % of Households 13.0% 11.3%

6.5% 6.0%

3.8%

1.7% 1.0% 1.0% 0.0% 0.2% 0.3%

2001 2005 2001 2002 2003 2004 Europe USA Europe USA

Sources: EMEA 2004, Kagan Research 2005, Screen Sources: EMEA 2004, Kagan Research 2005, Screen Digest 2005, Booz Allen analysis Digest 2005, Booz Allen analysis

are now providing in-depth coverage of local, state, and Leading Digital TV countries, such as the United regional news and public affairs. Kingdom, have established a strong pay-TV culture, which The second wave of growth—following improved quality enables the proliferation of new content. The analysis and more channels—is fuelled by the success of the of the programming spending of major UK television PVR functionality and VoD services. Both technologies channels during the early years of digitalization clearly give consumers more control over what they want, when highlights this trend with a doubling of the spending on they want it. In addition, interactive services provide a original programming between 1998 and 2003 more rewarding viewing experience for consumers, al- (Exhibit 9). lowing them to actively participate (Exhibit 3). Other interactive services effectively help to drive digital As a result, the United Kingdom has roughly four times inclusion because they are offered on the TV screen, as many pay TV channels than Germany, where digital

Page 12 Exhibit 8: Development of U.S. National Cable Networks 1) TV Channels (1996–2004)

Cable Networks #

400

350

300

250

200

150

100

50

0 1996 1997 1998 1999 2000 2001 2002 2003 2004

(1) Cable networks are programming services that deliver packages of information or entertainment by satellite to local cable television systems. The cable systems then redistribute the network programs, through wires, to individual residences in their local franchise areas Sources: FCC, NCTA

penetration rates are just slightly above 10 percent Freeview customers can upgrade to Sky to receive an (Exhibit 10). As illustrated in Exhibit 10 the number even wider choice of TV channels. The company has of dedicated pay-TV channels is closely linked to the also introduced Sky+, a PVR that allows customers to Digital TV penetration level of a country, creating a record TV shows digitally on its built-in hard disk. Partly virtuous cycle: Attractive pay-TV content attracts viewers as a result of these strategies, 57 percent of British and drives digital penetration, while a high digitalpen- households have Digital TV (Exhibit 6). etration increases the fi nancial at- The success of BSkyB builds on three key factors Pockets of excellence in Europe tractiveness for that provide lessons for all players migrating to show that European consumers content providers digital services. First, BSkyB has strongly emphasized adopt new interactive PC and to develop more high-quality content from the start. BSkyB provides a TV services quickly—if the value channels. wide variety of high-quality channels, including chan- proposition is attractive and well nels with premium content (e.g., particularly around communicated The high rates sports and movies). Particularly in light of the limited of Digital TV pe- programming choice of free-to-air channels in the United netration in the Kingdom, BSkyB was able to establish a highly United Kingdom and Ireland are driven primarily by the attractive and differentiated offer for consumers. In success of satellite-based BSkyB, which has become European countries with many free-to-air analogue Britain’s largest Digital TV platform with 7.3 million channels, operators typically fi nd it more dif- subscribers. BSkyB owns and operates 22 channels fi cult to position the digital offer as distinc- focusing on premium entertainment (e.g., Sky Movies) tive and high value against the current and sports (Sky Sports). To boost further growth, the analogue offer. But as seen in the United States, a high company has launched Freeview, a joint venture with number of analogue channels does not necessarily the British Broadcasting Corporation (BBC), providing prevent Digital TV from becoming a mass market customers with access to digital channels without success. Second, BSkyB established an attractive pay requiring a monthly subscription. The incentive is that business model. Basic digital subscribers receive

Page 13 only a basic bouquet but have the possibility to upgrade their package “à la carte”—fi tting their needs and Exhibit 9: Original Programming Development Driven by Digitalization (£ million, example UK) spending ability. Of equal importance is the attractive- ness of BSkyB’s model to other content providers. When using BSkyB’s satellite-based platform, content providers receive a fair share of the revenue and are awarded with long-term contracts and thus 4,305 UK case stability. Third, BSkyB has demonstrated the importance +97% of excellent sales and marketing skills. BSkyB was able to establish a strong, high-quality brand in line with 1,560 Other Digital Channels the premium content offerings. 209 BBC Digital Channels 2,185 153 Five To sum up the infrastructure discussion, it is im portant 48 118 436 Channel 4 for industry and regulators to not focus exclusively 380 on broadband as the only digital infrastructure in place. 817 ITV 1 Consumers’ needs for entertainment, information, 691 356 BBC 2 and interactive services can be met by both broadband 331 and Digital TV. In fact, in more advanced countries 665 774 BBC 1 such as the United Kingdom, Digital TV has already outgrown broadband in terms of penetration and is 1998 2003 expected to continue to bring digital services to the majority of the population. Analogue programming Digital programming

Source: Booz Allen analysis

Exhibit 10: Dedicated Pay TV Channels versus Digital Penetration (selected European countries)

Channels # Digital Penetration %

450 60

400 50 350

300 40

250 30 200

150 20

100 10 50

0 0 UK France Italy Spain Germany

# Channels Digital penetration

Source: Screen Digest

Page 14 III. EVOLVING COMPETITIVE LANDSCAPE FOR THE DIGITAL HOME MARKET

1. Industry Convergence Has Become a Business In contrast, the focus on service-based broadband Reality competition (e.g., unbundling of local loop) in Germany or France has led to average penetration rates of only In many European countries, cable operators have left 19 percent and 27 percent, respectively. their traditional TV market and expanded their service offering fi rst with broadband internet access and then Cable operators’ role in driving penetration becomes with telephony. For cable operators, this move into even more apparent when comparing access speeds broadband and telephony has been a way to grow and average prices (Exhibit 12). Cable operators their businesses—offering additional services to their typically offer a more attractive offer to consumers: customers. Faster broadband access at lower prices compared with telecommunications incumbents. As illustrated in Exhibit In markets with strong infrastructure competition, 12, cable operators offer more than twice the access cable operators were particularly successful in driv- speed as well as signifi cant price discounts compared ing broadband with telecommunication incumbents in countries with a Many cable operators have penetration (Ex- strong cable presence. successfully rolled out broadband hibit 11). As a and telephony services across result countries Telecommunications incumbents are catching up fast, Europe—balanced infrastructure with a high share investing in network upgrades and aggressively enter- competition has driven innovation of cable broad- ing the Digital TV world with their TV over DSL services and service uptake band access (Exhibit 13). An example is France Telecom with its show overall high “MaLigne” TV over DSL offering. France Telecom re- broadband pen- cently invested etration rates on a national level. Cable affi ne coun- € 50 million in a 3- Telecommunication incumbents tries, such as the Netherlands, Belgium, or Switzer- year wireline exclu- are reacting and adding TV and land, are clearly leading in broadband penetration in sive soccer deal video services to their portfolios Europe, with penetration rates beyond 37 percent. with Canal+ (Ex- hibit 26). Telecom- munications operators also invest in network upgrades, such as Belgacom’s € 300 million investment in planned upgrades to very high speed digital subscriber line Exhibit 11: Broadband and Cable Broadband Penetration (VDSL) by 2007. (Europe, 2004) Broadband Penetration For telecommunication incumbents, the move into TV (as % of Total and video has been predominantly a defensive move Households) to protect their fi xed line customer base (Exhibit 14). 50 In recent years, their fi xed line customer base came NL under attack with attractive alternative offers not only CH 40 from cable operators, but also from unbundled local B loop carriers and mobile operators. Because the TV DK distribution market with ~21 bn € is relatively small FIN 30 compared with the fi xed telephony market of ~90 bn € in F E S Europe, telecommunications incumbents cannot expect AT LUX UK a major revenue boost from entering the TV market. 20 D EE Sl For example, France Telecom launched its “MaLigne TV”

10 IRE HU offer in December 2003 to react to the loss of broad- PL band market shares and falling wholesale prices. The customer base grew quickly to 100,000 subscribers in 0 the fi rst quarter of 2005. Rapid geographic expansion 0 10 20 30 40 50 to big French cities gives the TV service a current poten- Cable Broadband Penetration (as % of Total Broadband Households) tial reach of 8.5 million households (33 percent), which is expected to increase to 10 million households by Sources: Screen Digest 2005, Booz Allen analysis the end of the year. At the same time, alternative tele-

Page 15 Exhibit 12: Comparison of Broadband Offerings—Cable versus Telco (Flat Rates for Unlimited Access, Sept. ’05)

UK CH B NL AT

20,4

12,3 10,0 Max 8,0 Download 6,0 4,0 4,0 Speed 2,0 2,4 2,0 (Mbps)

32.37 26.70 26.80 20.70 Price per 18.57 month per 13.73 Mbps 9.99 (€) 5.99 7.24 3.90

Sources: Company information, Booz Allen analysis communication providers are expanding their service operator, pioneered the TV offering via a broadband con- portfolios. Fastweb, Italy’s second largest fi xed network nection, launching VoD offerings as early as 2001 and

Exhibit 13: TV Offers of Telecommunication Incumbents (examples)

Operator Prices and packages Comments

MaLigne TV basic package @ € 16 (includes a Commercial launch of TVoDSL services end of range of VoD movies and special TV shows) 2003, significant rollout

“TPS Panoramic” @ € 35 (exclusive soccer Extensive VoD library (à-la-carte model) coverage, movie channels, music programs, all French and many international channels)

BTiPlayer plus Freeview @ € 126 Offer includes EPG and interactivity features such as answering machine, SMS and e-mail on Sky+ box plus Sky TV @ € 125 (including Sky+ TV channel package, PVR, pause live TV and instant rewind) Sky offer includes PVR

TV and VoD over ADSL: Offer includes PVR - “Classic+” Package @ € 9.95 per month - Football package @ € 15-25 per month Interactive services include voting, e-commerce, - Football PPV (Saturday night games) information services, email and SMS on TV @ € 8/game - VoD from € 2-6 per view and 24 hours

Currently offer a VoD offering Enables VoD, additional TV programs, web mail services Movies @ € 0.95-€ 4.95 per film and view Coming in 4Q05: EPG, triple play, interactivity (emails on TV, Information on TV)

Sources: Company websites, Communications Week International, Booz Allen analysis

Page 16 Exhibit 14: Triple Play Motivation for Telco Operators

Broadband Internet

Telephony

Defend customer relationship

TV Offer discounts for multiple services Enhance attractiveness of services for broadband Internet

Packet -/B-undle offers

Objective: Become the only provider for communication services to the home Source: Booz Allen analysis

full TV over DSL in the summer of 2003. Vital for Fast- 2. The Rules Are Changing: Emerging Patterns of the web’s success is a strong entertainment content strategy New Competitive Landscape (broadcast TV, Pay TV, VOD), which drives the take-up of core telecommunications products (VoIP, Broadband internet access has been the fi rst broadband internet access). Fastweb now successfully battleground in this new convergent space (Exhibit 15). offers an extensive triple play entertainment suite via In broadband, cable operators and telecommunications its fi bre network to differentiate its offer from Telecom companies compete for share by continually improving Italia: in 2004, 35 percent of all residential custom- access speeds—to the benefi t of the consumer. Voice ers subscribed to the bundle “Tutto Senza Limiti”, telephony was next, and the emerging battleground is which offers un- the TV/video market. limited phone Alternative telecommunications calls and internet, Several infrastructure providers are competing in the providers increasingly use triple and 10 percent future TV distribution market. The shift from analogue play offerings to differentiate of new custom- to Digital TV will accelerate these changes in the TV versus the competition ers selected the market structure because Digital TV services require a premium bundle digital set-top box (STB)—at this stage, the consumer “Fastweb Total”. will make a buying decision, which offers entry opportu- Low PC penetration (~50 percent in Italy) has not nities for competitors. Different types of new providers represented a barrier to growth: appealing TV content was are taking advantage of the analogue to digital conver- vital to attract non-PC users also. As such, roughly sion to enter the TV distribution market (Exhibit 16). Fu- 20 percent of Fastweb’s customers do not own a PC. ture competition in the convergent landscape will focus largely on triple Similarly, Iliad’s “Free” in France, offers a com- play or multiplay plete triple play suite at currently € 29.99/month. offers. Consumers After broadband and telephony, At the end of the second quarter 2005, Free had will have the TV distribution is the next market 1.3 m ADSL subscribers, 1.1 m phone users, 1 m choice between a that is challenged by triple play subscribers with basic TV offer (80 chan- number of state-of- new competitors nels), and 130,000 pay TV subscribers (up to the-art distribution 260 TV channels). With these operating fi gures platforms, which Iliad is the # 1 TV over DSL provider and # 1 telephone act as a one-stop-shop for the provision of triple play over DSL provider in Europe. services. Success stories from advanced markets are

Page 17 Exhibit 15: Competition in the Convergence Space (selected European markets)

Fixed Line TV Broadband Telephony Cable Operators Telcos

Telcos entering TV Full competition in broadband Cable entering telephony

TV Market Share France Broadband Market Share Austria Telephony Market Share Belgium – 2004 Revenues €1,178m – – 2004 Revenues €317m – – 2004 Revenues €920m – France Telecom Cable Maligne TV Telephony 1% (est.) 12%

Telekom Cable Austria Examples Internet DSL 49% 51% Belgacom Fixed Line Cable TV 88% 99%

Note: Total revenues do not represent the total market size but only the revenues of the incumbent and the cable industry

Sources: Screen Digest, Company websites, Booz Allen analysis already apparent, including, for example, the Telewest customers Telewest acquires, 80 percent subscribe to offering in the United Kingdom or the SBC/Bell South/ more than one service. A similar story holds true for NTL Cingular bundle in the United States (Exhibit 17). in the United Kingdom, with 25 percent of subscribers Multi-play bundles play a central role in the commercial being triple play customers, and more than 70 percent service offering of Telewest. Of its current customers, of all subscribers using more than one service. How- 30 percent subscribe to a triple play bundle; but of all new ever, not all platforms have the same technical potential

Exhibit 16: Different Providers in the TV Distribution Market

Player Type Strategic Thrust Platform Initial Success Examples

Defend/expand Digital Cable Good consumer Comcast, US CATV core business acceptance, when s

t done properly

n Enter triple play s e t

b market n m e u b c m n

I Defend/expand Digital Satellite Good success for

u Astra, pan - Europe c core business (DTH) free TV and pay TV n DTH I Sky, UK services in Europe

Defend core TVoDSL First successful France Télécom, F business trials Telefónica, ES Telco Incumbents (telephony/Internet) Possibility to Enter triple play expand to mobile market distribution s t n s a t r Enter triple play TVoDSL Significant Fastweb, IT t n n a market subscriber

r New Telco Players E

t Fibre to the Home Free, F

n ramp-up within w (FTTH) E e franchise N w e N Develop new DTT Varying success - Freeview, UK business in digital good traction mainly DTT Providers TV in free-to-air market Digitenne, NL

Source: Booz Allen analysis

Page 18 Exhibit 17: Triple Play and Bundle Success Stories (examples)

Bundle Success Example (US) Triple Play Success Examples (UK)

Triple Play Pick-up Approach - %, 1Q04-1Q05 - Comprehensive bundling strategy 27% 30% Integration/alignment of wireline/wireless activities 22% 24% Partnerships with Yahoo (DSL) and EchoStar (Sat. TV) 19% Bundled services: telephony, call mgmt services, wireless services, satellite TV, DSL – à-la-carte approach Integrated products: Single wireline-wireless mailbox, device-based 1Q04 2Q04 3Q04 4Q04 1Q05 forwarding, multi-access to data

Impact Strong bundle adoption Key-product bundle penetration1) 2Q05 at 66% Strong bundle sales with wireless component Triple Play Customers (on-net) Increased revenue: Customers buy more services - %; 1Q04-1Q05 - Churn reduction: Customers with three key-products are 40% less 25% likely to churn than customers with only two key-products 24%

22%

SBC Key-Product Bundle Penetration (%)1) 1Q04 4Q04 1Q05 61% 64% 66% 44% 50% 54% 58% 23% 31% 36% Customer split (on-net) - 000’; 1Q04-1Q05 - 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 2,923 3,008 3P 632 740 25% 3P subs 2P 1448 1375 (1) Percentage of customers with a retail access line plus at least one key service (long distance, DSL, jointly billed Cingular wireless, 1P 843 900 SBC/Dish network satellite TV) Sources: Company Information, Booz Allen analysis 1Q04 1Q05

to offer triple play. Digital terrestrial television (DTT) has The early digitalization success of DTH triggered a com- achieved a substantial geographic coverage. But the petitive reaction from the other platform providers. DSL platform also shows major disadvantages: it has a lower has been faster to bring broadband into European homes video capacity compared with other technologies and no owing to lower capital costs per household than cable capabilities to deliver telephony or broadband. Similar and the resulting effi cient short-term returns. But in constraints are true for digital satellite transmission entering the Digital TV market, this platform still faces (DTH), which also the challenge of signifi cant upgrades to achieve suffi - The competition will be increasingly lacks the full tri- cient capacity for enhanced digital services. The cable based on multiproduct bundles ple play capacity technology currently is the benchmark in video differen- (TV, internet, telephony) that cover with only limited tiation capacity. In addition to PVR, VoD, EPG, and the all household needs—triple play broadband and like, cable offers an integrated triple play capacity and success stories are becoming a telephony pos si- very high bandwidth for video and data. Although net- reality across the globe bilities. Further- work upgrades are necessary in the medium term, cable more, a signifi - offers superior cant upgrade technical capa- “TV only” distribution platforms will of existing satellites is necessary in the medium term bilities as a dis- be disadvantaged, because they are to offer limited broadband capabilities and more band- tribution platform. not capable of delivering triple play width—with all the risks associated with deployment To compete suc- services of the satellite and with spacecraft technology. On the cessfully in the other hand, the satellite-based television providers are triple play market very fast to market, enjoy low maintenance costs, and environment, the economic size and strength of the have been innovative in developing differentiating video players will be increasingly important. Developing the features like PVRs or near-VoD. Digital Home requires large upfront investments that

Page 19 are not scalable with the customer base, that is, they telecommunications incumbent KPN with the largest need to be undertaken long before the customer sub- Dutch cable operator, UPC, the ratio is 14:1. scribes to the service. Key fi xed costs include network upgrades, develop- Telecommunication incumbents still generate huge cash ment of new dig- fl ows with their fi xed and mobile telephony services, Scale will be increasingly ital content, and which they are willing to spend to enter the Digital Home important in the convergent upfront marketing market. This imbalance, as shown in Exhibit 19, could competitive landscape to expenses to mi- prove to be problematic to the development of the Digital sustain the necessary upfront grate consumers Home. Thus a more holistic view on the convergence investments and to offer full to the digital plat- space is crucial. triple play services form (Exhibit 18). Before an innovative EPG or VoD offering can be de- Players need sig- veloped and brought to the consumer, the necessary nifi cant fi nancial strength to shoulder the described two-way capable infrastructure has to be in place. DTH large upfront investments and deal satellite and DTT lack the return with the risks involved. Operators Telco incumbents will be in a good channel and point-to-point capa- with large, stable cash fl ows and position to dominate the Digital bility required for advanced digital open access to capital markets have Home market value-added services (e. g., VoD, an advantage. A large subscriber interactive services). Hence, the base is also key to recoup large prime platform providers that will upfront investments because the average costs per drive digitalization in the convergence space are tele- subscriber will be lower. In addition, larger players can communications and cable operators: Only they can offer use their existing customer bases as a launch integrated triple play pad for new services. Critical mass is required to packages with broad- market successfully to mass market audiences, In many markets, cable operators band internet, Digital for example, via national TV campaigns. will be the only credible contender TV services, and fi xed to challenge telecommunication telephony. The two Although cable and telecommunication operators incumbents in the Digital Home providers will have to will both be driving the migration to the Digital Market develop the business Home, they do not compete on an equal footing. models for the indus- In the convergent industry, in which triple play bundles try; it is their task to make convergence work across the are the basis for competition, operators compete using entire value chain and to devise win-win solutions for all their full fi nancial strength from the combined tele- parties. These platform providers also show the highest phony, broadband, and TV businesses (Exhibit 19). Exhibit 18: Importance of Scale in the Development of The big national telecom- the Digital Home munication incumbents have an advantaged start- Key Areas ing position in this new in- Larger network coverage/subscriber base enables dustry. In many countries, Infrastructure/ faster penetration of new services including cable affi ne coun- Subscriber Base Penetration speed is key driver of economics for tries such as the Nether- new services lands and Belgium, the tele- Large subscriber base allows use of more effective communications incum- marketing tools, e.g. TV advertising not suitable for Marketing/Sales bent is more than seven regional franchise, better x -selling due to large subscriber base (lower cost per customer) Size will increasingly times the size of the total become important in the combined cable industry digital home competition (i.e. Triple Play) (Exhibit 19). The situation Core operations, e.g. customer service, IT Operations platforms provide economies of scale resulting in is aggravated because the lower cost per subscriber cable industry is fragmen- ted into regional cable Infrastructure-based business are capital intensive franchises, which are Financial Strength - higher cash flows and better access to capital competing against a tele- markets increase flexibility to move fast, if needed communications incumbent with national presence. Source: Booz Allen analysis Comparing for example,

Page 20 Exhibit 19: Revenues of Telecommunications Incum- bents versus Cable Industry (€ billion, 2004)

Total Domestic Revenues Total Cable Industry Cable Fragmentation of Telco Incumbent Revenues (# of cable operators to get a combined market share of 80%)

10:1 D 35.1 3.5 4

F 32.7 23:1 1.4 3

UK 24.2 8:1 2.9 2

8.7 NL 7:1 1.2 3

4.8 B 7:1 0.7 > 5

AT 3.6 9:1 0.4 > 5

0 20 40 0 20 40

Note: Revenue includes fixed telephony, mobile telephony, internet access and TV distribution Sources: ABN Amro 2004, Screen Digest 2005, Company Information, Booz Allen analysis

Exhibit 20: Converging Markets in Europe 1)

Fixed Telephony

Telco Incumbents Size: 90 € bn Attack CATV Operators

Defend Core New Markets Markets

Broadband Internet d Size: 14 € bn fen De

DTT Attack Defend Operators TV Distribution New Core Size: 21 € bn Market Market DTH Defend Operators

(1) Includes: Austria, Belgium, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, Switzerland, and UK Sources: EITO 2005, Booz Allen analysis

Page 21 strong platform for basic digital and premium digital 1) Exhibit 21: Platform Subscribers in Europe (million services owing to the integrative nature Subscribers, 2004) of the satellite- based providers. 2) 160 151.5 But DTT will most Industry consolidation would 140 likely be a niche improve the competitiveness player in most of cable operators vs. the telco 120 countries (Exhibit incumbents and spur market 100 21). Both DTH and development DTT players will 80 compete only in 60 51.2 the TV distribu- 5.6 36.2 tion market (Exhibit 20). 40 45.6 20.7 In contrast to European countries, the United States 20 6.7 15.5 shows the benefi ts of a more homogeneous and balanced 0 Telco CATV DTH DTT industry landscape, in which cable operators were allowed to build scale in the competition with telecom- Digital Analogue munications players (Exhibit 22). In contrast to the

(1) UK, France, Germany, Netherlands, Austria, Denmark, Finland, Sweden, Italy, situation in most of Europe, the U.S. cable industry has Portugal, Spain, Switzerland, and Belgium undergone a major consolidation during the past 10 (2) Number for telco include only the incumbents’ subscriber numbers Sources: Screen Digest 2005, ABN Amro 2004, Informa 2004, Booz Allen analysis years, triggered mainly by the deregulation after The digitalization of TV requires infrastructure investment ratios: capital expenditures of 1996. This con- new “win-win” business models revenues of about 20 percent. Eventually, cable and tele- solidation ena- and partnerships across the communication players will compete head-to-head in all bled large, contin- value chain that allow different three markets—broadband, telephony, and TV—if cable uously increasing players to recoup high upfront can achieve the necessary scale to counterbalance investments in investments the market power of the telecommunications platform content and the (Exhibit 20). Both players strive to defend their current development of new digital services (Exhibit 23). U.S. share while developing new revenue sources out- cable operators’ investments in programming have risen side their respective core markets. DTH will remain a continuously from U.S. $3.8 bn (1992) to almost U.S.

Exhibit 22: Competitive Landscape in the United Video ARPU Developme- nt Comcast

States r - 2002–2004 - e p

r Revenue Comparison US Telcos and Cable Operators e e u $ 56.3 $ 60.0 b n

- $ billion, 2004 - i $ 53.7 r e v c e Cable Operators Telcos s b R

u o S e

20.3 71.3 c 1. Comcast 1. Verizon d i i s V

a l a B t

2. Time Warner Cable 11.1 40.8 2. SBC o T

2002 2003 2004 3. Cox 6.4 27.4 3. Sprint

PVR Penetration of Digital Subscribers

f 4. Charter 5.0 20.3 4. Bellsouth ) - 1Q03–1Q05 - o e

s % a

B 15% s

r a

5. Cablevision 3.1 13.8 5. Qwest ( e

b n i r o i c t 10% s

Largest national cable operator a r b 6. MediaCom 1.1 t u Comcast

in Europe (KDG) is similar in size e S n

l

to 6th largest US player e

a 5% P t

(KDG 2004 Revenues = i g R

7. Insight 1.0 i € 1.044 billion) V D P 0% 3 3 4 4 5 Note: Players do not necessarily compete in the same geographic region 0 0 0 0 0 Sources: Vintage Research, A.G. Edwards, Annual Reports, 1Q 3Q 1Q 3Q 1Q Booz Allen analysis

Page 22 tising revenues for deliv- Exhibit 23: U.S. Cable Programming Investments ering the content to as ($ billion, 1992-2004) many viewers as possi- In $ billion ble. The switch to digital 14 operations presents fi - 12.6 nancial challenges for 12 11.5 both distributors and 10.9 broadcasters. For dis- 10 tributors, the switch to 9.2 8.8 digital requires large up- 8.0 8 7.4 front (fi xed-cost) invest- 6.4 ments that are not easy 6 5.6 to recoup. Thus, they will 4.9 4.3 try to develop new and 4.0 4 3.8 attractive services on a per-view or per-use basis. 2 Content producers and broadcasters, on the 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 other hand, face loss of a part of the advertising Note: Programming expenditures include license fees, copyright fees and investments in local programming Sources: NCTA estimates based on data from Kagan Research, LLC, and the U.S. Copyright Office revenues in the more personalized Digital TV environment in which $12.7 bn (2004), resulting in more choice and higher- the number of viewers becomes less important quality programming for consumers. For example, the scale than having the right viewers. In tomorrow’s digital of Comcast has been instrumental in driving new digital world, this potential loss will be more than services and content, including an extensive, free, on- counterbalanced by higher earnings from subscription demand offering, which gives opportunities for consum- fees as well as lower carriage fees. To develop ers to become acquainted with future-oriented services. these new business models will be a key challenge, but it can be overcome, as more advanced markets have Compared to U.S. cable operators, European cable shown. Particularly, smaller to mid-sized broadcasters players are signifi cantly smaller in size. The largest will have the opportunity to participate from the U.S. cable player, Comcast, has more than increasing revenue streams, for example by en- 20 times the revenues of Kabel Deutschland larging their channel suite. Smaller broadcasters, (KDG), the largest national cable player in Europe. which were challenged by distribution capacity bottlenecks in the analogue world, will fi nd it easier The opportunity is signifi cant, but requires strong to get access to the consumer, now being able to entrepreneurship. Many different players need to invest freely choose between alternative distribution platforms. against one opportunity. Hardware and software manu- A good example for a successful business model is the facturers need to develop low-cost STBs and infrastruc- partnership between BSkyB and Eurosport, in which ture. Distributors need to invest in new infrastructure Sky delivers the premium sports content and and build up/migration of their customer base. Content Eurosport the non-premium sports content. On the providers must develop new digital interactive content basis of a long-term strategic partnership and fair that may initially have limited viewership. As a conse- revenue sharing model with BSkyB, Eurosport was quence, all parties must share the upside provided by able to develop a new digital channel, called Eurosport 2, the increase in overall revenues. Digital Home services which has a stronger focus on live events and sports are complex to deliver and typically require different news. All parties in the value chain must agree on, players to interact across the value chain: network and commit to the overall growth opportunity that the operators, broadcasters, content producers as well as digital world offers. Growth will come from more targeted service providers. Therefore, a key challenge for all play- and interactive advertising, higher subscription revenues ers in the new convergent digital world is thus to develop for improved services and content, and new revenue new business models and partnerships. Exhibit 24 streams from interactive services, such as targeted depicts a small part of the revenue stream between information, shopping, and gaming. In Italy, for example, distributors and content providers to illustrate this chal- broadcaster Mediaset already offers premium content lenge. Today, broadcasters rely on the proven business on a pay-per-view basis via the conditional access model of the analogue world, strongly based on adver- module in the STB. A special and anonymous prepaid

Page 23 Exhibit 24: Changing Business Models in the Digital World

Advertising revenue Pay for content/ copy rights Analogue World Content Broadcaster Distributor (Today) Producer Subscription fees Pay for Carriage fee content/ copy rights

Migration implies high risk

Revenue from Advertising revenue Pay for content/ interactive services copy rights + (e.g. T-Commerce) share of subscription fee Digital World Content (Tomorrow) Producer/ Broadcaster Distributor Service Provider Subscription Pay for Carriage fee fees and pay content/ per view/per use fee copy rights

Source: Booz Allen analysis

card can be purchased at any shop, and it can then be differentiating factor for distributors because it drives used for any single event or special package that the the overall attractiveness of an offer and ultimately mar- customer decides to watch. The card can be ket shares. All advanced Digital TV markets show that reloaded several times and has to be substituted after its high-quality content is required to drive penetration. In expiry date—the revenue is shared between all the the United States, the fi rst wave of Digital TV penetration different parties involved. The success of this “low cost” was driven by offering consumers a signifi cant increase in interactive offering is stunning: channel choices. Consumers will 4 months after its launch, 1.2 million subscribe to Digital TV services prepaid smartcards have been sold. Content will be the most to have access to more and bet- important differentiator in the ter content. Service features by 3. Premium Content Is Key for competition for the Digital themselves, however, will not be Success: Competition Will Further Home suffi cient to signifi cantly drive Intensify penetration because they tend to (initially) attract niches rather In the convergent market, different infrastructures are than a mass audience. And they tend to be an important capable of delivering increasingly similar offerings. It “add-on” to fully is no longer necessary for a consumer to subscribe enjoy the content to a telecommunications provider to have reliable tele- and to enhance the Competition for (premium) phony service. The infrastructure and the underlying overall Digital TV content will increase with the technology will diminish in importance; the only real experience. Some development of the Digital Home interest of the consumer will be content and serv- of the features, ices. In this environment, distributors will need to such as IPG, are differentiate themselves from their competitors. anyway required They have essentially three ways of differentiation: only to cope with the increased content variety. So, (1) Content offering, including on-demand content, (2) compelling content is a must; service features are an Service features (e.g., HDTV, IPG, PVR), and (3) Price. important nice-to-have. Finally, price can also serve as a In this respect, content is by far the most important differentiator in the competitive environment. However,

Page 24 Exhibit 25: Cost for Premier Soccer Rights 1 ) (Total Cost per Country, € million)

in € million CAGR 800 (’95-’05) UK 16% 700 2) France 600 45%

500

400

300 Germany 14%

200

100 Netherlands 14%

0 '94- '95- '96- '97- '98- '99- '00- '01- '02- '03- '04- '05- '06- '07- '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08

(1) France rights cost pre ’99 estimated at € m 10, based on the TF1 bid in 1999 of € m 10.7 (2) Rights cost included total price paid for all offered packages for the national soccer leagues rights, i.e. included price paid by the different parties

Sources: E&Y, KeK, Euromarketing Crain Communications, Reuters, Booz Allen analysis

price itself will not drive penetration. It is the value-for- of TV over DSL through exclusive Jupiler League (Belgian money that drives penetration. Attractive content at premier league) coverage (Exhibit 26). Exclusive premium acceptable price levels will be key. sports rights clearly are platform drivers, but often fail to be stand-alone profi t generators for content aggre- The competition for content, particularly for premium gators and distributors. content, will increase as distributors strive to drive over- all digital penetration and to capture market share in the The intensifi ed competition for premium content in distribution market. As illustrated above, the number the future will most likely lead to additional price of (premium) pay-TV channels is linked with the overall increases for distributors. Hence, in the competition for penetration rates of digital services in different European premium content, a distributor’s scale and fi nancial countries (Exhibit 10). strength will become increas- One of the key areas of premium content is premium ingly important, Fair access to premium soccer across Europe, and competition for soccer rights clearly putting content supports public interest has increased signifi cantly, driving up prices (Exhibit telecommunica- objectives 25). In the United Kingdom, Sky successfully brought tion incumbents the pay TV model from conception to market leadership, at an advantage. and now faces restrictions on the premiership rights it can buy going forward. In Germany (1997) and France Fair access to premium content is an important pre- (1999) rights prices jumped from 10’s to 100’s of requisite to ensure a balanced competition. The value millions as Premiere and Canal+ entered the market. of premium content is typically protected and some- More recently premium soccer content is targeted to times enhanced by exclusivity rights. However, different drive TV DSL offers: in the Netherlands Versatel TV degrees of exclusivity are feasible, ranging from strict DSL offers center on the Eredivisie (the Dutch premier platform exclusivity to the availability of rights to all league) live matches, and Belgacom aims to drive uptake channels and platforms (Exhibit 27). Different degrees

Page 25 Exhibit 26: Competition for Exclusive Football Content Rights (examples)

Canal+ purchased exclusive rights to France Telecom the French League for € 600 m per year for 2005 - 2008 €50 m for 3 years FT obtained wireline exclusivity for 7 out of 10 matches for a reported €50m for 2005 -2008

Belgacom purchased exclusive rights to the Belgacom Jupiler league as flagship of the TV offer it launched mid 2005 €36 m per year However, national coverage not expected before end of 2006

Rights have been sold on exclusive basis in Versatel advance of full-scale DSL TV roll out

€30 m In start-up phase, only several 10’s of thousand for 3 years of Dutch subscribers have access to the live Eredivisie matches

Sources: Company Information, Booz Allen analysis

of exclusivity have very different (positive and negative) availability of content to consumers. Although an in- impacts on the distribution industry as well as on the creasing level of platform exclusivity can drive new

Exhibit 27: Different Levels of Content Exclusivity

Degrees of Rights Exclusivity Pro’s Con’s

1. Platform exclusivity: Rights exclusive to one or few platforms, not Supports uptake of new Limits availability of made available to other platforms (e.g. Versatel with live Eredivisie in NL) platforms/technologies this content to select group of viewers Creates adverse competitive landscape

2a. Full channel exclusivity and channel customer ownership: Rights are Helps to create competitive Enhances dependency of purchased exclusive by one channel. This channel holds the customer channels distributors on premium rights relationship (e.g. Canal+ in France) Distribution to large audience holders possible Higher complexity for users

2b. Channel exclusivity and distributor customer ownership: Rights are Helps to create competitive Requires intervention by purchased exclusively by one channel, which wholesales content to all channels regulators on setting “fair and other platforms at reasonable commercial terms (e.g. Sky Movies and Distribution to large audience reasonable” terms Sports in the UK) possible

3. Parceling up rights by platforms: Rights are split and tendered by Ensures wide availability of the Limits differentiating Increasing Level of Exclusivity Increasing Level access platform (i.e. specific rights for 3G mobile, for DSL, etc.) content capability for new platforms

4. All rights available to all channels and platforms Widest possible availability of Limits value for rights holders the content Limits opportunity for new platforms to enter the market Source: Booz Allen analysis

Page 26 Exhibit 28: Platform versus Channel Exclusivity

Platform Exclusivity: Example Foot+ in France Channel Exclusivity: Example SKY Sports in UK

Canal+ purchased exclusive rights Sky Sports has exclusive content on to the French League for € 600 m its branded channel per year for 2005-2008

The channel is wholesaled to all other FT obtained wireline exclusivity for 7 platforms (e.g. cable like NTL) at out of 10 matches (foot+) for a reasonable commercial terms reported € 50 m for 2005-2008

Content available to all platforms should they

s decide to take on these channels o

r Stimulates uptake of new platform (TV over DSL) P Customers can choose preferred distribution s

o platform without limits to content availability r P

Limits availability of specific content to select Wide availability of content group of viewers Allows channels to build their brand on several platforms

s Fragmented (premium) content is spread over n

o several platforms, which is confusing and C complex for consumers

s May require intervention by regulators on setting n

o “fair and reasonable” terms

Consumers need to adopt several technologies C to have access to all available content

Sources: Company Information, Booz Allen analysis

services uptake (for that platform), it may well lead are not able to differentiate themselves from existing to the exclusion of consumers to access the offers. Another alternative is channel exclusivity content because they have subscribed to a different (Exhibit 28). In this case, a channel holds exclusive distribution platform. For example, France Telecom is content rights, but the content is distributed across the exclusive wire line platform to distribute several alternative platforms to ensure a wide consumer premium soccer in France, effectively depriving cable reach. Through the exclusivity agreement the channel is subscribers from this content (Exhibit 28). In the able to differentiate and to establish a brand, for other extreme, the availability of premium content to example, Sky Sports as a brand for premium sport all channels and platforms, which implies in effect events. The challenge in the case of channel exclu- no exclusivity at all, may lead to a wider audience sivity is the establishment of fair terms and conditions reach. However, it reduces the rights value for the between the channel and the distributor. Particularly, original content owner, potentially limiting the develop- if the channel is affi liated or vertically integrated ment of premium rights altogether. It also may limit with a particular distribution platform, the fair access the entry of new channels or platforms because they of third-party distributors could become an issue.

Page 27 IV. CHALLENGES FOR REGULATORS IN SUPPORTING THE DIGITAL HOME 2010 Technological developments, competitive moves and Finally, some countries, like Germany, Italy, Sweden consumer preferences are changing many underlying and Austria have held the view that public support is assumptions of the current regulatory regime at an required to push certain digital distribution technologies ever increas- to the home, such as DTT. However, as distribution ing speed. In markets are already evolving on a competitive basis, The move towards the Digital the light of the a biased, not technology-neutral support risks creating Home has changed underlying development an artifi cial market imbalance and lead to market assumptions of current regulatory of the Digital distortions. In its recent ruling of 9 November 2005, the frameworks Home and the European Commission ruled against state subsidies for convergence commercial broadcasters for the use of DTT in Berlin- of media and Brandenburg under EU State Aid rules. Earlier, the communications markets, policy makers need to re- Commission did approve support for DTT in Austria. think and adjust some of the foundations of traditional The Commission stresses that allowable public policies media and telecommunications regulation. One tradi- under EU State Aid rules to support the transition to tional view is that media distribution digital broadcasting should be is a bottleneck. limited to interventions through (technology neutral) regulation, For example, in the past, regulators, Existing regulations may fi nancial support to customers, based on perceived limitations of dis- hinder the advancement of the information campaigns or subsidies tribution capacity and a lack of inno- Digital Home to overcome specifi c market failures vation in audiovisual services, often or to ensure social or regional took a protective stance towards cohesion. content providers to ensure that to they had a fair chance to distribute their content. This The industry structure around the Digital Home is has changed in the Digital Home environment: Frequency very dynamic, and technology advancements will and bandwidth are less of an issue. In fact, there might happen rapidly. Thus, regulators face the challenge well be an oversupply of distribution capacity and an to continuously revise their policies and regulatory undersupply of content. The traditional paradigm is that assumptions and adapt them to new realities. media distributors are (regional) monopolies. Again, com- petition in the digital world has changed fundamentally. Without refl ecting the changing realities around the Competition at distribution level is clearly emerging and Digital Home, its advancement may signifi cantly slow will further intensify. Market behavior by the distribution down with signifi cant impact on ICT growth. A too narrow sector towards content providers will increasingly be market defi nition may lead to erroneous decisions constrained by new platforms entering the market. regarding signifi cant market power, potentially limiting Consumers do have a choice among different media industry growth through inappropriate regulatory distributors and can choose the best value-for-money remedies. offer themselves. For example, taking an isolated view regarding horizontal Another traditional policy perspective is that the consolidation on a single cable market may well European audiovisual industry requires governmental have been a justifi ed decision in the past: a regional and regulatory support, e.g. via broadcasting quotas for monopolist is being prevented from getting larger and local content. In the digital world, this is not necessarily potentially abusing its power vis-à-vis the consumer. true as entry barriers for European content providers In a converging market environment that consolidation are much lower and niche channels are evolving. The case is getting more complex. The cable provider needs increase in multi-platform competition and triple play will to compete against a telecommunications incumbent, lead to a strongly increasing demand for new content, as who has national coverage and who is many times the well as to a sharp rise in the value of premium content size of the cable operator itself. rights, sports in particular. There is thus a genuine scope for market forces driving the competitiveness of In this context, the same regulatory action will entrench the European audiovisual industry. A plethora of content an imbalanced market structure—ultimately also to will emerge as distributors strive to differentiate their the potential disadvantage of consumers. For example, content offers. several cable consolidation efforts in Germany have

Page 28 been blocked by the Bundeskartellamt. This has led Other EU policy and regulatory initiatives refl ecting to signifi cantly reduced investment levels and a slower the challenges of a new convergent information roll-out of digital services—to the disadvantage of the society include those to bridge the digital divide and consumer. to accelerate the transition from analogue to digital (terrestrial) broadcasting. On the content side, the Similarly, vertical Commission is engaged in an ongoing process of The EU has realized the challenge integration bet- application of competition policy principles on access and launched several initiatives, ween content to (and exploitation) of content (rights) for different most notably the i2010 agenda providers and distribution platforms, as well as the forthcoming distributors can revision of the Television without Frontiers directive. drive the pene- The current regulatory framework for electronic tration of Digital communications networks and –services (“NRF”) Homes. This is because infrastructure players need to will be reviewed in anticipation of ‘next generation differentiate themselves in an increasingly competitive networks’. Also the effects of convergence and multi- distribution market. And one of the key differentiators platform competition on currently regulated markets will will be content. Hence, as distribution has clearly be taken into account during a forthcoming review of ceased to be a monopoly and alternative infrastructures the list of relevant product- and services markets as are available, more freedom in content acquisition, recommended by the Commission under the NRF. including vertical integration, would be benefi cial to fos- ter the development of Digital Homes. The potential benefi ts of developing the Digital Home in Europe are signifi cant. Consumers will have access to more During its 2000 Lisbon summit, the European Union diverse content, both educational and entertainment. (EU) set a goal to turn the EU into “the world’s most Digitalization and convergence promise the emergence competitive, knowledge-based economy by 2010”. of niche content, fostering cultural diversity (e.g., Now, halfway to 2010, there has been little progress minority content, special language content, European in encouraging the spread of broadband, e-commerce, and local content). By adding an interactive element and, more recently Digital TV. Hence, governments to the most widely used media platform, Digital TV will and regulators are currently re-defi ning their roles strongly contribute to digital inclusion: the TV has the in this rapidly evolving industry, facing the challenge potential to reach the masses with interactive services, of fostering a healthy competitive and balanced which are currently only available for households with environment as well as protecting consumers’ interest. personal computers and internet access. Thus, all The European Commission has realized the need for European consumers will have a realistic chance to proactive policies which respond to this fundamental access interactive services, such as on-demand content, change in technological development and its adoption educational content, governmental and parliamentary by consumers. As the digital convergence becomes real, information or transactional alternatives. The European policies need to converge as well and need to refl ect Commission’s endeavors to actively stimulate digital the new digital economy. Acknowledging the information switchover policies for terrestrial television services and communication technology (ICT) sector’s signifi cant by 2012 should facilitate this development and build contribution for long-term growth and employment in the basis for wider policies presenting a coherent view Europe, the European Commission also launched a on the digitization process of all transmission new strategic policy framework, “i2010—the European networks. Information Society 2010” in May 2005. Within this framework the Commission proposes three high-level Concurrently, the priorities for Europe’s information society and media development of The development of the Digital policies: Digital Homes Home can become a driving force has the potential to advance the i2010 agenda 1. The completion of a Single European Information to spur signifi cant with its strong ambitions to Space which promotes an open and competitive industry growth drive sustainable growth and internal market for information society and media and the creation employment in Europe through 2. Strengthening Innovation and Investment in ICT of jobs, all stimu- information and communication research to promote growth and more and better lated by intense technologies jobs competition for 3. Achieving an Inclusive European Information Society access to the that promotes growth and jobs in a manner that is home. This competition will require high investments consistent with sustainable development and that because both media distributors and content providers prioritizes better public services and quality of life are gearing up to develop and launch new digital services

Page 29 to meet consumers’ expectations. Convergence calls the convergence for a signifi cant coordination effort between media and of markets and Many ongoing initiatives are telecommunication policies. The EU Commission has avoid using too pointing in the right direction, but already taken a fi rst step in the right direction by entrust- narrow market some areas still need to refl ect the ing one single Commissioner with the responsibility for defi nitions when new market realities both the Information Society and the Media, effectively determining sig- establishing a Commissioner for convergence. Similarly, nifi cant market Ofcom in the UK is the single regulator and competition power of an operator. By extending regulation from lin- authority for the UK communications industry, with re- ear to non-linear content, the revision of the Television sponsibilities across television, radio, telecommunica- without Frontiers (TVWF) directive runs the danger of tions and wireless communications services. However, posing unwarranted regulatory burdens, like having to most European countries continue to regulate media observe European content and production quotas, on and telecommunications without much coordination providers of new convergent (on-demand) services, among authorities, which makes regulation and policy potentially stifl ing the development of the emerging making in the convergent world extremely challenging, European new media industry. Moreover, unbalanced and vulnerable to wrong decision making. regulatory burdens for the provision of content on traditional broadcast transmission platforms (cable, After the focus on liberalization of the European satellite, and terrestrial) versus on new transmission telecommunications markets throughout the 1990’s, a platforms (IPTV) could further lead to competitive dis- signifi cant part of EU information society policies were advantages by raising the cost of content for operators geared towards stimulating broadband deployment of traditional broadcast transmission platforms, po- across the EU. Both EU policy and regulations have tentially reducing their fl exibility around programming set important parameters to stimulate infrastructure and new business models. The directive may therefore competition across the EU, thereby driving broadband transcend its original objective of creating an internal (services) deployment. In particular in countries market for content by spilling over into the domain with strong cable and DSL competition broadband where it infl uences the competitiveness of the various penetration has accelerated and provided tangible providers of video transmission platforms. Hence, consumer benefi ts (Exhibit 9). Despite major strides in the directive may confl ict with the new regulatory frame- boosting broadband penetration levels, the broadband work for electronic communications networks and policy of the EU has however not achieved the ambitious services. growth objectives for the European digital economy as set by the 2000 Lisbon summit. Digital divide is still an Fair access to premium content is also on the issue in most European countries – sharply in contrast regulators’ agendas and needs to be further monitored to the EU’s policy objective of an all-inclusive information to prevent the abuse of a dominant market position society. by blocking competitive distribution platforms from having access to attractive content. Particularly in Consumers, industry players and policy makers cases of an unbalanced market structure intervention agree that there needs to be signifi cant work to catch up may be required to prevent the abuse of market to the level of Digital TV and broadband access available dominance in the acquisition and exploitation of pre- in the United States and Asia, and to achieve the i2010 mium content rights. This could, for example, be the objectives. However, there is a sharp divide between case in undeveloped pay TV markets, in which a dominant policy makers, who favor more regulation aimed at con- player tries to enter into long-term exclusivity straining existing players, and others, who favor less agreements to prevent market entry of new competitors. regulation aimed at increasing market-led competition. In this case, regulators may ask for a time limit of the Some of the regulatory instruments of the past, for exclusivity agreement. Similarly, “unused” content rights example local loop unbundling, have not proven to be typically illustrate an excessive exclusivity power: successful everywhere in fundamentally changing the A dominant player acquires content rights without using balance of power between the incumbents and new them, mainly to harm competitors and with no intent to (infrastructure) entrants in the broadband market. The air them. This might be the case when large operators need for new regulatory intervention to remedy market acquire signifi cant premium content packages without failures on a set of relevant markets recommended by exploiting them and without making them available the European Commission is currently being considered to other distributors (“warehousing of rights”). by national regulatory authorities (NRA) through national market analyses under the new regulatory framework for electronic communications networks and services (NRF). However, regulators on all levels need to bear in mind

Page 30 V. “DIGITAL DIVIDENDS” OF THE DIGITAL HOME MARKET 1. Scenarios for the Development of the Digital Home Changes in the competitive environment 2010 Uncertainty about the competitive environment is The purpose of this study is the assessment of “digital twofold: fi rst, the level of competition within the dividends” that can be gained by an accelerated pene- distribution area; and second, the level of competition tration or likewise lost by an decelerated penetration of along the value chain between content producers and Digital Homes in Europe: industry growth, investments, distributors. In both cases, a key question is whether job creation, and new services penetration. dominant players will emerge or whether a number of equally strong players will coexist and compete for A quantitative as- customers? The competitive environment will be affected The future development of the sesment was con- by the level of fragmentation (e.g., of distributors Digital Home promises “digital ducted, projecting or content providers) and the entry of new market dividends” in four areas: Industry digitalization, re- players. Of particular interest is the impact growth, investment, job creation, venues, and in- of (incumbent) telecommunication players leveraging and services penetration dustry structure their fi nancial strength and customer base until 2010. The and the impact of increasingly powerful content quantifi cation is players. Strategies of entertainment companies such based on our market research and ongoing research as Time Warner exemplify the potentially growing and project work in the fi eld, on the latest fi gures from power of integrated content providers combining media and telecommunication research fi rms, on distribution and content assets. Finally, hardware and analyst and fi nancial reports as well as on over software producers such as Sony or Microsoft may seize 30 in-depth interviews with industry experts—rang- the opportunity to build on their respective positions to ing from leading grasp a share of the new market. platform providers such as Comcast and Scenario planning is a structured approach de- Two main areas of uncertainty content players such signed to enable an understanding of complex affect the development of the as MTV to senior future situations. This approach is widely used in the Digital Home 2010: regulatory and staff of different regu- work environment of Booz Allen Hamilton. Scenario competitive environment latory bodies and planning builds on the thorough understanding experienced consul- and analysis of industry trends already apparent in tants. The analysis of the marketplace (Exhibit 29). Certain trends are the Digital Home includes top-down separated from uncertain trends to make uncertainty ex- as well as bottom-up assessments of different plicit. To deal with the uncertain trends described above, markets and the extensive benchmarking of different consistent scenar- European players to understand the sensitivities of ios are developed Advanced scenario planning the different levers such as technology, consumers, or based on a deep has been used to analyze and regulation. understanding of quantify the impact of uncertain drivers and inhibi- developments by establishing a The market development and with it the “digital tors for the de- solid fact base and focusing on key dividends” depend strongly on two areas of uncertainty velopment of the uncertainties in the development in the future: regulatory environment and changes in Digital Home. The of the Digital Home the competitive environment. To evaluate the impact of scenarios then these uncertainties we developed scenarios to answer build the basis for the most critical questions around them: “what-if”insights, which are then translated into an economic model. The starting point of the model is Regulatory environment backed by empirical evidence. In the course of this study, a full picture of four distinct possible futures What is the potential impact of a heavy regulatory was developed (Exhibit 30). environment? What are benefi ts and downsides if a “light-touch” regulation is put into place? Specifi c Four distinct scenarios were developed to assess uncertainties and levers around regulation that the “digital dividends” associated with the have been analyzed include blocks to horizontal or evolution of the Digital Home across Europe (Exhibit 30). vertical integration and the imposition of must-carry Each scenario represents a potential future outcome rules, price caps, or open network provisions. of the Digital Home market in 2010.

Page 31 scenario for key decisions. It could be portrayed as Exhibit 29: Scenario Planning Approach a mix of light-touch regulation, as seen for example in the United Kingdom, combined with an emphasis on infrastructure based competition as seen in coun- tries such as Switzerland or Austria. Thus in most Trends with low countries, a market structure is established in which uncertainty different strong distribution players compete on a Trend Impact relative at par basis at a national level. They invest Identifi- Quantifi- Scenarios Recommen- cation cation dations heavily so that they are able to offer bundles and ne- Trends (Model) gotiate for new with Option high and digital con- space Four scenarios were developed uncer- tent at eye level. tainty These prospects to outline and quantify the likely attract new pro- evolution of the Digital Home ducers with local across Europe Supporting Analyses & Evidence and niche content offerings to enter Source: Booz Allen analysis the market, and they attract customers who take up the services and thus fuel even more investments. A virtuous circle is created.

Scenario 1: Digital Head-to-Head Scenario In general, the service offerings to the consumer signifi - cantly improve in terms of quantity, quality, and price, as In the “Digital Head-to-Head” scenario, a level playing does the demand for new services and higher broadband fi eld leads to a fair competition of equally strong play- speeds. Consumers are willing to spend money for the ers creating a growth environment that triggers invest- steadily increasing number of attractive digital services, ment and job creation. This scenario implies a regula- adding premium and interactive packages to their basic tory approach that is adapted quickly to the new market subscription. Thus, Digital TV as well as broadband pen- environment following a rather light-touch approach on etration rates rise sharply, while the average price per antitrust issues and distribution constraints to allow for service actually goes down (as seen in the European consolidation and fair infrastructure competition. The broadband development to date, for example, in Austria regulatory framework builds on a convergence market and the Netherlands, Exhibit 11 and Exhibit 12).

Exhibit 30: Four Scenarios for the Digital Home in Europe in 2010

Scenario Description 1 Light regulation: horizontal consolidation allowed, very limited intervention Digital Balanced infrastructure-based competition Head-to-Head Strong investment, broad service variety, quick consumer uptake

2 Heavy regulation: consolidation blocked, strict consumer protection Industry Digitalization stalemate (“wait and see”) Stalemate Very low innovation and investment, sluggish consumer uptake

3 National telco dominance also in digital home market Telco Imbalanced competition: cable blocked from national consolidation Mammoth Monopolistic prices, low service development, normal consumer uptake

4 Imbalance along the value chain: fragmented distributors vs. dominant Content (consolidated) content players Rules Content players extracting (excessive) rents, limited investment by distributors Low content/ service development, sluggish consumer uptake

Source: Booz Allen analysis

Page 32 Scenario 2: Industry Stalemate Scenario the investment opportunities of the distributors. Domi- nant content producers manage to steadily raise their A stalemate closely resembles the actual situation in prices because they can leverage their market scale some European countries (for example Germany) that and programming brands. Ultimately, rights owners and are seriously lagging behind in digital penetration and vertically integrated pay TV providers dictate the terms innovative digital service offerings. In these countries, and conditions in the industry, seriously limiting the investments are hindered by unfavorable and infrastructure players’ insecure regulatory policies. New services are The analysis of the “digital abilities and incentives not developed because build-out in the digital dividends” is based on a to invest. Because mar- infrastructure is missing, and there is limited comprehensive quantitative keting investments by uptake of digital platform subscriber numbers market model covering 19 distributors (e.g., subsi- which in turn again diminishes the incentives European countries, representing dizing STBs or heavy to invest. 99 percent of Europe’s TV marketing spending) is In the stalemate scenario, we assume that households limited, consumers only those countries do not remove barriers in place gradually sign up for the and that a number of countries follow more new services. restrictive regulative policies. In this environment, the main concern of the regulator is to control the TV plat- The analysis of “digital dividends” is based on the forms, mainly by enforcing short-term consumer protec- in-depth assessment of each scenario for six coun- tion measures such as must-carry rules, content quotas, tries (Austria, France, Germany, Netherlands, Poland, price caps, and blocked consolidation. This situation and United Kingdom) as well as an extrapolation of an leads to complacency of the main industry players and additional 13 countries (Belgium, Czech Republic, results in a lack of competition, triggering market- Denmark, Finland, Greece, Hungary, Ireland, Italy, skimming strategies rather than large investments. Portugal, Romania, Spain, Sweden, and Switzerland). In addition to the distribution and the content indus- The European aggregation thus includes a total of tries, the consumers also adopt a “wait-and-see” 19 countries and 186.6 million TV households attitude because they have limited opportunity to ex- (Exhibit 31). perience the service and therefore fail to appreciate the added value of the digital service. Thus, in the long 2. The Uptake of Digital Homes 2010 Promises term, consumer benefi ts are greatly reduced by this Signifi cant “Digital Dividends” in Regard to Growth, regulatory approach. Investment, and Employment

Scenario 3: Telco Mammoth Scenario Our analysis of the different scenarios reveals that they react very sensitively to three independent factors: The “Telco Mammoth” scenario is centered on European telecommunications incumbents such as Deutsche Tele- 1. Regulatory environment kom, France Telecom, or KPN aggressively leveraging their scale to dominate the Digital Home. Cable opera- 2. Resulting competitive environment tors, in contrast, are blocked from consolidation on a national level and cannot fairly compete with the 3. Consumer acceptance (driven partly by competition resources and marketing power of the incumbents. As because it is a push market) both cable and telecommunications operators move into each other’s core markets, investments into broad- The results show that a balanced competition, in par- band and triple play offerings fi rst rise, only to slow down ticular on the infrastructure level, is the most important markedly when the incumbents have outplayed driver of a healthy de- the cable operators. Within 5 years, subscrip- Getting the migration to the velopment. The Digital tion fees are thus expected to rise slowly, the Digital Home 2010 right has Head-to-Head scenario telecommunications operators’ position playing signifi cant upside on a European as described above out and enabling them to charge monopolistic level—revenues, investments, and shows the results that prices. This, in turn, again leads to lower con- jobs in this sector will grow at a can be achieved if such sumer acceptance of the digital services. fast pace an environment can be established quickly on a Scenario 4: Content Rules Scenario European level. All other scenarios induce an overall slowdown or imbalances in In the “Content Rules” scenario a signifi cant amount the market structure that lead to less favorable results. of value is extracted by content providers which limits In the following, the “digital dividends” that can be ex-

Page 33 Exhibit 31: Countries covered by the Digital Home Quantification Model

In Scope Countries and Country Clusters

Cluster Countries Cluster Countries  Cable weak, France  Poland  UK highly Some Cable,  Italy  Romania DSL emerging  digitalized  Spain Czech (Eastern EU) Republic Denmark   Hungary Netherlands Netherlands  Germany Finland Cable and DSL  Sweden  Austria  Switzerland Some Cable, strong  Portugal  Denmark DSL emerging  Ireland  Belgium (Western EU) Sweden  Greece  Finland

Modeled in Detail Extrapolation via Clusters Ireland UK Poland 1) Germany Czech Republic European TV Households - m, 2004 - Belgium Hungary 1 1 1 0,2 187 3 3 3 3 2 France 4 4 Romania 4 4 4 7 7 Italy 13 13 21 Portugal Spain 25 Greece 26 38 Switzerland Austria

Modeled in Detail Extrapolation via Clusters D UK F I E PL ROM NL B CZ S HU GR AT P CH DK FIN IRE Sl EE LUX Total

Modeled in Detail: 60% of TV HH Extrapolation via Clusters: 39% of TV HH

(1) Represented are the EU 25 households plus Romania and Switzerland, but excluding Cyprus, Latvia, Lithuania, Malta, and Slovakia

Sources: Screen Digest 2005, Booz Allen analysis pected if the virtuous circle of a Digital Head-to-Head form into the digital world. The summary fi ndings of the environment can be achieved in most countries will Digital Head-to-Head scenario are shown in Exhibit 32. be described in detail. Subsequently, the focus will be In broadband, cable internet subscriber numbers will on the most im- grow a lot faster than DSL connections—fuelled by portant drivers higher speeds and attractive bundles provided by the Digital TV can be expected to having a poten- cable operators overtake broadband within 5 tial negative (Exhibit 33). In the years: 64 percent (DTV) vs. 53 effect and the developed Digital With an optimal uptake, overall percent (broadband) penetration analysis of their TV market of the subscriber revenues will reach of households–Digital TV would impact on the United States, € 80 billion by 2010 – Digital TV be the major means to secure the market develop- this situation can will account for roughly digital inclusion ment. already be seen in € 50 billion the marketplace: Getting the mi- Comcast adds at- gration to the Digital Home right has a signifi cant upside tractive content to internet access—VoiceMail, on a European level. The Digital Head-to-Head scenario PhotoShow Deluxe, a multimedia player, and premium shows the most favorable results and can be regarded content from leading publishing houses—and delivers as an ideal scenario for industry development. In this online gaming by leading publishers such as Atari and scenario, revenues, investments, jobs, and penetration Strategy First. This offer includes unlimited access for rates can be expected to more than double until 2010. consumers who can play as long as they want without Compound annual growth rates will be well above 10 additional charges. percent—and far higher than the average GNP growth. Subscriber revenues will grow at a steep rate of 14 Access to digital services will proliferate and reach two- percent per year, to reach € 80 billion by 2010. The thirds of European households by 2010, with Digital more than doubling of the total subscriber revenue TV overtaking broadband as the most important plat- will be largely driven by selling more comprehensive

Page 34 Exhibit 32: Summary Results of the “Digital Head-to- Head” Scenario

Total Annual Subscriber Revenues Total Annual Investments2) Total Incremental Job Creation - € billion, Europe1), 2004 & 2010 - - € billion, Europe1), 2004 & 2010 - - ‘000, Europe1), 2004–2010 -

100 30 80 23 15-30 84-107 20 9-17 50 35 60 10 7

0 0 Status Quo Digital Head-to-Head Status Quo Digital Head-to-Head Total Content Multiplier Total (2004) Scenario (2010) (2004) Scenario (2010) Distribution Effects(3)

Total digital TV Penetration Total Broadband Penetration - %, Europe1), 2004 & 2010 - - %, Europe1), 2004 & 2010 -

70% 64% 70% 60% 60% 53% 50% 50% 40% 40% 30% 30% 24% 20% 20% 20% 10% 10% 0% 0% Status Quo Digital Head-to-Head Status Quo Digital Head-to-Head (2004) Scenario (2010) (2004) Scenario (2010)

(1) Includes: Austria, Belgium, Denmark, Czech Republic, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Netherlands, Poland, Portugal, Romania, Spain, Sweden, Switzerland, and UK (2) Investments in Capex and programming Opex (3) Multiplier effects capture the additional employment with suppliers and other linked activities associated with an expansion of the distribution industry, e.g. network infrastructure or STB Source: Booz Allen analysis

Exhibit 33: Proliferation of Digital Home Services in the “Digital Head-to-Head” Scenario

Number of Digital TV Households by Platform Number of Broadband Households by Platform - m, Europe¹), 2004 & 2010 - - m, Europe¹), 2004 & 2010 -

121 14 Total Digitalization Rate Total BB Penetration 2004: 20 % 2004: 24 % 101 2010: 64 % 39 2010: 53 %

24 71 36 45 6 44 36 22 1 30 7 9 2004 2010 2004 2010 Cable DSL DTH DTT DSL Broadband Cable Broadband

(1) Includes: Austria, Belgium, Denmark, Czech Republic, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Netherlands, Poland, Portugal,Romania, Spain, Sweden, Switzerland, and UK

Source: Booz Allen analysis

Page 35 services, not by higher prices. Up-selling is basically a where for example, material from the Democratic and function of consumer demand; more and better digital the Republican National Conventions as well as presi- services that meet consumer demand fuel the uptake dential debates of bundles and persuade customers to upgrade their were available on current package. This can already be seen in the United VoD to 20 million Proliferation of Digital Home States where VoD and HDTV penetration rates rise homes. services will lead to shifts in sharply. The new or enhanced Digital Home services market shares—both in broadband will include HDTV channels, premium sports and movie As with any other and in Digital TV packages, thematic and foreign language channels, large-scale chan- as well as interactive services such as VoD/PPV, ge in an industrial EPG, games, voting, dating, and information services landscape, the digital uptake will lead to shifts in market (Exhibit 34). share. The number of digital satellite homes will still increase by almost 20 million despite the platform’s These new services will change the nature of television. disadvantages in a triple play environment. This refl ects Instead of being a passive entertainment platform, digi- the very strong content position of major players talized television will become an interactive informa- such as BSkyB, operating mainly via rented satellite tion, communication, and entertainment platform. Apart capacity. TV over DSL penetration is picking up, too, be- from purely commercial services, this development also cause of the successful up-selling of the large broad- provides an opportunity for T-commerce, T-government, band subscriber base (once the technical problems and other information services to reach out to a much are fully solved, which is expected to be the case greater number of homes. In a number of regions in It- from 2007 onwards). The number of cable subscribers aly, people can already contact the local government by will grow fastest; technical maturity and reaching scale using their TV set and remote control (checking impor- quickly to be able to invest in infrastructure and content tant telephone numbers and opening hours, download- will form the basis for this success story. The ing forms etc.). Similar developments can already be subscriber numbers of digital terrestrial television seen in some Asian countries and in the United States, will double, too, but remain on a rather low basis

Exhibit 34: Subscriber Revenues in the “Digital Head-to-Head” Scenario

Total Subscriber Revenues Subscriber Revenue Split by - € billion, Europe1), 2004 and 2010 -- Distribution Platform - 2010 - 80

DTT 7% 30

DTH Cable 20% (TV/BB) 4 36% 35 19

14 DSL (TV/BB) 3 37% 9 25

9 2

2004 2010

Basic Analogue Basic Digital Premium Packages Interactive Services Broadband (Cable & DSL)

(1) Includes: Austria, Belgium, Denmark, Czech Republic, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Netherlands, Poland, Portugal, Romania, Spain, Sweden, Switzerland, and UK Note: Figures exclude VAT and excludes inflation

Source: Booz Allen analysis

Page 36 given the backchannel limitations and unaligned eco- and digital signals in Germany highlights this interrela- nomic interest of different stakeholders. tion.

The last point clearly shows the importance of The delivery of more services to more customers will partnerships and alliances in the digital world. Different result in the creation of about 100,000 jobs—60,000 companies will have to align to drive the penetration of alone within the distribution platforms. Cable will display digital homes. Microsoft’s and Alcatel’s global alliance, the highest job growth at 22,000. (This number already announced in February 2005, can be cited as a case takes into account the associated consolidation pro- example: “The two companies will jointly market cess.) In addition, 9,000 to 17,000 jobs will originate an integrated IPTV delivery solution using in the content industry, refl ecting the consumer demand Alcatel network access equipment and systems for local digital content, the related investments of the integration services, and the Microsoft TV IPTV distributors, as well as the content producers’ incen- Edition software platform, to broadband providers tives to develop innovative services. Furthermore, ad- worldwide”. Together, Microsoft and Alcatel “expect ditional knock-on effects can be expected by the indus- to bring down IPTV costs, speed up the try’s suppliers and other linked time-to-market and enable the introduc- activities associated with an tion of innovative new services to con- 100,000 jobs would be created in expansion of the distribution sumers” (microsoft.com). Other partner- this favorable environment—cable industry, for example, in the ships, for example, Nokia and several TV being the strongest job engine network infrastructure or the local Asian broadcasters, further validate consumer premises equip- the argument. However, missing alli- ment manufacturers. These ances or imbalances in the market will severely hinder will account for another 15,000 to 30,000 new jobs the development of the Digital Home. If, for across Europe and highlight the role of infrastructure example, content providers or broadcasters are players as key catalysts for investment and job growth reluctant to produce new digital content, the in other industries. network build-out to enable digital services will be slow because attractive content is important to In addition to the effects on digital access and employ- drive consumer uptake. The power play ment resulting from the expansion of the distribution between major broadcasters and the cable industry, the level of investment is of great importance; operators about simultaneous provision of analogue a modern communications infrastructure is part of the

Exhibit 35: Total Job Creation in the “Digital Head-to- Head” Scenario

Incremental Jobs per Distribution Platform Total Incremental Job Creation - ‘000, Europe1), 2004- 2010 - - ‘000, Europe1), 2004–2010 -

DTT 15-30 84-107 5

9-17 DTH Cable 60 15 22

DSL 18 Total Content Multiplier Total Distribution Effects(2)

(1) Includes: Austria, Belgium, Denmark, Czech Republic, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Netherlands, Poland, Portugal, Romania, Spain, Sweden, Switzerland, and UK (2) Multiplier effects capture the additional employment with suppliers and other linked activities associated with an expansion of the distribution industry, e.g. network infrastructure or STB

Source: Booz Allen analysis

Page 37 i2010 objectives because it is a fundamental enabler This expectation is clearly supported by past develop- for other businesses to fl ourish. Total cumulated invest- ments in the United States and the United Kingdom. ments, comprising capital expenditures (capex) and Total basic program investment of the U.S. cable operators programming operating expenditures (opex) spent on rose from $1.4 billion in 1990 to $9.2 billion in 2002 content, will amount to € 98 billion over 7 years in this (compound annual growth rate of 17 percent, Exhibit optimal scenario. Annual investments of the distribu- 23). But the growth in content investment is not con- tion industry will grow from € 7.5 billion to € 23 billion strained to the United States. In the developed Digital between 2004 and 2010. Cable will show the largest TV market of the United Kingdom, a doubling of spend- investments of all plat- ing on original programming between 1998 and forms, as a result of both 2003—the period during which digitalization broadband infrastruc- Total cumulated investments picked up—could be observed (Exhibit 9). ture and digital content amount to almost € 100 billion expenditures. DSL in- during 7 years assuming an Industry estimates assume that 30 percent to vestments will be driven accelarated market development 60 percent of all original programming expen- mainly by infrastructure ditures go into the development of local con- capex (starting from tent—amounting to € 10 billion to 20 billion only a very small TV cus- in additional investments in European (local) tomer basis); whereas DTH investments will be applied content. This investment will signifi cantly strengthen mainly to premium or “exclusive” content (Exhibit 36). the European audiovisual industry. BSkyB is a prime example, show- An accelerated digitalization is benefi cial for Europe as a During a 7-year period, € 35 billion ing 85 percent whole. In 2004, the different penetration rates of Digital of programming investments can to 90 percent TV ranged from 2 to 6 percent (Czech Republic or Neth- be expected—a signifi cant boost total operating erlands) to 57 percent (United Kingdom). By 2010, the also for local content production expenses. Sat- digitally emerging countries will reach penetration rates ellite capacity of 45 percent and more, and the mature countries will rental is one of the line items of the operating expenses come close to but with almost 60 percent, programming constitutes by saturation and In an favorable environment, every far the largest part thereof. full digitalization country will achieve at least a 40 with well over 90 percent penetration rate of Digital percent penetra- TV— countries already highly tion. The differ- digitalized in 2004 will come close Exhibit 36: Total Cumulated Investments (€ billion, ence between to full digitalization by 2010 Europe1), 2004-2010) the countries will thus have be- 6 98 come a little smaller. Especially for the Eastern European 18 countries, the Digital Home development shows great prospects and growth opportunities—the growth rates Programming 35 33 Opex of 2 percent to more than 40 percent penetration are in the range of well over 50 percent Developments in Germany will be compound annual instrumental in the EU’s reaching 41 growth rate its digitalization objectives Infrastructure 63 (CAGR). The pos- Capex sibility to catch up with some of their Western counterparts is an attractive outlook for them.

Cable DSL DTH DTT Cumulated Germany is of prime importance for Europe in reaching Investments its digitalization objectives. It is the largest European ‘04 - ’10 economy and with more than 38 million TV households it represents roughly 21 percent of the total European TV (1) Includes: Austria, Belgium, Denmark, Czech Republic, Finland, households. Unfortunately, it is lagging behind not only France, Germany, Greece, Hungary, Ireland, Italy, Netherlands, Poland, Portugal, Romania, Spain, Sweden, Switzerland, and UK in current penetration rates of broadband and Digital TV

Source: Booz Allen analysis but also in investment activity. Compared with the next largest market, the United Kingdom, Germany currently

Page 38 invests only half as much in infrastructure and will not erode the value of their investments, innovative digital content. It is crucial for the entire for example, through price regulation or open continent that network provisioning. These two prerequisites A regulative regime securing a the German play- can be viewed as “qualifi ers”—meaning that balanced industry structure is the ers overcome these elements must be in place so that they key “qualifi er” to achieve such an their investment will not obstruct the uptake of the Digital Home, but accelerated penetration of Digital stalemate and also that these Homes close the gap elements will not to developed drive uptake in Delayed Digital Home penetration digital econo- themselves. involves signifi cant risks: mies such as the United Kingdom or Sweden. cumulated investments of € 39 To achieve such an accelerated penetration of Uptake will ulti- billion and 89,000 jobs could be Digital Homes, certain pre-requisites must be fulfi lled mately occur only lost or delayed (Exhibit 37). First, a balanced market structure is crucial if two additional for driving investments into the development of new prerequisites are digital services. The highest levels of investment occur fulfi lled—”drivers” that are instrumental to achieve when several strong national players compete on a the growth of investments, revenues, and jobs level playing fi eld. Second, a (and are only fully effective if the regulatory regime that is friendly qualifi ers are in place). Thus, third, toward investment and innova- Upfront investments, proactive distributors must make upfront invest- tion must be in place. This ap- marketing, and new partnership ments and must take a proactive proach to regulation includes will be the key “drivers” for an marketing approach to migrate cus- considering the evolving competi- optimal penetration of Digital tomers to digital services. This in- tive landscape in a convergent Homes cludes tailoring the new services market, for example, by taking to customers’ wants and needs and wider market defi nitions into ac- setting the barriers to acquiring the count when ruling on consolidation and building the Digital Home services as low as possible through, for confi dence among all players that regulation example, marketing the benefi ts proactively or

Exhibit 37: Qualifiers and Drivers of an Accelerated Digital Home Development

Prerequisites Rationale

Regulatory framework needs to reflect Investment and competition in the convergent market innovation friendly i.e., apply wider market definitions when regulatory regime ruling on market dominance or SMP “Qualifiers” Regulation needs to consider investment requirements and needs to provide If not fulfilled, these investment security prerequisites can obstruct the uptake of the digital Investments drive new digital services home – but will not drive uptake by themselves Balanced market Highest levels of investments occur in a structure balanced landscape with infrastructure competition in place

High upfront investments are required to Upfront investments & drive uptake “Drivers” proactive marketing Services should be tailored around customers’ These prerequisites are approach to migrate wants and needs instrumental to achieve consumers Proactive marketing is required to educate and growth of revenues, convince customers investments and jobs from the uptake of the digital Shift from revenue to subscriber revenues home – they can only Emergence of new requires new business models become fully effective if the business models/ Content players and distributors need to create “Qualifiers” are in place partnerships win-win partnerships to develop and market new digital services

Source: Booz Allen analysis

Page 39

Exhibit 38: Investments and Jobs “At Risk” in the “Industry Stalemate” Scenario

Cumulated Investments1) Incremental Jobs - € billion, Europe2), 2004-2010 - - € billion, Europe2), 2004-2010 -

107 89 98 39

59

18

Digital Head-to-Head Investments Industry Stalemate Digital Head-to-Head Investments Industry Stalemate Scenario ”At Risk” Scenario Scenario ”At Risk” Scenario

(1) Investments in Capex and programming Opex (2) Includes: Austria, Belgium, Denmark, Czech Republic, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Netherlands, Poland, Portugal, Romania, Spain, Sweden, Switzerland, and UK

Source: Booz Allen analysis

Exhibit 39: Investments “At Risk” in the “Telco Mammoth” and “Content Rules” Scenarios

Annual Distribution Industry Investments Annual Distribution Industry Investments - € billion, Europe1), 2010 - - € billion, Europe1), 2010 -

23 23 Yearly investment Gap -8 € bn Yearly investment Gap -11 € bn 15 12

Digital Head-to-Head Investments Telco Mammoth Digital Head-to-Head Investments Content Rules Scenario ”At Risk” Scenario Scenario ”At Risk” Scenario

(1) Includes: Austria, Belgium, Denmark, Czech Republic, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Netherlands, Poland, Portugal, Romania, Spain, Sweden, Switzerland and UK

Source: Booz Allen analysis

Page 40 subsidizing set-top boxes (as BSkyB does). Fourth, all 3.1. Failing to adapt the regulatory framework fast players must be aware of, and prepare for, new business enough will have signifi cant impact models and partnerships. Although the decrease in traditional (advertising) revenue streams will drive the In the Industry Stalemate scenario, the “wait-and-see” need for new attitude of consumers and industry players will lower cum- business models, ulated investments by € 39 billion compared with the One player dominating the market win-win situations Digital Head-to-Head scenario. This translates into too strongly poses a serious threat will have to be cre- 89,000 fewer jobs compared with the “Digital Head-to- to the development of the Digital ated for content Head” scenario (Exhibit 38). The main reason for the huge Home, with considerable impact players, broad- differences in relation to the optimal environment is on investments and jobs casters, and dis- the missing infrastructure build-out. The lagging digital triutors so they infrastructure constrains platform providers to offer can successfully innovative and bundled services. This in turn does not develop and market the new digital services (Exhibit 37). convince the consumers to switch to digital, which lowers the incentives for producers to develop digital content. No stakeholder will make the fi rst move. 3. Delaying the Digital Home Greatly Affects the “Digital Dividends“—Regulation Being the Key 3.2. Imbalanced industry structures will slow down Enabler or Barrier the development towards the Digital Home

Correctly managing the migration to the Digital Home In both the “Telco Mammoth” and the ”Content Rules” offers signifi cant benefi ts for European society; alter- scenarios, market imbalances will distort industry native scenarios clearly show the potential investments development. Both of these imbalances in the Digital or jobs that are at risk. The development of a new Home market will ultimately lead to monopolistic market market requires optimal management by companies and structures, complacency, and value extraction by the regulators as well as the interplay of technological dominating players. Missing incentives and capital of the innovations and consumers. Of the different drivers, distribution industry will lead to fewer investments in both including technology, consumers, and regulators, the innovative content and infrastructure. The “winners”will regulatory regime has the highest potential to slow be the telecommunications incumbent and the content down the development. If these issues are resolved, industry, respectively, but the“losers” will be all European then the industry is in the driver’s seat to determine societies with lower annual investments of € 8 and 11 the speed. billion, respectively (Exhibit 39).

Page 41 VI. RECOMMENDATIONS An accelerated development towards the Digital Home an inclusive digital society, a more balanced policy will be key to advancing the EU’s digital economy perspective on broadband and Digital TV is justifi ed. objectives as set out in the i2010 agenda. Signifi cant Policy makers and national governments need to realize “Digital Dividends” are to be gained. To achieve the the importance of the analogue to digital migration and, objectives of a digital economy, both policy makers and hence, should support the migration efforts initiated by industry players need to act. industry players.

1. Recommendations for Policy Makers and 1.2. Ensure a Balanced Market Structure and Regulators Competition in a Convergent Digital World

The regulatory regime has a particularly strong impact The scenario analysis shows that a balanced head- on development of the market, and the stakes are to-head competition among strong national players high: unfavorable regulatory decisions could prevent or leads to the greatest economic benefi ts, the greatest delay accumulated investments of up to € 39 billion digital penetration, and the greatest proliferation of new (2004–2010), leading to a signifi cantly slower growth in services. In contrast, uncontested dominance (e.g., by employment in the industry (2 percent versus 8 percent telecommunications, cable, DTH, or content providers) per year). In the convergence space, the negative in the battle for the Digital Home leads to signifi cantly impact of “wrong” decisions will affect a much larger lower investment and job creation levels as well as market then ever before. Decisions need to be made reduced variety in services. Five key action points will both in light of converging markets and from a European help to achieve a balanced industry structure: perspective. The subscription fees of television and broadband internet constitute a European market of 1. Broaden market defi nitions to refl ect the convergence € 35 billion in 2004, and the industry accounts for of TV, broadband, and telephony markets roughly 100,000 jobs. Fixed-line voice revenues account 2. Allow national consolidation to enable the creation for another € 90 billion, and mobile communication for of strong national distributors roughly € 125 billion. Therefore, policy makers need 3. Avoid unbalanced support for specifi c distribution to be aware of the wide impact of their decisions. The technologies to prevent distortion in the development margin for error is decreasing. of the industry 4. Allow content exclusivity and vertical integration To foster the development of Digital Homes in Europe, to enable differentiation—intervene only if market policy makers need to act on four key themes: power is abused 5. Consolidate fragmented regulatory bodies 1. Refocus attention from broadband to convergence/ DTV The convergence of markets (TV, broadband, telepho- ny) requires new defi nitions for “relevant markets”, 2. Ensure a balanced market structure and especially when applying concepts such as SMP. competition in a convergent digital world Formerly largely separate indus- 3. Balance consumer protection with long-term tries, such as Broaden market defi nitions to investment and employment objectives telecommunica- refl ect the convergence of TV, tions or television broadband, and telephony markets 4. Rebalance regulation in favor of infrastructure- distribution, now based competition compete directly in their respective 1.1. Refocus Attention from Broadband to core markets and combine the different services into Convergence/DTV one Digital Home industry. In this new playing fi eld, eco- nomic size becomes increasingly important—especially To date policy makers and regulators have by and large for former niche players now having to compete against focused on broadband to drive their digital economy formerly monopolistic telecommunication incumbents. objectives. Policies were geared towards stimulating But the scale of the players has to be measured against broadband deployment across the EU. Our analysis the converging basis. These new market realities shows that Digital TV becomes increasingly important have to be taken into account, particularly when and can be expected to overtake broadband penetration judging market dominance or the abuse of market by 2010. As Digital TV becomes the main enabler of power.

Page 42 In most European platform decision on the basis of full information about Allow national consolidation to countries, both the respective platform’s capabilities. Satellite is not yet enable the creation of equally DTH and telecom- capable of a full VoD service, digital terrestrial does not strong national distributors munication play- offer broadband internet, and the technology of TV over ers provide their DSL is in the early stages of mass market roll-out. Finally, services on a rapid commercial success of one platform triggers national level, whereas cable operators function under strong reactions from the other distributors, as seen a regionally constrained franchise model. At the same in the United States, where a strong digital satellite of- time, scale within a country is crucial to enable large up- fering prompted the cable operators to invest heavily front investments in the convergence space. To ensure to sustain competition (including investments in cable equal and fair competition, cable operators need the infrastructure of roughly $ 1,300 per customer). Policy freedom to build scale and to establish a national makers should therefore support rapid consumer migra- presence as well. Looking at fi xed-line telephony today, tion to the Digital different entities already compete with the same serv- Home regardless Allow content exclusivity and ice in the same market for the same customer: Tele- of the technology vertical integration to enable communication incumbents, cable operators, and of the distribu- service differentiation—intervene potentially VoIP service providers such as Skype. But tion platform, for only if market power is abused the size of the companies is of a strikingly different example, through magnitude—thus preventing the smaller players from publicity cam- consolidating means to extrapolate the unequal situa- paigns or clear analogue switch-off dates. Hence, digital tion of today into the future. In contrast, an even dis- switchover should be technology neutral. However, most tribution of investment and marketing power leads to countries have a biased focus on terrestrial switchover effective competition and benefi ts for all: The consumer only. Similarly, an unbalanced support for specifi c distri- has more choices at lower prices, the industry achieves bution technologies should be avoided (e.g., subsidies much higher levels of investments and jobs, and society for DTT only). It distorts a healthy market development achieves a higher digitalization. and is not in line with EU policy—as the recent ruling of the European commission on the DTT subsidies in Berlin- During the past decade, the UK’s cable industry has con- Brandenburg, Germany, has clearly shown. The shift solidated signifi cantly: 29 companies (1992) fi rst consoli- from analogue to digital is a risky challenge for all indus- dated to 13 (1997) and then to 2 (2003). Most recently, try players; any unequal support of technologies and/or the remaining two operators (NTL and Telewest) an- platforms may lead to an imbalance in industry structure nounced their and a slowdown of overall market development. merger to be Avoid unbalanced support for able to bet- Policy makers also should ensure balanced and fair specifi c distribution technologies ter compete competition along the value chain, namely, between to prevent distortion in the with BSkyB content providers and distributors. Our scenario analysis development of the industry and British suggests that a severely unbalanced dominance by Telecom on a content players can also lead to signifi cantly lower levels national level. Similarly, early deregulation in the United of investments by distributors (€ 11 billion of yearly States (Telecommunications Act, 1996) led to a con- investments at risk in the “Content Rules” scenario). solidation wave among cable operators, providing the This in turn leads to a decrease in the development scale for signifi cant content investments. Basic pro- of new content and services, which slows down overall gramming investments rose from $1.4 billion (1992) Digital Home uptake and reduces consumers’ choices. to $9.2 billion (2002). These investments have led to U.S. cable operators offering a wealth of advanced In general, the content industry and the distribution digital services including, but not limited to, VoD, PVR, industry are in a state of mutual dependency: the EPG, HDTV, information services, and games. A similar content players need wide reach and therefore strong development can be expected in Europe. distribution players; whereas distributors in turn require strong content as the basis for an attractive value Rapid consumer migration to digital must be achieved proposition. Traditionally, near monopolistic market to break through the industry stalemate, to fuel invest- structures in distribution put the platforms into an ments to achieve industry growth and digital inclusion. advantaged position, and they were thus prevented There is no reason why the digital platform distribution from entering the content market. But it is time to (DSL, cable, DTH, and DTT) should resemble the ana- rethink this dependency in the convergence space logue market shares. Instead, regulators should take because distribution will no longer constitute such a care that consumers are able to make their distribution signifi cant bottleneck. On the contrary, with competing

Page 43 infrastructures in place, content, in convergence by merging fi ve particular premium content, will be media and telecommunications a key differentiating factor. Today’s Consolidate fragmented regulatory regulatory authorities—the changing reality paves the way for a bodies to enable a holistic view of Broadcasting Standards new relationship and integration of the convergence market Commission, the Independent content and distribution. Our analysis Television Commission, Oftel, suggests that market forces will lead the Radio Authority, and the to a balanced relationship between content providers Radiocommunications Agency—into a single entity and distributors in most cases. Therefore, only extreme (Ofcom) in 2003. Ofcom is now the single regulator cases of unfair blocking of platforms or unfair treatment and competition authority for the UK communications of own versus other content will require regulator’s industry, with responsibilities across television, radio, attention. telecommunications and wireless communications services. This allows Ofcom to have a holistic view of New services such as VoD and PVR will give consumers market dominance or of the abuse of market power greater control over their viewing experience; they can across all communication industries. Similarly, the decide when they want to watch what kind of content. EU Commission has entrusted one Commissioner Similarly, broadband offers consumers access to a with responsibilities for both Information Society and wealth of information and services, which they can Media. retrieve and control at their discretion. To foster the development of new digital services and to enable Very often this consolidation is diffi cult because of differentiation, regulators should generally allow vertical entrenched structures or a division of legal competencies integration between content providers and distributors. as in Germany where telecommunications is under Policy makers should intervene only if a dominant federal legislation whereas TV resides within the Länder. position in content is unfairly leveraged in distribution Nevertheless, solutions have to be found because or, alternatively, if a dominant position in distribution is market and technological developments are in danger unfairly leveraged in content. The basis for a dominant of being severely slowed down. position should refl ect the new reality of a convergent market. 1.3. Balance Consumer Protection with Long-term Investment and Employment Objectives Differentiation through content exclusivity will help to drive penetration for certain platforms. However, Policy makers face the challenge of balancing short- unbalanced content exclusivity may in some cases term consumer interests (e.g., low prices) with adversely affect fair competition and long-term industry midterm objectives concerning economic growth and structure. Hence, policy makers should restrict content employment. For the regulator, the need to support exclusivity only if signifi cant market power is abused. As this balance drives the need for a coherent regulative mentioned earlier, the defi nition of abuse of signifi cant framework across services (TV, broadband, telephony) market power should be made in the context of a and distribution infrastructures (cable, DSL, satellite, convergent market. To prevent abuse, regulators may terrestrial), as well as along the value chain (content want to intervene to limit the scope and length of an versus distribution). exclusivity arrangement or to oblige rights holders to make content available to other players at fair rates. Regulatory decisions must be put into context, and The regulatory intervention in the Telepiu/Stream the long-term implications must be taken into account. merger in Italy is a good example case for ensuring The focus on fair competition: The merged DTH entity is not allowed long-term indus- to acquire (and warehouse) exclusive rights for other try development Focus regulatory action on long- distribution platforms—to the benefi t of fair competition creates greater term industry development to and ultimately the consumer. service variety, achieve maximum benefi t for which increases society To date, frequently this Digital Home market is consumer choice regulated by different authorities (e.g., one regulatory in the long run. body for telecommunications, another one for media) in There is no reason to allow for excessive pricing in mo- isolation. However, the convergence of TV, broadband, nopoly-like situations. But when making decisions on and telephony will require much closer coordination— consumer protection, policy makers need to make a if not even a merger—between different regulatory trade-off of short-term gains against positive long-term bodies. For example, the United Kingdom has reacted effects on investments, jobs, and industry structure. positively to refl ect these new challenges of market They should ensure that short-term measures (e.g.,

Page 44 price regulation, network access) do not constrain in- ments of infrastructure providers to protect their assets vestments in long-term growth, in particular in a highly and investments. Increasing service competition on dis- competitive environment. For example, in the case of tributors’ infrastructure will deter them from making sig- price regulation, regulatory bodies need to refl ect that nifi cant upfront infrastructure investments because they regulated price levels have an impact on the cash fl ow may not be able to earn an adequate return on those of distributors and thus their ability to invest. In the investments. As infrastructure investment is reduced, time of isolated regional franchises, this was less of an the overall penetration of the Digital Home will be lower. issue. But in the convergence market, cable operators Because the Digital Home is far more than just another need signifi cant investments in future growth to avoid entertainment being disadvantaged in regard to other platforms (DSL, fad, the im- DTH) that often have a much higher cash fl ow basis pact of a slow Provide suffi cient investment to operate from. Strict short-term consumer protection penetration is security to increase industry measures will lead to reduced penetration of the Digital immense: sub- incentives to upgrade the networks Home, which in fact potentially offsets the intended stantial invest- benefi ts of such measures. ments in digit- al content and Regulatory decisions thus need to be put into the wider new businesses are delayed, small and medium-sized market context and consider the impact on related enterprises are deprived of up-to-date communication markets as well as the mid- to long-term perspective of features, and the digital inclusion is not realized to the the entire industry. extent possible.

1.4. Rebalance Regulation in Favor of Infrastructure- 2. Recommendations for the Cable Industry Based Competition The cable industry has to cope with fast-changing Infrastructure-based competition leads to the best rules of the game. It used to employ (often) a heavily results in investments and technological innovation as regulated, utility-driven business model: delivering one well as in in-country job creation. Strong infrastructure- well-engineered product to as many homes as possible. based competition has made Switzerland one of the The pace of the customer base expansion was driven leading broadband and Digital TV countries in Europe. largely by the infrastructure build-out. Today, the industry Switzerland’s Cablecom offered broadband services as fi nds itself in a consumer product market in which early as 1998 and telephony in 2003. Digital TV offerings companies have to react with many different products include more than 130 digital channels and several to diverse and changing consumer needs. And for every premium packages (movie channels, foreign language one of these products, several credible competitors try packages). Similarly, Austria’s telecommunications to secure their part of the market. To successfully drive regulator favors strong infrastructure competition in the development of the Digital Home, cable operators broadband. thus face three key challenges: making large upfront investments, capturing the mass market quickly, and In contrast, ser- changing revenue streams. Stimulate infrastructure-based vice-based com- rather than service-based petition typically Making large upfront investments: The move to the competition to foster consumer leads to lower in- digital world requires large investments from the cable choice vestments by in- distribution industry, including network upgrades, frastructure pro- consumer premises equipment, marketing campaigns, viders because and (jointly with content producers) new digital content they cannot suffi ciently protect their assets. Job crea- and interactive services. Most of these investments tion levels may also be lower, and jobs are more likely to must be made up front, leading to signifi cant risks and be created out of, instead of within, the country in ques- uncertainty in cable investment business cases. In tion. In addition, regulators need to be aware that ser- addition, the majority of these investments represent vice competition on a network may lead to degradation in fi xed costs, that is, they are by and large independent quality of service, both to the service provider’s custom- of the number of subscribers. This poses particular ers and the infrastructure provider’s customers. In addi- diffi culties for the more fragmented cable countries. tion, opening up networks to third-party service providers also limits the effective protection of content rights Capturing the mass market quickly: Most consumers because new players from other legal territories may who have used Digital TV services have expressed a enter the market. To drive in-country innovation and strong interest in these services. Positive signs about industry growth, policy makers need to refl ect the require- consumers investing in Digital Home equipment to

Page 45 enhance their viewing and broadband experience to upgrade will be crucial. This requires tailoring of are increasingly evident. However, consumers who offers to specific customer segments. Consumers need have not yet experienced digital interactive services, to experience a clear added value from the enhanced such as a PVR, EPG, and on-demand content, do not digital services, well beyond the current analogue offer directly appreciate their added value. Thus, a significant and independent of their current TV platform. The challenge is to stimulate demand in the mass market industry should focus on those services that have the for the Digital Home. potential to generate consumer pull (e.g., VoD, HDTV) in addition to attractive content. The distribution industry Changing revenue streams: The digital world creates should also focus on developing services that are not the opportunity for new digital services and hence network dependent but that will constitute an integral new revenue streams such as targeted information, part of the digital viewing experience (e.g., EPG, PVR). online gaming, or video telephony. Bringing these new information and entertainment services to market The cable industry is especially well positioned to drive requires the joint effort of many players along the this development. It has very close relationships with value chain—managing numerous partnerships and traditional and innovative content producers as well as establishing fair revenue and/or cost sharing models broadcasters. This proximity to the TV entertainment will be a challenge. Besides the rising complexity sector can be leveraged to successfully bring new with new services and partnerships, the Digital Home products to the market and establish a credible brand for market will be a completely new competitive ground for the digital world. Cable’s reputation for state-of-the-art many of the companies: Telecommunication firms have television and high-speed internet connections is a very had limited experience with television content to date, good starting point. But unlike with former experiences and cable providers in many countries are still quite in the analogue world, the cable industry will have to unfamiliar with the telephony market. New capabilities learn to cope with offerings and services that will not will have to be built up quickly. be taken up by customers. Maybe online voting fails to reach the high expectations associated with this These challenges and the outcome of the scenario service. Then the price and the service itself will have analysis lead to six strategic imperatives for the cable to be modified and adjusted to the customers’ needs. industry to heed to play a lead role in driving the Digital The development of a whole range of different services Home in Europe: will have to be tracked over time and managed with the 1. Understand the Customer: Develop Consumer-Driven growing customer base. A single killer application to End-to-End Entertainment Offers migrate all the customers to digital will not exist, but 2. Serve the Entire Digital Home: Offer Compelling a complex set of product features needs to be in place Bundles and managed successfully: A variety of new services 3. Give Consumers What They Want: Build Marketing (VoD, HDTV, EPG), premium content, new hardware such and Sales Capabilities as STB and PVR, as well as the right pricing for all these 4. Give Consumers What They Want: Proactively Migrate applications. the Customer Base 5. Size Matters: Build In-Country Scale 2.2 Serve the Entire Digital Home: Offer Compelling 6. It’s a Team Play: Build New Business Models and Bundles Partnerships for Superior Digital Services The Digital Home will be characterized by integrated 2.1 Understand the Customer: Develop Consumer- triple play services: telephony, broadband internet, and Driven End-to-End Entertainment Offers TV provided by a single company. This convergence of different services onto single platforms makes To create customer pull for digital services and to deliver differentiation by technology obsolete. Of course, some on the promise of more and better digital services, technological differences will persist, but consumers cable operators must develop attractive end-to-end know they can get a good and reliable basic Digital TV entertainment offers. These can be built around three offer from both satellite and cable operators. And DSL key differentiators: (1) Content, (2) Features/services will be joining soon. In the United States, competition (e.g., HDTV, PVR, IPG), and (3) Price. The most important already centers on bundles, and the best service in differentiator is content because it will drive penetration which an integrated triple play offer with a single bill and will be a key determinant for market shares. Initial and a single point of contact makes all the difference. opportunities reside in proposing a solid basic digital Of course, besides the service, offering an attractive content package that offers more than the analogue price will be key to satisfying the consumer. And over package at the same price. For those subscribers wanting time, as consumer preferences shift and technology more content variety and new services, the possibility evolves, these bundles will have to be modified. In the

Page 46 future, mobile telephony will most likely be a must, and expansion to reach a substantial number of a nation’s a convincing home network solution will be the next households—or even full national coverage—should be major milestone. a priority for cable operators. To extend coverage, cable operators need to expand through acquisitions (cable, 2.3 Convince Consumers: Build Marketing and Sales alternative platforms) and/or build additional Capabilities infrastructure, possibly with alternative distribution technologies. In the expansion, operators should Although marketing power is an important building block prioritize in-country scale expansion over footprint of the digital success, a compelling sales strategy is extension into new markets. another. The cable industry to date has by and large lacked sufficient customer orientation in many regions. The main reason for the need for scale is the upfront However, the development and the successful launch of investments associated with the migration to digital. new entertainment offers requires deep marketing and The necessary infrastructure is but one important sales capabilities. Cable operators need to establish factor, the other factors being the substantial marketing a stronger consumer focus clearly addressing the efforts and the buying power. To secure the access to consumers’ wants and needs in their service offering and (premium) content, cable operators have to compete market communication. This requires a sophisticated against well-established satellite-based operators such customer segmentation approach and the development as BSkyB or Canal Plus. Driving the uptake of their of offers tailored accordingly. Not every consumer might platform with exclusive content has been their strategy immediately opt for the full triple play offer, and not for the past decade. But even their buying power is every consumer might be willing to pay the same price. by far surpassed by telecommunications incumbents. Technology arguments do not resonate with consumers. If they decide to enter the Digital Home market with Instead, consumers will require a significant amount their huge cash flows, alternative platform operators of education on the advantages of new digital will have to offer superior products and a clever market entertainment services. To proactively penetrate the strategy. But first and foremost they need adequate market and to drive rapid digital uptake, cable operators size. need to develop and implement focused marketing campaigns. In addition, increased competition in a 2.6 It’s a Team Play: Build New Business Models and convergent market will require cable operators to build Partnerships for Superior Digital Services a strong entertainment brand, both for their products and for their company. An area in which many players The digital migration will create new business are lagging behind new potential competitors. opportunities that will lead to shifts in business models and in the industry structure as a whole. As new players 2.4 Give Consumers What They Want: Proactively emerge and enter the market (predominantly in the Migrate the Customer Base content and services arena), traditional players will need to adapt. This will require the development of new The enhanced marketing and sales capabilities must win-win business models with content/service providers drive a sophisticated digital migration strategy. Targeted and broadcasters that establish fair revenue and/or marketing and migration, for example, by neighborhood or cost sharing schemes. A long-term commitment to by customer segment, can ensure a favorable economic partnerships and cooperation may help to mitigate the return as well as a timely rollout. A rapid execution will inherent risks in this emerging digital landscape. Beyond be crucial to minimize the risks associated with the large the cooperation with content and service providers, upfront investments. However, the rollout speed needs cable operators need to reach out for partnerships with to be adjusted to address competitive pressures and various hardware and software providers to develop cable franchise attributes (e.g., other digital platforms, easy-to-use customer equipment. Easy navigation in national regulation). the converging Digital Home is crucial to ensure a rich consumer experience and ultimately to drive uptake. 2.5 Size Matters: Build In-Country Scale Regulators are challenged to secure a level playing field and investment security for all players willing to invest Economies of scale will be increasingly important. in order to make the Digital Home a reality. Once this is Only a consolidated cable industry will have the scale granted and all players take advantage of this market and resources to compete with alternative platforms opportunity, Europe will look at a very exciting decade of having a national footprint. Thus, the geographic moving into the digital age.

Page 47 Authors of the study

Thomas Künstner Gero Steinröder Dr. Hannes Gmelin Vice President Senior Associate Associate [email protected] [email protected] [email protected] Tel: +49 211 3890 143 Tel: +49 89 54525 545 Tel: +49 211 3890 263

Page 48

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