There are a number of certainties attached to the growing battle between Canada’s telcos, or broadcast distribution undertakings (BDUs) as they’re formally known, and new competitors like Netflix from the “over-the-top” (OTT) space. One is that, following recent trends in the U.S., the BDUs can likely expect some combination of subscriber loss and cord shaving, which is where consumers pare back the packages in favor of Netflix or other OTT services. Another is that cost of buying new content will continue to rise as Netflix applies pressure to the bidding wars for film and TV. When all of this shakes out there will be winners and losers. Right now the jockeying is determining who those will be. While Netflix arguably has momentum on its side, its victory isn’t a foregone conclusion. There remains a lot the incumbent BDUs can do to fight back—and maybe even neuter Netflix entirely.
For the biggest of them—like Bell, Rogers and Shaw—that means leveraging the vertical integration they’ve been pursuing over the last decade. In content negotiations, owning or having direct access to multiple platforms and distribution points—online, TV broadcast, pay TV, etc.—means a buyer can offer a studio a package deal for its content as opposed to rights on only one platform, which is Netflix’s limitation. Combined with some other moves (see sidebar: “Wildcards: Unexpected developments that could make for winners and losers”), this could keep consumers tied into the existing ecosystem, thus denying growth to Netflix and rendering it forever a bit player on the Canadian scene.
As Peter Miller, author of a major CRTC report on the program rights market, puts it, “If you’re a broadcaster and you know the only platform you control is cable or over the air, you don’t want to spend a lot of money on VOD rights or OTT rights because you can’t necessarily control it. But if you’re a vertically integrated entity you’ll spend the money on mobile rights if you’re Bell because you know you can monetize it. There’s no doubt it’s an advantage. How much of an advantage, I don’t know.”
David Purdy, SVP, video product management for Rogers, says vertical integration certainly doesn’t hurt. He notes that Rogers has pursued live sports in particular as a way of staking out territory where OTT can’t reasonably compete. “We believe sports are going to become even more valuable in an [Internet Protocol] world. And that doesn’t mean that we’re going to hoard our rights. We’re going to do deals that make sense for the media company. We’re going to embrace all forms of distribution with our content.”
On the other hand, smaller telcos without vertical integration say the Bells and Shaws have little business complaining about Netflix. Telus, for example, says it has difficulty getting access on “commercially reasonable terms” to a variety of content such as HGTV and TSN, which are owned by Shaw and Bell, respectively. Ann Mainville-Neeson, director of broadcast regulations for Telus, says this also gives those companies an advantage over Netflix. “The top content—the programming people really want to watch—is generally on TV first. And once it’s on TV then the person who brought it to TV—Bell or Shaw or Rogers—are in the best position to then negotiate for all the other rights, because Netflix rights are ancillary. These are the library rights, the other platform rights, and they definitely are nowhere near the cost of the actual TV rights.
“So if all the other rights are ancillary then the person who’s going in to negotiate the TV rights—and that’s not Netflix—has a huge leg up and it’s possible for them to truly put services like Netflix out of the market entirely.”
He who controls the pipes …
Another advantage the BDUs have over Netflix is control of the Internet network over which consumers access content via their ISP. How that network is used and paid for hearkens back to issues of net neutrality and usage-based-billing, but the advantage is more basic than even that. Consumption of OTT content is paid via Internet subscription, not cable or satellite, meaning the more you watch the more bandwidth you use and hence the more you potentially pay for Internet. That’s money in the pockets of the incumbent BDUs.
In the same vein, bandwidth caps in Canada are much less generous than in the U.S. (see sidebar: “Internet Data Caps – Canada vs. the US”). The average cap in Canada among the six largest telcos is 83 GB/month. Among the top 10 in the U.S. it’s 160 GB/month—and three have no caps at all.
The low caps will tend to push consumers toward the more expensive data plans with higher bandwidth caps the more they move toward OTT. And as detailed calculations by both RBC Capital Markets and Scotia Capital show, the costs of consuming data over the Internet don’t necessarily make going exclusively OTT the cheaper solution (see sidebar: “The cost of cord cutting”). A “lite” user, for example, would actually pay 8% more to consume content exclusively through OTT than she would for the same content via traditional cable. For an “extreme +” user, that figure is 6%. It only becomes economical to switch to OTT for very heavy content consumption—but then you’re also paying dramatically higher Internet access fees, which the telcos are only too happy to receive.
Netflix isn’t thrilled with this state of affairs. At the Bank of America/Merrill Lynch 2012 Media, Communications and Entertainment Conference in September, Netflix’s chief content officer Ted Sarandon described high Internet access fees in Canada as “almost a human rights violation.” But Joris Evers, director of corporate communications, says caps haven’t yet been a drag on Netflix’s growth—just on Canadians’ ability to get the highest quality stream. (Netflix lowers the quality of the streams Canadians see so as to limit bandwidth usage.)
The incumbents’ true ace in the hole may lie in the regulatory sphere. At present, there are a host of rules under the Broadcasting Act and Telecommunications Act that govern everything about the industry, from how much money it must contribute to Canadian film and television production, to the ways in which it’s allowed to monetize its content libraries. When the BDUs in 2011 presented their comments to the CRTC for a wide-ranging report they were unanimous in saying they believe these rules prevent them from competing with OTT services (see sidebar: “Wildcards: Unexpected developments that could make for winners and losers”).
Shaw called them an “outdated regulatory framework.” Bell complained of being “weighted down by regulatory obligations.” All say the solution is simply to deregulate the industry. (Bell argues for a combination of deregulation and regulation of any new OTT players by forcing them to contribute as the incumbents do to the Canadian film and television industry.) For example, one of the key strategies incumbents would like to pursue is the ability to offer large blocks of library content (say, previous seasons of Modern Family, not just the current one) via SVOD. The current rules prevent them from doing that.
Says Rogers’ Purdy, “One of the things we’ve asked for a number of times and continue to ask for is for the regulator to free us from the shackles of not being able to launch subscription video on demand services that would mirror, mimic or perhaps even improve upon what other OTT providers have done. That would go a long way in helping us compete with these global players.”
In addition to potentially stopping Netflix dead in its tracks, it would add to the incumbents’ bottom line as well. “Certainly on the margin something like that [service] would help,” says RBC Capital Markets analyst Drew McReynolds, co-author of a 2011 report called “Pricing in a Potential OTT Inflection Period.”
The roadblock presently facing the BDUs is that CRTC rules, as re-affirmed in March 2010 in Broadcasting Regulatory Policy CRTC 2010-190, prohibit them from offering SVOD services that could compete with a Canadian specialty service or “genre-protected” Canadian specialty service. These are services such as Astral’s and Corus’ movie channels, and specialty channels like HGTV, MuchMusic and the History Channel. Further, as Rogers pointed out in its 2011 comments to the CRTC, any SVOD service from a BDU by law must be “tethered” to its linear service. Tethering refers to content taken from channel programming already available on the cable service. This imposes a de facto limit on what a BDU’s SVOD service can offer. As Rogers explained in its comments to the CRTC, “these linear services buy only a fraction of the thousands of titles that are readily available through Netflix’s $7.99 SVOD package. As a result [Rogers On Demand] is unable to create SVOD packages that provide a truly competitive response to what exists online.”
(In this respect, Bell’s recent attempt to purchase Astral could have potentially provided a way to end-run these restrictions.)
And so the great irony may very well be that the underpinnings of the Canadian film and TV industry could be undone not by the efforts of Canadian BDUs themselves, per se, but by the entrance of new foreign players whose technology allows them to get past the walled garden, Trojan horse style, forcing a change in industry rules.
Time not on incumbents’ side?
Nevertheless, while the incumbents do have the range of potential advantages listed above, they perhaps don’t have unlimited time in which to act on them. That’s the finding of an RBC Capital Markets report (“Pricing in a Potential OTT Inflection Point”) co-authored by Drew McReynolds, which predicts a tipping point in favor of OTT will arrive somewhere between 2017 and 2019. By this time four trends will have intersected: OTT services will have reached about 20% penetration of TV households; they’ll command purchasing power at least equal to that of Canadian broadcasters; Internet-enabled TVs will be common in households; and a majority of users will have access to very high Internet speeds. Once this period arrives RBC predicts OTT will become a “viable substitute for cable and satellite television” and directly impact incumbent margins. Until then, RBC sees the growth of OTT having a negative effect on market sentiment but not BDU valuation.
Roger’s Purdy takes issue with the timeline, saying, “What makes [OTT] a replacement technology is when it can offer you the combination of news, sports, live broadcast plus the on-demand offering.” That’s not to say he’s unconcerned. He lauds the “proactive” introduction of Rogers On Demand Online, which moved the telco’s value proposition from linear TV only to multi-platform, saying “the time to act was two years ago. Would I wish we had done more? Sure, absolutely. But it’s always a challenge trying to get the capital to spend on projects that at the time customers aren’t clamoring for because they haven’t thought about it yet. But I don’t think you can ever be too paranoid or too focused on trying to meet evolving customer needs.”
In the coming digital world, which promises to be radically different from the past one, it’s an observation both sides in the battle are going to have to take very close to heart or risk potentially crippling surprises.
At the moment, and despite rising content costs, there’s room for both over-the-top players and the traditional broadcasters. But as online consumption of film and TV continues to grow, one side will likely take a commanding share of that pie and become the broadcast world’s leading player. Regulatory issues will probably become a major point of contention in the medium term, the results of which could change the economic fortunes not just of the BDUs but of the Canadian film and television landscape itself. Meanwhile, Netflix hopes to quietly bide its time, building its subscriber base so that should those changes occur, it remains in a position where it can withstand the BDU counterattack. So bring some popcorn and have a seat—this is going to be a contest worth watching.