The season of second quarter 2013 results (or third in Apple’s case and fourth for Microsoft) gives us a chance to re-appraise the strategies of the Internet giants for pay TV or at least generating revenue from video, not so much from the headline figures but the underlying trends.
Taking Google, Apple, Intel, Microsoft and Amazon in so far as these are all well into the video game, as opposed to Facebook and Twitter which are not yet there, the results highlight the very different business models and revenue sources. Netflix is also included in our round up since it has become a significant force in video alone even though it is still dwarfed in total size by the others. The other big force making up the 7 is Samsung, given that it has become the world leader in smartphones and smart TVs, and notably is emerging as a distinct force from Google.
On the one hand Samsung has relied on Google’s investment in the Android platform, but at the same time has contributed to its success in becoming the biggest force in smartphones and a major one in tablets. Most recently Samsung has been exerting this power by distancing itself from Google, for example in launching its first developers’ conference to be held in October 2013 and in partnering with Intel over development of an alternative mobile operating system called Tizen. One factor here was Google’s acquisition of Motorola, whose position as a rival licensee of Android technology naturally concerned Samsung.
If there is something of a common trend it is of rising sales but a squeeze on margins as a result of intensifying competition in core sectors, whether online advertising as in Google’s case, or consumer electronics devices for Apple. In several cases the tightening margins translated into falling profits. Amazon of course competes on tight margins in the retail sector as well to an extent over its own devices like the tablet Kindle Fire and so investors should not complain too much about falling profits over the last two years. While Q2 results were not quite out it looks like Amazon was going to be reporting a slight loss, compared with profits of $107 million for Q2 2012 and $201 million for Q1 2011.
Samsung is the most notable exception to the story of falling profits, which instead soared 47% year on year to reach $8.5 billion for Q2 driven in large part by the immense popularity of the extended Galaxy smartphone range. But even this failed to satisfy the market, which had been betting on something around $10 billion profits and the actual figures provoked a 4% drop in share price amid concerns that Samsung too would be forced to compete more strongly on margins as the global smartphone market becomes more saturated.
Google’s results also evoked negative sentiment, with concern in this case being an accelerating fall in online ad prices. Average online prices for Q1 2013 were down 4% on the year earlier, but the year on year decline has increased to 6% over Q2. Yet net income was up 16.5% year on year at $3.23 billion for the quarter, on revenues of $14.11 billion against $11.81 billion in Q2 2012. This was despite being held back by Motorola acquired during the year, which lost $218 million in Q2, four times the $49 million it lost a year earlier.
There is an extent to which Samsung and Google may become victims of their success. Samsung has contributed to impending saturation of the smartphone market, while the success of Android devices has played a big role in declining PC sales ‘ and yet Google cannot make as much money for selling ads shown on mobile devices as it could previously on PCs. This does partly reflect the different content consumption patterns on mobile devices as against PCs, with people snacking more and perhaps being less receptive to ads.
Of course Apple has also played a major part in declining usage of desktops and laptops despite still being very much in that market and ironically has been enjoying its traditional comfortable margins in the Mac arena. Overall its gross margins have sagged from 42.8% in its Q3 2012 to 36.9% in the recent quarter (remembering that its financial year ends September 30th). In its case even revenue was only slightly up at $35.3 billion compared with $35 billion Q3 2012, reflecting in particular the savaging iPhone has received at the hands of Samsung’s Galaxy.
The actual effect does not appear like a savaging, being to retard iPhone sales growth, from 26 million Q3 2012 to 31.2 million this quarter. But that is a bad result against Samsung’s 40% gain in smartphone sales from 50 million to 71 million over that period.
Apple is feeling Samsung’s heat equally in tablet sales, with 14.6 million units shipped in its Q3, down from 17 million a year earlier. Over the same period Samsung tablet sales have soared from 2.25 million to 9.4 million to become the clear number two, leaving Amazon, Microsoft and others well behind.
Yet Apple had recovered during 2012, partly because it was ahead of the others in launching models with greatly improved displays. That led to a 44.1% surge in tablet sales over just one quarter, to stand once again with 69% of the global tablet market with that 17 million figure in its Q3. But in the year since then, while iPad sales have declined, the quarterly global tablet market has expanded by 65% to reach 51.9 million in Q2 2013, according to one count from Futuresource Consulting. Following that growth curve and allowing for a little tapering off, it looks like 240 million tablets could be sold this year.
Meanwhile Microsoft, whose financial year ends June 30, has just reported operating income up 23% at $6.07 billion on revenue up 6% at $77.85 billion for 2012/2013. Revenue for the last quarter fell because of a $900 million charge for ‘Surface RT inventory adjustments’, plus a $733 million European Commission fine over an antitrust case relating to Internet browsers dating back to 2009. Microsoft had failed to honor a pledge it had made in the EU to let users see a “choice screen” offering 11 different browsers, including its Internet Explorer. That prompt, not perhaps so mysteriously, disappeared following an update to the Windows 7 operating system in February 2011.
Amid all these results one common factor is a growing focus on video and TV as a lever for future revenue growth. All seven lack their own distribution and all have been focusing on content, having identified that as the only way of establishing a bulkhead in pay TV as well as for competing among themselves. This has involved frantic bids to acquire content through often factitious negotiations with existing studios and broadcasters, as well as increasing involvement in original content production. The two fit together in that spiraling rights costs for finite content reserves, makes it more and more attractive to produce in-house content, which also provides an immediate point of differentiation.
In Microsoft’s case this has led to morphing from being just a software provider following its Windows tradition, to being a provider of services and devices. This is why Microsoft sold its Mediaroom IPTV platform to Ericsson in order to focus on OTT around its already successful Xbox gaming console. It had already stepped into content in 2011 through deals with nearly 40 TV entertainment providers around the world for the Xbox 360 console. New partners included Bravo, Comcast, HBO and Verizon in the US, with the BBC, Channel 4 and Lovefilm in the UK, and with ZDF in Germany and ABC in Australia.
Having already reached deals with Netflix and Hulu+ in the US as well as Sky in the UK, Microsoft was at that stage seeking to provide an extra link in the distribution chain to gain traction, but is now aiming full square to take over the living room as the main provider of entertainment. In line with this revised strategy it is currently producing premium interactive TV shows that will launch on the company’s Xbox Live service later this year for the US market initially, aiming in particular to exploit interactivity of the latest Xbox One due for launch November 2013, about the same time as Sony’s latest PS4. But more than ever before, the focus will be as much on the console’s status as a TV gateway device.
Microsoft may find itself in competition with its long standing partner Intel over TV, although the latter’s strategy continues to be ambivalent. Like Microsoft, Intel has had to cater with a longstanding decline in the PC business and the power of the ‘Wintel’ brand, but has been unable to articulate a clear direction. It launched a SoC for smart TVs in 2007 but this failed to gain traction.
Then in May 2010 amid much hype that was quickly deflated Intel became one of the four partners in Google TV mark one, with its Atom CE4100 processor driving both the Logitech and Sony TVs that made up the quadrumvirate. Subsequently Logitech pulled out after disappointing sales, leaving Sony alone as the supplier with the whole venture emasculated by Google’s inability to prize much premium content from rights holders.
Intel meanwhile realized it could not build a TV strategy around a chip alone and so has been investing around $2 billion of its considerable cash mountain on content. At the same time it was struggling to make inroads in the smartphone and tablet markets with the Atom range, which had cut its teeth in the field of netbooks, slimmed laptops requiring efficient low power chips enabling longer battery life. The mobile device space appeared sewn up by ARM based chips such as Qualcomm’s Snapdragon range.
But then came a new twist following Google acquisition of Motorola, whose Razr i then became the first significant smartphone with Intel inside in the shape of its 2.0GHz Atom Z2460 processor. This trumped the then existing Atom smartphones that ran at 1.6GHz, supposedly enabling smoother browsing and better video performance. At any rate it gave Intel a leg up into the smartphone and Android markets and also signified further possible alignment with Google over TV and mobile strategy.
Even so mixed messages continued to emerge, with Intel’s new CEO Brian Krzanich, appointed in May 2013, casting doubts over TV strategy in his first media interview. He confessed that despite all the investment and the existence of relevant technologies for TV, Intel was find it hard going acquiring premium content. He hinted that as a result Intel would delay further any pay TV launch based on a set top box and refocus on core strengths in manufacturing. He did emphasize the importance of capitalizing on the entry of Atom into the smartphone and tablet markets to build up its position there.
Intel’s problem is that it has yet to make much progress in developing its own content, which is now seen as an essential plank for a successful pay TV strategy in the online arena. So while Google has had a similarly frustrating experience as Intel in acquiring content it is way ahead at producing its own on the back of YouTube, which has been at it since 2011. YouTube is now well into a second round of a long-term plan to reshape the original content landscape in its own image, with around 160 ventures feeding OTT programming service. It has signed up some key performers such as Tom Hanks, Amy Poehler and others to produce new programs and curate branded channels. It also supported numerous start-ups run by established indie makers and others.
The top 25 of its new channels now average more than a million views a week suggesting that headway is being made. This has led to rumors that YouTube is about to launch an a la carte subscription package for upwards of $2 a month enabling customers to pick and choose the channels they watch. This was supposed to be Intel’s proposition aiming to appeal to customers fed up at paying for numerous channels they don’t watch, even if in practice they would end paying much the same for the premium content they do want.
Google has confirmed such a service is coming, stating that it will give channel operators a new source of finance for producing TV shows and movies. This brings us onto Netflix, which in its US heartland has shown more than any of the others the power of original content with its House of Cards political intrigue Series modeled on a UK production two decades earlier, followed by the current Arrested Development series, helping gain 630,000 customers in Q2 2012. This brought the total to 29.8 million in the US plus 8 million international, helping more than triple Q2 earnings from $16 million to $57 million on revenues 20% up at $1.07 billion. It has also emboldened Netflix to return fully to its earlier strategy of using US earnings to finance international expansion with the aim of achieving a more balanced customer base across the world.
At present Netflix simply lacks the cash to expand on all international fronts to the extent of becoming a major competitor in pay TV. In much of Europe the big challenge lies in getting hold of premium sporting content compounded by the issue of distributing it at sufficient quality. Obtaining the content would enable it to reach distribution deals with existing pay TV operators and Telcos, so that is the main hurdle. At the same time it is coming up against local broadcasters already well-established in OTT in some markets. Across the Nordics Sweden’s Modern Times Group’s Viaplay already has a strong customer base and can exploit its extensive sports rights. As a result Viacom is able to charge three times as much for its Viaplay package, including sports, than Netflix can get.
Similarly in the UK Sky and BBC have the all-important English Premier League rights carved up between them and are using that to attract OTT subscribers as well, with Netflix confined mostly to movies and old TV shows. So given the unlikelihood of Netflix acquiring any significant sporting rights anytime soon it will have to invest in original local content to get anyway near emulating its domestic success. But even the big players are a long way off making much greater inroads. Samsung for example is still struggling to get off first base with smart TV, despite reaching some deals with platform operators to distribute high quality premium content. An early foray in that direction came in a deal with Telco TeliaSonera to deliver its IPTV service directly to Samsung smart TVs, avoiding the need for a set top box. This involves jointly developed software running in the TV and will be replicated across the Nordics if the trial is successful. But so far indications are that it has failed to achieve any increased rate of IPTV growth in Estonia after its launch there late in 2012.