How wifi routers are sold in Indonesia?

As I explained in my other article about distribution channel in Indonesia, every product category (computers, lamps, bulbs, cell phones, fabrics, clothing, etc) have a trade center location where each building hosts thousands of similar stores.  People living in Jakarta know that these are the places they need to visit to get the best deals and lowest price on each product category (retail or wholesale).  For example, people would tell you to go to Kenari trade center for lamps or Mangga Dua trade center for computer and accessories.

WiFi router falls in the computer category so all the computer retail stores in Mangga Dua also sells consumer WiFi routers.  These stores sells everything you can think of in the computer category including motherboards, CPU, hard drives, DRAM, keyboard, mouse, fan, heatsink, power supply, laptops, web cameras, pirated software, servers, desktops, and tablets.  I decided to tour the building and check out the products.  TP-Link is the dominant brand because they are good quality and cheap.  In addition, I also see routers from D-Link, Buffalo, Cisco, and Belkin with prices ranging from USD $30 – $100.  So I decided to ask the sales associates in a few of these stores to understand how they sell these products.  I walked into the first store and asked the sales lady which router is best and what product she would recommend for me.  First, she said that if you have 2 stories house, you need to get a router with 3 antennas that cost $50’ish.  Otherwise, she recommends 2 antennas router for $40’ish.  Sometimes one of the antennas on some products are just accessories and the signals are not processed because of software/silicon problem.  And yet this becomes the main metric for selecting a product.

3 antennas router

The second store I visited, I asked how all these products (D-Link, Belkin, Buffalo) in your store are different from each other.  The sales associate is obviously not trained.  He said the differences between these products are the distributors.  Nice…so now the product features do not even matter anymore.

The bottom line is that WiFi routers in Indonesia, where fixed line broadband bandwidth is in the less than 2 Mbps range, are no different than pork belly or other commodity.   Some brands are successful in obtaining a position in the market.  TP-Link is the best value for the money.  Cisco/Linksys is the best product so you should pay premium for it.  The rest do not really have a position and will be pushed based on distributor incentives/rebates or whatever your friend recommends.  Most people just want WiFi router that is easy to setup with solid and consistent wireless performance everywhere in their house.  It is my view that this is an example of a product category that has overshot the market’s ability to utilize its performance even in the United states.

Sony Pictures Entertainment

Sony Pictures Entertainment is a subsidiary of Sony Corporation that operates the movie/tv shows production and distribution business.  Here are some samples of recent movies that they produced:

  • 21 Jump Street
  • Ghost Rider: Spirit Of Vengeance
  • Men In Black 3

I am writing about Sony because I want to know why they are in the movie production and distribution business.  So I ran into this NYT article from 1989 that explains the Sony/Columbia Pictures deal.  Sony’s stock was trading at $24 in 1989 from Yahoo Finance.  Assuming the same number of outstanding shares,  Sony was valued at $24B and paid $3.4B for Columbia.

At the time of the acquisition, Sony was the number one brand for consumer electronics products.  Sony’s success in the consumer electronics business started in the late 50’s when they commercialized portable transistor based radio.  The killer app is portable as most radios at that time were bulky because the electronics were made up of vacuum tubes that were much bigger and consume more power than transistors.  From this initial success, Sony went on to become the dominant consumer electronics empire and produced many new successful product categories including color television, VCR, CD player, gaming console and walkman.  Sony was the Apple of that era.

In the 70’s, Sony introduced their own proprietary Betamax video cassette format to store/record movie contents.  Their strategy is to keep it proprietary and they were initially unwilling to license the technology to other OEMs while VHS (originally developed by JVC) was license free.  If Betamax was the winner of the format war, Sony will not only be king of VCR category in terms of sales and profit but they could (if they chose to) also make money from licensing fee from competitors that want to produce Betamax VCRs and cassettes.

There were 2 main use cases for VCR, play rented or purchased cassettes and record TV shows.  Although Sony touted Betamax’s superior audio and video quality, recording time is limited to only 1 hour while VHS tapes can record longer.  Somehow the VHS camp was able to exploit Sony’s weakness in recording time and position their strength successfully in consumers’ mind.  VHS had over 90% adoption in the late 80’s and emerged as the clear winner.  Here is a link to more detailed story.

Even though they lost the VCR format war, Sony was still a large and dominant consumer electronics company in the late 80’s.  They were probably not happy with the results and so they thought that if they can control the content then they can certainly force the format.  Imagine if some of the great movies like Star Wars video cassettes were only available in Betamax, Sony will have more control over how consumers will choose the types of VCR they bought.  In order to ensure they do not lose the next  new media format war, they bought Columbia.  Although they won the BlueRay format war against HD-DVD recently but the ground underneath them is already shifting to a new internet distribution channel.

Fast forward to 2012 today, we all want similar home entertainment with movies and TV shows that stars the latest  Hollywood actors/actresses.  To enjoy the contents in the home, we will need some kind of consumer electronics devices (tablets, TVs, set top boxes)  that are the main distribution point of the contents.  The question is which device (Apple/Microsoft/Amazon/Cable STB) will I buy/lease and whose service (Netflix/HuluPlus/Cable TV) will I hire?

The giants of consumer electronics industry are moving toward vertical integration (Amazon Kindle Fire, Microsoft Surface, Google/Asus Nexus) following Apple.  They will have control over the distribution points of contents on their respective devices.  To make things even more complicated, the distribution lane of where the contents flow are owned by another set of operators such as Verizon, AT&T, Comcast.  The network operators also want control over which services or contents flow through their network.  Sony did not have the latter problem with VCR and Betamax.

Here is my overall take :

Consumers will always want Hollywood contents with the latest and greatest stars.  Contents will always have a large pull in consumers’ mind.  Consumers want to own devices that are easy to use and allow them to consume *all* the content they want.  Some segment of consumers will only want to buy beautiful branded products that reflect their self image and status.  Consumers do not really care whether they get their content on Verizon or AT&T network as long as the network is good enough to do what they are hired to do.

So to me, it is clear that network providers need to own content to differentiate themselves.  Device makers need to own content as a competitive weapon if they fail to compete on product attributes.  Content is always the winner.  However, major movie studios are already owned by larger companies (Comcast owns Universal, Sony owns Sony pictures, Time Warner Group owns Time Warner and HBO, Liberty group owns etc).  If Microsoft failed to carve a good market share for their tablet, maybe they should buy the smaller ones like Sony which is valued at $14B today and secure Sony’s exclusive contents.

In the long run, independent services company such as Netflix and HuluPlus do not have a chance to survive alone – they will be bought because of their large subscribers base.  They were already trying to control their own destiny by producing their own original TV series and becoming movie/content producers.

Amazon is experimenting with Amazon studios.  They are trying to disrupt the movie production value chain by sourcing creative talents and content producers to do a movie directly with them.  The content will get guarantee showing time on Amazon video service.  The effectiveness of this experiment is yet to be determined.

Netflix and Starz

Netflix added 1.7 million subscribers in the US  to end the quarter with 23.4m US subscribers in Q1 2012 that ended on March 31, 2012.   They also added an additional 1.2 million subscribers outside the US for a total of 2.9 million subscribers addition in Q1.  This is a very good number considering 2 major negative events in the past 6 months that the company endured.

The first is the price increase and the split of their streaming and DVD business that triggered massive exodus of subscribers back in September 2011.  In addition, the Qwikster announcement which they quickly reverted also added to the negative sentiment about the company and the brand.

The other significant event is the removal of Starz/Disney contents from their streaming lineup due to contract expiration which happened in late Feb 2012.  These are samples of movies that Netflix lost (here is the link for 50 others that are notable) :

  • Tangled
  • Toy Story 3
  • Scarface
  • Tron:Legacy
  • Secretariat

Although Netflix claimed in their shareholder letters in Q3 2011 that Starz contents only constitutes 6% of the total subscribers viewing hours, I still felt that these are blockbuster contents that could generate positive halo effect on their brand and streaming service.  These contents were prominently displayed in their website’s landing page for non-subscribers and served as window dressing to attract people to come to the store and try the service.  It would have been more difficult to add new subscribers without these contents.

The quarterly result indicates 2 things to me.  The first is that Starz contents do not matter as much.  People subscribe to Netflix for mainly long tail contents.  Second, the work that Netflix has done on the distribution channel in 2011 to enable tablets, smart phones, and connected TV/blueray players are paying off and offsetting the Starz negatives.  With the recovery of the brand and competition that are still trying to catch up, I anticipate Netflix to continue to add subscribers in 2012 and ride the mobile internet video adoption wave (in addition to fixed line).

Netflix’s distribution channels

Having spent enough time on the cost side of Netflix, I want to write a bit on the sales and distribution channels.  When Netflix started offering their streaming video service 7+years ago, I remember that I can only use the service on a browser window that runs on a Windows PC.  Fast forward to 2012, almost all of our entertainment devices are connected.  There are additional categories of products where Netflix can be watched such as televisions, blueray players, network streaming player, tablets, and smart phones.

Let’s review them briefly:

Category Dominant players Dominant Platform/OS 2012 units (source: Qualcomm Analyst Day presentation, Asymco, various) Have Netflix?
Smart phones Apple, Samsung, HTC iOS, Android 500m+ yes
Tablets Apple, Samsung iOS, Android 70m+ yes
Smart Televisions Samsung, LG, Vizio various (Linux/BSD) 30m+ yes
BluRay players Samsung, LG, Vizio various (Linux/BSD) 40m+ yes
Gaming devices, Streaming players Xbox, PS3, Roku various (Linux/BSD) 100m+ yes
Cable/satellite STB Comcast, DirectTV various (Linux/BSD) 70m+ no

From engineering stand point, Netflix has done a good job of getting their streaming software running on these various platforms relatively quickly.  From business/value chain point of view, signing these consumer product OEMs and platforms to Netflix is relatively easy given the pull of the Netflix brand from consumers.  20m+ Netflix subscribers want to watch Netflix content on their new devices and having a new TV/Blueray player that can stream Netflix will allow device manufacturers to up sell new or replacement product.  From marketing perspective, Netflix is prominently displayed in various consumer product packaging or promoted in App Stores with very good product placement.  They now have a much better distribution channels compared to other competing service.  Amazon is catching up, Verizon does not have a product, Comcast and Dish offer the service as defensive strategy to keep their subscribers.

The number of devices can mislead you into thinking that this is Netflix’s potential.  However, the real potential number for Netflix is 100m+ US households + their international expansion.  Each household will pay for 1 service and share the account with the family members.  At 20m+ subscribers, there is still room to grow.  At $8/month, this is 2-3 cups of Latte per month.  The price is so low it could almost be an impulse buy.  With much better consumer sentiment, why can’t they go to 35m-40m households with a bunch of niche contents, a few blockbusters, and original series (on-demand cable channel)? 70% of American households have shown that they are willing to pay $80/month for pay TV.

On the international side, DirectTV has proven that South America can be a big market as they grew their Latin America subscribers to 7m+ in 5 years.  Their satellite operation allowed them to have wider coverage for their service.  I am not convinced that the internet infrastructure in Latin America can reach many potential subscribers to be Netflix’s growth engine.

How much does it cost to offer pay TV service?

I want to know how much it cost for providers to offer pay TV service.  Especially, I want to compare the cost to offer pay TV services between cable TV MSOs, satellite TV providers, and over the top providers (direct over the internet).

Note I used the word subscription versus subscribers.  Comcast ended 2011 with 22.3m video subscriptions, 18.1m broadband subscriptions, and 9.3m voice subscriptions.  However, they did not mention how many unique subscribers (households) use their service.  Each household may have 1 or more subscription (i.e.: video and internet).  To get the number for Comcast, I divided Comcast’s cable business operations cost with the total number of subscriptions at 49.3m at the end of 2011.  ARPU is also lower because broadband and voice pricing are lower than cable TV.

DirectTV can generate $80/month from each of their 20m+ subscribers and spends $60/subscriber/month to attract, install, retain, and offer programming services.  About 40% of the cost goes to contents (cable channels, sports, movies, TV shows).

Netflix does not require cable/satellite dish installation, set top boxes to lease, or cable equipments to operate.  They just borrow the internet to offer the service and therefore only spends $9/subscriber/month to offer the service.  They offer the video service over the internet where the infrastructure is already built by Telcos and MSOs.  They do however spend ~40% of the revenue on streaming content.  Content Delivery Networks (CDN) cost and renting servers from Amazon is insignificant to the size of their revenue.

From technology stand point, the internet is definitely the future of pay TV as it can offer the service with the lowest operational cost.  There is no technology barrier today that prevents the same contents you get on cable channels via the internet.  However, as I mentioned in my previous blog, the cable and satellite operators who are also content owners will starve the internet-only player from contents.  At the same time, they are also offering similar services as Netflix as additional feature for their subscribers (see Xfinity Strempix, Verizon/Redbox).

The cable and satellite operators seem to be winning the war so far as they are able to maintain (lose less for Comcast) their subscribers in 2011 and come up with their own internet streaming solutions.  Netflix, on the other hand, is positioning itself as a premium cable channel where they are producing their own original programming (see NYT article).

Click the image for details

Netflix streaming video cost structure

Netflix does not distinguish between their DVD and streaming business operational cost.  All the operational cost is consolidated into 2 line items:

  • Cost of subscription – includes amortization of content/programming licensing cost, amortization of DVD libraries, postage costs to mail DVDs and CDN costs to stream content.
  • Fulfillment expenses – includes cost such as content processing facility such as shipping and receiving center for DVDs, encoding of streaming content, etc.

I just want to quickly understand the cost structure of their streaming business which includes mainly CDN and content licensing cost.  Netflix recently announced that their subscribers watched an aggregate of 2 Billion hours of content in Q4 2011.  Here is my estimate for their CDN cost based on this data.

2 Billion x 60 minutes x 60 seconds = 7,200,000,000 seconds.  Assuming an average Netflix stream of 2 Mbps, the number of bits streamed = 2 Mbps * 7.2 Trillion seconds = 1,800,000,000 GBytes (1 byte = 8 bits).

Based on data from Dan Rayburn’s streaming media blog, Netflix pays CDN providers 2 cents per GBytes of video steamed to their customers.  So their CDN cost per quarter = 1,800,000,000 GBytes * $0.02 = $36m/quarter or $144m/year.  This is only 4.5% of their 2011 revenue.

Netflix has a funny way to account for streaming contents in the financial statement.  It claimed that it needs to follow some ASC rule, who knows.  Please check for yourself on Netflix’s IR website.  This is how I interpret the streaming content cost.

For contents that are considered Asset and has balance sheet components (based on slide #10 of the content accounting guide from their IR website), I used the “Amortization of streaming content library” line item from the cash flow statement as the amount charged for content cost in 2011 ($700m).

Some content licenses are not capitalized and are not considered in the balance sheet.  I suspect that this is some kind of revenue sharing plan with the movie studios where there is a minimum amount Netflix has to pay to make the content available for streaming plus Netflix may have to pay additional fee based on the number of times the movie is streamed.  There is no easy way to get a breakdown of this since they are all included in the Cost of subscription line.

Based on slide #11 of their content accounting guide, I had to go back to Netflix’s previous year (2010) 10-K and check the contractual obligation that is due in 2011.  I took the Content obligations line that is due “Less than 1 year” as the amount that will be included in the 2011 cost of subscription ($530m).  This does not include new contracts signed in 2011 that were amortized in the immediate quarters.  It also does not include provisions for additional fee from the increasing frequency of movie streams as subscribers grow.  So this estimate is on the low side because Netflix grew their subscribers 30% in 2011 and signed a bunch of new content deals in 2011.  I am going to add 10-15% to this estimate and just round it up to $600m.

To summarize, my estimate of their streaming content cost for 2011 is $1.3B.  I did not have to work so hard to get the programming/content cost for Direct TV or Comcast because they just make it obvious in the line item.  Here is a more detailed estimate of their cost breakdown in 2011.

Click on this image to get the actual dollars

US Pay TV market overview

Recent earning reports from DirectTV, Dish, and Comcast have indicated substantial subscriber growth in the industry. I want to compare the metrics in these companies and also compare them with over the top player such as Netflix.

motion chart for US pay TV market

I have to make some assumptions to build the chart as I need to consolidate financial reports from different companies.  I will write some articles on my takeaways in the next few days.  The chart is work in progress and I will keep updating as I learn more about the companies.