Betting on the Wrong Side of the Market

Here’s some bad advice:

You don’t have to shell out hundreds of dollars every year to watch your favorite shows. This year, consider canceling your cable and taking advantage of several free and low-cost entertainment services. The website Hulu, for instance, lets you watch a variety of hit shows for free such as Glee, The Office and Modern Family, plus movies and documentaries. Or for $7.99 a month, you can take advantage of Hulu Plus, which gives you access to all of the selections on regular Hulu, plus more shows and movies.

You can also watch many shows for free on the network’s website, or pay $7.99 for Netflix, which provides access to unlimited movies and TV episodes.

The reason why cable is so expensive is because ad revenue alone is insufficient to cover both production costs and distribution costs. Cable and satellite networks are expensive to build and maintain, and content creation can often be pricey. As such, cable providers have to charge customers in order to be profitable.

The problem internet-based entertainment services face is that they are causing a significant portion of data transfer (i.e. the amount of data transmitted across the various data networks) but aren’t paying for any of the network upkeep and maintenance. Essentially they are paying only for content creation and distribution rights. This, incidentally, is why Hulu+ and Netflix subscriptions are so cheap (that, and Hulu is pretty well-connected to the NBC and Fox family of networks).

More importantly, it is the data service providers who have to pay for the creation and upkeep of data networks, and these networks have data transfer limits known as bandwidth. Essentially, there are limits to how much data can be transferred across a network at any given time. As more and more people begin to use online video content providers, there will be even more at being transferred at any given time, pushing up against physical network limits.

Data service providers will then have two options when this inevitably happens: increase bandwidth or cap data transfers. Most data transfer providers have relatively tight margins, so upgrading a network is not particularly feasible, nor will it be particularly widespread. Thus, the more common choice will be to cap data. Data caps (whether in terms of bandwidth usage or total data downloaded) will significantly curtail entertainment options, and so whatever profitability online video sites may have now will be either significantly reduced or completely eliminated, unless they decide to raise their fees.

Quite simply, the internet is not yet ready to replace cable. The network is not sufficiently built up. More importantly, the producers and aggregators of online content are not paying for the distribution of their content, and those who distribute content (data service providers) don’t have much reason to upgrade their network.

Ultimately, there is a strong chance that the market for online videos will eventually come to resemble the subscription television market. The separation of content providers and content distributors provides a problematic incentive structure that won’t be easily remedies unless content aggregators/producers have a financial stake in distribution, and vice versa.

Note: one thing that complicates this discussion immensely is the role of IP. If there were no IP, there would be many more aggregators of videos, and their subscription costs, if any, would be minimal since it would be considerably easier to find advertisers for pre-existing content, thus leading to an easy method of third-party funding. On the other hand, the amount of original content would diminish, and would probably become more low-brow.

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