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According to the January-February 2013 telecom industry statistics released by China's Ministry of Industry and Information Technology (MIIT), short message service (SMS) traffic during the Chinese Spring Festival season climbed by only 0.7% compared to the previous year. The annual growth rate is much lower than 2011 and 2012, which were 5.7% and 7.6%, respectively. The traditional telco business is supposedly being encroached upon by emerging over-the-top (OTT) applications such as Tencent's WeChat (Weixin) and microblogs (Weibo), which provide free Internet-based messaging and information sharing services.
Other telecom operators are also feeling the squeeze. At the Mobile World Congress 2013, Vodafone's CEO Vittorio Colao pointed out that more and more users are turning to free Internet-based applications such as Skype. OTT players may erode 18% of Vodafone's revenue in Europe, as revealed by Informa.
The dispute over whether WebChat should be charged has also emerged. Some argue that WeChat services consume a large volume of mobile signaling and should be charged by operators. Others believe that WebChat gives users more freedom of choice and the charging issue should be left to the market. Then comes a bigger question: are Telcos and OTTs friends or foes?
The rise of OTT applications is not that threatening to the Telco group. In retrospect, despite the once disruptive effect of mobile services on fixed-line PSTN services, fixed network operators managed to reinvigorate themselves upon fixed broadband. Although traditional voice and messaging services are losing ground, mobile broadband services are booming and bringing new profits.
It is evident that neither fixed nor mobile broadband can be in complete control of the Internet ecosystem. Without appealing content, the broadband pipe means little to end users. In this sense, Telecom operators and OTTs should work together for their mutual benefit and the benefit of their shared stakeholder: the end user. When questioned about the WeChat dispute, Chang Xiaobin, the Chairman of China Unicom, said, "I hope both operators and OTTs will get on board and work together, and I believe OTT companies hope for the same thing. We can jointly implement a win-win business model." This anticipated partnership recently materialized when the Guangdong arm of China Unicom and Tencent officially launched the Weixin-Wo SIM card. The customized card offers special services and data plans for WeChat users over China Unicom's network.
The foundation for collaboration is well established. Netflix, a US-based Internet television network, contributes to a 70% annual composite growth in network traffic (Global Internet traffic has witnessed a 207-fold increase from 2004 to 2013). In China, the popularity of Voice of China, a reality talent show, has driven the exponential growth of Internet traffic from video-sharing websites such as iQiyi. In 2012, the Voice of China finale show was watched 65 million times from the online video player PPS.tv. This surge of broadband-delivered services is also welcomed by telecom operators.
The seemingly unlimited demand for bandwidth poses technological and business challenges. There are concerns over whether Moore's law can keep up with traffic growth. While Telecom operators are busy investing in router technologies and capacity expansion, average revenue per user (ARPU) lags behind. It is no surprise that Telcos want to charge bandwidth-hogging Internet companies like Google.
Growing traffic also exerts cost pressure on Internet content providers (ICPs). For video websites, two major cost drivers are bandwidth consumption and content rights, and their revenue primarily comes from ads. To reduce operational costs, some video sites may cut bandwidth costs by compromising video quality. This lowers customer satisfaction and increases churn, which in turn hurts ad revenue.
Facing the same cost pressure, telecom operators and OTT content providers can partner to deliver quality services at lower bandwidth costs. The Open Connect model adopted between Netflix and operators is one such success. With this model, Neflix moves its content delivery network (CDN) edge servers into operator data centers (DCs) to speed up content delivery. Bringing content closer to users means smoother video experience. What's more, this move cuts Netflix's content delivery costs and alleviates congestion on operator networks.
The USD7.99 monthly fee to each Netflix subscriber breaks down like this: Netflix pays USD3.00 for content rights, USD0.15 for CDN transmission, and USD2.26 for marketing and management. The monthly net profit of Netflix is USD2.58 per user. On the operator side, the ARPU is USD0.15 (from Netflix) plus USD29.99 (from broadband users). Netflix's services account for 30% of peak downstream traffic in North America, helping operators attract and retain valuable broadband users.
As of the end of 2012, Netflix subscribers totaled 25.47 million with over 85% of them using four terminal types (PS3, Xbox, PC, and Wii) for service access. That a terminal must support the Netflix application has become a default prerequisite for entry into the North American market. Thanks to the commercial success of Open Connect, more than 300 terminal types in North America, including mobile devices, HDTV, game consoles, and Internet players, are pre-installed with the Netflix application.
Telco-OTT synergy supports a win-win ecosystem that benefits all. From the basic goal of enhancing user experience, the Open Connect strategy results in lower bandwidth costs for Netflix and smaller bandwidth scalability pressure for operators.
Besides cost reduction, telecom operators and OTT can collaborate for service innovation. Operators typically have a large subscriber base with subscribers accustomed to paying monthly bills, while some ICPs hunger for quick bursts of attention, especially from paying subscribers. If they complement each other, content providers can strengthen market position by leveraging the operator billing channel and distribution channel, and operators can earn more through innovative broadband services.
China Unicom Tianjin (Tianjin Unicom) and Galaxy Internet Television illustrate this perfectly. (Their cooperation is supported by the Tianjin branch of China State Administration of Radio, Film, and Television.) Tianjin Unicom provides a bandwidth of 10Mbps or higher per user over its urban FTTH network. Galaxy Internet Television specializes in large-screen Internet TV services and its content is fed by the online video site iQiyi.
The two sides jointly deliver a "gold" service package targeting Tianjin Unicom's high-end subscribers (10Mbps FTTx). In this complementary business model, Tianjin Unicom leases bandwidth to the content provider for free, and in return, the content provider offers rich video content and 1080p HD video at a rate up to 5Mbps. By providing differentiated video experience, Tianjin Unicom has managed to expand its subscriber base, including high-value subscribers, strengthen pricing power, and win a competitive edge over its peers. Exploiting the operator billing and distribution channel, the content provider has gained regular users and stable cash streams, rendering ads a lesser revenue source.
While some OTT content providers eye operator's powerful channels to garner attention, more established ones may look to mature pipes for delivering superior service experience and outperforming peers. To have more say in the co-opetition with content providers, operators need to proactively engage, and meet varied bandwidth requirements using a pipe differentiation strategy. The Fujian provincial branch of China Telecom has set up a smart service acceleration platform (also called Yibite in Chinese) that assures differentiated bandwidths for ICPs and Internet service providers (ISPs). This platform allocates bandwidths on a per ICP/ISP basis and implements differentiated billing based on a destination address accounting (DAA) solution. In its effort to optimize service experience, video-on-demand service provider Xunlei teamed up with Fujian Telecom to deliver the Speed-of-Light Download service based on the operator's platform. The service allows Xunlei's VIP users, who pay based on special service hours, to enjoy optimum video quality through one-click bandwidth acceleration requests. This service has raised Fujian Telecom's annual net profit to over RMB10 million, and won lots of high-value users for Xunlei.
Continuous and strong growth of Internet traffic is a positive sign for fixed network operators. In the long run, the expansion of mobile broadband services will counteract the waning of traditional SMS and voice services, and operators can benefit from the new mobile landscape.
OTT content such as online video plays an important role in driving traffic growth and bandwidth consumption. Recognizing this role, telecom operators should collaborate with OTTs to cultivate a win-win ecosystem that enhances user experience, reduces operation costs, and even boosts profits. In practice, operators can seek receptive OTT partners by considering the latter's business scale and service offerings, to bolster sustainable growth on both sides.