While many want to imply and insist that video delivered over the internet is going to one day rival or surpass cable TV as the main broadcast medium, which is an incorrect notion on its own, most are missing the bigger picture and ignoring the business side of the discussion. They want to argue about network capacity, improved compression algorithms, server deployments and other technology pieces without realizing or even acknowledging that the business model of delivering video does not work. Delivering video over the web, even at scale, isn't profitable, unless you're YouTube and you can afford to subsidize the bandwidth of nearly the entire Internet.
Even at scale, you can't make money from delivering video on the web. It's a flawed business because unlike traditional broadcast TV and radio models, with video on the web, each new viewer you get costs you money. You don't have a fixed cost when it comes to delivering video and the cost to a CDN always rises. Just ask any content delivery network why they are diversifying their revenue away from video and focusing on high-margin value add services. They can't make money from video only content, and that's not going to change any time soon.
Last year, Limelight Networks (NASDAQ:LLNW) cut their capex from about $40M in 2011 to about $25M in 2012 as the company decided they could no longer spend money to build out scale for video customers they don't make money from. And last month, Akamai (NASDAQ:AKAM) , the largest service based CDN, said on their earnings call that they will be, "winding down some contracts with a few media accounts in the first quarter that are not of long-term economic value." They also said that moving forward they would, "refuse to pursue deals that we deem to be unprofitable or of little strategic value", pertaining to their media and entertainment CDN business. This is Akamai's way of saying these contracts didn't have margins that were good enough to make it worth their time.
Delivering video on the web isn't profitable. No CDN today is profitable, based solely on delivering high volume, low priced bits on the web. The only reason there is so much web based video to begin with is the fact that Google (NASDAQ:GOOG) subsidizes it. And while some will argue that the price of bandwidth will always decline, it's not declining at the rate it use to. Between 2009-2012 the industry witnessed the slowest rate of decline in CDN pricing ever (www.cdnpricing.com). On average, pricing was only down 20%, versus previous years dating back to 2000, when CDN pricing would drop at least 45% every year. Today, CDNs can't afford to give it away, their costs are always rising and no one can debate or argue about their lack of profitability.
Many are quick to point out that online video advertising is growing and that's going to allow content owners to monetize their content and as a result, make more money and be able to pay for more video delivery services. That would be the case if video delivery pricing fell at 30-40% each year, but it's only falling at about half that. It's one of the reasons that all of the projections made years ago of just how big the online video ad market would be are completely off. None of those numbers came true and part of that is due to CDN prices not falling as fast as some thought, which has had a direct impact on the growth of the online video advertising market.
Broadcast TV networks were built to distribute video and the Internet was built to distribute everything but video. Large objects weren't even around when guys like Akamai started building their CDN and even fifteen years later, the Internet is still not capable of delivering TV quality video to the number of subscribers cable/satellite have, at the same quality. When a webcast does take place, for everyone who says they got the stream, there are always others who had problems. Just look at the recent webcasts of the Super Bowl, launch of the iPad Mini, Red Bull Stratos or the recent PlayStation 4 press event. They all had problems, for a large portion of viewers.
Every time I write about the topic of cable versus Internet video distribution, some always want to argue about technology. But no one can argue about the business model of delivering video on the net, which to date, has never been a profitable business for any CDN, at scale. In 2000, I remember many in the industry saying that in five years, everyone would watch all video online, cable TV would be dead and the Internet would give you the ability to watch anything, anytime, on any device. Remember Quest's "ride the light" commercial? That was thirteen years ago yet still, many continue to preach that Internet video will displace cable TV.
Some might argue that Netflix (NASDAQ:NFLX) has already proven this model as they currently have more subscribers than a lot of MSOs, but comparing a service that costs $9 a month to a service that costs $50+ a month isn't exactly fair. Not to mention, Netflix's quality isn't even close to what you get via cable from an HD channel and they have less choice. Also, no one seems to mention that Netflix is being forced to change their CDN strategy and move away from using service based content delivery networks due to the fact that the CDNs don't want Netflix's video delivery business anymore. Sure, they love using the Netflix name as a customer, but they all make slim margins on Netflix's traffic and the capex required to support Netflix is huge. In Q4 of 2010, Level 3 (NASDAQ:LVLT) disclosed they spent at least $14M in capex to add capacity to their network, just for Netflix. Level 3 is the one CDN who actually owns their network and has a lower cost of delivering video, so for them, the Netflix business makes sense. Three years ago all the major CDNs were fighting over Netflix's video business but today, they no longer see it as a smart use of their network capacity or resources. What does that tell you about the business of delivering video on the web, even at scale?
And even with the business CDNs already have today, many still struggle to deliver it with good quality. Conviva measured the video quality of 22.6B video streams in 2012 and found that roughly 60% of all streams experienced quality degradation. Viewer interruption from re-buffering affected 20.6% of streams, 19.5% were impacted by slow video startup and 40% were plagued by grainy or low-resolution picture quality caused by low bitrates. And these streams are the ones that matter as they come from content owners like ESPN, HBO Go (NYSE:TWX), Turner, Disney (NYSE:DIS), Vevo and others who actually have content consumers want to watch and a way to monetize them. 4% of all streams Conviva measured never started. When was the last time you turned on the TV and your video signal didn't work 4% of the time? Video delivered over the web simply isn't reliable, for large audiences, at good quality and things like multicasting, better codecs, more fiber etc. isn't going to change that.
The reality is that without Google subsidizing a large portion of the Internet's bandwidth, thanks to YouTube, we'd have far less video on the web today. But even by YouTube's own data, they monetize less than 25% of all their video streams every day. So they are paying to deliver billions of streams each month that no one can make money from. Does this sound like a business model that makes sense or better yet, one that will allow streaming media technology to displace cable TV as the broadcast medium that the majority of people will use to get their video? No chance. Those who suggest that cable TV will be replaced by video being delivered over the web can debate and argue all day about the technical details, but you can't argue with nearly sixteen years of CDN data which proves that it's a not a business companies can make money from. If there is not a profitable business model behind any technology, it can only go so far.
I'm not down on the CDN market, it's still a very important part of the video ecosystem and many vendors will still be in the industry for years to come. But video delivery is not the portion of their business they will make money from and it's not the product that will grow their top line. Profitability is now the measure of a CDN's success and not the number of video streams they deliver.