With Internet TV, cable wins even if it loses

Americans, little by little, are cutting the proverbial cord on cable television. But that doesn't mean they're breaking up with their cable companies.

In addition to controlling most of the paid TV market in the U.S., cable companies are also poised to dominate the broadband market. This means that even when people drop their pricey cable TV packages, they're still likely to pay the cable company for access to the Internet, which is used to deliver the video streams to their TVs. For cable operators, it's a "heads we win; tails we win" situation.

Neil Smit, president of Comcast's cable division, admitted as much during the company's third quarter conference call earlier this week.

"If over-the-top comes into being, there is more consumption of online video," Smit said. "We feel very good about our capacity. That is one of the reasons we have invested so heavily in DOCSIS 3 (the cable technology that allows operators to provide download broadband speeds up to 160Mbps). We feel that that big pipe into the house is important and we will continue to invest in speed increases like that, like DOCSIS 3. We think it's an important component and the consumers continue to consume more bandwidth."

So what does that mean for average consumers? For those of us left behind with traditional cable services, it could well mean that the cable companies increase fees in order to pay for the contracts they have with content producers like the TV networks. For those who do leave cable TV, there's a very good chance they're paying the same provider for a different service--broadband access.

"People should not think of cable companies as media companies," said Craig Moffett, a senior analyst at Wall Street equities research firm Sanford C. Bernstein. "They are infrastructure companies. And they are in business to make a return on their physical infrastructure."

But instead of simply raising prices on cable broadband, Moffett said it's more likely that cable operators would move toward usage-based pricing. That way consumers who use more bandwidth to stream movies and TV shows end up paying more per month for service than people who may be getting their video from the traditional cable TV network.

Time Warner has tested usage-based billing, but the company faced a huge backlash from consumers. Still, Moffett said that broadband service providers may have no choice as bandwidth-intensive video streaming services like Netflix become more popular. Sandvine recently issued a report showing that Netflix traffic already accounts for more than 20 percent of downstream traffic during peak times on U.S. broadband networks.

Of course, the number of people today who are cutting their cable cord and watching TV from the Internet is still small. But people are cutting the cable cord. Just ask Comcast, which went on the defensive earlier this week explaining why it lost a net of about 56,000 TV subscribers during the third quarter of 2010. (Comcast announced it had lost 275,000 basic cable subscriptions during the third quarter. Meanwhile it added 219,000 digital TV subscribers. This means that it lost a net of about 56,000 video subscribers during the quarter.)

"All our exit surveys have seen almost no impact (from people switching to Internet TV)," Smits said during the conference call. "We have seen customers who are disconnecting and not going to a competitor. That small number of customers appear to be going over-the-air (using antennas to get free TV) much more than any over-the-top impact (TV from the Net)."

Even though Comcast denies these people are flocking to sites such as Netflix, they have admitted that the weak economy is driving them toward less expensive forms of entertainment. As more content deals are struck with companies such as Netflix, people looking to save a buck on TV, and who also have a broadband connection, will likely gravitate toward the Web for TV and movie viewing.

Netflix, which is just one of many over-the-top video options available to consumers, is quickly expanding its customer base. During the third quarter the company saw its subscriber base jump 52 percent compared to a year ago.

Netflix's CEO Reed Hastings said on the company's earnings call earlier this month that the streaming offer was definitely fueling subscriber growth. Netflix said 66 percent of its subscribers used its streaming content during the third quarter, up from 61 percent in the second quarter and 41 percent during the same quarter a year ago.

Broadband benefits
But regardless of whether this trend continues, Comcast and other cable companies are likely to benefit since they also control the broadband connection into the home. The phone companies' biggest weapon in the broadband fight has been their new fiber-based networks: U-verse for AT&T and Fios for Verizon. These services have competed head-to-head with cable in markets where they're available. But neither AT&T nor Verizon is covering its entire territory with these expensive network upgrades, which means that many customers without access to U-verse or Fios services have the choice of slower DSL or cable. As the numbers show, many are choosing cable.

During the second quarter of 2010, cable captured a record 90 percent of all new broadband additions, according to a report Moffett wrote.

"Cable's broadband dominance opens the door for renewed share gains in the adjacent video market," Moffett said in his report. "Cable companies could simply increase their a la carte broadband prices (since in most markets, households have no other choice for sufficiently fast broadband) and simultaneously drop their video pricing, leaving the price of the bundle unchanged, to recapture video share."

He pointed to an example of this in Albany, N.Y., where Time Warner Cable raised its broadband price by 10 percent for its Internet-only customers to a rate just $2 below its promotional bundled rate for both services. The Internet-only price increased to $54.95 from $49.95. The 12-month promotional rate for video and data was $56.95.

Even without changing its pricing, cable companies are starting to see consumers choose more expensive services with faster speeds. Smits said during the company conference call that more than 20 percent of Comcast's customers subscribe to higher speed tiers of services. He considers the "blast level" services to be 8 Mbps and above. As a result the company saw an increase in the average revenue per user of its broadband services. And with faster 50 Mbps and 100 Mbps speeds on the way, the company has a lot of leg room to up-sell broadband consumers.

Of course, Comcast and the rest of the cable industry are not giving up on their TV business. This week Comcast relaunched Xfinity TV, the company's TV-everywhere on-demand video service. It provides access to 150,000 movies, TV shows, and other premium HD content online and can be viewed on various different devices such as laptops and tablets. The service is available to digital video customers who will get an ID and access to the service at no extra charge. By the end of this year, the company expects to have the service available on Apple iPhones and iPads as well as Android tablets.

The company is also improving its user guide and constantly adding new titles to its video-on-demand service. For the time being, it does not see Netflix or any other Internet-based TV service as a threat.

"I think even Netflix on their own call felt that they were more complementary than anything else to the existing marketplace," Brian Roberts, Comcast CEO said during the conference call. "I think you are also seeing an expansion of usage as you can use more devices. We are very excited about devices like the iPad. It gives us a chance to now start from scratch with a user interface that is using Web technology, not cable box technology."