DOCUMENTO DE TRABAJO N o 13. Over-the-top (OTT) applications, services and content: implications for broadband infrastructure

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1 DOCUMENTOS DE TRABAJO DOCUMENTO DE TRABAJO N o 13 Over-the-top (OTT) applications, services and content: implications for broadband infrastructure Juan José Ganuza Universitat Pompeu Fabra [email protected] María Fernanda Viecens U. de San Andrés-CONICET [email protected] Febrero de 2013 This paper has been published in Spanish as chapter 11 of Más allá del acceso: banda ancha en América Latina, edited by Valeria Jordan, Hernan Galperin and Wilson Peres, CEPAL-DIRSI-@LIS2, Santiago, Chile, This book was produced with the financial assistance of the European Union, under the Alliance for the Information Society Programme (@LIS2), implemented by ECLAC's Division of Production, Productivity and Management.

2 Abstract Incumbent telecommunications operators that offer services such as fixed and mobile telephony, broadband and pay TV services, among others, are being invaded by online content, specifically those known as over-the-top (OTT) applications, services and content. The best known examples of OTT are Skype, Whatsapp, online video games and movies (Netflix, Pandora). A fundamental characteristic of OTTs is that the Internet Service Provider (ISP) does not profit nor is involved in the distribution of the OTT applications, services and content. Furthermore, in general, OTT suppliers, which need the ISP infrastructure to reach the user, offer products that compete with the services offered by the ISPs (voice, instant messaging, online TV). In this regard, and paradoxically, the broadband that incumbent operators supply acts as a platform for the development of these new businesses that represent the challenge faced by incumbent operators. At the same time, the OTTs generate a growing flow of traffic and an increasing demand for broadband, which translates into a need for investment in the network. The objective of this paper is to analyze the implications of the presence of OTTs in terms of telecommunications operators incentives to invest. We also study the level of development and/or importance of the over-the-top market in Latin America. Specifically, we discuss two elements: on the one hand, we study which strategies incumbent operators in Latin America are implementing in response to the threat represented by OTTs; on the other hand, we analyze the Latin American population s access to OTTs. 2

3 1. Introduction Incumbent telecommunications operators that offer services such as fixed telephony, mobile telephony, broadband and paid TV services, among others, are being invaded by the online content industry and what is known as over-the-top (OTT) applications, services and content. The best known examples of OTT are Skype, Whatsapp, online video games and movies (Netflix, Pandora). A fundamental characteristic of OTTs is that the Internet Service Provider (ISP) does not profit nor is involved in the distribution of the OTT applications, services and content. Furthermore, OTT suppliers which need the ISP infrastructure to reach the user, offer products that, in general, compete with the services offered by the ISPs (voice, instant messaging, online TV). The arrival of smartphones, their declining pricing trend and the update of access networks are contributing to OTT growth in the communications market. At the same time, the technological change has transformed creative industries and impacted their supply and production cost structures. Digitalization has reduced conservation, reproduction and distribution costs, among others things, (Weeds, 2012), which, in turn, have promoted the explosive increase in the supply of online content. In this regard, and paradoxically, broadband supplied by incumbent operators acts as a platform for the development of these new businesses that represent the challenge faced by incumbent operators. At the same time, the OTTs generate a growing flow of traffic and an increasing demand for broadband, which translates into a need for network investment. In spite of the increase in the number of OTTs, specialized literature that studies the incentives for incumbent operators to invest in infrastructure deployment, in particular new generation access networks (NGANs, fiber optic networks), has not addressed in depth the importance of OTTs in regard to incumbent operators incentives to invest. 1 1 As mentioned later, Ganuza and Viecens (2012) try to cover part of the gap. An industrial economic theoretical model is used to analyze the interaction between the development of the next-generation network (NGN) industry and the content market. There are a significant number of papers that focus the analysis on the incentives to invest in the effect of the regulation of wholesale prices (see Hoernig et al. (2012) for a review of this literature); others look at the high ratio of fixed costs/variable costs of deploying a fiber optic-based industry (Noam, 2010). 3

4 On the other hand, in terms of infrastructure investment needs, while efforts in developed countries are focused on how to take fiber to the home (or in an analogical sense, in assuring high access speeds) 2, the strategies and incentives in Latin America prioritize the correction of regional imbalances in the supply of firstgeneration broadband services with much more modest speed goals for access. In other words, while developed countries prioritize an increase in service quality, the factors that guide broadband plans in the region are expanding geographical coverage and an increase in the number of accesses (for an analysis of the initiatives spearheaded by governments in the region, see Galperín, Mariscal and Viecens, 2013). In this respect, low access speeds or reduced coverage of high-speed broadband service may represent a limitation for the use of OTTs among the Latin American population or that the possibilities of access to OTTs are reduced to those groups with high speed access (specific neighborhoods and large cities). The objective of this paper is to analyze the implications of the presence of OTTs in terms of telecommunications operators incentives to invest. We also study the level of development and/or importance of the over-the-top market in Latin America. In particular, we will discuss two elements: first, we will study the strategies incumbent operators in Latin America are adopting in response to the threat of the OTTs; secondly, we will analyze the possibilities the Latin American population has to access OTTs. The paper is organized in the following manner: in the next section we will describe the characteristics of the OTT content, applications and services. Jointly, we raise the dilemma or challenge that each type of OTT represents for incumbent network operators; in the third section, we will review the literature published on the subject; in the fourth section, we will analyze the market of OTT content and services in Latin America; in the aforementioned section, we will examine the supply of OTTs and the strategies deployed by incumbent operators, and the possibilities the Latin American population has to access the OTT services and contents; in the fifth section, we pose a discussion about the current situation and the unanswered questions; we will present our conclusions in the sixth section. 2 For example, the Digital Agenda for Europe aims for 100% of all European to have access to an access speed of 30 Mbps by 2020, half of which shall have connections above 100 Mbps. 4

5 2. Characterization of over-the-top services, applications and content In this section, we establish what we are referring to when we talk about over the top (OTT). This definition is fundamental for organizing the amount of information available about the subject, which, as far we know, has not yet been systematized. At the same time, this characterization will allow us to present the first analysis about the challenges that the OTTs pose for those we refer to as incumbent service and network operators. We will use a concept that is not restricted to over-the-top contents (which were the first ones to be called OTT). Table 1 below presents a diagram and classifies the different types of OTTs. We also present some examples of OTTs and identify the main sources of cannibalization of incumbent operators sales. TABLE 1: Characterization of the over-the-top services OTT Minimum speed requirements for a good quality service Challenge for the incumbent operator Implications for the incumbent operator. Communication services VoIP: Skype, chat with and without video Gmail, Whatsapp 1-2MBps Fixed and mobile telephony substitute. SMS substitute Increased competition; Loss of value of proprietary services. Applications Social networks: Facebook, LinkedIn Twitter 1 MBps Telephony and SMS substitute Increased competition; Loss of value of proprietary services. Content OTT-TV, OTT-Video, streaming and video on demand (VoD): Netflix Netmovies, Hulu, Ultraviolet, Cuevana, Youtube 6 10 MBps 1 4 MBps TV substitute Disintermediation by the content providers; Possibility for differentiation reduced; Loss of audience for advertising. Online video games Online music 1 3 MBps Source: Authors In Table 1, we recognize basically three types of OTTs: instant messaging and voice services; applications, which we linked mainly to social networks; and video and audio content. De Bijl & Peitz (2010) evaluate the profound impact that Voice over Internet Protocol (VoIP) telephony services are having on the outlook for the telecommunications industry. They examine the competition between an incumbent operator forced to offer VOIP services in addition to the service it already offers 5

6 over the Public Switched Telephone Network (PSTN) and a new operator that offers the service. In this context, the authors analyze the effect regulation of access to the switched network has on competition and investment incentives for VoIP. However, they limit their analysis to what they define as managed VoIP and they omit from consideration unmanaged services, such as Skype. On the contrary, in this paper when analyzing the OTTs we take into consideration unmanaged VOIP services, which as highlighted by de Bijl & Peitz (2010), lead to business models unlike those implemented by incumbent telephony operators. There are those who question what we outline in Table 1 in regard to instant messaging replacing SMSs. 3 While it is true that a perfect degree of substitution cannot be assumed, the capacity of instant messaging for undermining SMS revenue is undeniable. In this regard, Nikou et al. (2012) point out that European operators income dropped as a result of OTT services such as WhatsApp and social networks like Facebook and Twitter. The authors warn that young people in particular are changing SMS usage on a massive level by using these free services based on the Internet. OTT TV/Video involves distributing video or television over the Internet directly to users connected to any electronic device. This is different from IPTV (Internet Protocol Television), which is also IP TV but a "managed" type. IPTV requires a private cable line and uses Internet protocol (the same IP is used for Internet service) so that a certain minimum level of bandwidth (at least 3 to 6 Mbps downstream) is required. Meanwhile, Web TV or OTT TV/Video requires even better access (at least 6 to 10 Mbps downstream). 4 Access to online content or OTT content enables disintermediation, i.e., once Internet access and use is widespread and high speeds are available (which nextgeneration networks (NGNs) enable), certain content owners and operators which up until now had to negotiate with telecommunications operators (or television operators) in order to reach consumers will have the option of no longer doing so and be able to interact with the consumer directly through a web page. 5 3 See the example of 4 If we want high definition (HD) requirements are even higher: 10 to 25 MBps for HD IPTV and MBps for HD video. 5 A notable example of this fact is the recently announced Internet platform Ultraviolet ( created by leading Hollywood studios (Paramount Pictures, Sony Pictures Entertainment, Twentieth Century Fox, Universal Pictures and Warner Bros among others) to 6

7 Finally, note that we have highlighted in the table primarily those pathways involving revenue cannibalization that most OTTs represent for incumbents. However, the table does not mention the fact that for the telecommunications operators the OTTs also represent higher management costs, congestion and infrastructure needs, due to higher capacity utilization and demand for speed. For example, online video games and streaming music may not represent a challenge to the operator s proprietary products but they do represent an increase in traffic to the network. 6 In order to provide a more complete characterization of OTTs, we close this section by presenting a map of the main agents involved with them. FIGURE 1: Map of main agents Providers of OTTs (communication services, applications and contents) Device manufacturers Smart TVs Videoconsoles Set-top boxes Smartphones Tablets Computers and PCs Network operators, telecommunication and Internet services providers Users Source: Authors In order to enjoy OTTs, users need a device and Internet access. This means, in order to have access to the OTTs, the users have to access a device connected to the Internet. As a result, from the users perspective, the OTTs, the devices and Internet access are complementary products. At the same time, as we indicated in Table 1, the OTTs offer products that are close substitutes for those products offered offer consumers a wide choice and freedom to purchase digital movies, TV shows and other entertainment via streaming. Similarly, there are platforms that provide access to sporting events also via streaming. 6 In the Telesemana.com survey (2012) to the question "Where do you think OTTs have the most negative impact?, 38% replied management costs, while 49% in the cannibalization of revenues and 13% responded the relationship generated in connection with users. 7

8 by telecommunications and Internet service providers. 7 The link between the different types of actors marks a complex strategic relationship that determines the market prices and the investment incentives for each of the players. In this paper we analyze mainly the strategic relationship between OTTs and Internet providers. Meanwhile, the supply of devices that can be connected to the Internet is wide and varied and their manufacturers compete for the user s attention. In this regard, even though the technological advances of these devices are playing a fundamental role in the development of the OTTs, we will refer to the market of these devices only in a tangential manner. 8 7 Chen & Nalebuff (2006) interpret the emergence of services like Skype as a problem of competition between complementary service providers. On one hand, Skype s voice service competes with the telecommunications operator. But at the same time, from the user's perspective, the network operator complements Skype s service because the user cannot enjoy Skype without an Internet connection. These types of rivalries raise the concern that the broadband provider may have an incentive to degrade the quality of Skype in order to increase the attractiveness of its own phone service. 8 An agent that has begun to play an important role within this group of players is linked to the CDN (Content Delivery or Distribution Networks) which operate as infrastructure solutions to perform a more effective delivery to customers. Some are owned by network operators and others by operators such as Akamai, Microsoft, etc. For a more detailed discussion of these and its impact on Latin America, see de Leon (2012). 8

9 3. Main conclusions of the literature The development of the OTTs is linked essentially to two debates in telecommunications-related literature: the changes in the value chain of the industry (in the face of the explosive growth of the online industry) and the convenience of maintaining, or not, the neutrality of the network. The changes in the value chain are the result of technological changes and the sector s remarkable capacity for innovation. In the face of these changes, the debate regarding Net Neutrality is fanned by incumbent network operators that recognize rent reallocations along the value chain (as a result of which they emerge as "losers"), and they need to resort to alternatives to reverse this trend. We discuss below the main conclusions or unanswered questions in the literature related to these topics Changes in the value chain and the threat of the online industry The rise and boom of Internet-based industries represents significant challenges to some traditional sectors of the economy, such as publishing, music industry, advertising and media. 9 In this sense, incumbent telecom operators are not indifferent to the new markets and services that appear as a consequence of accessibility to the Internet and in particular in the face of OTT services, applications and content. Grove y Baumann (2012) indicate that even though integrated incumbent operators (those that provide their proprietary services and possess their own infrastructure) have tried to develop VoIP services and products, video portals, social communities, as well as taking advantage of the possibilities offered by IPTV, they have not captured growth or penetration levels comparable to those achieved by YouTube or Netflix. In this regard, the authors ask why these integrated operators are constantly superseded by service providers based solely on the Internet (OTT services). They argue that over the long run an integrated operator may be able to achieve a better performance by controlling both elements (infrastructure and services) but that, in the short term, a service provider (without infrastructure) can 9 For example, Seamans and Zhu (2010) analyze empirically the effect the entry of a website that offers classified ads has on the traditional local newspaper market; Athey et al., (2012) focus on the fact that the Internet allows consumers to easily move between different vendors. 9

10 improve its performance with greater speed, given that the spatial configuration of its product is lower. Dedrick et al. (2011) analyze the distribution in the value chain of the mobile phone distribution. However, they ignore in their analysis the place occupied by applications (including OTTs), which implies an important limitation of the study. Shin (2012) examines the development of mobile VoIP (mvoip). Similar to what Nikou et al. (2012) points out in regard to European operators, Shin documents how mobile operators in Korea have faced a reduction in voice calls due to Internet calling services or applications based on text messaging for smartphones. Feijoo et al. (2012) analyze the evolution of gaming applications in mobile telephony (mobile gaming). They point out that in 2006, the arrival of the first wave of smartphones and flat-rate broadband connections marked the starting point of a change in market power from network operators to application and device suppliers. However, they also highlight that the arrival of the iphone in late 2007 also dramatically changed the market situation of "mobile gaming." 10 Ganuza and Viecens (2012) analyze the alternative that content providers have, such as sporting events or Hollywood movies, to offer their products through online portals (OTT-Contents) i.e., the possibility of reaching consumers without having to negotiate with intermediary operators (disintermediation). They show that the presence of NGNs and the resulting high access speeds will result in a reallocation of rents among different actors in the value chain, in particular, a transfer of rent from service and network operators to content providers. Disintermediation by content providers will mean that telecommunications operators will lose an important source of differentiation and revenue, forcing them to find new resources to compete Net neutrality Net neutrality means that all content, no matter its type or origin, is treated equally by the infrastructure provider. In this regard, the discussion over Net Neutrality is complex and controversial. Some infrastructure operators claim that content providers take advantage of the free use of their infrastructure and at the same time recognize that they are threatened in the face of new initiatives and possibilities 10 In this market, the standard consumer model is to download games to a smartphone from an application store (Feijoo et al., 2012). 10

11 offered by OTTs (see Huertas Sánchez et al. (2011)). 11 Large Internet providers have proposed that content and application providers pay an additional price for access to their residential ISP clients and differential rates for granting priority to certain content. For example, Shin (2012) indicates that mvoip unleashed a debate about Net Neutrality in Korea and that telecommunications operators in that country are moving to restrict use of their networks by smartphone applications for free Internet telephony. The discussion regarding Net Neutrality has also been interpreted as a confrontation between the United States (where the main content providers are located) and Europe (with strong incumbent network operators). In fact, European companies have tried to exercise certain pressure on the companies that induce extensive use of their networks, in particular Apple and Google, to share network costs (Dedrick et al., 2011). On the other hand, content providers in the United States are destined to play a key role in the content market at a worldwide level. They have the advantage of being first movers and they are tightly linked with the leading software and hardware providers, among other things (Noam, 2008). Economides (2011a) cautions that there could be negative effect on society if network operators are allowed to charge content providers additional prices. In his opinion, in the face of strong network externalities that dominate the Internet, the network value depends mainly on two elements: the number of users (adoption) and the number of content creators. At the same time, the network value for users depends on the number and content quality, and the value of the content increases with the number of users. Internet providers do not internalize these network effects and, as a result do not take into account the impact content providers have on society when they set their prices. This would result in the value that users confer to the network, and the virtuous cycle that has characterized the development and innovation on the Internet so far would be jeopardized. The introduction of such prices, and related transaction costs, would be particularly harmful to those agents who have made notable contributions to the explosion of content and innovation in recent years (small business, startups, and individual content providers) (Economides, 2011a). Furthermore, in Economides (2011b) the author argues that the 11 In this sense, the words of Ed Whitacre, former CEO of AT&T, are notorious, when he said Now what they would like to do is use my pipes free, but I ain t going to let them do that because we have spent this capital and we have to have a return on it, in regard to Google, MSN, Vonage, among others, using AT&T s infrastructure. BusinessWeek November 7,

12 combination of ISPs with high market power and the presence of switching costs would facilitate the emergence of uncompetitive practices by ISPs in the absence of neutrality regulation. For example, Chen & Nalebuff (2006) point out the potential problem is that broadband providers may have an incentive to degrade the quality of an OTT such as Skype, in order to increase the attractiveness of their proprietary telephony service. 12 Some broadband providers have asserted that neutrality regulation discourages investment in broadband networks. One of the arguments in favor of allowing network operators to charge content providers for the use of their networks has been to encourage operators to invest in their networks (Krämer and Wiewiorra, 2009). In this regard, Economides (2011a) contends that this argument is flawed. For example, he indicates that if they are allowed to charge in exchange for access priority, the more congested the network, the higher the rate they could charge and as a result, there would be no incentives to invest in order to relieve network congestion. Similarly, the model proposed by Cheng, Bandyopadhyay & Guo (2010) predicts that the incentives for broadband providers to increase their network capacity are greater within a context of neutrality. Greater capacity leads to less congestion and more valued Internet services, which translates into benefits for the operators. Finally, Choi & Kim (2010) present a complete and formal analysis for the reader interested in the relationship between Net Neutrality and investment incentives. In this regard, they note that no general unambiguous conclusions can be drawn about this relationship. 12 However, their model determines that the ISP has no incentive to degrade the quality of a provider like Skype as these types of services give value to its network. 12

13 4. The over-the-top market in Latin America 4.1. Incumbent operators, OTT strategies and supply The challenges and changes in the industry come about in large part lead by the content market. Therefore, the bundling of services, in particular bundles that include TV, may be considered first- generation strategies implemented by operators to compete with and maintain market share in the new industry. For example, IPTV represents an alternative for competing against online content offered by OTTs like Netflix, in that for an ADSL operator it represents a monetization system equivalent to cable television. Next we can talk about second-generation strategies that imply initiatives implemented by incumbent operators with OTT characteristics or that include innovative proposals from the perspective of the activities said operators are used to. In this section, we present and analyze the first and second-generation strategies launched by operators in Latin America. In regard to the first strategy linked to the supply and bundling of their proprietary services with TV, what is available in Latin America covers a wide variety of combinations of technologies and agreements for the supply of bundles with TV. In this sense, there are cable operators (pioneers in double and triple-play) and telecom operators that have chosen a different technology in place of the one they use for communication services when developing their strategy for breaking into the content market. Finally, some ADSL providers have begun to offer IPTV, while others are signing agreements with Satellite TV (DTH) suppliers. The table below illustrates the panorama of operators offering pay-tv packages by country and type of technology. According to the table, there is at least one package that includes pay TV in 18 of the 24 countries. 13

14 TABLE 2: Bundling and first-generation strategies Country Triple-Play with cable Double Play (Internet TV) with cable Double-Play (Internet TV) with ADSL+ IPTV Triple-Play with ADSL+ IPTV Double play and Triple-Play with mix of technologies Double play and Triple-Play with agreements between companies Argentina Telecentro Telefónica + DIRECTV Telecom + DIRECTV Fibertel+Cablevisión Barbados Belize Bolivia Corporación COMTECO Brazil NET NET Telefónica GVT (DTH+IPTV) CTBC (DTH and cable) Oi (DTH)* Chile VTR VTR Telsur Telefónica Telsur Telefónica (DTH) Claro (DTH and Cable TV) Colombia Claro (Cable TV) Telefonica (DTH) ETB (ADSL) +DIRECTV Costa Rica Cuba RACSA (cable) +Cablevisión Ecuador El Salvador Portal Grupo TV Cable Claro (Cable TV) Claro (Cable TV and DTH) Tigo (Cable TV) Guatemala TVO Telecom Claro (Cable TV and DTH) Honduras Claro (Cable TV and DTH) Jamaica Flow Jamaica Mexico Cablevisión Cablemas Cablecom Megacable Cablevisión Cablemas Cablecom Megacable Maxcom Maxcom Telmex+Dish Nicaragua Panama Paraguay Cable Onda Claro (Cable TV and DTH) Peru StarGlobalCom Telefónica (DTH) Dominican Rep. TRICOM Aster Claro Claro (DTH) WIND Telecom (MMDS) Surinam Trinidad & Tobago Flow Flow Uruguay Venezuela Intercable Intercable Telefónica (DTH) Source: Authors with data from CETyS-UdeSA (2012) and information provided by companies on their webpages: * Oi announced its plans to launch IPTV services over FTTH (Fiber-to-the-Home) in high density areas by the end of

15 It is clear from the table that IPTV is poorly developed in the region, in contrast to the scenario in most developed countries where this type of service has existed for several years in the market. For example, in Spain, Telefónica began offering IPTV (Imagenio) throughout the country in 2005, and the first pilot tests were as early as France Telecom has offered IPTV in France since 2003 and Deutsche Telecom in Germany since In Latin America, Maxcom was the first company to launch IPTV in 2007 in Mexico. Telefónica offers its IPTV called Imagenio in some cities in Chile and Brazil. IPTV can also be found in some Chilean cities offered by Telefónica del Sur (Telsur) and in some cities in Dominican Republic provided by Claro (América Móvil, Telmex). In conclusion, IPTV is present only in four of the 24 countries surveyed. Argentina and Mexico, two of the most significant markets in the region, stand out from the other countries. Incumbent companies in both markets provide tripleplay packages through agreements with satellite TV companies. This can be explained mainly by the fact that the regulatory frameworks (including concession contracts) do not allow incumbent network operators to offer converged IPTV services. 13 In addition to cable companies, two incumbent company brands have strong presence in the supply of TV in the region: Movistar TV of Telefónica and Claro TV of América móvil-telmex. Movistar TV with satellite television is available in Chile, Colombia, Peru and Venezuela (in this last country, Telefónica offers all the services but not bundled). Claro TV, with cable or satellite TV, is available in eight countries, especially in Central America. The two brands overlap only in Chile and Colombia. Table 3 below includes a non-exhaustive list of "second-generation" strategies being developed by incumbent operators in Latin America. The strategies listed have been launched at some point in the last two years ( ). 13 In Mexico, a change in Telmex s concession contract that would allow the incumbent operator to offer IPTV is being discussed. In Argentina, only local cooperatives are allowed to provide IPTV; in fact there are already some cases, but local and almost anecdotal. 15

16 TABLE 3: Second-generation strategies Operator Name of the initiative Strategy Countries in the region where it is active Telefónica TU Me Free calls and instant messaging between users. Worldwide (iphone and Android devices) América Móvil- Telmex Claro Messenger Instant messaging services for Claro clients. Argentina, Peru, Panama, Dominican Republic, Guatemala and Honduras Telefónica Shopping Movistar Movistar clients can buy music. games. devices, etc., on the company s commercial website. Telefónica Movistar video Entertainment portal with access to exclusive content. Free for Movistar clients. Argentina Ecuador El Salvador Peru Telefónica On Video For Telefónica clients. Argentina Terra (Grupo Telefónica) Agreements with Samsung, LG y Philips. Application for live channels for Smart TVs. América Móvil- Telmex Claro Ideas Entretenimiento Online content for clients. Argentina, Peru, Uruguay and to be launched in Chile Telmex Claro Video Online videos for clients. Colombia América Móvil- Telmex Portal UnoTV Online and streaming content. Mexico Totalplay Total Movie Online movies Mexico Oi Video distribution and implementation of VOD To be launched in Brazil. Sky Brasil (Direc TV group) Sky Online Online video club with movies, television series and music that Sky subscribers can access. A monthly subscription is available through Club Sky Online Brazil Cablevisión, Megacable, VTR, CableOnda, MovistarTV, Wind Telecom The operator incorporated Moviecity Play to its package. VOD service that makes it possible to watch over the Internet almost 1,200 titles of this premium channel. The subscriber can access the service from anywhere in Latin America by entering with a username and password. Cablevisión in Argentina; Megacable in Mexico; VTR in Chile; CableOnda in Panama; MovistarTV in Peru; Wind Telecom in Dominican Republic. Source: Authors based on a survey of the operators websites. 16

17 In Table 3, two types of initiatives stand out: instant messaging tied to the operator s brand and the supply of online content. In regard to the first one, Nikou, et al. (2012) demonstrates that European mobile telephony operators base their defense strategy on the supply of safer and more reliable services than those offered by Skype or WhatsApp, for example. These findings are consistent with the survey for Latin America and its analysis presented in Telesemana.com (2012). The analysis of the survey noted that one of the advantages telecom operators have over OTT providers is linked to the guarantees they can offer in terms of billing and security levels of service, elements that are of particular importance in high level segments. At the same time, it is striking that applications like Mobile Me and Claro Messenger are successful in the standard user segment, which are less demanding in level and in regard to safety issues. The instant messaging market is characterized by strong network externalities so, free applications which do not discriminate by type of network, device, nor do they require any membership (for example WhatsApp) appear, a priori, as applications that will lead this segment. In terms of the supply of online content, the sale of videos (VOD) of movies and television series, video games and equipment stand out. In every case, only the operator s clients have access to the web-based portals with content, which sometimes is exclusive. In addition to those indicated in Table 3, other Telefónica initiatives include BlueVía, an open platform where external developers can interact to create applications, as well as its participation in Wayra, a global digital business accelerator for the ICT sector in place in Europe and Latin America sponsored by other companies like Microsoft, Nokia and various Spanish partners. Some device manufacturers are also venturing into new markets, which is the case of LG with its platform NetCast and Sony, which launched Crackle an online platform with free content in 17 Latin American countries. Crackle s advertisingbased business model and free content for users are two noteworthy factors. 14 Noam (2008) indicates three generations of TV technologies: TV broadcasting is the first generation; cable TV, satellite and home video comprise the second. The third generation emerges with Internet TV and mobile TV. From the discussion in the 14 New players less closely tied to the sector are also venturing into the OTT world. For example, there is the case of Walmart with the launch of its OTT service called Vudu in Mexico. 17

18 above tables, we can see that the second generation of TV technology has enabled incumbent telecom operators first generation of entry strategies into the content market. Then, the third generation of TV fosters and is represented by OTT content, one of the main threats incumbent operators are facing today. In response, it is clear from Table 3 that incumbents are launching proprietary channels of online content, which can be observed among providers using ADSL technology, as well as cable and satellite Netflix, Skype and WhatsApp in Latin America In this section, we will attempt to summarize the limited information available for the region about the three leading OTT providers, each one a leader in its segment. Skype has more than 250 million users worldwide (54 million per month), although less than 10% pay to use it. 15 Approximately 16% of these users are in the United States, 13% in the rest of North, Central and South America and 57% in Europe. In terms of penetration among Internet users, in the United States more than 9% of them use Skype, 7% in the rest of the continent (i.e., North and South America) and 16% in Europe. 16 In September 2011, Skype was acquired by Microsoft for US$ 8.5 billion. WhatsApp is born in August The company is reluctant to provide data on the number of users, although it is public information that in February 2012, WhatsApp handled about 2 billion messages per day. It continues to rank among the most downloaded application in 40 countries (the European Union, Asia, Middle East and Latin America). In Germany it led the ranking of downloads in 2011 and in Spain, it has accumulated more than six million downloads. 17 Netflix, which entered Latin America in September 2011, is a new product for Latin American users even though it has been around for several years in the U.S. market. The company has more than 27 million customers in the United States, Canada, Latin America, United Kingdom and Ireland, of which just over one million are in Latin America (ir.netflix.com). In this regard, analysts believe that the results of Netflix in Latin America are still disappointing because in ten months since its 15 Interview of Alejandro Arnaiz, market development manager for Latin America, Skype (

19 launch, Netflix has only gained 0.75% penetration of households, a sharp contrast with the 6% of households in Canada just nine months after Netflix s launch in that country, and 4% in the UK / Ireland, six months after its launch Access possibilities among the population Sabbag et al. (2012) present a digitalization index that aims to quantify for a country the accumulative effect of the adoption and use of information and communication technologies (ICT). 19 The authors calculate said index for 150 countries which allows them to create a digitalization ranking of those countries. Then, they identify four levels of digitalization: advanced countries, emerging countries, countries in transition and restricted countries. In this regard, of the 24 countries that appear in Table 2, none of them are in the advanced group. On the contrary, in the group of restricted countries are Cuba, Honduras, Bolivia, Guatemala, Dominican Republic, Paraguay and El Salvador. Meanwhile, Ecuador, Venezuela, Peru, Brazil and Costa Rica belong to the group of emerging countries. Finally, Mexico, Colombia, Argentina, Uruguay and Chile, the highest scoring, appear in the category of the countries in transition. On the other hand, those countries that appear between the first ones in terms of their level of digitalization (United States, Korea, Japan) are the ones that mark the rise of OTTs, and OTT content in particular. 20 These indicators offer us a first look at the situation in Latin American countries in terms of the possibilities of OTT access and use. 21 In the following figure, we show the maximum speed commercially available in the group of countries included in Table 2, out of all of the deals existing in each country. While this indicator is weak, by not taking into account considerations of price and coverage, it is a first approximation to what the situation is in each country in terms of quality and speed potential. 18 See 19 The index is composed of six components: accessibility, infrastructure quality, network access, capacity, use and human capital. 20 Telesemana.com (2012) indicates that the impact of the OTTs is produced in mature markets like Japan and the United States. 21 Similarly, it is apparent from the Broadband Quality Study 2010 by Cisco that only Chile and Brazil are in the group of countries that reach the technical requirements of today's applications. The remaining countries are among those that are below the level required for current applications or only support basic applications. 19

20 FIGURE 1: Maximum speeds available (mbps) Source: CETyS-UdeSA (2012) The graph illustrates that in Brazil, Chile, Mexico, Dominican Republic and Trinidad and Tobago, at least one group (probably small) of the population, can access good OTT experience, as these countries have deals with speeds of 100 Mbps. Although with lower speeds (50Mbps and 30Mbps), the same occurs in Uruguay, Argentina and Ecuador. In all other countries where maximum speeds of 10Mbps are offered, the possibilities are more limited, especially in the case of countries where the maximum speed offered is 8 Mbps or less (Bolivia, Peru, Honduras, Nicaragua, Belize and Suriname). The AKAMAI report for the first quarter of 2012 regarding the state of Internet (AKAMAI, 2012) includes data on the average speeds recorded. In this regard, it indicates that the worldwide average speed for fixed access is 2.6 Mbps. The highest speeds are registered in South Korea, Japan and Hong Kong (15.7; 10.9 and 9.3 Mbps, respectively). Meanwhile, in Latin America, the highest speed is recorded in Chile (3.4 Mbps), followed by Mexico (2.8 Mbps) and Colombia (2.7 Mbps). These are the only countries in the region with speeds that exceed the world average. Next, the countries that follow in terms of speed, although below the world average, are Argentina and Brazil (both with 2.2 Mbps) and Peru (1.6 Mbps). There are no data for 2012 for Uruguay but figures corresponding to the fourth quarter of 2011 indicate an average speed of 1.1 Mbps. The rest of the countries in the region register average speeds below 1 Mbps. 20

21 In terms of connection speeds on mobile networks, the most recent AKAMAI report regarding the state of Internet (AKAMAI, 2012) shows the following results, presented in Figure 2, for some of the countries in the region. FIGURE 2: Average connection speed in mobile networks (kbps) Source: AKAMAI (2012) Among the data presented by AKAMAI (2012) for Latin America, basically two facts stand out: one, the Bolivian provider BO-1 is one of three providers in the world that registered average connection speeds below 500 Kbps in the first quarter of 2012 (the other two are a Nigerian provider and a South African one). The second is that only one provider in the region the Argentine AR-2 registered an average speed that exceeds 2 Mbps. Relatively high average speeds offered by providers in El Salvador, Nicaragua and Guatemala also standout in the region. In the other countries, some providers recorded speeds of up to 1.5 Mbps (in Uruguay, Chile and Brazil), while others registered values between 500 Kbps and 1 Mbps (in Brazil, Colombia, Venezuela and Paraguay). In comparison, as is reflected in the AKAMAI (2012) data, the highest average speed of the mobile network connection was recorded by a German provider at nearly 6 Mbps Among European countries, Spain and Greece recorded speeds above 4 Mbps; Italy, France and the UK recorded average connection speeds on mobile 21

22 networks close to 3 Mbps Finally, providers in Hong Kong, Singapore, Australia, Canada and the United States show values above 1 Mbps and up to 2.5 Mbps. 22

23 5. Discussion The sector is being invaded by the industry of online content and unmanaged VoIP communication services. This fact will be enhanced as people gain access to quality in terms of download speeds that make it possible to have a good experience using the OTT. In this paper we have shown that in order to compete and stay in business, incumbents have developed and continue to develop basically two strategies: 1) bundling services (fixed and mobile telephony, Internet and TV); and 2) development of proprietary applications that compete directly with the OTTs. The bundling strategy is often effective to transfer market power held by one product to other markets. However, this strategy is questionable from the point of view of competition policy, and some national regulators may consider limiting the use of this strategy. Furthermore, the purchase of packages tends to be accessible only by those demand segments with high purchasing power, which are very sensitive to the quality of services, rendering it necessary that all of the products included in the bundle be competitive in terms of quality. In this regard, the increased quality of OTT audiovisual content (Netflix, etc.) threatens bundled deals that include pay TV. The second strategy of developing proprietary applications to compete directly with the OTTs appears to be very risky, since incumbent operators do not present a priori any competitive advantage in the creation of OTTs. The OTT market is very competitive in terms of innovation; it is global and possesses the characteristic of the winner takes it all. These conditions mean that the leading OTT providers are few, very specialized and exploit important economies of scale (fixed costs of innovation and content acquisition, etc.). On the contrary, the incumbent operator is not specialized in a concrete service/content and is limited in terms of exploiting economies of scale, as it is in a less advantageous position when entering markets dominated by leading providers. Table 2 illustrates that two of the main incumbent operators in Latin America Telefónica (Movistar) and América Móvil-Telmex (Claro) have been and continue to be very active developing strategies that involve bundling services. Both operators are positioned in the pay-tv market, implementing different technologies, developing IPTV (in very early stages) and signing agreements with satellite TV companies. Teléfonica s role as a protagonist in the launch of new applications or second-generation strategies also stands out, although not surprisingly, given that 23

24 the operator is already facing greater challenges in its markets in developed countries, where the connection speeds are much higher than those in the region. On the other hand, 51% of the Latin American operators surveyed in Telesemana.com (2012) recognize that the deployment of a strategy in response to OTTs is not a priority. It is argued that this is due (at least in part) to the low levels of maturity in the region in terms of smartphones and indicates that even though penetration is growing in countries like Argentina and Chile, network coverage still represents a limitation. This is consistent with the findings of Sabbag et al. (2012), which show that the levels of maturity in digitalization in countries in the region are inferior to those corresponding to those countries where OTTs are booming. In a similar manner, the low levels of average connection speeds leads one to think that Latin America is still at a delayed stage in regard to the development of OTTs. In this regard, the limitations in bandwidth and service quality indicate that the region is not prepared to confer widespread access to OTT videos. At the same time, low penetration rates of OTTs like Netflix in Latin America could be explained, at least in part, due to the different piracy controls and regulations that exist in countries where the penetration of these OTTs is considerably higher and those that exist in the region. Latin American users are of a mindset that once the Internet connection is paid for, everything available online is free and there is no reason to pay for contents found online without too much effort and at no charge. 22 Some authors argue that in certain circumstances late adoptions can bring some advantages linked to lower equipment costs; lessons learned based on experiences of other countries; avoiding getting trapped in obsolete standards, among others (Dedrick et al., 2011). In this sense, the delay observed in Latin America could mean that IPTV, for example, is never developed in the region to the same degree as more advanced countries. In fact, Huertas Sanchez et al. (2011) note that some operators have decided to abandon European IPTV because they cannot compete with OTT content. In any case, and underlying all of this discussion, there remains a fundamental long-term problem that operators in the region must eventually address. OTTs provide users with the possibility of obtaining the same services (and in some cases, 22 See for example the post 10 razones para no contratar a Netflix (Ten reasons not to subscribe to Netflix ) published on Taringa, the largest hispanic social network, which ranks among the top ten most visited sites of Argentina with almost 20 million members in the region. 24

25 better quality services) through a simple high-speed Internet connection as those services they obtain today for the most part from incumbent operators; furthermore, the OTTs are less expensive, if not free. At the same time, the high speed Internet service market has all the makings of a highly competitive market. First, there are practically no elements of differentiation between companies. The incumbents sources of profits are not clear, unless they find a way of offering a differential service. For example, with investment in broadband, European IPTV operators entered the pay-tv market offering contents to attract subscribers to their services (Weeds, 2012). In this case, the exclusive contents were the mechanism of differentiation. With high-speed access networks that will allow widespread nonexclusive OTT content, telecommunications operators will be obligated to innovate their business strategies (Ganuza y Viecens, 2012). Second, the entry barriers to the market of Internet service providers, depending on regulations, could be lower, which constitutes a factor that increases the threat of new players entering the market. For example, given that the deployment of networks involves essentially a major civil works, infrastructure construction companies are natural candidates to become new players in the medium to long term. All these factors call into question the traditional business model of operators and private returns on investment in new networks. Therefore, from a social point of view, the negative consequence of OTTs is that they can reduce incumbent operators incentives to invest in the deployment of networks that ensure access to the speeds necessary for a good OTT experience. Note that this view is consistent with the active government intervention we see today worldwide. However, as we mentioned in the introduction, the interventions in the region prioritize expanding geographic coverage and increasing the number of accesses, with less importance placed on quality/speed (Galperín, Mariscal and Viecens, 2013) ). Therefore, in the short to medium term, it is expected that in Latin America the deployment of high speed access networks (and the OTT services that require it) is limited only to countries and regions with consumer segments with high purchasing power. Moreover, given the above analysis, it is possible that even in these market segments incumbents do not have sufficient incentives to deploy high speed networks. Either way, in addition to redistributive issues, public intervention to subsidize the selective deployment of networks of fiber to the home would be questionable (national plans in Latin American only contemplate deployments of fiber backbones --see Galperín, Mariscal and Viecens (2013)). However, in the medium and long term, investments aimed at the provision 25

26 of good quality public services (schools, hospitals, government) could have very high social returns. For example, in Ganuza and Viecens (2011), we highlight and analyze the deployment of a project spearheaded by the Autonomous Government of Catalonia (Spain). This project involves an investment by the Catalan government to take fiber to all public offices of the autonomous region, to ensure that citizens have high speed access to all services with a high social return such as education, health, security, etc. On the contrary, expenditures of public money to take high speed access to households would be difficult to justify from a social standpoint, where currently high-quality residential connections are used only for entertainment and recreational activities such as OTT content (high definition movies and videos). Moreover, given that a good part of OTT services only need access speeds up to 2 Mbps, guaranteeing access to them becomes a more feasible objective for countries in the region, at least in the medium term. This may be an opportunity to reduce the costs of telecommunication services, ensuring access to what we have called OTT applications and communication services. At the same time, from a regulatory point of view, the provision of services through OTTs simplifies the comparison of price vectors, since what matters is the basic cost of data transmission. This simplification could help countries with weak regulatory authorities develop effective policies. Thus, a feasible objective in the medium term with high social returns for the countries of the region would be to ensure widespread access to OTT applications and communication service (ideally with 2 Mbps) and leave the provision of higher speed access to the private sector, which will ensure the enjoyment of OTT content (with less obvious social returns). Finally, certain public services such as education and health may justify the use of public funds for the deployment of high speed access networks to ensure the best quality of services. 26

27 6. Conclusions The traditional income model based on subscriptions and metered services is showing signs of running its course. At the same time, growing communication services like Skype and WhatsApp do not contribute any type of income to access providers, they use their networks and, they compete with the providers own proprietary services. Furthermore, the companies that are emerging as part of the new industry (like Google and Yahoo) take advantage of new possibilities to obtain income by exploiting the two-sided aspect of their markets and, in many cases, base their sales mainly on advertising. 23 In this regard, incumbent operators are showing signs of difficulty adapting to this model which they have no experience using (Huigen & Cave, 2008). At the same time, their market power is being eroded by competition and is shifting toward the content providers. Also, if the current trend continues, there may come a time when the user shall demand an Internet connection with speeds that make it possible to access quality services in the home. How are telecommunications operators positioning themselves in this new industry? At one extreme, some authors argue that infrastructure operators should focus exclusively on its role as a "bit pipes" rather than remain integrated companies that provide services and infrastructure (Grove and Baumann, 2012). The debate applies especially to those countries with infrastructure that can provide consumers with coverage and relatively high access speeds. One objective of this study was to analyze how these circumstances are in Latin America and discuss how the challenges and opportunities in the region are different from those observed in more developed regions or countries. Some of this discussion may irrelevant for Latin America insofar as the region lacks the infrastructure and technology needed to ensure quality OTT content and services. Bandwidth and current service conditions are far from providing a gateway to quality video streaming, for example. Consequently, there is still some way to go before Latin American operators feel truly threatened by OTTs such as Web TV/OTT TV. 23 Two-sided markets/platforms are markets where companies create value by facilitating the interaction of two different groups of consumers. The success of the platform depends in a crucial manner on the pricing structure established for each side of the market, based on network externalities generated by each side. For example, in the case of Google s platform, the two sides of the market are the users and advertisers. 27

28 A different situation may be unmanaged IP voice services, such as Skype or Gmail video chat, which can be exploited with lower access speeds (although a minimum speed is necessary to ensure reasonable service). WhatsApp, as the penetration of smartphones increases, presents itself as a clear challenge to the text messages and even voice messages. However, today there does not seem to be widespread concern about these OTTs among operators in the region. 24 In this context, what economic policy recommendations or implications can be drawn? In the previous section, we noted that a medium-term objective should be to ensure widespread access to OTT communication services and applications (with 2Mbps speed ideally), but leave entirely to the private sector the role of providing access to higher speeds to ensure OTT content enjoyment (with less obvious social returns). On the other hand, and in our opinion, it is important to keep in mind at all times that high speed Internet access, the opportunities it offers for the development of new business models such as OTTs and the implications for telecom operators essentially respond to a technological revolution. Throughout history, technological revolutions have had "winners" and "losers," but finally what should be considered is the effect on aggregate welfare of society. 25 Therefore, governments should facilitate this process and should not implement measures that could hinder it. Decisions, such as those related to net neutrality, should be taken with a long term perspective and not in response to pressure from stakeholders or short-term objectives. Internet, and new services and business models that accompany it, have proven to generate much welfare among consumers. The variety of services and products, competition leading to lower prices, shortening distances and the resulting reduction in transport costs that are accessed by an Internet user, are all factors with a positive impact on their welfare. A good economic and regulatory policy should ensure and enhance these possibilities in society. 24 For example, when asked in Telesemana.com (2012) "Do you think the over-the-top (OTT) players, such as Google, Twitter, WhatsApp, are a threat to your mobile broadband business?" 42% of the respondents replied that they do not think they are a threat; 8% answered not sure; and only 50% answered yes. 25 The positive impact of broadband on growth is well documented, see Czernich et al. (2011) and Koutroumpis (2009), to name a few of the articles published on the subject. 28

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