The Demise of the Set-Top Box Makers

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 How does change happen? Slowly, then all at once.

I recently wrote about the disruption of cable TV (note here). As I dive further into the Cord Shaving theme, I find myself struck by the unnecessary complexity of the set-top box industry. And I can’t help but consider the parallels between today’s set-top box makers and Nokia, which went from a dominant handset maker to irrelevant in just a few short years (background here).

Instead of reviewing the maze of middleware, software and protocols that defines the set-top box market, I think it is more helpful to abstract the complexity away and start with a very simple question:

What is a set-top box?

To me, it’s just a technical layer that translates input to output.

Once you understand that part, you get to the question that really matters:

What’s proprietary about this “technical layer”?

And the answer to that question may surprise investors: Nothing.

You see, in July 2007 the FCC mandated that equipment that accesses video programming (e.g., set-top boxes) be opened up so cable providers wouldn’t have a monopoly on what controls your TV. They called this standard CableCARD (background here). CableCARD hasn’t been a massive commercial success (although TiVO uses CableCARD technology), but that’s not the point. What’s important here is that walled gardens became off-limits; from mid-2007 forward, no US cable company could lock you into equipment that controls your television, enabling competition to enter the market.

Today, not only can any consumer electronics company access your television*, but getting live TV data isn’t hard either – it doesn’t require special cable company or TV network contracts. All one needs is a licensing agreement with Rovi or Tribune Media Services and you’re ready to enter the set-top box market. Well, not exactly… you still need to solve the technical challenges of network delivery methods, subscriber side devices with multiple versions of control and physical layer transport, data decrypting / decoding, etc. It’s all very complicated. But these are exactly the types of problems Apple, Google, Amazon, Microsoft and Samsung excel at solving.

After this background, you might find yourself wondering why incumbent set-top box makers like Arris still have such large businesses today. The answer lies in their distribution. Set-top box makers have long-term contracts with MSOs (cable companies) to distribute their hardware to consumers via the “cable guy”. Without any other options (or unaware of any other options), consumers have been forced to accept whatever crappy hardware is pushed on them by the cable company.

But this is changing as two competitive forces are weakening the stranglehold legacy set-top box makers have on this market:

  1. New entrants: Apple, Roku, Amazon and others are aggressively developing streaming media players / platforms. Each of these companies has the marketing dollars and the distribution network to disrupt the status quo. Now, many investors will point out that consumers today use these products as companions to their set-top box – not as replacements for their set-top box. But this is only temporary… you better believe the upcoming product roadmaps for AAPL, Roku, GOOG, AMZN and MSFT all include true set-top box replacements – today’s products are merely a bridge to that eventuality.
  2. Open source alternative: The emergence of RDK as an open-source, royalty-free platform significantly lowers the barrier to entry for new set-top box makers going forward. Interestingly, in mid-December Samsung signed up as a licensee of RDK (source) – if Samsung’s entry doesn’t scare the shareholders of Arris, Pace, et al, I don’t know what will (side note: in a recent Charlie Rose interview – min 26:30 here – Larry Ellison said, “Samsung is perhaps the most formidable of all the [technology] companies. […] Maybe the #1 technology company in the world.”). My view is that RDK will compress the profits out of the market as commoditization catalyzes a race to the bottom. The outcome I envision already has precedent – just ask yourself who won the smartphone market: Android or Nokia?

These two relentless, well-funded competitive forces are working to impair the business of every existing set-top box maker and component supplier. It’s capitalistic Darwinism. And for investors, it’s time to start positioning yourself for this evolutionary shift – billions of dollars are at risk.

Here’s the list of public companies that I believe are in the early phase of a long-term secular decline (I have omitted Espial, Amino and Concurrent because their market caps are < $100MM):

US-Listed

International

The regime is changing. I expect the decline of the set-top box makers to happen slowly, then all at once.

 

*Here’s the back-and-forth with Jeremy Toeman, CEO of Dijit, and I on the nuances of today’s unnecessarily complex set-top box market:

Can a manufacturer use CableCard to build a set-top box that fully works with a cable company’s broadcast services?

Yes.

Can a manufacturer use CableCard to access every possible feature a cable company might offer?

It is technically feasible.

Can a manufacturer use CableCard to replicate the Roku app-driven ‘streaming cable app’ services?

Not without support from the cable company.

Can a manufacturer build their own internet set-top box to access a cable company’s app-driven ‘streaming cable app’ services?

Not without support from the cable company.

Can a manufacturer use CableCard to access the TV and change the channel / do DVR and concurrently use their existing technology to provide access to internet services like NFLX / iTunes without signing partnerships with all the cable companies?

I believe that is exactly what TiVo does.

My take is that CableCard is the “official way to get access to cable channels” and as such, Time Warner Cable (TWC) must support anyone who tries to use it. But the streaming TWC “app” – which is basically what it is – does not fall under the same rules and restrictions. After all, it’s now streaming, instead of broadcasting, so it’s definitely a different animal. I don’t believe the law in question covers streaming services. So in a cable / broadcast world, all TWC has to do to comply is support CableCard.


8 Responses
  • bryan Reply

    Nice article, very indepth. I disagree a bit – the cable set-top box replacement has been a graveyard for new entrants for a reason. I love my MSFT Media Center set up – but it’s been a commercial disappointment for the firm. By any objective measure, so has TIVO (as much as customers love them once they buy them). Look at the foot-dragging on 2Way – as far as I know there is no way to use a cableCARD device today and get PPV channel access through the device. I need to call the cable company (and get a $5 extra charge) if I want to use PPV. How many iPhone users are going to be pleased when they discover that “feature” with their new combo TV/box?

    Cable companies need to squeeze more money/provide more ancillary services to grow, and losing the set-top box is directly opposed to that goal. Consumer electronics companies can crack the customer side of the equation, but cable companies can make the experience through the upstream portion they solely control so bad that it’ll hurt the brand. And now that the Cable Industry head lobbyist is the head of the FCC, these brands can’t expect the FCC to have their back either.

    I do hope I’m wrong, and you are right though.

    • analyst Reply

      Thanks Bryan – solid thoughts. I don’t think this will be easy. But conceptually I can’t imagine it NOT happening – are we really going to have self-driving cars before we have a different access point for our televisions? (self-driving cars are 6 years out, according to this: http://techcrunch.com/2014/05/14/googles-self-driving-car-project-is-a-worlds-fair-fantasy-turned-city-street-reality/.)

      Every data point – from consumer behavior to new market entrants – is telling us a fundamental shift is underway. As I mentioned, I believe it will happen slowly, then all at once.

  • Bob Hannent Reply

    I’ve only been in the STB business for seven years now but I’ve worked with people who are much more experienced than me. The death of the set-top box is predicted annually and I am afraid you have joined that long pantheon of people who have prematurely declared it deceased. I will now let you know why I am quite sure you are mistaken:

    1) Set-top boxes aren’t a technological solution, they are a business solution. I know of one company who did actually eliminate them, but I am not aware of any other company who has followed their lead. The real essence of set-top box is about maintaining customer ownership. If the pay TV companies, and remember that a large portion of the market globally is satellite not cable, want to own their customer they have to own the access to content. Content access involves managing the user experience that the consumer sees, managing the programme guide, managing the channel numbers is an especially valuable business and managing interactivity.

    2) Samsung has been in the set-top box business for a long time and they aren’t a dominant player in the sector. People see Samsung’s consumer electronics business and they see one big player, when in reality it is a conglomerate business with different leaders fighting for their budgets/resources/customers. The TV business has nothing to do with the set-top box business, nothing at all, they are completely different business units with different agendas and different tools. Samsung’s entry in to RDK is about as significant as that of Humax.

    3) CableCARD: This is an predominantly American phenomena, in Europe there is the CI(+) CAM, but most Pay TV operators won’t allow it to be used because of the perceived security risks. The other interesting feedback I have from people who deal with the US market is that CableCARD is a PITA, so support is always going to be an issue.

    4) All operators complain about the capital cost of set-top boxes, an asset that sits in the field and causes them support issues, but none of them want to dispose of them entirely. This is why the predominant trend in set-top boxes is towards thin clients with cloud services. Unfortunately copyright players have made the introduction of services in this area difficult. Add to that the USA’s fragmented local content offering the regional deployment of cloud services isn’t trivial.

    Overall your post is very US centric and in my many years of travelling the globe working in television the one thing that I see as being constant: the USA is not typical of any other TV market. The USA has its own technology, its own legal problems and its own logistical problems.

    While there might be an increase in cord cutting/shaving around the world the risk to cable operators is mainly for those that don’t adapt to the needs of the consumer. Those companies deserve to suffer, because nature as well as economics always shows us that those who don’t adapt die.

  • tf Reply

    Research more about cablecard. In practice cable companies dont allow cablecard users to access all features : some digital channels, program schedules, and pay-per-view won’t work, and other technical issues abound. Plus the cable company charges nearly as much for a cablecard rental as a set top box. The FCC made a half-hearted attempt to foster an open ecosystem, but it didn’t go far enough. The cable companies have the power to make any alternative painful to use and so unlikely to achieve success.

  • analyst Reply

    Whether it’s Aereo or legislation by Congress, the rulebook will be re-written over the coming years. These changes will impact all incumbents (my thesis is that the impact will be negative and their businesses will suffer). This has nothing to do with CableCARD – CableCARD is simply what’s used today. If you look in the right places, you can already see the seeds of change being planted: http://www.broadcastingcable.com/blog/bc-dc/commactupdate-promote-innovation-and-economic-growth/128361

  • Daniel Georges Reply

    Interesting article – toward the end you allude to TWC broadcasting shows over the internet as ‘streaming’. So how do you think a future Supreme Court ruling for or againt Aereo will affect customers being able to access all forms of broadcasting from a cable company?

  • analyst Reply

    An interesting development in the set-top box market: http://www.multichannel.com/news/tv-apps/comcast-tivo-working-non-cablecard-approach/375989

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