Consumers, Convergence, Connectivity, and the Cloud

RECALL No16

Telecommunications, Media, and Technology

Consumers, Convergence, Connectivity, and the Cloud

RECALL No16

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Welcome ...… to the 16th issue of RECALL, a publication for lead-ers in the telecommunications, media, and technology (TMT) sectors. The theme of this issue focuses on how new devices, services, and connectivity change con-sumer behavior and business models. Continued con-vergence and digitization offer many new opportunities and challenges for consumers and TMT companies: connectivity will be limitless, with TMT permeating most waking hours. What user desires fuel this transfor-mation? How can TMT companies best reinvent them-selves to succeed in this technology-driven revolution?

An excellent compass for charting direction, recent McKinsey market research into consumer trends in TMT forms the basis of three articles. The first looks at how TMT companies anticipate sector trends and see their own performance by 2015 in light of denser con-nectivity. An umbrella article follows that analyzes the user perspective. Part 1 summarizes the most recent iConsumer survey across a dozen countries, identifying market differences and trends ahead. The second dis-cusses the amazingly swift uptake of tablets with their pros and cons from a consumer viewpoint. The last in this triad explores convergence and its pace. Findings from NM Incite, McKinsey’s joint venture with Nielsen, are the third article’s focus, exploring the up- and down-sides of mobile apps developed on various platforms.

The new frontiers of total access and immersion are the subject of the two articles that follow. Web centricity is set to be the next major discontinuity, enabling unbri-dled Internet access for developers and consumers

alike. Innovations will also soon introduce TMT into new domains of our lives, with multiple devices extend-ing our senses and mental capabilities.

Research conducted by McKinsey for the Internet Advertising Bureau (IAB) Europe in the sixth article reveals – surprisingly – that today’s Internet consumer derives value from ad-funded online services that far outweighs user frustration at the disturbance.

The following three articles cover TV and video develop-ments in the TMT field. The first examines how digital TV is becoming a powerful driver behind revenue streams and growth in telco strategies. The next, on over-the-top (OTT) video, looks at the shifts OTT could cause to the video ecosystem and how TMT companies should prepare for this coming trend. The last article analyzes how quickly mass-market development could take off if the 3-D video value chain coalesces.

The penultimate piece investigates ten consumer trends – many counterintuitive – that should shape TMT players’ strategy going forward. An interview with Nielsen’s President of Media Products, Steve Hasker, rounds off this issue, discussing the challenges of cross-media tracking and the fascinating insights it reveals.

We hope these reflections on how TMT will further enhance our lives and productivity provide inspiration for your corporate strategy. As always, we welcome your feedback on these articles and any ideas on topics you would like to see covered in future issues.

Jacques BughinCo-Leader of McKinsey’s EMEA Telecommunications, Media, and Technology Consumer Cell

Markus FrerkerLeader of McKinsey’s German Telecommunications, Media, and Technology Practice and Editor of this RECALL issue

Guido FrisianiCo-Leader of McKinsey’s EMEA Telecommunications, Media, and Technology Consumer Cell

Jürgen MeffertLeader of McKinsey’s EMEA Telecommunications, Media, and Technology Practice

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud

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Contents01 Fast-forward: An insider’s journey into the future(s) of TMT 9

02 The 24-hour digital day 15

A iConsumer 2010

B Tablets

C Access convergence

03 Troubleshooting mobile apps: Insights from social media buzz 27

04 Cloud cover: Web centricity grants total access 33

05 Complete TMT immersion: Implications for consumers and industry 39

06 Pop-ups, privacy, and price: Consumer value and ad-based online services 45

07 Going over the top: Preparing for a streaming world 53

08 Tuning in: TV equals telcos’ “triple value” 59

09 Virtually there? 3-D video for the masses 67

10 Expecting the unexpected: Ten twists to shape your TMT strategy 73

11 Footprints in the ether: An interview with Steve Hasker, Nielsen 79

Appendix 83

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud

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How fast will tomorrow’s connectivity be? How will mobile Internet develop? The emerging consensus of companies in telecoms and high tech is that their sector will face game-changing consumer trends along with performance challenges.

McKinsey recently conducted a survey of telecommu-nications, media, and technology (TMT) companies to understand how they anticipate sector trends as well as their own performance to develop by 2015. The majority of respondents predict four trends: denser connectivity and a cloud versus devices battle; user spending shifting from pure access to application and services; stronger competition arising for multisided convergence; and the rise of new business model innovations that challenge previous ones.

Most respondents also believe these game-changing trends will lead to declines not only in revenue growth but also in EBITDA margins. The story isn’t entirely one of doom and gloom though. A small set of “winners” is also emerging, i.e., players expecting gains in both growth and margins. These players share two compel-ling attributes. They anticipate future trends more extensively than others; but mostly, they strive to adapt their business models and business scopes quite quickly in order to capture shifting sector opportunities.

Challenges to sector performance

Managers typically gauge a company’s value creation performance using two key financial health indicators – margin evolution and top-line growth. As McKinsey research on the granularity of growth has demonstrated

(along with other factors): companies that beat capital market expectations and generate significant total returns to shareholders (TRS) grow faster than the global GDP, while transforming this growth into margin improvements. What the emerging picture from sur-vey respondents reveals, however, is that the average TMT player will likely fall short of meeting these two conditions. According to the survey, short-term average performance in the sector will not exceed a 25.5 percent EBITDA margin, with annual revenue growth remain-ing in the low single digits at about 4.5 percent for the average player in 2010 (Exhibit 1).

Though growth prospects through 2015 are slightly bet-ter, annual average growth still clusters at around 5 to 6 percent globally – just below expected worldwide GDP growth and a benchmark to maximize chances of strong TRS – while margins will barely improve. Furthermore, the consensus is that competition will continue to in-crease, raising the industry’s systemic risk in two ways. First, as a result of convergence (i.e., telecoms players entering media and technology), industries invade each other’s territories, leading to more intense price compe-tition. Second, new companies are emerging that focus primarily on online and cloud-based services, thus also vying for a piece of the same pie.

Over the longer term, the survey answers demonstrate that performance among companies is likely to be redis-tributed, with seven out of ten companies expecting to change trajectory (for better or worse) in at least one of the two dimensions of growth and margin. Among those expecting change, most expect a downturn; only a minority expects gains in both dimensions.

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Fast-forward: An insider’s journey into the future(s) of TMT

Fast-forward: An insider’s journey into the future(s) of TMT

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01 The TMT earnings and growth forecast is modest

Below

Above

Top-line revenue growth

SOURCE: McKinsey survey

Percent of respondents, 2010 estimated

Below 20% 20 - 30% Above 30%

(-2%)

6%

12%

EBITDA margin

41% 18% 41%

47%

53%

Structural GDPgrowth worldwide

17 9 21

24 9 20

Median company:4.5% CAGR revenue 25.5% EBITDA margin

� Smartphones to become the norm in 2015

� Smart connectivity to arise predominantly from applications and storage capabilities that reside in the Internet “cloud.”

To support these changes, most of our TMT survey respondents are of the opinion that “ultra-band” con-nectivity (i.e., more than 100 Mbps/second down-stream) will be the median industry offering by 2015. Consequently, fiber to the home may well become the dominant last-mile technology by then, replacing DSL technology.

Trend 2: Shift in consumer spending toward smarter “everywhere” products and services. In high tech, com-panies expect to benefit from the growing consumer appetite for new digitization. This should lead users to buy new, smarter devices (e.g., Apple’s iPad) and seek a faster replacement cycle for device upgrades (e.g., phones or high-definition televisions). In the telecoms industry, insiders say spending will increase only in favor of digital “everywhere” products and services.

When it comes to products, most believe that “every-where” access will become a major trend, be it for video (e.g., 90 percent of respondents), communications, or

Four game-changing trends

The four core trends highlighted by the survey illus-trate an increasingly more connected Internet-based environment, with a shift in customer spending toward more applications and services. This environment will affect industry dynamics by fostering more intense, convergence-based competition and by inducing the emergence of business model innovations.

Trend 1: A world of denser Internet-based connectivity. Nearly 85 percent of the people surveyed believe that most infrastructures in telecoms and media will use Internet protocol by 2015, as will most product applica-tions. For example, they expect:

� Mobile voice over IP to make major inroads into applications, exceeding the current penetration of fixed voice

� “Long-tail” television, user-generated content, and thematic programming to operate under Internet protocol

� Digital television to be connected to the Web and the electronic programming guide to move toward third-party platform solutions

The TMT earnings and growth forecast is modest

11RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Fast-forward: An insider’s journey into the future(s) of TMT

data. Survey respondents also foresee a large market emerging as a result of deeper mobile data penetration. The majority believe that smartphones will comprise over half of all phone devices by 2015. But growth will come more from adoption than from higher user spend. If user spend grows, it will be for more applications; only a minority – 30 percent of companies – believe that mobile data access can grow in terms of user spending.

Trend 3: More competition. The majority of those sur-veyed say that competition will increase in the industry, pointing to three reasons for this ramp-up in intensity. First, competition among incumbents will continue. In last-mile telecoms access, for example, both cable and telecoms companies think they will be able to take share from each other. Cable is expected to do this based on its own infrastructure – believed capable of offer-ing more high-speed data and robust video solutions in the next ten years – before the arrival of an all-IP, fiber optics endgame. Telecoms will continue (and have no choice but) to expand in IPTV. Many respondents bet on integrated telecoms offerings (mobile plus fixed ser-vice) to deliver a differentiated “Internet everywhere” value proposition.

Second, competition will come from deeper and broader convergence. In last-mile access, some mobile-only operators have announced that they are thinking of investing in fixed-fiber infrastructure. Most TMT respondents believe that convergence will occur on multiple levels – high-tech players will expand into IT services and vice versa, and the media and telecoms industries may still converge.

Third, newcomers (mostly pure Internet companies) will continue to besiege the industry. The sense among respondents: these players will try harder to invade the media segment than telecoms services.

Trend 4: New ways to compete. A final crucial trend is the evolution of expected scope and business model innovation in the TMT sector. Of those surveyed, 85 percent believe that ways of operating and com-pany scope will change, and 25 percent predict that change will be “dramatic.” In high tech and (to a lesser extent) telecoms, many see cloud services coalescing as a new business model. Respondents overwhelm-ingly believe that B2B users will seek cloud services for infrastructure-related applications by 2015. Likewise, 80 percent contend that consumer applications will be predominantly cloud-based and more than 40 percent

of respondents say that cloud computing is likely to span the entire stack of infrastructure, platform, and applica-tions. Finally, riding the cloud is not limited to a go-to-market business model among telecoms and high-tech players. These companies also plan to adopt cloud ele-ments for their own operations, with 43 percent claim-ing that they will rely on cloud-based network outsourc-ing, 54 percent on managed services, and 52 percent on specific stand-alone applications.

The winning profile

The 30 percent of TMT companies who forecast a growth trajectory for themselves – in an environment of fundamental change – share a few commonalities. First, they have a knack for being in the right place at the right time – that is, they are companies located in growing regions and/or the right subsector of TMT. For example, according to survey respondents, short-term growth looks radically different in the telecoms indus-try (roughly 3 percent for 2010) compared with that in high tech (9 percent). Furthermore, high-tech compa-nies (especially B2C ones) are also expecting to benefit from the development of digitization in the form of the new smart access device replacement cycle for mobile and television.

Fixed and mobile telecoms players in Western Europe, on the other hand, face especially low growth prospects in the range of 2 to 3 percent. In part, this is due to pres-sure on their core voice markets. Generally speaking, EBITDA margins remain in the low 30 percent range for both telecoms and high-tech players, which contrasts with cable companies. Cable companies in the sample still hope to continue generating EBITDA margins in the mid-40-percent range and to find growth above the benchmark of global GDP (8 to 10 percent) based on fur-ther penetration of triple play along with extension to B2B and to mobile and wireless (e.g., Wi-Fi) services.

Winners also anticipate and act on key trends more aggressively than their industry peers. Consider cloud computing. Any migration to cloud computing must have a business case, and associated risks are slowing down migration efforts. For example, security (or the potential lack thereof) ranks high on the list of risks, followed by the provider’s potential to lock in excessive levels of control. Conversely, three benefits counterbal-ance these issues and are thus driving the move to cloud services: lower total cost of ownership, greater flexibil-ity to upgrade applications, and improved scale. Cloud

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services will thus likely put price pressure on the system and serve to reallocate industry profits.

Statistical analysis of the variance in company perfor-mance helps illustrate the factors that may explain win-ners’ trajectories (Exhibit 2). Statistically, companies that exhibit superior TMT performance benefit from two attributes. First, some simply operate better than others, have stronger brands, and better marketing capabilities. In fact, while winners acknowledge the rise of new Internet brands and consumer choices, they also believe their local presence will make the difference in terms of brand trust and positive customer experience.

More crucially: compared with average players, win-ners have quite different mental models regarding future industry dynamics and the urgency to play and adapt. They are twice as likely, for example, to run sce-narios that assume the scope of their operations will change drastically in the next five years and that they will implement changes in business models, such as adopting cloud services more quickly than anticipated. Winners also see the importance of new companies emerging from convergence, such as Google or the rein-vention of Apple. They view such players more construc-tively than average companies do – as challengers, even “complementors” to their own business models.

Meeting the challenges head-on

While managers will certainly have to tailor their road-maps to the needs, strengths, and assets of their own companies and subsectors, several actions may prove to be universal. Executives might find these worth keep-ing in mind as they map out their strategies.

Recognize the emerging trends. While the survey reveals consensus on the four trends described, some companies disagree or are not yet fully convinced of how forcefully these trends will unfold. In the meantime, industry winners are already taking steps to adapt their business models to accommodate future changes.

Develop your own strategic vision. Precisely when these four trends forebode new performance pressure, com-panies need to identify ways to turn this pressure into advantages. If the rise of cloud services puts pressure on the high-tech equipment maintenance services, for example, this could open up a great entry point for com-panies to build up a larger share in managed services. Likewise, if connectivity becomes a critical factor for smarter products and services, companies could seg-ment access according to smart product user needs or look into ways to better deliver connectivity by seam-lessly interworking infrastructure services.

Companies expecting significant growth have a few features in common

1 Probit model: 1 = winners, 0 = otherwise

Winners vs. rest of TMT100% = variance explained1

Among winnersPercent

SOURCE: McKinsey survey

55New business model imple-mentation

Location effects

Brand effects

Subindustry effects

New business model imple-mentation

Better brand and marketing capability

Location effects, e.g.,Asia vs. continental Europe

Subindustry effect, e.g., High tech Cable Fixed mobile vs.

telecoms in general

15

20

25

40

5

25

15

02 Companies expecting significant growth have a few features in common

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Develop a clear view on ways to compete. In this new world, traditional ways of competing will also change. Today, partnerships are still viewed with skepticism by key TMT companies – or worse: as risky Trojan horses to attack business models. Most television companies have yet to accept YouTube on their online video portals and a lot of publishers will be hesitant to grant e-readers access to their catalogs via the iPad. While companies must certainly be cautious, partnerships might be nec-essary. For example, cable operators could require a mobility component to deliver “everywhere” products service, while mobile companies will need fixed net-work investments to transmit the flow of wireless data to their users. New forms of competition will emerge, from high-tech companies moving into IT equipment (e.g., routers to servers) to IT players moving into cloud services against telecoms services, and so on. Each company needs to examine its own environment, work out new ways of doing business, and define how to best shape the new ecosystem in order to compete effectively.

Invest in new capabilities. Operationally speaking, the emerging TMT world clearly requires companies to develop new capabilities. These could include cloud ser-vice operations, better brands, and improved customer

experience performance along with the marketing capabilities necessary to support new business model innovations (quad plays, tiered pricing plans, etc.). Currently, a great deal of companies are not taking the time to logically map out the convergence diversifica-tion they need to upgrade their capabilities for the new future(s). Just having a few servers and a few applica-tions is not likely to make a good entertainment cloud if telecoms companies don’t master traffic, platforms, and the Web. The entry of IT services into telecoms will also fail to work effectively if companies don’t understand mission-critical tasks and information/work flows. These capability issues are possibly the ultimate dif-ferentiator for long-term success, and experience shows that the TMT industry might largely overlook these.

The picture that emerges from the TMT survey reveals an industry in flux, with changes ahead for most compa-nies – many that would reduce baseline profitability of the sector. But for some companies, these changes actu-ally present opportunities to grow. Those prepared to act aggressively may find themselves riding the wave of change as opposed to being crushed beneath it.

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Fast-forward: An insider’s journey into the future(s) of TMT

Jacques Bughinis a Director in McKinsey’s Brussels office. jacques_bughin@mckinsey.com

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There was a time when computer-related activities were confined to certain areas of life (largely work), con-cerned only the most tech-savvy, and occupied discreet time slots during the day. Today, everyone has jumped on the digital bandwagon, leading to fundamental shifts in how we communicate, access information, purchase goods and services, and organize our social lives.

With the rise of digital and the rapid changes that it brings to the economy, McKinsey decided to invest in a uniquely deep and comprehensive survey. The research seeks to understand changing consumer behavior across digital experiences, spanning a dozen countries. The first edition of McKinsey’s iConsumer survey was conducted in the US in 2008. The research has mean-while evolved and now includes France, Germany, Italy, the Netherlands, Poland, Russia, Spain, and the UK, along with China and India.

Evident in the 2010 edition is the overarching theme of adoption speed and the pervasiveness of digital con-tent and services across all consumer segments. These behavioral shifts will soon drive value shifts. Thus, telecoms, media, and technology players should likely invest heavily in consumer insights to shape and/or be well prepared for some of the industry changes that will inevitably result from some of these major shifts in con-sumer behavior. Here are some of the findings.

Communication redefined

Continued, steady, massive growth in social networks or inclusion of voice add-ons in other services are two key trends that are redefining how we communicate.

Take social networks: more than a third of the Internet users who participated in the research described social networks as an important or very important means of communicating with friends. The phenomenon is not only about its mass adoption, it is also about the time spent using it. In the UK for instance, social network-ing already represents 27 percent of Internet time. Even among the most traditional consumer segments, over 50 percent of users access a social networking site at least once a month – and 10 percent do so on a daily basis.

In the same way social networks are expanding into other categories such as gaming, voice is increasingly an add-on feature to other services. For example, half of the over 25 million active Xbox LIVE subscribers regu-larly use the embedded voice chat service – 47 percent of them use video chat regularly. In 2010, for the first time, less than a third of the time spent communicating was on traditional voice – landline and mobile combined.

Striking as it is, this is likely not an end state. With the expected adoption of social networks and other collabo-ration tools in the enterprise world, traditional voice will be even further dwarfed by new forms of communi-cation. Of the companies surveyed, 17 percent already have an internal social network; several companies are thinking of suppressing e-mail and replacing it with new collaboration tools considered to be more effective.

The golden age of digital media

While social networking is perhaps the most remarkable example of consumer adoption of digital technology, other uses – media in particular – are gaining traction

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud The 24-hour digital day: iConsumer 2010

02 The 24-hour digital day: iConsumer 2010

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as well. Reading is merely one example. Be it newspa-pers, magazines, or books, a significant shift to digital content is apparent. Magazines show the most impact, with 17 percent of consumers saying they are turning less to printed content in only one year. Newspapers, however, are also hit with 11 percent of readers consum-ing more online compared to a year ago.

One further example of media gaining traction is over-the-top (OTT) video. Close to 50 percent of all users say they watch some form of video on the computer weekly. On average, 10 percent of users already watch OTT video on their TV. Such figures are likely to increase with 7 percent of all users intending to buy an Internet-connected TV in the next six months.

The drivers behind increased digital usage are the same for OTT video as they are for magazines and newspa-pers: consumers value the control and convenience that OTT services provide. Control and convenience are cited by iConsumer respondents as being among the top three reasons to watch OTT video, both on TV and on PC. In addition, new devices further enhance this con-trol and convenience. With tablets, users can now com-fortably browse the Internet or catch up on a favorite TV program whenever they want and truly wherever they want – in any room at home and even on the go.

Everyone goes digital – some just do it differently

In the most advanced European and US markets, our research has surfaced six different segments when it comes to digital behaviors: the Basic TV Viewer, the Audiophile, the Educated Reader, the Digital Beginner, the Technophile, and finally the Young Online Communicator. These segments represent the vast continuum of behavior apparent today. Young Online Communicators are one extreme, spending most of their time communicating via social networks, chat, videos or on blogs. Basic TV Viewers, in contrast, largely spend their media time watching linear TV.

Not only do individual segments differ regarding the time people in them spend engaged in digital activities, they also differ in what people in these segments do dur-ing the time spent. A large proportion (roughly a third) of users in three of our segments, for instance, use social networking platforms to make new friends. Educated Readers are particularly interesting in how they use social networks: mainly for research purposes – staying

up to date on news, finding friends, doing research for work or school. They spend substantially less time stay-ing in touch with friends.

Probably the most counterintuitive finding of this seg-mentation concerns e-commerce. The three segments that are the least advanced in terms of their media consumption volumes and usage diversity are the ones who buy the most online. Take the Educated Reader for example: in seven product categories, more than half of the segment buys most in that category online. This includes household appliances and mobile phones along with travel, music, books, etc. At the other end of the spectrum, the Technophiles and the Young Online Communicators still have some way to go before they make most of their purchases online.

The next billion digital consumers

In 2010, the emerging market Asia represented 38 per-cent of the world’s 1,9 billion Internet users. By 2014, this continent is expected to account for 51 percent of the projected 3 billion users worldwide – an increase of 800 million users. Taken together, China and India alone should add 600 million Internet users by 2015.

What are the drivers behind such growth? Will new digital consumers show similar usage preferences? While many of the factors driving adoption are similar – including a decline in access price in those countries combined with a significant rise in purchase power – two important differences become apparent.

First, an important adoption driver in emerging mar-kets is the latent demand for “utility” services. This includes e-education, e-health/m-health, and mobile financial services. In India, between 61 and 83 percent of consumers surveyed show very high interest in these services. Arguably, the innovation in these domains is taking place in these very countries, where the barriers to adoption are lower and the demand is stronger than in the more developed markets.

Second, leading Internet players face strong local competition in the emerging digital markets, in which national champions often prevail. For instance, Facebook is lagging behind both in Russia and China. In Russia, only 3 percent of users log on to Facebook as their primary social network destination, while three local sites enjoy widespread usage. In China, only local players are among the top five social networking sites.

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud The 24-hour digital day: iConsumer 2010

In addition, we see no evidence that the trend might reverse. Over 70 percent of Russian users intend to spend more time on local sites, and only 7 percent intend to increase their time spent on international sites.

Significant value shifts expected

Changes in consumer behaviors signalled by this re-search will inevitably be profound. For telecoms, media, and technology (TMT) players, these will have far-reaching implications.

For telecoms operators. This study shows that social networks and voice chat are cannibalizing all other well-established means of communication across coun-tries, including basic voice and e-mail. The immediate revenue impact is likely to be limited given the high penetration of “all-inclusive” packages. However, the longer-term impact on the brand and on the perceived service value might be higher, unless operators manage to back their brands with new service promises.

VoIP on mobile is likely to have greater impact for telcos. Users have experienced VoIP on fixed lines for a few years now – a familiarity that may facilitate the takeoff of VoIP on mobile. McKinsey research shows that the share of users willing to use VoIP on mobile is around 40 percent in Western Europe and close to 70 percent in Russia. Thus, this phenomenon will likely have signifi-cant impact on usage and price, requiring an important rebalancing of revenues toward data.

For media players. The pace of business model transfor-mation is likely to accelerate for media players. A shift toward digital content, the attractiveness of social net-work sites for advertisers, and audience fragmentation could prove fatal for those not capable of deep reinven-tion. Simultaneously, the emergence of new business models – such as paid applications in app stores and infinite service innovations resulting from new tech-nologies – create real growth opportunities. The players who can capture opportunities faster and exploit all the benefits from the new digital world have a unique chance of displacing competitors in a short time frame.

For pure Internet players. Adaptation will also prove necessary for this segment. The likely emergence of new champions in emerging countries could pose a threat to today’s leading players over the medium term. Also: keeping today’s customers loyal to a company’s digital attributes means constantly questioning the offer. An example: pure online gamers who have not taken the leap into the realm of social network gaming could severely suffer in the near future.

All players in the TMT space should closely monitor consumers and their behaviors within their domain and beyond. Detecting and understanding important trends early on and adapting value propositions accordingly is the key to remaining relevant in an environment that is changing faster than ever.

Radim Rimanekis an Associate Principal in McKinsey’s Prague office. radim_rimanek@mckinsey.com

Alexander Dahlkeis a Principal in McKinsey’s Hamburg office. alexander_dahlke@mckinsey.com

Sergio Abreuis an Associate Principal in McKinsey’s Lisbon office. sergio_abreu@mckinsey.com

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No singular piece of digital technology better exempli-fies the degree to which TMT players have become inter-dependent than the new tablet. This device also dem-onstrates consumer desire across segments to quickly adopt new technologies, an attitude confined to a niche segment not so long ago.

In the first nine months after launch, 14.8 million iPads were sold – a rate faster even than the iPhone and more than five times faster than many analysts predicted. To put things in perspective, it took three months to sell one million iPhones but just 28 days to sell as many iPads. In fact, the iPad is on its way to becoming the fast-est-selling consumer electronic device ever – and this in its first year on the market.

In retrospect, the success of tablets was certainly not obvious when Apple decided to develop one. It was an outright audacious innovation because it was positioned as a “third device” – somewhere between the smart-phone and the laptop. There was no evidence at all that consumers were clamoring for a third device. There was also very real concern that this new device could eat into the sales of Apple’s other products. Needless to say, that didn’t happen.

McKinsey recently conducted extensive research in order to understand how people use their tablets, and what they like and dislike about them. This research included quantitative analysis in addition to 90-minute interviews with a variety of users and several “safaris” – in-home ethnographic explorations with iPad users and their families. This served to provide insights that could prove highly beneficial for TMT companies.

How owners use their tablets

For all the bells and whistles associated with tablets, the most common uses are the most basic: browsing the Web and watching videos/movies. A few other trends will help TMT players better understand the role of digi-tal media in the lives of the average consumer:

Partial PC replacement. The presence of a tablet at home means that desktop computers (and even laptops) begin to get short shrift. Since a tablet does not need to be plugged in or booted up, it displaces PCs for quick searches, watching videos/movies, or checking e-mails (the most common uses). In addition, it is easier to use in bed to watch television or videos. In iPad households, the PC is getting a reputation as a workaday machine, while the iPad is used more for fun and leisure activities.

Reading and gaming. People who love reading love read-ing on tablets. This was observed from the start with the iPad, as it included all the e-book stores and provided instant access to newspapers and magazines. For gam-ing, tablets are introducing a whole new generation – i.e., grown-ups – to the fun, while still appealing to young users and even to hard-core gamers. Other home uses are emerging, such as making the tablet a remote control for other devices. In fact, the longer owners have a tablet, the more willing they are to experiment with it: 57 percent of iPad owners in the survey stated they use their tablet more now than they did in the first three weeks of ownership. Only 4 percent said they use it less. Applications. Unsurprisingly, a key driver behind increased usage is applications: 60 percent of iPad own-

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud The 24-hour digital day: Tablets

02 The 24-hour digital day: Tablets

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ers have downloaded ten or more apps. Early adopters spent EUR 27 on apps in their first month, confirming their economic potential. This could only be the start. The vast majority of the 300,000 apps available were created for the iPhone and do not fully exploit the capa-bilities of an iPad. By contrast, iPad-dedicated appli-cations lead to higher user satisfaction and generate greater demand – and users want more of them.

At home versus on the go. The tablet is used most often in the home or a family environment and less often as a mobile device. Only 16 percent of users most often or always take their tablets with them when they leave home. They cite their reluctance to take along a device they see as expensive and somewhat flashy when there are mobile alternatives, such as smartphones. The desire for permanent (e.g., 3G) connectivity is limited, and many who bought the device with 3G connectiv-ity say Wi-Fi is sufficient. Almost a third of those who bought a 3G-enabled iPad, for instance, did not sub-scribe to a 3G offer. Still, we see nomadic usages devel-oping. First, some reasons for not taking the tablet out-side the home will disappear. A number of iConsumer participants told McKinsey they didn’t want to be seen as showing off, a concern that will diminish as tablets become more widespread and affordable. Second, some already see the tablet’s potential as a travel companion.

What people love about tablets

Among the iPad owners McKinsey surveyed, 98 per-cent said they were satisfied with it and 95 percent said they would recommend it to their friends. There are not many products that can boast these figures. How do owners love their tablets? Let us count the ways.

First, they love these devices for being intuitive and easy to use. iPad users surveyed praised the speed, screen quality, and reliability. Another pleasant surprise is that the devices come out of the box ready to use. The more users learn, the more they like. The most delighted users are those who have discovered new uses for themselves.

Second, users love that they can – and in fact do – use it almost everywhere. The tablet may not make it out of the home often, but it is taken to and used in virtually every corner of the home – the kitchen, the living room, the bathroom, the bedroom – whether seated or lying down.

Third, they love that the device can be shared easily. In fact, it reintroduces a social aspect to some of the

activities that are often performed individually. On our domestic safaris, we noticed children playing together on the family tablet. One ten-year-old girl told us that she preferred using Facebook on the tablet because she could do this in the kitchen with her mother rather than being on her own in the study.

As a result – although many people initially bought a tablet without knowing what they would do with it – the vast majority consider it worth the price. Almost two-thirds (64 percent) of iPad owners called it an extremely good value and 33 percent a somewhat good value.

How tablets miss the mark

Based on what iPad owners stated, the device enjoys a fantastic reputation, but it still has shortcomings. The key frustration is concerned with the inability to easily connect and share data with other devices. It has no USB ports; instead, it has a single Dock Connector. Thus, it is not possible to directly plug in a camera or printer. This is an issue for a product designed to view pictures and watch videos. Users who do not already have a Mac at home lose out in terms of functionality and ease of use.

Beyond the connectivity downside, users regret the lack of storage capacity and processing power that would make it either the central hub at home or simply a better device for personal use. Owners also question using a touch screen keyboard for extended periods.

Furthermore, people express frustration when it comes to entertainment. The tablet is not ideal for music, for example. It is too big to be practical for on-the-move music, which remains the territory of the dedicated devices. Beyond this, the quality is not good enough for in-home music, where users say better options exist. Finally, the iPad is incompatible with Adobe Flash, so users cannot view some Web videos or play Flash games.

No surprise: the most recent tablets on the market already address many of these shortcomings.

Implications for players

Players in the tablet and tablet-adjacent fields should act now to seize short-term opportunities, while preparing for and shaping the longer-term evolution of the device. The reading app, for example, could inject new life into old media based on subscription and aggregation ser-vices for newspapers, magazines, and radio providers. It

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud The 24-hour digital day: Tablets

could also benefit e-tailers like Amazon as digital book distribution increases.

In addition, there is real monetization potential in using video, interactive graphics, and other features that take advantage of the tablet’s capabilities, backed by an easy payment process. So far, such great expectations have yet to be fulfilled. At Wired Magazine, for example, downloads dropped sharply after a few months as the tablet novelty wore off. More work is needed to tap into a tablet’s full potential, designing offers that attract new readers and enhance loyalty among current customers.

For telecoms operators, tablets could bring a number of opportunities – once they figure out how to generate more mobile network usage. We believe that current data plans, in many cases, do not meet the demand for occasional usage. High data prices are a deterrent, as is

spotty Wi-Fi coverage. To turn Wi-Fi visitors into loyal, high-value customers, operators must create appeal-ing plans for mobility, for example, by bundling it with Wi-Fi access; creating plans for occasional 3G usage (e.g., prepaid); and offering one-click purchasing. Finally, telecoms operators should look into opportuni-ties to leverage tablets for the promotion and the sale of their own products and services and should aggressively pursue the large enterprise opportunity.

Potential for tablets is likely huge, particularly if the shortcomings described can be addressed. The implica-tions for other industries – particularly media and tele-coms – are intriguing. Predicting the future is an excel-lent way to be proven wrong. What is certain, though, is that the tablet’s journey has only just begun.

Bengi Korkmazis an Associate Principal in McKinsey’s Istanbul office. bengi_korkmaz@mckinsey.com

Jean-Hubert Lenotteis a Principal in McKinsey’s Paris office. jean-hubert_lenotte@mckinsey.com

Georges Desvauxis a Director in McKinsey’s Paris office. georges_desvaux@mckinsey.com

Jean-Baptiste Coumauis a Principal in McKinsey’s Paris office. jean-baptiste_coumau@mckinsey.com

21

23RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud The 24-hour digital day: Access convergence

phones) that were technologically immature and often high-priced. Neither offering attracted strong consumer demand. Furthermore, the platforms, the brands, and even the distribution did not converge – so in the con-sumer’s eye, the worlds remained separate.

The road has been cleared

Since these early days, the telecommunications land-scape in Western Europe has evolved tremendously. Recent trends could very likely lay the groundwork to push the industry toward convergence from both the consumer and the operator sides.

From the consumer side. Consumers are now on a quest to simplify their lives, and this includes house-hold administration. With mobile penetration topping 100 percent and broadband close to 80 percent in most developed countries, a typical household has 2.4 mobile bills and 1.5 for fixed service. Recent surveys indicate that, for more than 30 percent of households, bill sim-plification is enough to trigger a move to a convergent offer. In addition, holding fixed and mobile products from a single supplier is a reality today for approximately 40 percent of customers. The brand convergence is even stronger when looking into purchase intent, as a majority of users perceive fixed service providers as credible on the mobile market and vice versa. As a result, a very sig-nificant portion of consumers – up to 50 percent in some European countries – either already have switched or plan to switch to a quad-play offer.

The emergence of mobile broadband is also driving consumers toward access convergence. Indeed, mobile

There is a growing need to work and play on and connect to our “networks” anytime and everywhere. This – com-bined with the increasing number of connected devices and consumers’ quest for simplicity – is paving the way for convergence. Surprisingly, consumers seem more advanced than operators on the subject.

Access convergence has been on the tongues of industry players for many years, yet it has not become the stan-dard. At least two main reasons have contributed to its slower-than-expected uptake.

Previous barriers to access convergence

The first reason was the existence of significant residual growth in both mobile and fixed, leaving mobile-only or fixed-only operators focused on capturing growth in their core markets. Mobile network operators (MNOs), for instance, positioned mobile as a substitute for fixed voice. Later, they were busy creating a market for mobile data. Secondly, most incumbents did not actively pursue access convergence. While they had the infrastructure to build convergent offers at full margin, convergence arguably made less sense for them given their high initial market shares in both fixed and mobile markets and the risk of repricing – not to mention regulatory constraints.

Despite the reasons against access convergence, there were still several attempts made. Some attackers – mainly MVNOs or BBVNOs – tried to differentiate by offering low-end fixed-mobile offers, e.g., bundles with no minutes or Internet at lower-than-market speed. At the other end of the spectrum, some established players pushed convergence with hybrid products (e.g., UMA

02 The 24-hour digital day: Access convergence

24

broadband is seen as complementing fixed broadband (by approximately 75 percent of users) rather than as complementing mobile voice. And mobile broadband is a household purchase decision in 70 percent of all cases.

The multiplicity of devices is a third factor driving con-vergence. Customers are increasingly asking to pay for bundled connectivity at home (e.g., accessing HD video through game consoles) and on the go (e.g., one subscrip-tion for a smartphone and a tablet). With tablets, the bor-der between mobile and fixed is further blurring.

Finally, the rise of remote work from home and of remote home management means users need to access content from everywhere. Service convergence is already a real-ity with the constant growth in using cloud applications such as Google Docs and Dropbox, which offer device-agnostic access to content, with HTML5 as the standard for this new revolution. Winning tomorrow’s customers will require an infrastructure that follows this need to push content across mobile and fixed devices.

From the operator side. Just as the consumer landscape is now fertile ground for convergence, there are more reasons for telecoms operators to move in this direction. First, it is an opportunity for growth at a time when many successful attackers are confronting market maturity and revenue stagnation, sometimes even decline.

Beyond this, intention to churn decreases as the number of products from the same provider increases – particu-larly when the portfolio covers both fixed and mobile products. In markets where customers with different fixed and mobile brands churn at a rate of 18 percent, convergent households (i.e., households with the same brand for all products) churn at a rate below 6 percent.

McKinsey has also established a strong correlation between the intention to churn the fixed Internet ser-vice provider and the mobile service provider. Some 50 percent of “fixed churners” would be willing to switch their mobile product at the same time, and 30 percent of “mobile churners” would be ready to do the same for fixed. All of this opens the door for quad-play offers.

With hybrid offers emerging everywhere (for instance, Google TV, Apple TV, Hulu, and Netflix) and blurring traditional boundaries between media, telecoms, and Internet players, the risk increases that access providers get locked into a commodity play and gradually lose the direct relationship with customers. In addition to the

market opportunity it represents for players who will be most successful at capturing it, convergence can be a way to fight the new competition by deepening the relation-ship with customers based on increased product holding and taking a central position in the household through additional hardware, applications, and services.

Implications for market behavior and players

From experience in markets where access convergence is the most advanced, we can derive three main findings:

First, aggressively priced quad-play offers can signifi-cantly affect market dynamics. Recent real-life examples from countries like France – and confirmed by market surveys in other regions – show that a discount of 15 to 20 percent (on the overall package) creates a new quad-play market representing 25 to 30 percent of the market’s fixed gross adds and 10 to 15 percent of the market’s mobile gross adds. This is a major disruption to market dynamics, equivalent to or even bigger in size than the entry of a fourth or fifth mobile player.

Second, the launch of an aggressive offer by one of the leading players quickly forces others to follow, leading to rapid market changes. Such speed requires a high degree of responsiveness and therefore a high degree of prepara-tion as significant value is at stake – with a high risk of value destruction from inappropriate pricing.

Third, quad-play offers initially increase market churn because they give an opportunity to single-product hold-ers to group their products under one provider with a discount. However, once consolidated, these households tend to churn less. Dynamic market strategies will there-fore be key for players who should think about how to consolidate their existing households and penetrate oth-ers before convergence happens at their expense. Central to this strategy should be the deep understanding of the differences between individual product holding and household product holding along with price sensitivities.

As a concept, access convergence is not new, but its time is just now arriving. Growing consumer comfort with and the expectation of constant connectivity is compel-ling industry players to provide an integrated, cross-platform, mobile and fixed digital experience. Business opportunities for operators are plentiful, and success will be in the hands of those who are best prepared.

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud The 24-hour digital day: Access convergence 25

Gatien Gillonis an Associate Principal in McKinsey’s Brussels office. gatien_gillon@mckinsey.com

Eric Hazanis a Principal in McKinsey’s Paris office. eric_hazan@mckinsey.com

Jean-Hubert Lenotteis a Principal in McKinsey’s Paris office. jean-hubert_lenotte@mckinsey.com

Jacques Bughinis a Director in McKinsey’s Brussels office. jacques_bughin@mckinsey.com

27

03 Troubleshooting mobile apps: Insights from social media buzz

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Troubleshooting mobile apps: Insights from social media buzz

McKinsey’s joint venture with Nielsen is yielding insights on a microlevel, revealing what users really think of telcos’ mobile apps offers. A case study shows how this research can be used to generate highly tar-geted solutions.

The rise in popularity of mobile apps has energized mobile operators, smartphone manufacturers, and mobile operating system providers. These low-cost applications enable customers to access a never-ending stream of innovation. With much of the future growth of mobile telecoms resting on the uptake of mobile data and applications services, the mobile apps space is seeing unprecedented focus not just from traditional mobile operators, but also from players in the larger consumer electronics, software, and online arena, including Apple, Google, and Microsoft.

What are the real drivers behind the use of these increasingly popular software packages? To assess the impact of user behavior, McKinsey initiated a knowl-edge effort on mobile apps and user attitudes leverag-ing the NM Incite platform – a joint venture between McKinsey and Nielsen. NM Incite collects and analyzes online conversation from social sources to understand what consumers are saying about a product, topic, or brand. In this way, NM Incite collects aggregated, real-time insights from the buzz social media can generate. The capability also allows us to analyze the sentiment in these conversations and the underlying drivers of con-sumer views.

McKinsey has deployed three new lenses to assess driv-ers of user adoption and the use of different application

ecosystems based on insights from this platform. These lenses cannot capture the entire consumer perspec-tive on mobile applications; they do, however, offer a very new view of the evolution and choice of applica-tion ecosystems. The first is social recommendations and voice, a major driver behind the telecoms decision process according to marketing studies. The next is consumer sentiment, with research suggesting that 50 percent of consumer choice in telecoms is linked to emotional ties to brands. The third lens is scale and depth of insight. This is a particularly important angle given that unprompted data can now be gathered on a massive scale – far more than is possible via traditional prompted market research methods.

Listening for mobile apps in social media

In the fourth quarter of 2010, the joint McKinsey-NM Incite team identified over 140,000 English-speaking social media “conversations” about mobile apps across blogs, blog comments, message boards, groups, micro-blogs, and videos. NM Incite’s approach made it possible to surface current trends in consumer behavior, senti-ment, and perspectives. “Listening in” on the public con-versations of consumers not only unearths opportunities that enable industry players to meet or exceed consumer expectations with new value propositions, service mod-els, and prices. It can also provide early warning for key trends and discontinuities, and enables rapid diagnosis of the root causes behind performance challenges.

McKinsey’s analysis of consumer and developer senti-ment on mobile applications highlighted three very interesting areas along the application purchase funnel.

28

01 Operators do not play much of a role for consumers in the mobileapps space; when they do, user sentiment is exceedingly negative

SOURCE: NM Incite Mobile Apps Knowledge Effort, 2011

Operators are rarely mentioned in mobile apps conversationsPercent of sample by topic

Sentiment scorePercent

NegativePositive

Most common complaints

Preinstallation of apps

Over-the-air updates destabilizing phone

Over-the-air installationof mobile apps

Stealth network data usage

0

92

Operator mentions –without troubleshooting

No operator mentions

Operator mentions –with troubleshooting

Neutraland mixed

8

Operators are mentioned in only 6% of total mobile apps conversations

494 2

Operators do not play much of a role for consumers in the mobile apps space; when they do, user sentiment is exceedingly negative

devices. Only a few app categories receive large amounts of specific buzz: Facebook, “smartphone simplifiers,” location-based service apps, and a variety of time wast-ers. Interestingly, mobile network operators (MNOs) are rarely mentioned in consumers’ apps-related conversa-tions. Only 6 percent of all apps-related social media conversations allude to any specific operator names at all. When they do, consumer sentiment about the opera-tor is overwhelmingly negative (Exhibit 1).

Looking across the three areas of findings, it is clear that the mobile apps space is both hotly contested and highly fluid. Despite Apple’s current lead in consumer and developer buzz across a number of dimensions, McKinsey’s research shows that the battle between the various competitors is still wide open. No player so far has been able to achieve top user perception along all dimensions. Still, the findings show that the various players could actively learn from each other to round out their offerings.

Deeper dive: Troubleshooting conversations

While results in the three topic categories above reveal that players in the mobile apps ecosystem are still very much jostling for end-to-end leadership, there appears to be one area where more fundamental differences are

App discovery. Blogs are the No. 1 forum where new apps are discussed most often. Spikes in consumer app buzz occur virtually simultaneously when companies launch new ecosystems (such as Windows 7) or new device for-mats (such as Android tablets). The way in which devel-opers market their applications can, therefore, have a major impact on the ultimate success of any app.

App store perspectives. While users seem to view Apple’s iTunes app store as the best app store platform, they still see room for improvement. Social media con-versations indicate that this platform clearly excels in the areas of access and payments experience compared with the Android and RIM stores. On the flip side, both developers and customers seem to respond very posi-tively to the more open nature of these app stores in con-trast to Apple’s more restrictive app policies.

From buzz to download. Ecosystems vary significantly in terms of the commentary they generate. Apple’s iPhone operating system iOS currently receives the most. The level of buzz tends to fluctuate very rapidly and sometimes seems to be directly influenced by new product or operating system introductions. In terms of individual applications, the apps that typically get the greatest buzz are often functionally simple, widely avail-able, content-driven, and typically not preloaded onto

29

02 Operators have been pushing Android hard, but it generates nearly twice as many troubleshooting conversations as iOS

1 Note that mentions do not add up to 100: they are weight-adjusted by source in sample

SOURCE: NM Incite Mobile Apps Knowledge Effort, 2011; Strategy Analytics

RIM

iOS

Android

EcosystemMentions in blog/forum posts1

Percent of total sampled troubleshooting conversations

Installed basePercent of smartphones Ratio

6:1

3:1

2:1

Top 3 ecosystems drive substantial majority of overall mobile apps conversations

11

12

1527

38

59

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Troubleshooting mobile apps: Insights from social media buzz

Operators have been pushing Android hard, but it generates nearly twice as many troubleshooting conversations as iOS

becoming visible: mobile apps troubleshooting. Almost 30 percent of the social media conversations concerning mobile apps that were analyzed focus on troubleshoot-ing – a finding in line with other technology rollouts (e.g., Windows ). There is also a discernible difference between “closed” and “open” platforms – and that is where the difference in competing mobile apps comes in. It is notable that this level of conversation is observed despite the greater developer flexibility in some of these ecosystems and the broader range of devices available compared with prior rollouts.

Similar to the PC evolution over the past twenty years, mobile-apps-related conversations reflect the common trade-offs found between open versus closed platforms. MNOs have been heavily promoting the Android OS – an open operating system developed by Google and other members of the Open Handset Alliance as an alternative to Apple’s closed iOS. While sales figures for Android devices have seen extremely impressive growth, the very open platform generates nearly twice as many troubleshooting conversations (proportion-ally) in the sample as the Apple iOS and three times as many as RIM’s BlackBerry relative to their installed bases (Exhibit 2). Key issues raised by users include app incompatibility with different Android devices and Android’s higher potential for user “adjustments.” These

can lead to unintended consequences, since its OS can be more easily modified than iOS.

The most frequent Android-related troubleshooting topics picked up in the survey involved app installation failures, app/device incompatibility, and app availabil-ity. These contrast sharply with iOS issues, where the top three focus on phone system freezes, side-loading and syncing hints, and over-the-air update failures. Even though underlying consumer issues differ, cus-tomer sentiment is surprisingly similar: around half of all troubleshooting conversations leave the customer with neutral or mixed feelings, 10 to 15 percent are posi-tive, and the rest are negative.

Apple iOS also faces its own unique challenges. In par-ticular, social media conversations frequently make negative reference to Apple’s stricter guidelines for mobile apps availability and development. The iOS eco-system is more restrictive on mobile apps content and functionality, since Apple has complete control of iOS access through its iTunes portal.

As noted, consumers rarely mention MNOs in their social media conversations about mobile apps. Con-versations about mobile apps are far more likely to men-tion specific device names rather than more generic

Operators. Given the potential for significant mobile apps-driven customer service challenges, the differing ecosystem perceptions caused by repair and replace-ment policies, and the problems MNOs face in finding consumer acceptance for their branded apps, operators can explore four types of countermeasures:

� First, they may wish to consider enhanced point-of-sale education and channel capabilities. This could include revisiting device repair and replacement policies, while boosting retail capabilities to demon-strate solutions to common app-related challenges at the point of sale. A further possibility along the same lines would be to seek greater cooperation among indirect channel partners to promote user education on issues of this kind.

� Second, they could offer user-selectable app bun-dles, segmenting them by common consumer types and installing them at the point of sale. MNOs could also put new channel capabilities in place to flash-install app suites, or set up customer tracking sys-tems to ensure purchasers walk out with a working acquisition or upgrade (similar to the UK’s Carphone Warehouse “Walk Out Working” strategy).

� Third, they could offer remote device monitoring to identify mobile apps conflicts, OS lockups, and potential for software updates. This could simulta-neously create new sources of revenue and enhance customer satisfaction scores.

� Finally, operators might consider altering their handset ranging decisions to limit the number of models and OS versions on their network to simplify troubleshooting. They could also consider reducing the complexity of operator-specific overlays such as screen openings or unmovable apps, which appear to decrease rather than increase customer satisfaction.

Device OEMs. OEMs can adjust device repair and replacement policies with channel and operator part-ners and limit the proliferation of devices to improve compatibility and user experience. They could also collaborate more closely with OS providers to improve hardware compatibility and performance.

App developers and content providers. One effective strategy for these players would be to limit very deep application programming interface calls to prevent device lockups. Others are to widely test their apps

references to ecosystem or operator. When the MNO is mentioned in a troubleshooting context, the most common consumer issues involve problems with over-the-air mobile apps installations, over-the-air network updates that destabilize handsets, and app preinstalla-tion by MNOs. These issues appear to be driven by the very personal nature of a mobile phone’s front screen: customers feel it is theirs, so any attempt to prefill or modify it by operators or others is viewed as an intru-sion on their own “space.” Preinstallation is a particu-larly thorny issue. While some MNOs have attempted to address mobile apps troubleshooting challenges by pre-installing apps, consumers’ social media conversations on this practice have been highly negative. Feedback reveals that users do not want preinstalled apps, especially if they cannot remove them. In some cases, preloading branded handsets has driven customers to choose “clean” unbranded phones instead.

Operators face a potential customer care challenge from mobile apps uptake, especially in open ecosystems. iOS users seek help and assistance from Apple (through Apple-owned forums and Apple-dedicated user com-munities), while Android users turn to a wider range of sources. Android users leverage Facebook most often in their troubleshooting conversations and turn to opera-tor message boards more frequently. Since operators typically play a much larger role in hosting Android troubleshooting conversations, MNOs may have much greater potential to shape a positive customer experi-ence. In doing this, however, they must balance the additional pressure that this could place on their cus-tomer service resources. Android owners also appear to exhibit lower levels of loyalty to handset OEMs as infor-mation sources as well as a willingness to explore widely for information they can use.

Interestingly, the difference between closed and open platforms seems to extend to problem resolution, too. Apple users report much greater frequency of handset replacement than Android consumers, who often report that their handsets are more likely to be repaired. This difference in customer experience opens up yet another opportunity for operators to differentiate their service to consumers through their smartphone repair and replacement policies.

Resolving the troubleshooting challenge

The user insights observed have clear implications for MNOs and other players across the entire value chain.

30

31

Philipp Nattermannis a Principal in McKinsey’s London office.philipp_nattermann@mckinsey.com

Jay Scanlanis an Associate Principal in McKinsey’s London office. jay_scanlan@mckinsey.com

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Troubleshooting mobile apps: Insights from social media buzz

using different handset/OS version combinations, and closely monitor and test their apps on new OS updates in both closed and open ecosystems.

Software platform and app store providers. Providers in these areas could create greater capabilities for veri-fying an app’s compatibility prior to its download and installation, and consider building device-specific app stores or virtual store-in-store touch points. They could also consider tightening the requirements for hardware and OS version control to reduce ecosystem complexity and deliver a more streamlined user experience.

Indirect channel players. These retailers and other sales points should consider introducing differentiated service on device repairs or replacements. Establishing a “walk out working” policy would enhance customer experience at the point of sale.

There also appears to be latitude for greater service and performance differentiation for many players in open

platform ecosystems. If a player were to implement a rigorous testing and certification process for app devel-opers, essentially guaranteeing the stability of the apps in its app store, this would both reduce the challenges of open ecosystems and enhance the strong consumer and developer benefits of open platforms.

This McKinsey/NM Incite research is unique in that it provides the first clear view of user and developer needs along with current experience levels surround-ing mobile apps. Showing that mobile apps have very real impact on the physical world across retail distribu-tion, customer care centers, and repair processes, it goes beyond this to illustrate the emergence of distinct best practices across the end-to-end user experience journey. While the perfect solution may not yet exist, all players can – and should – learn from each other and from candid user remarks as they pursue precisely this objective.

33

04

The number of Web-based applications and services has skyrocketed, facilitating everything from social net-working to on-the-go video entertainment. Total access, however, has been limited, since this content (and the application stores that sell it) is tethered to a particular operating system. Web centricity is positioned to change all of this, opening up a new frontier to developers and consumers alike.

Cloud computing is often thought of as an enterprise play. In reality, the cloud represents a material change in the world of consumer media and telecoms – with con-tent and services stored in the “Webosphere” and easily accessed via a variety of devices. Thanks to significant network, server, and content delivery network (CDN) investments, the infrastructure is already in place. Today’s applications, however, do not run on open and standardized cross-platform technologies, posing the biggest challenge to seamless functionality. This barrier limits distribution opportunities, increases costs for developers, and hinders seamless multiscreen experi-ences for consumers. With mobile devices in particular, consumers are forced to commit to a specific technology such as the Android, iOS, or BlackBerry OS to enable them to access and use Internet content and services.

All this is about to change. The next generation of browsers and HTML – the programming standard that fueled the Internet – are delivering multiscreen appli-cations through device-independent interfacing and processing. In this world of “Web centricity,” consum-ers will have a choice of application stores that deliver seamless multiscreen experiences through browsers and Web applications. Simultaneously, content owners

and developers will be able to distribute their content and applications globally through multiple stores, while leveraging scale from standardized Web technologies.

The pace of evolution

Web centricity will arrive fast, but this does not mean that native applications will be fully replaced by Web applications. Native applications will coexist where higher performance and deeper device integration is required. McKinsey analysis indicates that over 50 per-cent of all smartphone applications can be Web-centric within the next three to four years (Exhibit 1). Three realities are accelerating the arrival of Web centricity.

Driver 1: Mobile devices are driving adoption. Mobile devices, smartphones, and especially tablets are playing a critical role in accelerating the adoption of HTML5-based Web applications. These will be deployed to mobile devices faster than to PCs due to shorter replace-ment cycles. Moreover, mobile devices show far less browser segmentation, easing standardization efforts. Finally, battery constraints make some technical advan-tages of HTML5 (e.g., more efficient video rendering) more relevant for mobile devices than for PCs.

Driver 2: HTML5 means more Web browsing. Smartphone users spend 47 percent of their time talk-ing; 75 percent of the remaining time is spent on rela-tively “simple” applications, such as e-mail, social net-working, and – once new technologies to enhance Web application quality have become widespread – video that can be easily delivered via browsers (see table). Facebook (where people spend the most time per day),

Cloud cover: Web centricity grants total access

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Cloud cover: Web centricity grants total access

34

01 Web applications will grow to account for up to 53% of total mobile application space within the next three to four yearsPropensity of Web vs. native application to be developed

SOURCE: McKinsey

Performancepreference

Business model preference

NativeWeb

Web

Native

Finance

News

Reference

Social networking

Sports

Weather

Lifestyle Medical

Travel

Productivity

Casual gaming Education

Health/fitness

Hard-core gaming

Business Photography Utilities

Books Navigation Entertainment Music

Web applications will grow to account for over 50% of total mobile application space within the next three to four years

for example, is emphasizing Web-centric usage of its site rather than introducing new native applications. It does not even have an application for iPads and is pushing its “touch.facebook.com” site for mobile users instead.

Driver 3: Industry leaders support Web centricity. Google, Apple, and Facebook are committed to accel-erating HTML5 adoption as the open standard for the Web. From a competitive perspective, operators and multidevice OEMs also support Web centricity, view-ing it as a means to counter Apple’s dominance in the application store game (Exhibit 2). Consequently, all major browser producers support the HTML5 standard. Apple’s Steve Jobs is an outspoken fan of its potential to provide a much smoother Internet experience. Google’s new Chrome operating system is a bet that the new stan-dards will provide users with 100 percent of their com-puting experience via Web browsers. The latest versions of Internet Explorer and Firefox also support HTML5.

While developments are encouraging, three potential barriers could still slow progress:

Challenge 1: Delayed standardization. Although many HTML5 features have been agreed upon, it may take some time to finalize all functionalities, particularly those related to the hardware access components.

Challenge 2: Incomplete/inconsistent implementation. Full compatibility with standards may also take time, and variances across implementation efforts may occur.

Challenge 3: Security and IP concerns. Consensus has yet to be reached on critical aspects such as digital rights management and source code protection.

Signs are apparent that the industry is willing to over-come these barriers. Despite delayed standardization, a de facto working subset is emerging. Even Microsoft’s latest Internet Explorer 9 browser, for example, is touted (with some controversy) to have the most support from HTML5 based on a recent study by the Worldwide Web Consortium. Concerning security, previous experi-ence with new platform launches shows that issues do indeed arise, but their effects are mitigated by solution vendors over time.

A revolution in the making

No matter how quickly Web centricity develops, it will have profound implications for the consumer experi-ence and industry players. Today, many consumers mul-titask on PCs as they watch television. With Web cen-tricity, these devices will be connected via the cloud, run a consistent user interface, and interact with each other.

35RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Cloud cover: Web centricity grants total access

In the Web-centric world, consumers will have multi-screen experiences, able to browse, program, and man-age their television viewing with their tablets or smart-phones. Users could then vote on TV programming, get recommendations for shows similar to those they enjoy, and use “pause and play” functionality across devices.

Web centricity will also revolutionize the TV experi-ence itself. With all sorts of Web applications available, TV’s role will expand from “linear content provision” to a gateway for home entertainment and management. Many Web applications – such as videoconferencing and remote healthcare – will be available via TV. Beyond this, the cloud will deliver a rich set of leisure games to the television, eliminating the need to purchase addi-tional hardware. This could disrupt the industry value chain, since game developers currently pay up to 40 to 45 percent of their revenues to game platform/console providers for distribution and licensing.

The role of the device itself will also be vastly different in a Web-centric world. Consumer information collected and stored in the cloud can easily be transferred to any device that runs a compatible browser. This will make all devices “smart,” allowing smarter content creation, presentation, and personalization. Consumers will no

longer need to enter the same information (identity, billing, and preferences) on every device they use. Personalized and targeted content and applications will be available across tablets, smartphones, PCs, and TVs, delivering simple and relevant experiences to users.

Finally, Web centricity will fuel digital advertising based on audience scale across devices and advanced targeting and measurement capabilities. Current plat-form fragmentation and a lack of “prime” inventory limit growth in digital advertising, particularly display advertising. Proliferation of mobile devices – tablets in particular– with standardized browser-based delivery promises greater inventory variety with the ability to reach consumers in unprecedented scale as they view TV. Providing advanced advertising features like tar-geting, versioning, and measurement, Web centricity opens up new avenues of growth in digital advertising.

All these implications combined point toward new power dynamics in the value chain. Web stores will lib-erate distribution, and content will be available every-where. This means that content and application own-ers will receive 100 percent of the revenues. This new “digital freedom” will also lead to increased demand for bandwidth across all platforms, elevating the impor-

Browser-based activities already account for 75% of non-voice time

Activity on phone

Time spent on activity (indexed)

% Future delivery method (expected)

Voice total 100 47Messaging/chat 14.9 7 BrowserMusic download 12.1 6 BrowserE-mail 11.3 5 BrowserViewing photos 10.4 5 BrowserSocial networking 9.4 4 BrowserOther sites 8.9 4 BrowserWatching videos 6.4 3 BrowserStreaming music 6.2 3 BrowserTwitter 7.1 3 BrowserBrowser total 40 (75% of non-voice)Video games 9.6 4 NativeRecording videos 6.0 3 NativeEditing documents 4.0 2 NativeEditing videos 4.3 2 NativeOther apps 4.6 2 Native

Native total 13 (25% of non-voice)

Users of smartphones spend 47% of their time talking on the phone

40% of the time is spent on activities that can be deliv-ered by the browser when new technologies (such as HTML5) enhance Web app functionalities

Time spent on native applications will be limited to 13% of total time spent on phones as Web apps replace native apps

36

Mobile and PC browsers are competitively implementing the current working draft of HTML5 to challenge Apple’s top spotHTML5 support evaluation score1

Points (out of 300), Sep 2010

0

PC

Mobile

IE Opera Firefox Safari Chrome

v7 Mini 5.1 Mob 10 v1.0 v2.1 v2.2 v4 v5v6

IE Opera Firefox Safari Chrome

v9 v10.5 v11 v4.0 v4 v5 v5 v7v8 v3.6

SOURCE: html5test.com; literature search; McKinsey

1 Browsers are given a weighted score based on their support for features defined in working subset of HTML5 as of July 2010

n/a

145125

27

176185139

5712

197

129139129

32

248208

235223

80

All browsers are increasing their support of HTML5 in new versions

Mobile browsers are not far behind PC browsers in terms of HTML5 support

Apple and Google are lead-ing the industry in HTML5implementation

02

tance of quality of service and associated delivery sys-tems like CDNs. Web centricity will create a world where the power shifts from operating systems to browsers, with greater importance placed on user experience, per-mission, and information.

The road ahead for mobile players

The new frontier of Web-based applications and servic-es holds an array of benefits for consumers. For industry players, however, the implications are quite nuanced and not without challenges.

Software developers have the opportunity to adjust to a new, open world that combines a broader, freewheel-ing marketplace with lower development costs. Rather than seeing 70 to 80 percent of the proceeds of applica-tion sales go to app store owners, they will keep 90 to 100 percent of revenues – standard practice on the mainstream Web. Beyond this greater opportunity to sell entrepreneurial applications to consumers, larger software players will have the potential to sell fully mobile and device-independent versions of major enter-prise programs. This means, for example, that corporate IT departments could implement a single e-mail service that works on any platform from iPhones to Android to BlackBerry devices.

The flip side of these opportunities, however, is the chal-lenge of identifying new revenue streams. Web centric-ity promises to lower the barriers to entry and introduce more intense competition. Thus, developers may find that their business model for the mobile Internet relies more heavily on advertising support and other moneti-zation opportunities, such as virtual goods, rather than on application purchases.

Telecoms operators face a double-edged sword. On the one hand, Web centricity promises a further explosion in mobile Internet traffic, causing these players to make significant investments to expand their networks. And while operators would ideally seek to raise prices to recoup that cost, the fact that consumers will increas-ingly view operators as interchangeable means price wars are likely. On the other hand, operators can them-selves set up Web stores, loosening the grip of current native application stores (e.g., Android Marketplace, Apple App Store). We are already seeing examples of this: operators are currently working to set up a global “wholesale application store” – one that allows users to download HTML5-based Web applications across more than 24 operators.

Content providers will benefit from the transition in three ways. First, Web centricity will increase content

Mobile and PC browsers are competitively implementing the current working draft of HTML5 to challenge Apple’s top spot

37

consumption, encircling consumers by offering relevant content with every device interaction. Second, Web cen-tricity will soften the distribution monopoly and bring a greater revenue share to content owners. Movie studios will supply content to a variety of aggregators, one of these being iTunes. Third, it will improve profitability. Media companies can access a wider audience across devices, with lower production costs. Production and distribution efficiency will allow news and magazine companies to create content once and deliver it across devices seamlessly.

Device makers will also get a mixed bag of changes from Web centricity. Although it will reduce the likelihood of one single player owning and controlling an ecosystem of developers, this development threatens to further commoditize the hardware industry. Most smartphone and tablet makers would be less pleased with a PC-like outlook for the industry. The shift does, however, cre-ate opportunities for device makers to better and more easily integrate the software and hardware experiences both within and across their devices. Hardware makers can just as easily develop compelling cross-device

applications and partner with cloud players to create a seamless experience (e.g., working with gaming com-panies to create exclusive content that works only on their devices). They can accelerate the push to create cross-device sync and storage capabilities. Some control would also be theirs (along with operators) in deciding on the default set of Web-centric services and applica-tions to embed on the device.

Web centricity is likely to be the next major discontinu-ity for the Internet, yielding new winners and losers across the value chain. For users, the Internet experi-ence will lose none of its momentum, becoming more open, complex, and dynamic. Companies directly involved as well as those indirectly affected will need to prepare themselves for this next Web-centric revolu-tion, while anticipating the changes it will bring.

The authors would like to thank Chandra Gnanasambandam, Jay Jubas, and Nathan Marston for their significant contributions to this article.

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Cloud cover: Web centricity grants total access

Ickjin Parkis an Associate Principal in McKinsey’s Seoul office. ickjin_park@mckinsey.com

Richard Leeis a Principal in McKinsey’s Seoul office. richard_lee@mckinsey.com

Bengi Korkmazis an Associate Principal in McKinsey’s Istanbul office. bengi_korkmaz@mckinsey.com

39

05

Telecommunications, media, and technology (TMT) has been a consumer companion since the television gained popularity over 50 years ago. Today, this relationship is only getting stronger and more nuanced. Those opera-tors who can anticipate the innovations in technology and understand the consumer desires fueling them will be best positioned to succeed.

No industry has managed to permeate people’s lives to the extent TMT has done. In 1960, the average American dedicated 6.7 hours per day to TMT activities, including watching television, listening to the radio, and using the phone. With the proliferation of television networks, the emergence of the personal computer, and the rise of gaming, per capita time spent engaged in TMT activities had climbed to 8.3 hours per day by the year 2000.

This pace accelerated dramatically during the past decade, with the widespread adoption of mobile phones and much heavier Internet usage. Since 2000, the annu-al growth of TMT-dedicated time has tripled, pushing its daily hours to 9.4 in 2009 – or 59 percent of the aver-age American’s waking hours (Exhibit 1). The average consumer day has become TMT-crowded, especially in the categories of leisure and housekeeping, which are already over 70 percent TMT-permeated.

The next phase in TMT

A look into the technological innovations already in the pipeline hints at what could be the next wave of TMT growth. Four key themes point to a technology-driven revolution in the way we interact with our environ-ment – whether physical or virtual (Exhibit 2).

Technology as an extension of our senses and brains. Technology will complement our natural senses, pro-viding a richer experience in our day-to-day lives. As an example, in 2009, MIT Media Lab released Ted, a USD 350 augmented reality prototype that shares information with the objects and people one interacts with. This portable device is able to recognize a friend’s face on the street and let the user know his latest post on Facebook, read a boarding pass in the cab and warn the passenger of a delay, or provide customized infor-mation on products in the supermarket.

The University of Arizona developed a new material in November 2010 to record and display real-time holo-grams – allowing virtual reality to become part of our daily life. We may not be far from being able to host our favorite action hero at home for a cup of tea.

In a step toward removing barriers and bringing con-sumers closer to their devices, Israel-based PrimeSense is already providing technology that captures body movement. This is making the consumer the actual interface with, for instance, a TV set or video game with-out needing a handheld remote control anymore.

Technology also complements our brains. IBM’s advanced answer-generating machine Watson – able to “understand the nuances of ‘natural language’ that humans use every day” – defeated human competitors on the popular TV show Jeopardy in February 2011. Right after that, the company announced a deal to com-mercialize Watson’s capabilities by developing a system to help doctors and nurses in diagnostics – the first of many applications to come according to IBM.

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Complete TMT immersion: Implications for consumers and industry

Complete TMT immersion: Im pli cations for consumers and industry

40

01

SOURCE: University of California, How Much Information? 2009 Report on American Consumers; US Bureau of Labor Statistics; iConsumer 2009; McKinsey

Daily hours(excluding double counting)

TMT is occupying more and more of consumer waking hours

Absolute TMT hours and percent of 16 waking hours1

1 TMT hours include every waking hour that the average American spends engaged with/exposed to newspapers, radio, music (online and offline), TV, computer (online and offline), games, and (smart)phone (mobile and landline) – e.g., it includes the time people spend driving a car while listening to the radio. Double counting has been excluded, e.g., 1 hour watching TV while browsing with the iPad accounts only for 1 hour

1960 2000 2009

Gaming

Mobile phones, Internet

PCs

TV, telephone, radio

6.7

8.3

9.4

59%

52%

42%

0.5%

1.4%

Annual growth rates

Technology to enhance our social lives. Another step toward connectedness and away from passive informa-tion and entertainment is evident in data on Google searches. The term “Facebook” has surpassed “news” and “sex” combined in search frequency. In response to this consumer desire to connect with each other, signifi-cant R&D investments are being made in the social net-working sphere. Innovation is directed toward enhanc-ing their functionality but also toward leveraging social networks in adjacent activities, such as increasing the relevance of Web searches.

To help consumers stay in the “social loop,” Google launched its Google Realtime Search homepage in August 2010. This function gives its users up-to-the-second social updates from Twitter, Facebook, and Google Buzz as well as news articles and blog posts about hot topics around the world. And to transform what has traditionally been a non-social activity (albeit often in the company of others), MIT partnered with BT in June 2010 to develop commercial applications for a concept that allows TV viewers to interact with friends and family without displaying on-screen messages.

Technology to enhance or create new devices. Enhancing device capabilities has been an area of intense innovation, and the recent success of new

objects such as the iPad is further fueling the efforts. Technology innovations for devices have traditionally revolved around enhancing design capabilities (new materials), increasing battery life, making objects smarter and quicker, and improving display and sound quality. Recent trends, however, involve adding TMT functions to everyday objects and activities.

One example of this increased functionality is Sony’s unveiling of a rollable screen in May 2010 that can wrap around a pencil – and is thinner than a human hair. Imagine a screen that could be folded and carried in a wallet. Just one month later, Fujitsu announced the development of a wireless charging technology that would allow for the creation of “recharge hot spots,” where users could recharge a device by just passing by. And in November 2010, European operators went up in arms against Apple’s plans to integrate soft SIMs into iPhones, thus allowing for a seamless switch of operator.

Technology to boost network capacity. To take advan-tage of an increasing number of smarter, always-on devices that enhance our personal and professional lives, technology innovation is also focusing on increas-ing network capacity everywhere at minimal cost. In the near future, significant Wi-Fi improvements such as Wi-Fi Direct or enhanced Wi-Fi (802.11n) will comple-

TMT is occupying more and more of consumer waking hours

41

02Technology ...

… as an extension of our senses and brains … that connects us socially … to enhance or create new devices

Technology to boost network capacity

TMT innovations are myriad, but fall into four distinct categories

Augmented reality software/hardware

Speech recognition

Image recognition

Motion recognition

Real-time holograms

Machine learning (IBM Watson)

3-D TV without glasses

Surround vision device

Video glasses

Real-time search

Social TV

Social networking analysis

– Digital aura

– Preference networks

Computing languages for cloud

Flexible electronics

Memristor

Hot spot wireless battery charger

Interactive projector

Brain-machine interaction

All-in-one smartphone

Morph concept

Soft SIM/Google voice number

Enhanced Wi-Fi (802.11n)

Wi-Fi Direct

Software-defined networking

DSA (soft radio)

SOURCE: McKinsey

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Complete TMT immersion: Implications for consumers and industry

ment long-term evolution by reducing the burden on mobile networks. Unlike today’s Bluetooth technol-ogy, Wi-Fi Direct will enable the exchange of large data quantities at very high speeds and over longer distances (up to 100 meters). And, with the enhanced Wi-Fi stan-dard 802.11n, consumers will enjoy improved signal quality, more reliable connections, optimized band-width, increased battery life from lower energy con-sumption, and tighter security.

TMT and the consumer of the future

If only a fraction of the innovations currently in the pipeline successfully hit the market, this would sig-nificantly affect the life of the average consumer. One likely change would be the way we experience media. The convergence of connected TV, social media, and new portable devices – providing a customer experience close to that of large-screen TV – could accelerate audi-ence fragmentation and the transition away from the traditional linear TV model. People will watch programs whenever and whereever they want on any screen they choose based on recommendations from friends, public votes, or preestablished preferences. Even live events, which will continue to draw large audiences, could be recomposed – for instance, watching soccer on TV with live commentary from a user’s preferred radio station.

Aside from enhancing current TMT activities, innova-tion will begin to introduce TMT into new domains of our lives. As new objects become connected – and with the pervasiveness of technologies such as holograms, 3-D, and geo-localization – TMT will likely touch parts of our lives exempt from technology today. It will spread throughout our homes, no longer confined to the living room but making housekeeping and other household activities simpler. It will also significantly enrich our lives while on-the-go by providing us, for example, with discounts for shops as we pass by.

At the office, smarter and less expensive devices with simpler, intuitive interfaces along with portable applica-tions will increase our productivity. For instance, many corporations are already starting to equip field sales forces with tablets to achieve precisely this.

Finally, the way we think about privacy and security will likely change. While consumers today certainly talk about these issues, research has shown that con-sumers do relatively little to mitigate privacy- and security-related risks. As social networks continue to expand their footprint and as information continues to be instantaneously shared and broadcast across various private and public networks, this incongruence between stated concern and action may very well change. The

TMT innovations are myriad, but fall into four distinct categories

42

Unconnected TV

Connected TV

Gaming online

Social networks

Internet browsing

Voice, offline radio,gaming, and PC

Interactive

Potentiallyinteractive

Linear/offline

A greater share of consumer TMT time will be interactive

TMT time, percent

31

20

13

2009

60%

11

23

8

1 2

15

2000 2015

65%

8

16

3

9

16

000

53%

2

AVERAGE CONSUMERSOURCE: McKinsey

03

mendations. Those interfaces are yet to be invented; but when they arrive, the potential to monetize should be significant. On the other side, traditional players – such as television networks – need to watch for these changes and decide if and how to influence policymakers to avoid the complete dismantling of their models.

Over-the-top (OTT) TV will increasingly challenge the relevance of other technology platforms, such as IPTV. These same developments should lead telecoms operators to, in some cases, reconsider deploying IPTV. Benefiting from better interfaces and from high-speed networks, OTT TV will indeed be increasingly competi-tive versus the more costly IPTV. Players should review options based on the competition landscape and current platforms in place.

TMT pervasiveness will create new growth opportuni-ties, particularly for players seeking industry-specific applications. As TMT further penetrates our homes, offices, and cars, the ability to monetize traffic becomes more important. A player’s ability to sell or codevelop integrated solutions to partners (B2B) or to the end user (B2C) will be a key driver of their profitability trajec-tory. Telecoms operators should develop a clear perspec-tive on traffic monetization – including machine-to-machine – with a view on customer and network profit-

consumer’s need for greater privacy protection and enhanced security could finally prevail. In any scenario, we expect both the time dedicated to TMT and its economic utility for consumers and enter-prises to materially increase (Exhibit 3). Even in conser-vative scenarios, the traffic on networks will explode. The patterns, however, differ significantly from what we have seen in the past: more interactive, more on-the-go (increasing four times faster than overall traffic), more on public networks, and with a much higher share origi-nated by objects (cars, identity documents) than today.

What are the implications for TMT players?

Each of the scenarios described will create significant business opportunities for players. At the same time – as always in times of rapid changes – the ability to antic-ipate will distinguish winners from losers. Here are only a few of the opportunities that we foresee:

Interactive, personalized media consumption will cre-ate a new role for content aggregation. Be it for TV, print, or radio, one can foresee the development of interfaces through which users will be able to customize their media consumption and set their preferences or let friends and/or software make real-time content recom-

A greater share of consumer TMT time will be interactive

43RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Complete TMT immersion: Implications for consumers and industry

ability, classes of services, and the billing requirements to capture all opportunities. At the same time, players should also think of “vertical” strategies and partner-ships in select domains if they want to be in a position to monetize more than pure connectivity.

The need for better privacy protection and security can create a large market. The ubiquity of social networks and their increasing importance in our lives will inevi-tably create, in parallel, a need for better control over and filtering of the information we send and receive. At the same time – as content becomes more and more dematerialized and private and public content get mixed – the need for security will increase as well.

These likely trends create the opportunity to invent an entirely new class of services, yet they also command players to develop customer strategies that address needs that are still ill-defined today.

TMT innovations are meeting (and perhaps driving) the desire to shift from passive, isolated telecoms and media consumption to active, social participation. This massive redirection brings an array of opportunities and warnings for operators. Those who are best able to anticipate, adapt, and innovate will find themselves on the winning side of the equation.

Cristina San Joseis an Associate Principal in McKinsey’s Madrid office. cristina_san_jose@mckinsey.com

Jean-Hubert Lenotteis a Principal in McKinsey’s Paris office. jean-hubert_lenotte@mckinsey.com

45

06

Conventional wisdom states that the value of free online services is diminished by consumer frustration with advertising disturbance and the threat of privacy violation. New research, however, demonstrates that the benefits far outweigh the downsides – and that the industry is on the right track in recognizing the value of advertising-based online applications.

Internet users have rapidly adopted a host of ad-based services. The various communications, entertain-ment, and information benefits to consumers are clear. Counterbalancing this value, however, is growing consumer concern over the disturbances and result-ing annoyance that go hand in hand with advertising. Specifically, to what degree is consumer value eroded by advertising intrusion and the risk of privacy abuse? At the request of IAB Europe, McKinsey set out to answer this question and determine the consumer sur-plus in ad-based online services – meaning the value to the consumer minus the associated disturbance costs.

The rise of value; the rise of annoyance

Internet penetration and use have been no less than impressive, creating a major multibillion dollar econ-omy. At the same time, the debate on privacy concerns has intensified because the Internet is largely financed by advertising formats such as ad banners and pop-ups, and because the Web makes it easy to search, compile, combine, and compare information.

Web applications have also grown explosively. Users enjoy a wide variety of online services, from e-mail and browsing to information services and search engines,

or collaborative services such as wikis, blogs, and social networks. The diversity of supply has increased dramatically as well with the rise of third-party virtual application stores on key Web platforms. For example, Facebook claimed 550,000 applications as of June 2010, and the iPhone hosted more than 225,000 applica-tions as of the same date. Still, these innovations must be financed. The Internet economy – comprising full infrastructure (routers, servers, etc.) and last-mile broadband access along with Web-based services and B2B/B2C e-commerce – is estimated to have generated USD 1.7 billion in revenues (USD 120 billion in value-added worth) in the US up to 2007.

Internet access is charged directly to users, with broad-band households in OECD countries paying roughly EUR 30 per month for an average access speed of 5 Mbps. The majority of Internet applications and services, in contrast, are offered at no additional cost. Instead, they are financed by Web advertising, which generated approximately EUR 16 billion in the US and about EUR 15 billion in IAB Europe countries annu-ally up to the end of 2009. This is roughly equivalent to EUR 10 and EUR 15 per broadband household per month in European countries and the US respective ly – or only a fraction of current access revenues.

The right to privacy and limited ad disturbance is noth-ing new. In the US, for example, the FTC reported in 2005 that over 100 million phone numbers were regis-tered for the “do not call” option. In Europe, laws define the maximum minutes of advertising interruption allowed in television programs. The Internet, however, poses a broader and more recent cause for concern. In

Pop-ups, privacy, and price: Consumer value and ad-based online services

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Pop-ups, privacy, and price: Consumer value and ad-based online services

46

EUR billions

Internet consumer surplus will continue to grow at around 13% per year, reaching EUR 190 billion by 2015

1 Includes Web tool platform for the following services: e-mail, instant messaging, social networks, search engines, comparisons, Web mapping, directories, yellow tapes, blogs, wikis

CAGR2010 - 15Percent

Total value in the US and IAB Europe countries, 2015

Mobile services value

OTT TV value

Total dial-up user value1

Total value growth for broadband apps

Total value in the US and IAB Europe countries, 2010

Growth

13

-8

43

24

13190

14

14

-3

65

100

SOURCE: McKinsey

01 Internet consumer surplus will continue to grow at around 13% per year, reaching EUR 190 billion by 2015

this medium, disturbances go beyond advertising and the general risks associated with collecting personal information. They can range from nuisances such as self-promotion on social ranking forms to very annoy-ing masses of spam and even to criminal activities like identity theft and credit card fraud. Cases of privacy ten-sion abound as well. One example is Facebook’s recent privacy glitches. The result was an either-or option for users: they are now forced to choose between making information about their interests available to everyone or removing it altogether. Indeed, privacy pushback has been palpable for more than a decade now, as seen in Yahoo! dropping the reverse telephone number search from its site in response to consumer anger.

Issues surrounding the topic of disturbances have also given rise to various self-regulation mechanisms, such as the increased use of pop-up blockers on the part of consumers. Web site operators also adopt seals of approval and offer users the chance to opt out. While consumers are voicing their concern, it remains diffi-cult to assess the actual value that consumers attach to privacy and data protection. The reason behind this is that the fears being voiced explicitly are not necessarily congruent with actual behavior on the Web. Despite the concerns they express, many consumers still seem to take relatively few risk-mitigating actions.

Calculating the value

Intuitively, it is difficult to assess whether the value of Web services should be higher or lower than the adver-tising revenues generated by Web application service providers. Access prices might be sufficiently high and exhaust consumer willingness to pay for Internet ser-vices. Still, growth in Web usage and innovations are passed on to users in the form of faster connections and new forms of access. Coupled with the continual flurry and diversity of long-tail applications, access to Web services – even for a fee – becomes an unbeatable deal for users. Only empirical evidence can tip the scales in favor of one of these opposing positions.

The objective of McKinsey’s primary research was to establish a robust estimate of the value underlying both Internet usage and protection against advertising over-load and data privacy issues, defined here as “distur-bance risk.” Methodologically, we sought to address the drawbacks in earlier research, which include the focus on only a narrow set of Internet services plus a rather pronounced US-centric approach.

To measure both the value of usage and the value of the disturbance risk associated with Internet services, we collected data on a broadband user sample from six

47RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Pop-ups, privacy, and price: Consumer value and ad-based online services

major countries: France, Germany, the UK, Russia, Spain, and the US. The sample was cleaned for data inconsistencies to generate a final working sample that is statistically representative of the online population. Furthermore, a comprehensive set of 16 online services was assessed – from e-mail, social networks, gambling, and gaming to search engines, wikis, maps, directories, and video/music.

Conjoint analysis allowed for an assessment of the trade-offs between the value of various service clusters (communication, entertainment, and information), the risk of disturbance (advertising overload and data pri-vacy), and the price attached to the services used. This derived methodology accurately measures the price elasticity of these different elements.

The true value: Key findings

The research findings provide a solid basis for the idea that the consumer surplus from ad-funded online services is around EUR 100 billion each year for IAB Europe and the US – and this surplus is growing rapidly (Exhibit 1). This ecosystem works well for the majority of Internet users, with privacy issues amounting to only a fraction of the total surplus generated. In other words, current ad-financed services generate significant value

for the average Internet user, being an order of magni-tude higher than what the same user would be willing to pay for eliminating the related disturbance of advertis-ing and privacy issues.

The aggregate picture confirms previous research find-ings that the consumer’s net benefit from using the Web is significant. If those messages were implicit at best and highly disparate with secondary research, they now emerge consistently under one robust, up-to-date meth-odology applied to a much broader set of countries and online applications. The three key findings stemming from the research are that consumer surplus is major, that consumers value free services, and that consumers value usage over disturbance protection.

Consumer surplus is major. The research examined consumer willingness to pay for services they currently receive free of charge, generating an estimate of the monthly amount at EUR 38. Scaling this to both the 23 IAB Europe countries and the US for the year 2010, the resulting conjoint-based consumer value from using online services is estimated at EUR 150 billion. Around 90 percent of this service value is currently concen-trated on the PC platform with other platforms such as mobile and Internet TV only now beginning to emerge to any significant extent.

Web services

Free services Paid services

Two-thirds of the total Internet surplus is captured by consumers

Paid servicesAdvertisingConsumers Providers

Web access

Consumers Providers

Total Internet surplus

Consumers Providers

SOURCE: McKinsey

EUR billions, 2010

120 30 30 120120

3020 22 70100

100% = 190 billion0 8100

30

18

12 5020Surplus

Implicit costs

Total

ServiceAccess

Access

Service

11

52

26

11

02 Two-thirds of the total Internet surplus is captured by consumers

48

Consumer surplus is concentrated on free services, with the top 4 representing over 50% of total value

Blogs Yellow paper

Wikis

Directories Web mapping Comparison Search engines

Internet phone Instant messaging E-mail

Social networks

Surplus

Communication

Entertainment

Information

Percent of total

Podcasts/content readingAdvanced updated services Videos Music Games/gambling

1610711

34433

15452434

52

SOURCE: McKinsey

EUR per month

0.60.8

0.80.5

1.10.8

3.1

2.21.4

2.13.2

0.8

0.7

0.90.7

0.6

Consumer surplus is concentrated on free services, with the top 4 representing over 50% of total value03

model for consumers. While all services contribute to consumer surplus, the greatest contributors to date are e-mail, social networks, and instant messaging (com-munication-based services) along with search engines (information-based services). Together, these account for over 50 percent of the consumer surplus (Exhibit 3).

Beyond this, the research emphasizes that the three most valuable services affecting consumer surplus also consistently appear as top contributors across coun-tries. The greatest differences, however, can be found within countries. Those 40 percent of Internet users who generate the greatest value can be further broken down into five clusters:

� Premium entertainment (1 percent of total market). These urban users place much higher value on enter-tainment services (i.e., TV, videos, and music).

� Premium information (2 percent of total market). 65 percent of this educated segment’s total surplus value comes from using search engines and map/route planning services.

� Premium communication (4 percent of total mar-ket). Members of this segment lean toward being young, urban, and female; they particularly value

To get from this overall consumer value to the surplus (value minus costs), two other costs were calculated. First, the value of protection against disturbance was estimated at EUR 20 billion. Second, the value of ser vices for which consumers currently pay is about EUR 30 billion. This brings the actual consumer sur-plus from ad-funded Internet services to EUR 100 bil-lion – the value over and above costs incurred by online users in 2010 within the US and IAB Europe countries alone. In contrast, the provider surplus from delivering those services is estimated at EUR 20 billion for 2010 (Exhibit 2). This means that consumers to date have captured almost 85 percent of the total surplus linked to Web services – a sharp contrast to the less than 30 per-cent of the total Web access surplus they have captured. McKinsey estimates that total provider revenues from online advertising was in the region of EUR 30 billion in 2010, with access revenues at EUR 120 billion. Weighing in at EUR 100 billion, the consumer surplus from Web services is almost as large as access revenues and more than three times the amount of online advertising rev-enues currently generated.

Consumers value free services. Free ad-funded services generate the bulk of consumer services surplus, high-lighting the significant value of the ad-based revenue

49RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Pop-ups, privacy, and price: Consumer value and ad-based online services

e-mail, social networks, and instant messaging (approximately 70 percent of the total surplus value).

� Complete Internet (7 percent of the total market). Consumers in this segment are “equal-opportunity” users, generating value equally from entertainment, information, and communication services.

� Traditionalists (26 percent of the total market). This segment represents the average profile and prefer-ences of remaining Internet users.

In general, younger, more affluent users tend to derive more value from the Web. This aspect is already widely known, generally referred to as the “digital divide.” The divide itself is not linked to disturbance risk, but more to the fact that other users do not value or use ad-based Web services as much – whether entertainment, infor-mation, or communication.

Consumers value usage over disturbance protection. Our research focused on two disturbance risks: the abuse of personal information and advertising intru-sion. Both genuinely bother users, who are willing to pay to avoid this nuisance. However, the price for protection is only a portion – about 16 percent – of total surplus, or EUR 20 billion in total. This makes it clear that hav-ing people pay to avoid the nuisances of advertising and information usage would not transfer a large amount of consumer surplus generated from ad-based Internet services to providers. Hence, caution is advised in order to avoid imposing too many restrictions on current ad services, given their high external impact and their dominant contribution to the Internet economy surplus.

At the household level, the price of protection is esti-mated to be about EUR 10 per month and is quite con-sistent among Internet users. The exception is a niche segment of 1 percent of the market that strongly values Internet services and simultaneously exhibits a very strong aversion to privacy breaches and advertising dis-turbance. More important, a sizeable share of Internet users (19 percent) derives as much value from the Web as it is bothered by disturbance risk. In essence, this segment is no more bothered by privacy issues than the market is overall. The real difference is: this segment also attributes relatively low value to Web services. Free services are the only way this group will continue to use the Web. This may suggest that one promising solu-tion for this segment is to harness the value of ad-based Web services. One approach would be to offer access to

higher bandwidth speed to enable those in this segment to enjoy online entertainment services.

Moving ahead

Our central finding is that user benefits from Web ser-vices are substantial – far greater than the advertising revenues from providing those services and much larger in scope than any disturbance linked to advertising and privacy issues. Scaling this finding to the existing broadband population of IAB Europe countries and the US, the estimated consumer service surplus lies around EUR 100 billion for 2010. This is more than tripple the current ad-based services revenues. In other words, online advertising revenues come nowhere near to equalizing the massive value that consumers derive from the online services they use.

Furthermore, while the majority of users do have con-cerns with advertising and privacy issues, the value they obtain from using Web services – separate from the value of access – is six times larger than the price they were willing to pay in 2010 to avoid such distur-bances and risks. In practical terms, for one euro that an Internet user would pay to limit privacy and advertising disturbance, they gain EUR 6 in value from current ad-funded Web application services.

While the aim of this research was never to prescribe the best revenue model for surplus maximization, the findings depict what is apparently a well-working ad-funded ecosystem. This calls for caution in any attempt to change it. In fact, replacing the current ad-funded model with a user-paid model to compensate for the associated revenue losses would cut user interest in half.

This body of research suggests that the current pay versus free mix is already in equilibrium. Paying cus-tomers, on the one hand, are also the ones that generate the greatest value from Internet use. In contrast to free-service-only users, they are willing to pay a hefty pre-mium (67 percent). Calculating this willingness-to-pay premium in euros per month suggests that it matches exactly what customers actually pay for services. This means they capture roughly the same consumer surplus that free-only users do, and that average paid service price points are at their maximum; only lower prices per service would increase the share of people paying for Internet services. Free services, on the other hand, generate the largest portion (80 percent) of total user surplus due to the sheer number of non-paying users.

50

Patricia Ferruz Aguilaris a Principal in McKinsey’s Madrid office. patricia_ferruz@mckinsey.com

Jacques Bughinis a Director in McKinsey’s Brussels office. jacques_bughin@mckinsey.com

The picture this new research paints is that today’s Internet consumer derives significant usage value from ad-funded Web applications – more than was previ-ously thought. In fact, advertising effectively financed a consumer surplus on the order of EUR 100 billion in 2010 in the US and in IAB Europe countries – and this figure is expected to grow at a double-digit rate. While disturbance from advertising interruption and fear of privacy misuse do exist and must be acknowledged, more than 80 percent of current Internet users generate significantly more value from using the Web than what they would be willing to pay to eliminate those distur-bances. Beyond this, what they would be willing to pay in total is less than current online advertising revenues. As a result, any potential focus on reducing disturbance should be weighed against the risk of reducing ad-fund-ed user innovations on the Internet.

53

Looking at the numbers, OTT video remains a relatively small sliver of the global media market. Even in the US – probably the most advanced market today – consumer OTT video revenues account for only around 2 percent of the combined approximately USD 100 billion in annual consumer media spend. Similarly, the online video advertising market is only a fraction of the tradi-tional advertising market for broadcast television. The only strong case for commercial success is Netflix, with its current USD 2.2 billion in revenues for physical and digital video distribution and more than 20 million sub-scribers. The question on everyone’s mind is whether this is all simply another wave of hype similar to that accompanying e-commerce in the late 1990s or 3G in 2001 that will take some five to ten years to materialize.

However, the critical mass of product launches, an-nouncements, and counterannouncements that go hand in hand with any bona fide tech craze is unmistak-able. This year’s Consumer Electronics Show (CES) in Las Vegas revolved around OTT video and tablets. Even Apple and Google are already making substantial moves and noise in this space. The underlying factors that will determine market adoption indicate a good chance of OTT video becoming a mainstay of our living rooms. As with other trends in the online world, this could happen fast (Exhibit 1).

The technology is ready. Until very recently, bandwidth constraints limited the quality of online video, and streaming video services were largely restricted to viewing content on a PC. However, high-speed broad-band connections are becoming ubiquitous (about 60 percent of Western European households have a

Over-the-top (OTT) video – while still limited today – has the potential to cause significant shifts in the video ecosystem. Depending on their starting position, tele-communications, media, and technology (TMT) compa-nies should carefully evaluate whether and how to place a bet, reserve the right to play, or adopt a “wait-and-see” approach, while mitigating potential threats.

OTT video (see text box) is still a nascent business. However, the key elements for the rapid development of this market are already in place: readily available technology, growing user interest, and relevant industry players driving market evolution. These factors make OTT video a trend that any TMT company should track carefully. The opportunities and threats for different types of players vary significantly depending on their current position. The plethora of options on where and how to play in this market mean that the strategic landscape is highly complex. This makes it all the more crucial for companies to understand what position they should adopt in the OTT arena.

Still small, but all the ingredients to grow

Netflix originally started out as a streaming company, but really grew through their physical DVD distribution business. When they recently revealed that their over 20 million customers were now watching more content via their streaming platform than on DVDs shipped by the company, this was yet another indication of how rap-idly video consumption patterns are changing. For some pundits, it represented crossing the digital Rubicon; for others, it was simply another negligible chapter in the long history of frenzied techno hype.

Going over the top: Preparing for a streaming world

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Going over the top: Preparing for a streaming world

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54

broadband connection today, for example). Coupled with this, new devices like connected TVs or cheap, Wi-Fi-enabled set-top boxes are bridging the gap between the Internet and the television screen. This all means the potential markets for a consumer-convenient OTT video offering are increasing fast.

Consumer interest is growing. Many promising tech waves have been delayed by those cruel arbiters of the marketplace – consumers. Customers need a compel-ling offering to switch their media consumption habits and overcome their inertia. McKinsey’s proprietary iConsumer market research in the US and Europe with about 6,000 respondents per country reveals the incon-venience of the PC as the key reason for not watching online video for close to 50 percent of respondents. With a broad library of attractive long-form content (movies, TV shows) becoming available in a convenient format on the TV screen, this hurdle could disappear in the near future in many markets – as in the US, where over 20 million subscribers use Netflix services.

Core industry players are placing bets. Many relevant market players have started to reserve the right to play in OTT video by leveraging the opening video value chain. Growing investments and offerings by many players could further drive market evolution and growth. Heavyweights are investing in a starting position for OTT video. In consumer electronics, it is Apple TV along with connected TV sets manufactured

by Samsung and other OEMs. Online players include Google TV, for instance. Most major US studios show presence via Hulu, and the telecoms sector is seeing Telefónica position itself with Movistar Videoclub and British Telecom with BT Vision, among others. Even retailers have claimed a stake: Amazon recently took over full control of Lovefilm in Europe, offering a sig-nificant library to its prime US subscribers.

While these developments will not inevitably lead to the success of OTT video – a typical American over two years old still only watches 20 minutes of online video per week according to Nielsen’s Three Screen Report. Still, we believe that OTT video is a significant trend that could affect TMT companies to a considerable degree in the future.

Multiple strategic options and four potential business models

Whether to play in the OTT video market and, if so, where and how are complex questions to address. The decision for a TMT company to engage in OTT video depends on its starting position in the context of spe-cific market environments and trends. Are its current businesses threatened by new offerings? How fast is the local market developing? How big are the opportuni-ties, if any? TMT players frequently view OTT video as a sensitive topic, since such an offering could cannibal-ize current revenue pools (for pay-TV providers, for

What is “over-the-top” video?

From a technological standpoint, OTT video is the delivery of video content to a consumer device via an IP network connection (fixed, wireless, or mobile) without end-to-end quality control and assurance. It is defined as a counterpoint to other video distribution technologies such as IPTV, cable, DTH, or DTT, which actually control the broadcast and ensure end-to-end quality, whether or not they partly use IP networks for distribution.

From a business standpoint, OTT is video delivery to a consumer device via an Internet connection without the Internet service provider or network operator needing to become involved.

OTT video comes in a number of different flavors. Many of these formats will be familiar to most video consumers:

� YouTube and all other forms of browser-based video delivery (e.g., Hulu)

� Video delivery via Internet-connected TV sets (allowing access to services such as Netflix)

� Video delivery via dedicated devices connected to a TV set (such as video services on Xbox or PlayStation game consoles, Roku or Boxee video boxes, or connected Blu-ray players).

55RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Going over the top: Preparing for a streaming world

77

1

97

19

2

104

83

19

Global consumer spendUSD billions

1 Digital downloads and mobile TV2 Excluding box office spend3 Excluding PSB fees and other mandatory license fees

SOURCE: Veronis Suhler Stevenson; Digital Entertainment Group; McKinsey

Pay-TV subscription3

Physical video2

Online video1

20102009

OTT video is not quite here yet, but seems to be emerging quickly

Headlines from January and early February 2011

“Could this be the year we get to ditch the cable box?”

“Verizon FiOS TV service now offers ESPN channels over the Internet”

“Warner packages movies as iOS apps, starting with The Dark Knight and Inception”

“New Netflix Watch Instantly interface showing up on Samsung HDTVs”

“Netflix passes 20 million subscribers; focuses on ISP disputes, HBO, Facebook in Q4 results”

“Samsung’s HDTV-based app store passes two million downloads”

“Amazon agrees to buy UK movie streaming and rental service Lovefilm”

“Six major studios to distribute UltraViolet titles by mid year, hardware to come later”

OTT video is not quite here yet, but seems to be emerging quickly01

instance). It could also cast doubt on past investments (such as those in a telco’s IPTV services). Leeway for fact-based strategic discussion on the OTT video topic is often limited within TMT players due to differing inter-nal views on the prospects of success.

Many options are available in answer to the questions where and how to play. These lie along the dimensions of content, access device, and user interface alongside the aspired revenue model, while balancing advertising and consumer revenues (see table). Content sourcing represents a particularly complex issue in terms of busi-ness model, since current capabilities in this area are limited for many players. In addition, content rights are awarded on a country-by-country basis, with very dif-ferent price levels and monetization strategies. While the range of possible strategies for approaching the OTT video market is very broad, four consumer-facing busi-ness models are currently emerging.

Own device. The “own device” model involves selling a device to the customer that can be connected to the different OTT services. Most consumer electronics players have a presence in this arena (Samsung, Xbox, and Sony, to name just a few), although some telcos (Telefónica, Telecom Italia, etc.) and pay-TV players (such as Digital+) are hovering on the fringe.

Fully integrated service. In a fully integrated service model, the player sells a simple, seamless, integrated TV service that includes the content, user interface, and device. This has been the traditional aspiration of telcos (PT, for example), cable, and DTH players (such as Sky), who continue to occupy this space along with Apple.

Content aggregator. A content aggregator sells content via an aggregation service that can be accessed using various devices. “Content is king” enthusiasts such as media companies (including Hulu, BBC, RTL) and online aggregators (Netflix and Amazon, for example) have chosen this arena.

Open user interface. Finally, Google is trying to perfect a video interface that can be used in any device to search any content in the most accessible way possible. This is very much in line with YouTube and what its Android smartphone OS represents for mobile applications.

Each model requires different strengths for success that depend on the specific local market and the particular players that attempt to execute it. Each also allows con-siderable flexibility in joint go-to-market approaches and alliances with adjacent players. These four models span the likely spectrum ahead, but it is too soon to say which will prevail or how they will perhaps combine.

56

Gearing up for OTT

Different types of players will be impacted in varying ways by these new business models depending on their industry along with their current video business and capability position. Thus, it is crucial for companies to understand whether they should play in the OTT field at all, to what extent they should participate, and whether they should take an aggressive or defensive stance. To make these decisions, they need a clear understanding of their markets, capabilities, and current positioning.

McKinsey has developed a rapid diagnostic process to size the opportunity from OTT video in a specific mar-ket and identify the right strategy to maximize potential and mitigate threats. The approach features three steps:

� First, it creates a fact-based, shared understanding regarding the scope and speed of relevant trends in a specific market. Consolidating market intel-ligence from a variety of sources will provide a clear perspective on the potential size of the OTT market along with an estimate of the pace of change in the market and potential moves by key competitors.

� Second, a rapid diagnostic offers a realistic assess-ment of a company’s strengths and weaknesses and areas in which it can play. Not every company is des-

tined to be an Apple competitor. McKinsey’s diag-nostic delivers an in-depth profile that outlines how well a company is prepared to play certain roles in the ecosystem. A pay-TV operator may, for example, might have excellent skills in sourcing and aggregat-ing content (and potentially already own the rights to online video distribution), but might not be best equipped to offer a world-class user experience across a range of end user devices.

� Finally, once companies have understood how well they are prepared to assume certain positions in the OTT ecosystem, they can specify a vision for their own OTT engagement. This will provide the basis to begin developing the capabilities and assets they lack to enable them to fully capture the opportunity, while mitigating potential threats.

While consumption of OTT video remains limited, the trends supporting it indicate a fair chance of success for this new market, making this a trend to watch for all TMT companies. The many entry strategies can be boiled down to four main business models. Companies need to decide on their positioning now by carefully evaluating existing offers, assets, and capabilities to develop a roadmap to their own OTT future.

Where to compete

Consumer media need Linear/lean back Non-linear/lean forward

Revenue/business model Advertising revenues Consumer revenues

Advertising inventory sales

Advertising network business (e.g., adver- tiser services, targeting)

Paid content (subscrip-tion or pay-per-use)

Other revenues (e.g., device purchase)

How to compete

Content sourcing strategy Exclusive professional content/rights

Non-exclusive profes-sional content

User-generated content Other content (non-video)

Device strategy Own proprietary devices Own devices with open system 3rd-party open system

Multiscreen/multiplatform strategy

Software user interface strategy

Content aggregation Content discovery (search)

Recommendation engine

TV app store

Many options on where and how to compete

Steven Neubaueris an Associate Principal in McKinsey’s Zurich office. steven_neubauer@mckinsey.com

Jaime Rodriguez-Ramosis an Associate Principal in McKinsey’s Madrid office. jaime_rodriguez-ramos@mckinsey.com

Markus Frerkeris a Principal in McKinsey’s Munich office. markus_frerker@mckinsey.com

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Going over the top: Preparing for a streaming world 57

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Tuning in: TV equals telcos’ “triple value”08

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Tuning in: TV equals telcos’ “triple value”

Once considered “yestertech” by the industry, television is now becoming the central element of many telco strat-egies. Operators in mature and emerging markets alike are benefiting from the revenues and new customers TV attracts, making this a must-have element in any telco’s product lineup.

Digital television is rewriting the rules of the game for telecoms operators. Long considered marginal to their business, successful players now view pay-TV as a criti-cal element of their go-to-market strategies for the resi-dential segment. Borrowing tactics from the attacker’s playbook, first movers in their field are finding they have a critical advantage. The key is to reconceptualize their business model, selecting the appropriate strategy for their market context.

Myth and reality

Several commonly held beliefs related to telcos and TV have proved a myth as full convergence gains momen-tum. The first is that TV is not a telco business. Actually, it is – or should be. A recent McKinsey survey in Europe revealed that over 60 percent of consumers seek triple-play offers (voice, data, and TV) and consider TV the prime element of the three. In some markets, TV is in fact the key attribute on average, with around 2.5 times the relative importance of the second most valued ele-ment (excluding price), and is indeed the one that best differentiates the offer. Research also shows that inter-est in pay-TV has exploded across all markets, both in developed and emerging economies. For example, telco-driven TV-based bundles make up over 65 percent of the revenue pool in one Latin American country, and

analysts expect these revenues to grow at a rate of over 9.5 percent annually through to 2014.

Another fallacy is that TV produces marginal revenues. Again, this is untrue. While currently still small in terms of revenues, bundles that prominently feature TV attract a full half of all broadband customers and are responsible for an outsized proportion of gross subscriber additions (Exhibit 1). Experience shows that adding TV to a bundle increases upselling opportuni-ties and boosts customer retention. Industry forecasts seem to confirm this trend: TV and related IPTV ser-vice revenues are expected to see the fastest growth in the telecoms industry (20 to 40 percent CAGR versus 1.9 percent in traditional telecoms services). This has provided a new tool for telcos to consolidate revenue growth by leveraging their current client base to gener-ate upsell and retention (with a combined upside of up to 35 percent in direct margin).

A further misconception is that TV’s only real use to incumbent telcos is as a defensive strategy in cable-heavy mature markets. In reality, non-cable players are aggressively offering television, including mobile opera-tors and satellite companies. One satellite operator in the UK – Sky, using its traditional TV offering bundled with fixed voice and broadband for the home – has suc-ceeded in entering the triple-play game and claiming a growing share of the broadband market over the past five years. Vodafone has also launched TV services over IP since 2009 as a strategy to enhance its fixed value proposition on top of ADSL. The compatibility of its platform with the Xbox 360 (in selected countries) has made this even more attractive over the last two years.

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01 Although small in stock, TV-driven bundles account for a large share of gross adds

Multiple strategies being applied

Players have taken a variety of strategic approaches to digital TV depending on their specific market context. Some who are competing in markets with fully devel-oped triple-play alternatives, where the importance of pay-TV is high, view a successful TV strategy as a clear make-or-break necessity and are investing heavily to make it happen. They purposely differentiate their products from other current offerings by employing a multiplatform strategy that enables fast penetration and makes advanced features available.

Other players in markets where the importance of pay-TV is lower – e.g., due to the high quality of free-to-air channel offerings – but many triple-play alternatives exist are investing in creating strong, competitive TV operations as part of their larger portfolio of businesses. Winning companies in this position focus on achieving fast “me-too” offerings and making use of platforms characterized by low cost-to-serve performance.

Operators who compete in markets where pay-TV is important but that do not yet have fully developed triple-play alternatives often view TV as a possible adja-cent business to their current portfolios. Still others, facing limited triple-play alternatives and little need

for pay-TV, basically see television as an upselling tool that can help them retain customers and sell premium broadband services, thus selectively investing in the most attractive customer segments or geographies.

Rethinking the telco business model

Telcos that have been able to quickly develop a TV-at-scale business tend to take a number of steps outside the box that defines the traditional business model (Exhibit 2). Acting like true attackers, they have reframed several elements of their residential segment business model, adopting similar strategies along five dimensions: their infrastructure, product development roadmap, go-to-market model, operations, and their organizational capabilities.

Infrastructure. Telecoms players can choose from vari-ous types of technology to add TV to their offerings: IPTV, satellite (direct to home), digital terrestrial televi-sion (DTT), or over the top (OTT). Several telcos have started to consider OTT as a way in, either to comple-ment existing offers or as a stand-alone disruptive offer-ing. The key driver behind technology adoption is relat-ed to how well technologies match the need for function-alities (number of channels, interactivity, and advanced services such as HD and video on demand – VoD), qual-

Although small in stock, TV-driven bundles account for a large share of gross adds

Retail segmentIndexed

SOURCE: Analyst reports; McKinsey

100%TV Other

Share of gross adds (in bundles) 60

Share of broadbandcustomers 50

Share of revenues 5Small in stock …

… relevant to customers …

… crucial for the future

DISGUISED EXAMPLE

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50

40

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RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Tuning in: TV equals telcos’ “triple value”

Many telcos have already launched TV operations, with significant penetration as a percentage of broadband subscribers

ity of service, coverage, and economics (including initial investment and subscriber acquisition costs).

Satellite requires significantly less up-front investment and lower customer equipment costs. This, however, entails higher annual transmission costs per channel for renting satellite transponder capacity. In terms of product capability, satellite allows high definition and a large number of channels but has limits regarding some advanced features that require using on-demand features, such as VoD. In most markets, satellite is the legacy platform for pay-TV, frequently associated with premium offers in content and streaming definition, i.e., HD availability (e.g., Digital+ in France and Spain, Sky in Germany and the UK). Telcos, in contrast, have been electing satellite as the service provision platform for the mid-/low-end segments (because it can achieve the requisite economies of scale) or for areas with no fixed access infrastructure that can handle IP or OTT TV services.

Satellite is a new technology for most telcos. They can either use a greenfield approach to build the infra-structure or acquire it from wholesalers that provide end-to-end solutions, which reduces time to market. Alternatively, some telcos have set up commercial part-nerships with established satellite players.

If fiber and copper platforms are used to deliver video services via IPTV, they can be leveraged in parallel for triple-play services: voice, broadband, and TV. This requires significantly higher up-front capex along-side high customer premises equipment (CPE) costs. However, such an investment allows the distribution of an unlimited number of HD and SD channels, and full interactive services. This solution is often pursued by telcos when there is potential for significant features-based differentiation – an attractive option in high-den-sity (and competitive) areas where there is a strong busi-ness case for extensive up-front business investment.

Finally, OTT video services have gained market accep-tance and play a variety of roles depending on the mar-ket and TV strategy. In some areas, OTT may be the key service for providing non-linear content and advanced TV services to complement rich free-to-air channel ser-vices (such as BT with Vision in the UK). In other geog-raphies, it may also supplement satellite offerings with interactive services such as VoD, EPG, and others.

Telcos often end up selecting a combination of technolo-gies to serve different customer segments (low/mid/high) and regional areas (with fixed coverage versus without). A strategic mix of this kind helps operators optimize their reach and economics.

Customer base penetration by TV serviceTV customers as percent of broad-band customers

Many telcos have already launched TV operations, with significant penetration as percent of broadband subscribers

1 Direct to home only

SOURCE: Screen Digest; operator Web sites; press clippings; McKinsey

Time since TV launchYears

2 11101

Svyazinvest

Telekom Slovenije

Romtelecom1

Magyar Telekom

O2 Czech R.TPSA

80

60

40

20

100

0 9876543

Portugal Telecom

Telecom Italia

Telefónica

Swisscom

France Telecom

Belgacom

KPNTeliaSonera

British Telecom

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It is always vital to establish the accompanying back-end IT systems, such as CRM and billing, in addition to customer support systems for both remote and on-site services. When integrated, these systems need to gener-ate a seamless customer experience – one single point of contact for sales, activation, installation, billing, and after-sales service – similar to the practice of the most cable players on the market.

Product development. TV product content and structure need to be aligned with a telco’s overall strategy. A zero-base redesign of the products and services the company offers is crucial to manage consumer and ARPU growth in parallel. Understanding consumers’ TV preferences as well as their total multiplay requirements allows a telco to develop offerings to satisfy its different seg-ments and maximize impact along both dimensions.

The process should be based on structured market research that provides deep insight into the usage pat-terns and key buying factors of both existing pay-TV users as well as prospective customers. McKinsey can use these insights to simulate the different potential structures for maximizing total revenues and margin contribution of the product. This process also enables a telco to define the best product bundles to capture and develop the complete household.

Go-to-market. One clear hurdle many telecoms play-ers struggle to overcome involves raising awareness of their pay-TV product on a broad scale. In one market, research into consumer purchasing patterns showed that the two biggest hurdles at the launch of an IPTV program are lack of consumer awareness and getting shoppers to move from considering the offer to actually purchasing it.

An attacker mindset requires a dual approach: strong above-the-line market communication to make con-sumers aware of the new offer, together with an effec-tive below-the-line commercial push to maximize effectiveness and acquire as well as win back consum-ers. A powerful marketing campaign is vital to position the product at the heart of the offering. Contrary to the other (voice and broadband) products, TV can provide significant differentiation via exclusive content, unique applications, or a distinctive user experience, and communicating these features to the market is key.

An attacker-like below-the-line commercial effort needs to be developed in parallel. It is not easy to recover

customers who have churned by selling TV via a call center, but a direct sales force focused on win-back and customer acquisition can be highly effective and effi-cient. A corresponding tactic requires different sales strategies depending on the region, with specific scripts and varying types of promotion, differentiating con-sumer types (upsell, win-back, and acquisition) – a criti-cal capability that telcos typically need to build from scratch. Door-to-door sales can represent up to 40 per-cent of pay-TV sales and is therefore key for competing with cable players. This channel is particularly relevant for sales in high-rise buildings. Many telcos typically outsource their door-to-door sales capabilities but need to find new partners for it as their traditional retail part-ners will not have the skills required.

Operations. Highly upgraded home installation and networking capabilities are essential for telcos to handle the complexity of new TV technologies. To deliver high-quality service, telcos will need to interlink sales, field installation and maintenance, customer care, and equipment purchasing into one seamless process. Accomplishing an end-to-end approach will require a strong sales force, highly skilled technical staff focused on quality of service, call centers capable of resolving issues the first time every time, and significant invest-ments in CPE. Telcos should consider CPE purchasing a strategic function, placing strong emphasis on both reliability and driving costs down. Telecoms players will likely already have many capabilities they can tap into to build a successful pay-TV operation.

Retail channels typically represent roughly half of pay-TV sales, so telecoms players often start with an advan-tage compared with established cable players in terms of retailing density. Their key task is to retrain channels and establish the right incentives so that the new pay-TV offering is not neglected vis-à-vis traditional and higher-volume voice and data products.

Players can also leverage their remote channels for customer service and telesales. It is particularly impor-tant to upgrade support systems and retrain operators so they can provide a single point of contact to cus-tomers for all elements of the offering (voice, broad-band, and TV).

Fixed operators that already have residential offers can use their existing field forces to install and provide on-site customer support for TV. As with retail and remote channels, operators need retraining to support

63RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Tuning in: TV equals telcos’ “triple value”

On the path toward TV leadership in Portugal: MEO case study

Portugal Telecom (PT) is an impressive story of an operator that used pay-TV to turn around its operations as its wire-line business encountered significant challenges. By the end of 2007, PT was facing several hurdles in its wire-line business, including fixed-mobile substitution due to a highly competitive mobile market, slowing ADSL penetra-tion growth, a restrictive regulatory environment fostering the emergence of attackers, and strong cable competition from the consolidation of a new pay-TV competitor, ZON, with a triple-play offering and significant household penetration.

In this context, PT envisioned a strategy leveraging the importance of TV in the customer’s choice of operator as well as the unmet demand for advanced TV services. PT assumed an attacker-like mindset and focused on making TV a core element of its resi-dential segment business by launching a disruptive TV offering. It utilized the unique advantages of an IPTV platform with non-linear TV and interactivity to create MEO. Its rich VoD range has DVD-like fea-tures and a catalog of over 2,500 movies, including high definition.

As a result, PT enjoyed growth levels that signifi-cantly exceeded expectations, achieving double-digit household penetration in less than a year.

Equally important, over 50 percent of IPTV cus-tomers are new to PT. The new brand has also pro-pelled its flagging broadband business to first place in the market in terms of net subscriber additions. Three years after it launched MEO, PT has captured around 30 percent of the pay-TV market share. MEO continues to be at the core of PT’s residential offering, acting as an engine for fiber penetration by offering various features that significantly differ-entiate its value proposition, including:

� Continuous improvement of the user interface, such as an electronic programming guide

� Remote control of the set-top box via mobile hand set or PC and access to the VoD library from a PC

� Multiroom personal video recorder for custom-ers with more than one set-top box

� Gaming, karaoke, and other interactive applica-tions and service areas

� Access to personal photo folders

� Customized content and features for children in a walled garden called “MEO Kids.”

SOURCE: Operator investor relations presentations; press clippings

NovSpin-off of TV Cabo

April Launch of MEO Kids

May Launch of MEO Fibra

Oct 500,000 MEOcustomers

JuneLaunch of video on demand, set-top boxes, and advanced TV services

2007 2008 2009

FebLaunch of 3-D

NovLaunch of MEO Jogosand Music Box

JulyLaunch of widgets

2010

Q4Q3Q2Q1 Q4Q3Q2Q1Q4Q3Q2Q1Q4Q3Q2Q1

“PT will be a strong compet-itor to TV Cabo within 3 to 6 months”

Sep 2007

“We want to achieve critical mass in TV”

Oct 2008

“We want to be leaders in TV and we are not going to apolo-gize to anybody for that”

July 2009

“We are on the path toward leadershipon the pay-TV market”

July 2010

Number of IPTV and direct-to-home subscribers and market shareThousands

8307697026465815054433843122111164721600

14%

1%

23%30%

April Commercial launch of MEO IPTV and MEO Satellite

Nov SAPO available in MEO

Dec MEO leads in client satisfaction

64

Patricia Ferruz Aguilaris a Principal in McKinsey’s Madrid office. patricia_ferruz@mckinsey.com

Miguel Fonsecais an Associate Principal in McKinsey’s Lisbon office. miguel_fonseca@mckinsey.com

a more sophisticated portfolio. This especially applies if satellite is chosen as the infrastructure technology, requiring installation of a dish, set-top box, and in-house cabling separate from the existing fixed voice/data infrastructure.

Organization. TV should be perceived as part of the core business rather than as an add-on. A firm case for organizational transformation is the result, evolving the corporate mindset from being a telco toward that of a media company. A clear organizational priority should be assigned to pay-TV to drive the necessary focus and transversal collaboration. To achieve this, senior man-agers – ideally the CEO – should adopt TV as their key responsibility, allocating the best resources in the resi-

dential organization to this field. Driving TV as a media business also requires specific organizational skills, which will probably need to be hired in. The same talent will also devise strategies to enable the most efficient use possible of the corporation’s content offering as a business lever.

Convergence at the end user is pushing the boundaries of traditional media, providing telcos with the oppor-tunity to promote a “one-stop media shop” proposi-tion and elevating their position in the value chain as a result. Pay-TV can become the central element in this mix, serving as a powerful driver of growth.

Armando Cabralis a Director in McKinsey’s Lisbon office. armando_cabral@mckinsey.com

Rodrigo Diehlis a Principal in McKinsey’s São Paulo office. rodrigo_diehl@mckinsey.com

67

“Avatar” may have been a huge box office hit, but the ramifications of 3-D are potentially much broader than just the big screen. A recent McKinsey survey shows that consumers could be ready to pay for broader use. However, mass-market development will only material-ize if the entire 3-D value chain comes together to yield superior consumer value.

With ever-higher rates of data flow, digital technolo-gies continue to create major advances in media and telecommunications. A growing opportunity from this technology evolution is that new, richer, and speedier services will develop – ones that are both compelling for consumers and deliver additional profit for providers.

A case in point is the emerging shift from traditional DSL-based broadband to fiber-based ultra-band offer-ings. In the typical European market, more than half of DSL users would be willing to upgrade to a fiber con-nection. They are prepared to pay a premium of at least EUR 5 per month. Users also indicate that this would make them much more reluctant to switch service providers – an aspect that could reduce churn rates by at least 50 percent. While the net present value of this upgrade to fiber is significant, it has yet to develop into broad profitability in many markets given the high engineering costs required to bring fiber to the home. In fact, the economics are positive only if the rollout is pursued from existing ducts or investment is shared among infrastructure providers, and if this rollout takes place in areas of high population density.

Although fiber connectivity presents profitability chal-lenges, it does offer greater opportunities to deploy rich -

er video services, such as broadcast services, gaming, and videoconferencing. However, the advent of larger-screen TVs, HDTV programming via fiber, and 3-D vid-eo may be the big game changer. The additional revenue streams that the latter group represents could improve the economics of connectivity significantly. Looking at 3-D TV specifically, the buzz is growing and lead-ing players are moving aggressively to bring 3-D to the home. Sports network ESPN is already showcasing 3-D channels, with around 85 live sporting events planned for the full year that began last June with the 2010 FIFA World Cup match, pitting South Africa against Mexico.

Most analysts are still withholding judgment on wheth-er 3-D will achieve widespread adoption and whether it will ultimately be profitable. A poll of pay-TV opera-tors in Asia (where fiber is more pervasive and HDTV is offered in 50 percent of pay-TV packages) conducted by Global Intelligence Alliance suggests that IPTV and 3-D offer the greatest untapped opportunities for sector growth. But, despite the awareness created by ESPN’s 3-D channels and Panasonic making viewing easier via glasses-free 3-D TV in the US, 3-D TV sales volume has reached only 35 percent of even the most conservative sales projections of television manufacturers. The same holds true in Europe.

To gain better insight into the future of 3-D video, McKinsey recently launched a study on user willing-ness to pay for 3-D content in the home covering three large European countries – the UK, France, and Germany. This was the first survey of its kind in Europe and unique in its use of a conjoint-based approach to understanding the multiple attributes that will drive

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Virtually there? 3-D video for the masses

Virtually there? 3-D video for the masses09

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3-D media will cover three screens. Some 60 percent of users cited television as the ultimate in-home 3-D experience. As many as 85 percent of respondents said they would be willing to invest in large-screen HDTV for this purpose. Using PCs to view 3-D ranked second, while mobile devices ranked third. In general, however, triple-screen capabilities (TV, PC, mobile) were seen as valuable, with respondents willing to pay EUR 2 in ser-vice charges per month for a triple-screen offering.

Could 3-D TV take off?

Based on these preferences for using 3-D via TV, McKinsey concentrated its analysis on 3-D’s value if transmitted via broadcast television. A conjoint analy-sis was performed in which respondents were asked to choose between different combinations of video content at varying monthly service prices, of differing image quality, and in a selection of service bundles (fiber plus 3-D TV, for instance). In choosing between different sets of video experiences, consumers are making trade-offs between various features in the 3-D experience. The marginal value of those features is estimated statisti-cally from the full sample of conjoint responses. Three major insights emerged from this conjoint-based analy-sis of consumer willingness to pay.

willingness to pay for 3-D services. McKinsey tested various price points, different access devices (from TV to game consoles), diverging content (from movies to game and television shows), and varying types of digital TV set diffusion (HDTV, etc.). The survey also assessed consumer appetite for 3-D services bundled with broad-band access (see text box for further details).

3-D appeal is broader than just video TV

User interest was tested soon after a sample of users had experienced 3-D content. This led to two findings, later confirmed in the conjoint analysis. 3-D’s greatest (but not exclusive) appeal is when watching video. Around 60 percent of respondents said they found the experience of watching standard 3-D video (very) appealing, while 74 percent found premium con tent (such as sports and movies) very appealing. Still, video is not the only service considered attractive. Among other pos-sible 3-D services cited by respondents, nearly 50 percent mentioned photos and games. This is confirmed by the conjoint analysis, where willingness to pay for 3-D is statistically higher for video than for any other offering (photos and games). Users would also be prepared to pay a few euros per month to store and share 3-D photos.

About the McKinsey survey

The in-person survey was conducted in September 2010 across three countries: Germany, France, and the UK. The survey recruited those who fit the sociodemographic profile of each country’s population based on monthly household revenue, family size, and gender/age of the respondent, while ensuring that respondents were the prime decision maker for entertainment purchases. The actual experience of 3-D images is critical to respondents’ ability to understand products and assess trade-off values. The questionnaire was also pretested on an early sample before the full survey was rolled out. The sample averaged 300 valid questionnaires per country and was limited to people who had a broad-band connection in their home.

The survey revealed that the experience of watching 3-D HDTV has a major impact on users, with inter-est more than tripling after their first 3-D viewing

experience. First, as a baseline, mass-market 3-D is primarily about video and TV, but respondents can easily imagine using 3-D for photos and games. Second, the value of 3-D services is also multiplied when combined with HDTV and premium services. Third, broadband (more than digital TV) drives 3-D service value. Fourth, as is often the case with new consumer service innovations, interest is divided, with a 20 percent segment of the household popula-tion representing 46 percent of those saying they would receive value from 3-D video services. In general, only committed consumers in that segment see enough value to induce them to switch their TV sets to 3-D capabilities at present. Another 33 per-cent segment in the survey population is more likely than not to upgrade a TV device to 3-D, but this is only the case if premium content is in 3-D format and only if they are offered a compelling triple-play bundle for video service.

69RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Virtually there? 3-D video for the masses

High demand for premium 3-D HDTV services. For those very interested in 3-D TV, the value of 3-D HDTV roughly amounts to a 65 percent premium over the value of basic non-HD digital television services. Those sur-veyed are willing to pay an average of EUR 5 per month on top of the fees for their basic tier of video services (with monthly payments thus increasing from EUR 8 to 10 per month to EUR 13 to 15 per month).

For the pay-TV premium content tier (such as sports and movies), the potential upside was higher, from EUR 7 to 9 per month on top of the typical movie and sports pack-age prices of EUR 15 to 25 per month that users might pay. The 3-D and HD features are complementary in the sense that the sum of the stand-alone value of 3-D and HD is only EUR 3 per month (versus EUR 5 if combined in a basic package), and EUR 5 per month for premium movies and sports. This premium is relatively high: in fact as high (EUR 4.5 per month) as the extra value most of customers place on upgrading from DSL to fiber.

Migration to better TV sets as a likely outcome. Can 3-D HDTV service value be great enough to prompt migration to more sophisticated TV devices? McKinsey found that each euro of extra value from 3-D HDTV usage leads to an increase of 5 points in the propensity to upgrade to a 3-D-enabled screen. The implications are twofold First, EUR 10 of service value is the tipping point that prompts users to upgrade to 3-D TV. Second, the device upgrade will be more likely when consumers combine HD video delivery with movie and/or premium TV offerings.

An ultra-fast broadband link is considered vital. The speedier the Internet connection in respondents’ homes, the higher they rated the value of 3-D and HDTV. At the same time, there was no statistical evidence that digital TV adoption per se had any impact on how con-sumers valued 3-D TV services. This is an interesting finding, since it shows that fiber and the 3-D HD propo-sition are complementary factors affecting adoption. The service bundles that lead to greater willingness to pay for 3-D services are those that combine digital TV with broadband speeds higher than 30 Mbps together with the further option of being able to subscribe to pre-mium content services.

Engineering a 3-D ecosystem

The conjoint survey showed that the value premium of EUR 5 to 10 per month is most readily realized among

users who opt for premium content and who also have a very high-speed Internet connection. While this market is larger than a niche (accounting for some 30 percent of the online population), it is also not yet a full-fledged mass market in Europe. As such, the segment size does not (yet) make 3-D a success. The current service value offered by the rest of the market does not justify con-sumer electronics companies heavily subsidizing the price of 3-D TV components either. The key question will be how quickly service and content providers step in to make the offering sufficiently compelling and how adeptly they weigh up the different potential trade-offs.

Different types of market elasticity. The following 3-D TV elasticities became apparent when regression analysis was used to correlate willingness to pay for 3-D content against a range of variables (such as premium content and household revenue). The various dimen-sions clearly require careful balancing to ensure that the ecosystem remains sustainable.

� Prices on the 3-D content market are relatively elas-tic, except for live premium sportscasts, underlining how important it is for content companies to develop unique 3-D offerings before the market can take off. Where live premium sports are concerned, premium direct-to-home and cable companies may wish to push 3-D as a key differentiator versus IPTV and/or OTT offerings.

� Positive revenue elasticity suggests price skimming strategies may be appropriate. The 3-D content market exhibits normal, positive revenue elasticity: higher revenues translate into greater willingness to pay for 3-D content. This means that marketing strategies might need to follow a price skimming strategy, first targeting higher-revenue households and then reducing their price to continue the pace of penetration. A corresponding strategy has been pursued systematically (and often successfully) by consumer electronics goods companies in anticipa-tion of economies of scale from greater penetration.

� Multiaccess elasticity is crucial. The market for 3-D content is access-elastic, at least where pre-mium content is concerned. Users are willing to pay a premium for multiaccess options beyond TV (iPad, game consoles, etc). Since users have become accustomed to the transmission of standard content across multiple channels, they expect the same from 3-D content.

70

3-D consumer segments. The elasticities above are not homogenous across the population surveyed. Statistical clustering of the conjoint-based utilities for 3-D TV reveals a market defined by four segments (Exhibit 1):

� 3-D enthusiasts. The first segment accounts for 20 percent of households, who display a willing-ness to pay for 3-D premium content that lies up to 2.5 times higher than that of average households. Together, these enthusiastic users comprise 46 per-cent of the value of 3-D – a level high enough to justi-fy migrating their TV sets to 3-D capabilities. Those in this segment tend to be weighted toward male and younger users. They are more likely to enjoy 3-D viewing in movie theaters and would be more inclined to use 3-D when playing animated games. This group would also be open to experiencing 3-D in a multiaccess environment, including game con-soles and mobile devices (iPad, etc.).

� Premium 3-D users. The second segment encom-passes 33 percent of the population (along with 44 percent of total 3-D value). These users display a willingness to pay for 3-D – for both basic tier and premium content – that is roughly 150 percent of what the average population would pay. Consisting mainly of family households with higher-than-

average incomes and slightly above-average educa-tion levels, their TV consumption lies up to one hour higher than that of the average household, with premium movies being their key 3-D preference. These consumers are willing to upgrade their TV to a 3-D TV set twice as often as the average user, but only if they were offered a compelling premium triple-play bundle in 3-D format.

� 3-D neutrals. The third segment (21 percent of the population) is open to 3-D, but is prepared to pay only a small premium – less than half of what the average population would be willing to part with, and only on their current TV sets. The service pre-mium captured would not justify upgrading their TV sets, implying that 3-D must be an embedded feature in their HDTV.

� 3-D deniers. The last group (26 percent of the popu-lation) is not open to 3-D TV. They say they will neither make an effort to upgrade their TV set to 3-D nor pay for 3-D content. A small portion of them (30 percent of the segment) have a negative propen-sity to pay for 3-D content and 3-D TV sets, meaning they see the service as more than premature. This segment is skewed toward lower-income, female, older, and single users.

01 Two consumer segments show high affinity to 3-D, but actual 3-D content remains decisive

SOURCE: McKinsey

Percent

100%

3-D enthusiasts

3-D deniers

Premium 3-D users

3-D neutrals

4

52

21

78

Online households

Willingness to pay for 3-D service Probability of upgrading TV set to 3-D

21

9

33

44

20

46

26

1

Two consumer segments show high affinity to 3-D, but actual 3-D content remains decisive

71RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Virtually there? 3-D video for the masses

Strategies going forward

3-D TV is one of many new innovations shaping the video value chain today. This study reveals that its de-velopment will not stop at video, but also comprise other media applications such as games and photos. When users experience 3-D, they are generally quick to spot the additional value it could add to their experience.

Nevertheless, the economics are still challenging and will require better synchronization in the value chain to ensure market takeoff. Looking at all the consumer seg-ments together, McKinsey found that only the first (3-D enthusiasts) would be willing to both pay for services and upgrade their TV set. The second (premium 3-D users) would not migrate unless the value of 3-D were enhanced by premium content and triple-play broad-band services. This implies that 3-D adoption will only extend beyond movie theaters and other niche content (some virtual games, for instance) to the living room when a full, integrated home video value chain material-izes and creates enough content value.

How far off is the day when every film will be produced with a 3-D upgrade? Will it be possible that past films can be viewed in 3-D, the way black-and-white films were subsequently colorized? Will new software make it possible to view photos and home videos in 3-D? Perhaps every house for sale and every holiday resort will offer a virtual tour, and social networks will incor-porate 3-D features that make “get-togethers” a vir-tual reality?

Many different players along the value chain will need to contribute to this new trend to make it irresistible. Judging by past trends, however, mass uptake could come much sooner than anticipated. The supply side of the 3-D equation is the key unknown that will determine how fast this market takes hold.

Jacques Bughinis a Director in McKinsey’s Brussels office. jacques_bughin@mckinsey.com

73RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Expecting the unexpected: Ten twists to shape your TMT strategy

10

From social media and connected TV to mobile app stores and e-readers, digital media has permeated the very fiber of the consumer lifestyle. This technology is obviously here to stay, but some of its associated trends are just as surprising as they are powerful.

One indicator of the importance of digital media in the consumer’s life is the degree to which the average user’s language has incorporated this technological phenome-non. The digital lexicon used to be reserved for industry insiders with terms like “long-term evolution” and “fiber to the home.” Today, “tweet” and “text” are uttered more frequently than “call,” and “Google” is a verb. The digital revolution has arrived, but how do players in this realm turn trends into action? This article offers ten glimpses into the future of media in ways that aren’t typically predicted – balancing the noise of exciting trends with ongoing research and some historical lessons.

1. Rich media’s true focus is at home

The current focus of the industry is on the rise of new connected and mobile devices that can port media in and outside the home. The iPod was the first clear development in this direction, followed by the Kindle for books and now multimedia e-tablets like the iPad, accompanied by the surge in smartphones. But one key factor has gone unnoticed. Eli Noam, Professor of Finance and Economics at Columbia Business School and Director of the Columbia Institute for Tele-Information, has pointed out that the bit price paid per minute of use for in-house media has remained relative-ly flat across the years: approximately 0.1 US cents per second or around USD 3.60 per hour. When a technol-

ogy is priced below that flat rate, it is consumed in the home; when above, it is consumed in shared environ-ments until it becomes more affordable.

Moore’s law, however, is that compression technolo-gies – especially under Internet protocol – allow the delivery of 30 percent more bits at the same cost for every year that passes. This means that an ever richer media experience (measured by bits per second) is becoming accessible for home consumption at an expo-nential rate. Even now, most rich media – even on con-nected devices – is consumed at home.

Key takeaway: Despite the adoption of connected on-the-go devices, the home will remain a growing center of media entertainment, revenue, and consumption.

2. Media brands continue to concentrate

In traditional media, tension has always existed between distribution and content. Usually, who was king depended on the relative size and competition of either part of the value chain. The online world has altered the balance of the value chain. Industry play-ers understand the speed at which new Internet giants, from Google to Twitter, have emerged as global compa-nies. They are less aware of how quickly Internet mar-kets are concentrating the new media brands – much greater than levels that normally prevailed in the tradi-tional media and content industries.

Traditional media industry concentration has re-mained relatively flat, at levels deemed low in the film and broadcasting industries for antitrust reasons.

Expecting the unexpected: Ten twists to shape your TMT strategy

74

Concentration of the Internet economy’s new media sector, however, has been doubling every five years, to the point where global new media companies are quickly reaching the same level of concentration as local Internet last-mile infrastructure players.

Looking specifically at global IP traffic data, Akamai reports that the Internet traffic generated by the top 100 brands has doubled in less than three years and that companies such as Google (with YouTube) have emerged in the last three years as one of the top generators of traffic on the cloud. The same is true even if you take a local market-by-market perspective: the level of traffic and revenues is always more concentrated than in tradi-tional media.

Key takeaway: Online media brands will continue to concentrate, creating a new balance between content and distribution. Traditional media will need to figure out how they wish to play in this new equation.

3. Long live TV!

The innovations in the consumer electronics, distribu-tion, and other technology industries offering new over-the-top (OTT) devices and services confirm the huge interest in targeting the video market. The impending changes from non-linear usage, long-tail offerings, and entirely new ways of accessing content (searching for and obtaining social recommendations directly via smart TV, for example) are multiple. They include the likely concentration on top TV shows and fragmentation of other content, and the lower effectiveness of horizon-tal and vertical programming. Nevertheless, television still has a long life ahead.

The latest figures for many markets show TV viewing still growing as new services such as video on demand or time shift viewing increase the pie, encouraging addi-tional usage as well as further revenue streams. 2010 saw the highest TV viewing times ever in some coun-tries: in Germany, figures were 223 minutes per day on average, up around 11 minutes compared with 2009.

Television has also largely defended its share in adver-tising markets, with the growth of online coming pri-marily at the expense of print media. Online and televi-sion have so far benefited most from marketers raising their budgets, while print media will most likely see another modest decrease in 2010. The evolution of video online to video on TV will likely be accompanied by a

further transfer of online-rich media to the TV screen. This development will also be responsible for introduc-ing new sources of revenue such as TV commerce, online TV search functions, or simply better-targeted and per-sonalized TV ads.

Live television may become stronger as a result of non-linear television evolution. Consumers are particularly interested in live sports and reality shows/soaps and other series, but show little interest in consuming these after the outcome is already known. Time shift offerings thus have limited substitutional appeal for this type of entertainment.

Key takeaway: TV access and consumption will likely change, but television will remain the center of gravity for the consumer at home.

4. Hype follows the Concorde

While online media consumption and online display advertising will doubtless continue to see substantial growth, it remains a difficult world. Digital efficiency is under constant scrutiny, especially where non-premium content is concerned. Marketers are increasingly mov-ing away from the CPM (cost per thousand impressions) model toward cost-per-click and other performance-based pricing models. Pricing is also under pressure. During the crisis – and to some extent even before that – CPMs saw a decline driven by overcapacity on the mar-ket and new sales models (the emergence of large adver-tising networks, online advertising exchanges, etc.).

The rise of Web 2.0 has brought many new offerings, ranging from user-generated content led by YouTube, virtual worlds like Second Life, and social communities (originating with MySpace). All of these, at least initial-ly, attracted large user bases and generated much hype. Many copies emerged around the world. Despite the rise in both offerings and usage, the underlying business model often remained a major struggle. Many players had to learn the hard way that traffic alone is a neces-sary but far from sufficient requirement to support a profitable business model.

Some former stars have already fallen from the sky. More than 20 million users registered for a Second Life account after its launch, but no more than 789,000 logged in per month (on average) during Q3 2010. MySpace is no longer hitting the headlines with new usage records either, but instead with its staff layoffs

75RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Expecting the unexpected: Ten twists to shape your TMT strategy

and potential disposals. Prospects for some of the for-merly hyped new Internet offerings are as dismal as those of the Concorde. The first commercial supersonic aircraft never achieved a sustainable business model with enough users showing sufficient willingness to support its operational costs. A business model that not only attracts usage but also creates a profitable ecosystem that sustains sufficient revenues – whether from advertising, paid content, or other sources such as commerce – represents a key success factor for any new business to last.

Google has shown the way by offering a search utility to users and powerful direct marketing click-through rates to advertisers. Couponing may epitomize a new trend of this kind, best represented by Groupon. Users benefit from coupons, while companies sell more of their goods. Even Facebook is not just driving up its user base: a major part of its focus now is to have emerging local sales teams monetize its large user base via its social graph.

Key takeaway: Hype always comes to an end. Successful online models will be those that swiftly anchor a sus-tainable revenue platform.

5. Free alternatives continue to impair paywalls

Results of the McKinsey newsroom barometer at the 2010 World Editors Forum revealed that 47 percent of respondents think most news on the Internet will cease to be free in the future. Uncertainty about how to monetize Internet content is still rife, however. Various models are predicted, ranging from user-paid content on subscription and pay-per-download models through to licensing and advertising. The latter covers different forms, too, including display, rich media, and sponsorship. But the introduction of paywalls has often decreased reach and usage dramatically. The introduc-tion of a paywall for the online version of the UK’s lead-ing Times and Sunday Times newspapers has decreased their user buys by two-thirds, with 58 percent refusing to register despite a price much below common print prices – GBP 1 per day or GBP 2 per week.

Paid online content is not just a hot topic for the print media and its associated Web sites. Given the cyclicality of advertising markets, this has become a strategic ques-tion for other businesses, too. It also reflects the fact that it is increasingly hard, particularly for focused offerings, to reach critical audience size and remain relevant for

marketers. Leading music TV player MTV Germany, for example, announced that it was ceasing free-to-air (FTA) broadcasting in October 2010 and instead mov-ing into basic pay-TV bouquets as of January 2011. Leading European FTA players such as Mediaset, RTL Group, or ProSiebenSat.1 Media AG have expanded – or announced aspirations to expand – their presence in pay-TV to capture new revenue streams and reduce their dependence on cyclical advertising markets.

With any of these ventures, however, one needs to remember the famous quote of NBC’s Jeff Zucker on “turning analog dollars into digital dimes.” Paid content revenues deteriorate if the prices of online offerings do not match physical copy prices. Advertising revenues are similarly jeopardized if reach and/or CPMs of the online offering are below those of traditional ones.

Key takeaway: Whatever the revenue model for content, the only winners will be those able to generate enough price and volume power.

6. Hidden face of social networks will come to the fore

Social networks are everywhere: their sheer size is already altering the way people interact on the Web. The lead site Facebook claims to now have over 500 million active users, bypassing Google as the most frequented site on the Internet. 50 percent of its users log in on any given day, spending a total of 700 billion minutes per month on the site. This means Facebook users spend more than an hour per day logged in to the site – equiva-lent to the time they spend watching their favorite TV channel each day. Users also claim around 130 friends each on average.

These are all impressive figures, but what do they hide? It is hard to believe that people are actively in commu-nication with each other for over an hour a day, on top of phone calls, texting, e-mail, and instant messaging. Something unnoticed must account for most of the time spent on social networks. The dominant activity on social networks is actually “silent” – browsing other people’s pages. Depending on the site, browsing as a share of total time spent varies between 50 percent on LinkedIn to up to 85 percent on MySpace.

The visible interactions are very skewed, with a highly interactive portion of the user base – 30 percent – accounting for most of such interactions. The social

76

“underground” is very different. Underground browsing interactions are rampant across the entire population of social networks, with around 90 percent of users contributing. Users in this sphere are also less inclined to feel the need to reciprocate visits. Visits by non-friends – a major measure of likely influence – make up a significant portion of views of most user profiles. All of this means that the social underground is much more diverse – and likely more powerful – than the active, visible social activities on Facebook and other sites would lead us to believe.

Key takeaway: Expect this underground – which can-not be deduced from trawling publicly available data – to come to light and reinforce the social nature of the Internet.

7. From reach to social structure

Social media is everywhere, from tweets to Facebook messages. But social structure is just as important. Someone sending a message to friends who do not care or to direct contacts who themselves have little to relay to other friends means the social message will die out very quickly. The key here is the social structure: how social media operate in networks structured to maxi-mize the fastest and broadest cascades among social groups. Fashion goods usually create a buzz in very broad networks, while community products have a hard time spreading outside their niche.

Media companies should try to sell the value of their social structure on top of basic reach. Advertisers are starting to get interested. Some companies are now lever-aging the social structure of their customers, for example, to boost the performance accuracy of their sales forecast model. Others, such as telcos, are mapping churners in the social vicinity of a customer using call patterns or social interactions on Web sites to better predict the fra-gility of their own customer base – sometimes with great success. Models based on social networks demonstrate that mobile subscription churn predictions can some-times be improved by up to 300 percent.

Key takeaway: Social media will soon add social struc-ture as a key enabler of its media relevance.

8. Digital marketing set to pole vault

Digital marketing continues to grow at roughly double digits per year, fueled by new formats (rich media), new

digital platforms (mobile), and the constant growth in Internet connections and usage. Forecasts are that digi-tal spending will continue to grow, but our predictions suggest it will quickly leap to an even higher figure due to the conjunction of multiple tipping points:

� In many countries, the daily reach of home broad-band has exceeded 70 percent of the population – a threshold at which advertisers are increasingly comfortable reallocating budget to new media.

� The return on investment (ROI) of digital advertis-ing is becoming widely known as an unbeatable proposition. Estimates of advertising campaign value are now being released publicly by lead information and measurement companies such as Nielsen, demonstrating that the ROI online is likely to be at least 100 percent. Hal Varian, chief economist at Google and a top US economist, also presented results at the American Economic Association showing that the ROI of sponsored searches yields minimum revenues of two euros for every euro spent.

� Companies are increasingly realizing that even if customers do not buy online, a vast majority research online and purchase offline (ROPO), whether via social network messages, access to their brand’s Web site, or key word brand and product searches. This ROPO effect is huge – usually as large as if not larger than the share of retail commerce performed online.

Key takeaway: Digital platforms – both traditional and new – are creating a unique occasion to corner the consumer and associate a targeted message. Digital marketing will become the major element in most com-panies’ marketing activities.

9. Community sourcing to storm the stage

Web-enabled technology and social media give media companies tremendous opportunities to test new ideas rigorously, at speed and low cost. Many media compa-nies now monitor feedback on their products in discus-sion forums or social networks, but only few go a step further and actually test or promote products within a community prior to launch.

MTV evidences how successful this can be. It heavily promoted its new drama series “Skins” months before

77RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Expecting the unexpected: Ten twists to shape your TMT strategy

launch across various social media, including Tumblr, Facebook, and its own community site in the US. The show already had a fan base in the US, since the origi-nal version was shown on BBC America. MTV’s online initiatives quickly attracted momentum, with 5 million video streams and 700,000 unique views on the Skins.tv community site. @skinsTV on Twitter had over 8,000 followers as of the morning before its debut as well as 36,000 Facebook “likes” and 2,500 follows on Tumblr. MTV is monitoring the community closely and using feedback to improve the show. This is a highly interactive process involving the show’s producers and dedicated resources.

An online check-in called Skins Captionbomb allows the audience to chat with other viewers and write their own commentary during the show. MTV even plans to reward users with MP3s and other bonuses using a points system. Innovative “community sourcing” techniques such as these can be adapted to every kind of product, and we predict much more intensive use of them in the future.

Key takeaway: Community sourcing will revolution-ize strategic planning for telecommunications, media, and technology (TMT) companies as well as audience participation.

10. Mobile media becomes mass market

As mobile access penetration becomes saturated and prices decline, new technologies such as long-term evolution as well as new devices like smartphones and tablet computers offer further growth potential from digital content and service offerings. Mobile media usage and advertising spending have ramped up quickly and are set to become a mass market. Smartphone vol-umes were already at 56.7 percent of mobile phones in the US in Q1 2010, and the number of smartphones in use worldwide is expected to exceed 1.1 billion by 2013. Mobile devices are also evolving rapidly in terms of their capabilities and features. The success of Apple’s iPad has defined a new market segment for tablet computers that will continue to see more players entering along

with flourishing sales. Analysts from eMarketer have projected that global sales will rise from 15.7 million in tablet computers 2010 to 81.3 million in 2012.

Users are increasingly receptive to content and marketing. App stores are attracting large numbers of paying users: almost 80 percent of all iPhone users download paid apps. However, huge potential still remains untapped. 87 per-cent of the German population, for example, has never downloaded an app onto their mobile phone.

Among paid apps, games are the overwhelming driver of value in the iPhone App Store, accounting for 65 per-cent of the top 100 grossing apps, followed by sports and entertainment (each accounting for 8 percent), music (5 percent), and navigation (4 percent). Mobile games are also expected to remain the most attractive category, especially if they blend social and location-based features. However, quickly declining price points and the domi-nance of free apps have affected monetization. Almost 50 percent of customers only download apps that are free.

The ability to consume, create, and share content via mobile devices translates into increasing involvement. Location-based services are becoming more sophisti-cated: retailers in particular will increasingly experi-ment with new opportunities. Mobile advertising is expected to see strong growth as a result. Major players in the field have already acquired mobile advertising networks, whether Google (AdMob) or Apple (Quattro), and are pushing the business forward.

Key takeaway: Surfing ahead of the mobile media wave is vital for success. Winners will enter into strategic partnerships, while keeping a keen eye on monetization potential.

The impact of the trends outlined above will continue to grow. Companies in the TMT arena would be well advised to integrate these trends into their strategic out-look to identify new opportunities and unleash competi-tive advantages.

Markus Frerkeris a Principal in McKinsey’s Munich office. markus_frerker@mckinsey.com

Jacques Bughinis a Director in McKinsey’s Brussels office. jacques_bughin@mckinsey.com

79

In the good old days, a consumer might watch televi-sion, go to a movie, or listen to the radio, but typically not all at once, and never on the same piece of hard-ware. Now, people do all those things and more on a plethora of smart devices located in their homes, cars, and coat pockets. This proliferation of “screens” makes consumer media consumption habits extremely diffi-cult to track. However, accurately following consumers across media and access technologies is vitally impor-tant to industry players. Device manufacturers and content producers need to gauge the potential profit-ability of their offerings, while aggregators and adver-tisers want to understand the reach and effectiveness of their campaigns.

To understand the challenge of tracking modern media use in this complex environment, McKinsey interviewed Steve Hasker, Nielsen’s President of Media Pro ducts. Mr. Hasker oversees the media products and services of Nielsen, a global information and measurement compa-ny headquartered in New York. He describes his respon-sibilities as delivering world-class consumer insights, quantifying multiple aspects of television, online, and mobile media, as well as devising effective techniques for cross-media and advertising measurement.

McKINSEY: What major changes in media usage trends are you detecting, and how fast are they taking place?

STEVE HASKER: The pace of change is incredible, but some constants remain. TV continues to be the premier mass-reach medium, especially when it comes to “mar-quee events” like the Super Bowl or the World Cup. The trend we see is that more and more multitasking will

occur. High-definition television will continue to grow, although 3-D TV will remain stalled until consumer electronics players develop a better user experience. Time shifting – prerecording programs to play later – has experienced significant recent growth, but will stabilize in the US at its current high levels, while other markets continue to catch up from a lower current base. Over-the-top (OTT) content, services, and applications will require high-speed access, and consumer electron-ics companies will need to push compatible products. OTT growth will likely come from Internet-enabled TV sets, as most consumers are unwilling to make room for yet another box connected to their set. Contrary to expectations, the TV screen won’t be where interactivity happens, largely because consumers expect and at times crave an uninterrupted big-screen experience. Instead, interactivity will occur via parallel and often comple-mentary use on other devices.

McKINSEY: How about new screens?

STEVE HASKER: What started as office equipment will return to being office equipment. Already a com-modity, sales of home desktop PCs will fall dramatically and more consumers opt for mobile devices. Enterprise sales of PCs will continue, but we are seeing a significant change in personal and in-home consumption. Mobile- and PC-based Internet experiences will continue to blur, and as Facebook reaches one billion users in 2012, the team there will find new ways to monetize how users are interconnected to one another.

McKINSEY: What mobile device trends do you currently observe in the market?

11 Footprints in the ether: An interview with Steve Hasker, Nielsen

RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Footprints in the ether: An interview with Steve Hasker, Nielsen

80

STEVE HASKER: We have seen tremendous growth in smartphone penetration and location-based applications and services. Consumers in both developed and develop-ing markets are increasingly viewing mobile devices – smartphones and more traditional mobile phones alike – as their primary source of personal computing, commu-nications, and entertainment. The next wave of mobile entertainment and information will be around social media and applications and will likely result in continued consolidation of smartphone operating systems.

McKINSEY: How are people responding to media on the iPad now that roughly 20 million of these gadgets are in circulation? Does the experience vary for different media like news and video, or in terms of the business model, such as paid or free service?

STEVE HASKER: We see consumers gravitating toward higher-end entertainment, including gaming, news, and video. The most compelling use case to date appears to be video. In recent weeks, multiple system operators (MSOs) have been moving to provide live TV to consum-ers’ iPads. Time Warner Cable in the US have made an app available that enables them to stream programs to a customer’s iPad at home. However, this has already raised a broad set of questions relating to content rights ownership. Apple have made the iPad a major area of product development focus in 2011, and we will see sig-nificant new functionalities and use cases from them, and also from competitors in the tablet space.

McKINSEY: Do trends differ by geography – the EU versus the US versus emerging markets, for example – and demographically?

STEVE HASKER: First and foremost, media busi-nesses are local businesses: they differ by country, with very few truly global competitors. This is true whether you look at TV, magazines, radio, or newspapers. Technology, on the other hand, is often ubiquitous and globally available. Social media usage and penetration, for instance, is as high in many EU countries as it is in the US. Mobile is more advanced in Europe, but the US is now catching up. TV costs per thousand impressions in the US are amongst the highest of any country in the world, and cable subscription fees tower over those in other countries. This will continue to foster develop-ment of high-cost content and often allows broadcast and cable players to exert significant influence over the future of valuable content, such as sports. These devel-opments aren’t limited to developed markets. Mobile

handsets have become a status symbol in the developing world and often serve as a user’s only communication device given the state of fixed-line networks in some of these countries.

McKINSEY: How are your clients and advertisers responding to these changing usage trends, and what are the main challenges they face?

STEVE HASKER: Advertisers are following “eyeballs” and moving into social media and mobile as a result. They demand – and receive – insights and metrics that inform their planning and evaluation of cross-platform campaigns.

Online display advertising will come of age as a result of developing a standard reach metric comparable to the one used for television and because of advances in creative advertising elements. Mobile advertising is also develop-ing viable value propositions, including the iAd platform, as well as location-based coupons and payment systems. Large branded advertisers continue to focus on television, especially in Europe and developing markets. In the US, campaigns are increasingly requiring a simultaneous online component as well. The multiplicative effects of simultaneous platform use are becoming clear in the form of positive return on investment for advertisers.

McKINSEY: Are consumer insights going to change marketers’ strategies?

STEVE HASKER: Our research shows that ads on Facebook that come with a positive recommendation from friends have two to four times the awareness, pur-chase intent, and overall impact of online ads that do not contain this social component. We are able to prove which ads work by combining media exposure data with purchase data. This is starting to have significant impact on the emphasis given to different types of media and the creative content used.

McKINSEY: How is Nielsen responding to these shifts in terms of audience measurement and insight generation? STEVE HASKER: Nielsen takes a consumer-centric rather than a platform-centric approach, which means we measure consumer media behavior no matter the device or platform. With that in mind, we’re currently rolling out an online industry standard reach metric to drive online display advertising. Nielsen Online Campaign Ratings will for the first time provide audi-

81RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Footprints in the ether: An interview with Steve Hasker, Nielsen

ence data comparable to Nielsen’s television ratings. The new measurement system significantly advances the state of the art for the media industry, providing greater accuracy, faster reporting, and wider cover-age than existing online measurement. Marketers and media companies alike will have a simpler way to measure the combined reach of TV, the Web, and even mobile advertising.

However, reach alone doesn’t tell the whole story, so we intend to combine these ratings with cross-platform advertising effectiveness metrics to provide a complete view, which we will continue to develop. We’re focus-ing on the US market first and intend to extend this to appropriate key markets around the globe later on.

McKINSEY: Let’s talk a little about the growth of display and video advertising in the digital world. Are consum-ers accepting it, and how can marketers best use digital to engage with consumers?

STEVE HASKER: Digital display advertising has grown to date based on direct response models – primarily priced on a cost-per-click or cost-per-action basis. This has been fostered by online ad networks and exchanges and has led to limited differentiation of online properties and muted pricing for a lot of inventory. We are beginning to see this change – first with the advent of online video (although inventory remains limited) and next with the development of more robust audience measurement. Our research shows that online consumers are accepting video advertising in many situations – particularly for product launches and major campaigns. Their engage-ment is often as high as with TV advertising. The next step will need to be improved non-video online creative content that consumers find compelling.

McKINSEY: What type of content are consumers willing to pay for? Do you see a change with the proliferation of app stores and transition to IP?

STEVE HASKER: Consumers will pay for “must-have” content that is not freely available elsewhere. This will include premium video and exclusive editorial content. It will still be hard to charge a premium for mass-market news, while consumer reviews, location-based services, and searches will be supported by advertising and e-com-merce revenues.

McKINSEY: How will content usage and costs evolve?

STEVE HASKER: Sporting events will continue to have a strong pull and will remain largely exclusive to cable and digital terrestrial television, which means OTT sports will continue to be a niche offering. Premium content providers will see new sources of growth in domestic and international markets as distribution channels continue to proliferate. This will support development of marquee programming. A further development is that the cost of production and distribution of niche and long-tail con-tent will fall as the costs of consumer electronics, data processing, distribution, and storage decline.

McKINSEY: We’ve talked a lot about the challenges inherent in tracking consumers across multiple screens. How about other trends, such as the all-IP world, the blurring of advertising and content, and the latest search-related innovations? What does the future hold, and how and when will we get there?

STEVE HASKER: Almost every one of these trends will benefit the consumer. Content will become easier to find and watch across multiple devices and geographies. The winners will be media companies who take a leaf from the Silicon Valley model, i.e., who create open platforms that leverage third-party innovations, owning key com-ponents of the value chain and leaving the rest to others. Losers will be those with expensive and outdated legacy systems that are overrun by new technologies in the absence of regulation to protect their assets.

McKINSEY: Will consumer behaviors shift in areas like brand preference and loyalty in response to the evolv- ing nature of content access? One example of this evolu-tion might be the movement from electronic program guides to search engines to Facebook, Twitter, and social recommendations.

STEVE HASKER: Social networking unlocks a force that has always been present but is sometimes hard to harness: social influence – the influence that friends have on their peers’ product and service selection. This will be increasingly important as digital content explodes and tests the limits of algorithmic search mechanisms. Heavy use of social media will reduce reli-ance on more traditional search methods. The impact will be to make hit content even bigger through amplifi-cation, while flops will implode all the faster.

Steve Hasker was interviewed by Markus Frerker, a Principal in McKinsey’s Munich office.

83RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Appendix

News, views, insightsMcKinsey’s Telecoms, Media, and High Tech Extranet is the gateway to some of the best information and most influential people in the TMT industry. The Extranet offers selected McKinsey-generated information that is not available on the general Internet.

Updated weekly with new articles on current issues and trends, this site allows extranet users to access selected McKinsey articles on topics such as mobile telecoms (including data, media, and broadband), fixed net-works, next-generation network infrastructure, enter-prise hardware, online services, software, and many more. Direct communication channels ensure that your questions and requests are addressed swiftly.

McKinsey’s Telecoms, Media, and High Tech Extranet lets you:

� Obtain exclusive information – free of charge – and access a portal specifically designed for the industry

� Access cutting-edge know-how, interact with experts to gain new insights, and contact industry leaders

� Stay well informed with daily industry news from fac-tiva that you can tailor to your needs and interests.

General information about the site is available at: http://telecoms.mckinsey.com

85RECALL No 16 – Consumers, Convergence, Connectivity, and the Cloud Appendix

Serving clients around the worldBuilding on the strengths of three of McKinsey’s stron-gest industry practices, the Telecommunications, Media, and Technology (TMT) Practice has been estab-lished to better address the convergence and value chain synergies for our clients in the sector. The TMT Practice serves clients around the world in virtually all areas of the TMT industry. Our consultants are indi-viduals who combine professional experience in TMT and related disciplines with broad training in business management.

As in McKinsey’s work in every industry, our Practice’s goal is to help our clients make distinctive, substantial, and lasting improvements in their performance.

The Practice has gained deep functional expertise in capability building and transformation, product devel-opment, operations, network technology and IT (both in strong collaboration with our Business Technology Office – BTO), purchasing and supply chain, as well as in customer lifetime management, pricing, branding, distribution, and sales.

Furthermore, we have developed perspectives on how new business models and disruptive technologies may influence these industries.

Telecommunications, Media, and Technology Practice May 2011Designed by Visual Media EuropeCopyright © McKinsey & Company, Inc. www.mckinsey.com