More than 18 million U.S. households had a smart TV at the end of 2011, and rising adoption of this device, combined with changing entertainment consumption habits, creates new challenges for pay-TV providers.

There are potential advantages, of course. Innovative pay-TV providers can leverage this new platform to develop and deploy apps, branded social media, and their own OTT (over-the-top) services. The smart-TV platform can serve as a DVR/set-top replacement, lowering equipment and deployment costs.

All pay-TV providers will have to explore these potential benefits because the smart TV is here to stay--and it presents operators with a number of risks to their core business.

Increased competition from alternate sources: Smart TVs lower the barriers to entry for alternative content options, and pay-TV services are faced with a growing set of potential competitors to their premium content services. For example, OTT services such as Netflix (Nasdaq: NFLX) Watch Instantly are easily accessible and offer alternatives to pay-TV VOD. But the list of competitors is constantly expanding. Content delivery technologies are readily available, including white-label services for complete online video offerings. As a result, a variety of companies, beyond independent OTT services, are entering the space, including retailers, technology enablers (such as Google (Nasdaq: GOOG) and Intel (Nasdaq: INTC)) and CE manufacturers.

Alternative interface options for the consumer: The smart TV provides consumers with an alternative to the pay-TV user interface. They can access content services such as YouTube through the company's own interfaces, rather than having to go through the provider's branded portal. As consumers demand access to alternative sources, operators must consider how to integrate these sources into their own interface without introducing a potential rival to their advertising and VOD revenues.

Changing delivery mechanisms: The greater demand for OTT video services could be the beginning of a shift from traditional delivery mechanisms to a new IP-based approach. Operators' current proprietary TV distribution networks are optimized for broadcast delivery and are not designed for a unicast environment. If the industry does indeed move to IP-based, multiscreen environment with significant scale, operators need to be in a position to move quickly to preserve their core business. As a result, most major operators are watching trends in OTT delivery closely to monitor the rate and degree of change.

Greater broadband network congestion: While the TV services side of an operator's business may be excited by the potential additional subscription, transactional, and advertising revenues from OTT delivery of content to a smart TV, the broadband side of the business is far less enthused by the prospect. Since video is one of the most data-intensive applications used on a broadband network, a move to OTT delivery of content would result in significant traffic congestion.

In early 2012, Korea Telecom (KT) disabled capabilities of Samsung smart TVs on its network, claiming that smart TVs consume between five and fifteen times as much data as an IPTV service. The operator insisted that Samsung must provide compensation to KT for the additional bandwidth capacity that it had to support for these devices. Korea's federal regulator stepped in and required KT to re-enable services for Samsung's smart TVs, but the incident highlights the importance of the issue to broadband providers and what will be an ongoing struggle in the industry.

In a similar approach, cable operator Comcast (Nasdaq: CMCSA) previously raised the wholesale rate that it charged to Level 3 (NYSE: LVLT), then the CDN for Netflix. Comcast increased the cost to compensate for the disproportionate broadband usage, and resulting congestion, represented by the Netflix service. Therefore, pay-TV providers must consider whether they ultimately want to offer their video services on a platform that produces substantially greater broadband traffic on their own networks.

Less control over and insight into the consumer viewing experience: On their proprietary television infrastructure, pay-TV providers have significant insight into the viewing experience and control over the quality of content delivery for all of their customers. Cable and telco providers have focused on "five-nines" delivery metrics that emphasize high quality and reliability for their television services. In contrast, they lack the insight and control over the experience when content is delivered via IP to an app on a smart TV. The best monitoring systems for CDNs today cannot provide real-time metrics on the quality of individual consumer viewing sessions. As a result, operators cannot quickly react to outages or delivery problems in their OTT services, potentially risking the perception among subscribers as to the quality of their TV service overall.

Uncertain business models: While the economics and business models of pay-TV are proven and accepted by an entire ecosystem of content, service, and equipment providers, the same cannot be said for OTT video services for the smart TV. Current revenues for OTT video services overall (not to mention for smart TVs alone) pale in comparison to pay-TV subscription and advertising revenues. Many operators are struggling to find ways to adequately monetize their OTT offerings in order to cover their content licensing and OPEX costs. This uncertainty over business models makes it difficult for pay-TV operators to aggressively move to offer content services on smart TVs beyond supplements to their existing pay-TV subscriptions.

The initial stage of these "supplemental services" generally took the form of TV Everywhere. Delivery of linear or on-demand TV content by pay-TV providers to the Internet-connected devices of their subscribers is referred to as TV Everywhere, multiscreen, or N-screen services. Several U.S. operators--among them Comcast, DirecTV (Nasdaq: DTV), DISH Network (Nasdaq: DISH), AT&T (NYSE: T), and Verizon (NYSE: VZ)--now distribute video content to multiple devices, although computers have far outpaced other devices so far as TV Everywhere delivery platforms.

The majority of operators in North America invested in TV Everywhere as a defensive mechanism, to counter the threat posed by online video services. In the U.S. market, hundreds of thousands of subscribers have dropped their cable or satellite television service since 2008. Seven percent of U.S. broadband households intended to cancel their pay-TV services in 2011, with 22 percent of these planning to use OTT services like Netflix as their primary source for video.

The North American market has the highest penetration of TV Everywhere services, with 86 percent of subscribers having access to some TV Everywhere offering, according to Parks Associates' TV Everywhere: Growth, Solutions & Strategies--North America (2nd Edition).

With these services now readily available to subscribers, pay-TV providers can move from defense to offense, with the smart TV, along with other connected devices, opening opportunities for new services, improved viewer experiences, and incremental revenue. However, there are multiple risks operators will need to address as they integrate the smart TV into their business strategies.

From the article, "Smart TV risks for pay-TV providers" by Brett Sappington. 

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