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Business Model Focus: The Changing Economics of Hosting

Specialization - sometimes to the extreme - is among the Internet economy's most recognizable attributes. Need sport socks? There's a site that focuses on sport socks alone. But as many of the tightly focused e-commerce and entertainment sites have learned over the past half year, it's not always good business to be a one-trick pony. Streaming media hosting companies are no exception: They are discovering that the provision of streaming content hosting services is simply not enough to satisfy customers - or the bottom line.

To survive in the fierce environment of the streaming media hosting space, many hosting companies are finding it necessary to provide a one-stop shop with value-added services - including pay-per-view, e-commerce, targeted advertising, content management, and more. For some, this could prove a burden too heavy to carry. But those that are able may find a wealth of new opportunities, since the fattest margins lie in services that go beyond simple content hosting.

Hosting's Changing Face

The streaming media space has changed dramatically over the last several months to reflect this shifting demand, with consolidations - and the amalgamation of services they bring - becoming the norm rather than the exception. Bundling services and sleeping with the enemy have indeed become the reality of the economics of streaming hosting. Two major cases in point are the joining of forces by Akamai and Intervu, and of Webcasts and iBeam.

What the survivors of the streaming service provider shakeout are learning is that content hosting is relatively low on the profitability scale, and such services could become a commodity as companies begin to compete more aggressively on price. "If you've got pipes, bandwidth, and floor space in a data center, you can become a player and drive down price," said Chris Maskill, founder of Activate, a Seattle-based streaming media services company.

So where can you go from there to ensure long-term competitiveness? According to Maskill, diversification of services is the key. "There may be big bucks [in content hosting], but the profit is not there," he said. "So we're looking at value-added services that may be more profitable."

That's not to say that Activate would stop offering content hosting services. That service will remain at the core of any streaming media services package - but the bread-and-butter will come from other services. "There are parts of the infrastructure business that are more profitable than others," Maskill explained.

According to Maskill, the major pieces of the puzzle are production; capturing, encoding and digitizing; content management; and hosting and streaming. Activate currently makes some of its revenue in all four of these areas. But while production of content brings a healthy profit margin, it requires a lot of labor hours, so Activate prefers to outsource that service. And since the company has already invested in a master broadcast center to capture, encode, and digitize signals, that portion of the business scales efficiently and provides "good margins," Maskill said.

But it is content management - the indexing and archiving of content for searchability, for example - that makes up "the most valuable infrastructure play you can be a part of," Maskill says. Though content management is still a nascent offering at Activate, Maskill expects it to be in high demand.

Targeted Services

Tom Gillis, vice president of marketing at iBeam, agrees that a hosting company must stand out from the crowd - first through quality, and second by offering a panoply of services. "I can't say [hosting] will become a commodity because there are clearly performance and price differences between different providers. But it absolutely has to be coupled with more services," he said.

To that end, Gillis puts his faith in value-added services like ad insertion and pay-per-view that will help iBeam customers - and iBeam - boost revenues. "The value proposition to the customer is to help them make money. If all you offer is streaming hosting, you are not helping them make money because it's a cost to them," he explained.

When a customer elects to purchase additional services like pay-per-view, targeted advertising and e-commerce, then they are venturing into areas where they can recoup that initial streaming investment and begin to make money on their online multimedia, he said.

The strategy has worked for iBeam. The company first introduced ad insertion to its customers in April, and in the first two weeks, 30 signed on for the service. IBeam now serves about five million targeted ads per month and counted 150 customers as of mid-June.

The ad margins can be quite large for iBeam customers. For ad insertion, IBeam charges $5 to $10 per 1000 ads served. IBeam's customers in turn, charge advertisers anywhere from $45 to $75 for the same 1000 ads, Gillis said.

"Increasingly, an important part of our business is these value-addedservices and they can be fairly high-margin because once you build thenetwork for streaming, the others you add on to the platform. The capital is already in place," Gillis said.

Basic streaming services cost a customer about one cent per megabyte transferred. The cost to iBeam, naturally, is substantially less, but the fixed cost of equipment is figured into that price.

Quality Counts

Though hosting may be among the least profitable services a streaming company can offer, long-term survival will still depend upon the ability to provide that service - and provide it well.

What separates the players in the hosting space currently is their reach, or coverage area, as well as price and ancillary services like promotions and bundling, said Tom Britt, chief executive officer of online streaming media guide Channelseek.com. "Soon they will all offer the same features," he said, adding that when that happens, more mergers can be expected.

Technical capacity and scalability will be key determining factors in the race for hosting market share, said Sandra D. Kresch, a partner in the entertainment and media practice at PriceWaterhouseCoopers. She predicts that streaming providers will integrate in the way movie studios have done with broadcast networks, so they can offer a range of services from hosting to distribution.

Eventually, the hosting space will be dominated by a few players who have made the investment in streaming equipment and infrastructure and achieved critical mass, Gillis predicts.

One of those players is likely to be Cambridge, Mass.-based Akamai, with a network serving 45 countries on 4,000 servers. This kind of breadth allows not only for quality in network performance, but also the ability to serve a wide range of customers, said Ray Weaver, director of product management. For instance, Akamai recently streamed a speech by Apple's Steve Jobs from the Jacob Javits Convention Center in New York -- a feat requiring five gigabytes of streaming media to reach "hundreds of thousands of users at the same time," he said. "If you are going to do a big event you need someone with headroom," he said.

To ensure that it maintains that headroom, Akamai formed an agreement in late May with Cidera, which employs satellite delivery methods, to extend its network and speed its delivery. Bandwidth over satellite is generally cheaper than via terrestrial networks.

Doug Glenn, president of San Francisco's Burst.com, also believes thatquality will always be key to success in the streaming arena. Burst sends content in bursts, rather than in constant bit rate streams, which enables the company to use bandwidth 40 percent more efficiently, he said. That also means Burst needs fewer data centers for the amount of content it handles. "Because our costs are lower and because our architecture is smarter, it costs less and we can charge less," he said.

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