The Internet Value Chain

THE INTERNET VALUE CHAIN
Many of the other online entertainment services
companies use a hybrid revenue model, combining
some free or partially advertising-funded services as
an enticement, with additional content and functionality
offered to users who choose to subscribe. This is
generally known as the ‘freemium’ approach. Although
some services may be viable with advertising revenues
alone, generally a key success factor is their ability to
convert free users into paying subscribers. In video,
69 per cent of revenues come from paying subscribers,
while 86 per cent of music revenues and 99 per
cent of cloud services revenues come directly from
users’ pockets.
It is important to note that these splits only refer to
the sources of revenue. In many cases, looking at a
split of the number of users who are subscribers versus
‘free’ could give a very different picture. For example,
a music streaming service may earn the majority of its
income from paying subscribers, while the majority of
its users listen via a free advertising-funded service.
Different companies are also following varying
strategies within segments: for example, in video
YouTube largely follows an advertising video-ondemand
(AVOD) model, while Netflix follows a
subscription video-on-demand (SVOD) model.
At the same time, it is important to note the
interrelationships across the value chain that govern
money flows and economic dependencies. Content
rights companies receive revenues from online services
operators, in particular consumer entertainment
companies in video, music, publishing, and gaming.
Enabling technology companies are mostly pure B2B
service providers, and many receive a large part of their
revenues from other companies in the internet value
chain, for example in relation to web design hosting,
advertising services, payments, and content delivery.
For example, an online video service provider such as
Hulu pays enabling technology companies in the
internet value chain to maintain its website, optimise
content delivery across multiple platforms, serve ads
on its website, advertise its own services on other
websites, and process subscription payments. In
addition, it pays media companies (in the content rights
segment) to license content for its platform, telecoms
operators (in the connectivity segment) for its own
in-office connectivity, and device manufacturers and
software firms (in the user interface segment) for its
office equipment.
Profitability
Beyond revenues, we assess the relative profitability
across the internet value chain as measured by EBIT
margin. This metric is useful, as it takes into account the
variations in depreciation between categories resulting
from their differing capital intensity.5
EBIT margins differ considerably across the internet
value chain and also within each of the five segments
(see figure 7 on page 26). The most profitable online
services and enabling technology categories—e-retail,
search, gaming, information and reference services,
payment platforms, and advertising services—all feature
significant network effects, economies of scale, or both.
The network effects of search and online advertising
businesses such as Google and Baidu, payment platforms
such as PayPal, and B2B e-retail platforms are significant
in their respective sectors, enabling the leaders to
extract high margins. The scale and long-term
reputation of the leading B2B information service
providers such as Experian and Bloomberg create a
significant barrier to entry in the business segment, thus
supporting the profitability of their online operations.
The companies with the leading operating systems and
app stores in the internet environment are also highly
profitable, using their scale and strategic market
positions as gateways to their benefit.
It should be noted that within categories and subcategories
there are often exceptions, where the overall
margins are low on average but the leaders have high
profitability. For example, in content delivery and
optimisation Akamai reports EBIT margins of more than
25 per cent, placing it in the highest bracket in the
internet value chain. However other content delivery
network operators have much lower profitability.
5 The margins presented here are not necessarily those of the players with the largest market shares. Please see the Methodology section for further information and clarification.
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