In the smart TV industry, will ad-supported business models drive free TVs in 2023?

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Summary

Roku and Vizio have been visible leaders in changing how TV manufacturers make money. Just a few years ago, TVs—like most other consumer electronics products—were sold on a cost-plus-markup model. New revenue sources emerged as TVs gained internet connectivity: conventional linear TV (over-the-air broadcast, cable, and satellite) gave way to internet streaming. Smart TV platforms could gain a place in the advertising and viewing data market, delivering platform profits that exceeded TV hardware margins. Helped by a pandemic surge in TV sales, platform profits soared. With a strategy to grow users and engagement, then monetize, a strong incentive emerged to reduce hardware margins in favor of platform profits.

Last week, the logical conclusion appeared, offering TVs for free in a rush to grow an active installed base. Enter “Telly,” established by the founder of Pluto TV and other smart TV and advertising industry veterans. We will examine Telly’s prospects.

Key factors in the TV market, 2020–23

• TVs are not equally valuable to advertisers. The smart TV platform battle will be won or lost on the main viewing TV. Secondary TVs in the kitchen or spare room do not get enough engagement to justify the investment.
• Roku and Vizio’s quarterly financial earnings reports allow us to size the business. They report the number of active accounts and total streaming hours; most importantly, they separate hardware/platform revenues and hardware/platform gross profits.
• Samsung, LG, and Google report some useful information about the number of smart TV accounts but do not publish platform revenues and profits.
• Free ad-supported streaming TV (FAST) or ad-supported video-on-demand (AVOD) have rapidly expanded as alternatives to ad-free subscription video tiers and conventional TV services.
• In the UK and Italy, pay-TV provider Sky, part of Comcast NBCUniversal, sells its Sky Glass TVs in a similar package as a cellular phone contract. You can pay off the TV hardware price over 48 monthly interest-free payments. Similar plans have not gained traction in the US market, but the product offering has been very different.
• Telly’s TV terms of service state that:
  • Telly is available only in the US. To use the product and services, you will:
    • Use the product as the primary television in your household
    • Keep the product connected to the Wi-Fi and internet

To be successful, Telly needs a rate of return 5 to 10 times greater than Vizio or Roku

Roku and Vizio monetize around $5 per user quarterly in gross profits. They make about $20 per user annually and, assuming an active TV service life of five years, yield about $100 over the lifecycle of a main viewing room TV.

This suggests that selling smart TVs at breakeven hardware cost yields around $100 profit. Note that platform EBITDA is about breakeven for both streaming companies. Selling TVs at cost leaves much fewer retail sales dollars and profits for the retailer. You can buy a 58-inch Hisense Roku TV at Walmart for $268 most days, and on Black Friday, you can buy a 65-inch TCL Roku TV from the retailer for $228. Pressure is increasing on smart TV platforms to share some advertising profit with stores. Already, Roku and Best Buy work cooperatively on exclusive Roku-branded TVs and a shared advertising business.

Figure 1: Vizio’s financial modeling, quarterly profits Source: Omdia

Figure 2: Roku’s financial modeling, quarterly profits Source: Omdia

Table 1 summarizes investor reports from Roku and Vizio for 3Q22, 4Q22, and 1Q23.

Table 1: Smart TV operating systems financial modeling, 1Q23

Source: Omdia

According to Dallas Lawrence, chief strategy officer at Telly, the free Telly TV is worth more than $1,000. A 55-inch TV retails for about $500. Telly requires an upfront working capital of $50m to $100m just to build the 100,000 sets for users who signed up in the first 36 hours. To meet their announced promise of 500,000 sets, Telly will have to raise between $250m and $500m.

Even monetizing at a rate 10 times better than Roku or Vizio, it would still take five years to recoup the initial investment. In advertising, scale matters. By comparison, Samsung has 200 million smart TV accounts, LG and Google have 150 million each, Roku has 71.6 million, and Vizio has just 17.4 million. Even if Telly gives away half a million sets a year, it will not scale fast enough compared with its peers. Samsung shipped over 11 million sets in North America last year, with four other brands shipping over 4.5 million. Financing will be the limiting factor for Telly’s ambitions.

We have seen a very similar approach in China in 2015–16, where TV streaming brands emerged with a similar value proposition: free or subsidized TVs in return for long streaming subscriptions. The most notable was LeTV, which suffered a financial collapse in mid-2017 after shipping at an annualized rate of 5 million per year.

The Telly pitch deck for investors touts Telly as much more than a TV. It has Zoom video calling, games, fitness programs, and more. In the terms of service, Telly explains that those services may become paid services in the future. A free TV’s features might not be free in the future.

In its investor pitch deck and website, Telly features the logos of well-known companies in its advertising examples, including McDonald’s, Walmart, Kia, BMW, Pepsi, and Pizza Hut. We observe some correlation between the brand of the main TV set and broader consumer purchase behavior. People who buy upmarket TVs generally have other upmarket spending patterns. Apple iOS consumers typically occupy wealthier demographics, for example. We fear that a Telly consumer unwilling to pay $268 at Walmart for a 58-inch Hisense TV (and will sacrifice privacy for savings) is a sub-prime consumer from an advertiser’s point of view. How will a Telly customer be expected to monetize many times more than other TV platforms? For ad-supported free TV hardware to make sense, something fundamental needs to shift to make this work.

If Telly can crack the code, they can expect fast followers with much more scale to be competing for the same opportunity. The most important conclusion is that the TV business model is evolving rapidly, defined by competition between platforms. The hyper-competition in hardware is evolving into hyper-competition in recurring revenues, with a dynamic to ship at ever-lower margins to grow the installed base. The role of brand and rich featuring is not yet clear, nor whether this business model transfers readily beyond the US.

Appendix

Methodology

Omdia’s TV Sets Spotlight Service provides detailed shipment, revenue and forecast data, country and feature analysis, and expert insights to guide strategic planning in the global TV set business.

Further reading

TV Sets Spotlight Service

Author

Patrick Horner, Practice Leader, Consumer Electronics

[email protected]