Internet Value Chain Economics
Gaining a deeper understanding of the Internet economy

W

hen considering the technological innovations of the past 50 years, the Internet is probably the one that has had the greatest impact on everyday life in developed economies. Nearly six out of 10 Americans now shop online and more than four out of 10 bank online. Twenty hours of video are uploaded to YouTube every minute, while 5 percent of all time online is spent on the social networking site, Facebook. The Internet has also changed the way in which businesses operate—today, 64 percent of C-level executives conduct six or more searches per day to locate business information. The Internet has been a source of great good—as evidenced by the role played by Internet-based mapping and communications in the relief effort following the recent Haiti earthquake. The Internet also has shown a negative side—more than 97 percent of all emails are spam, while more than 70 percent of Americans fear online identity theft and 57 percent feel that their personal privacy has been greatly diminished by the Internet.1
Behind these statistics and headlines, however, there remains a low level of understanding of how the Internet economy works. Who are the different players involved in the Internet, beyond the flagship names? How is the industry structured and how concentrated is it? How do players make money and how do revenues flow across the value chain? Is the industry attractive in terms of growth and returns? As the Internet continues to grow and develop, playing an increasingly important role in the lives and activities of people and organiza1

tions, a sound understanding of the Internet economy will be important for all stakeholders. This includes the companies playing a role in the Internet economy, private and business consumers, and the regulators and policy-makers who are increasingly being asked to oversee or intervene in multiple aspects of the Internet. To help improve the understanding of the Internet landscape, Vodafone commissioned A.T. Kearney to conduct a review of the Internet’s value chain and economics. This paper has been produced independently and does not necessarily

Data sources include Pew Internet & American Life Project survey, 2009; YouTube, May 2009; ComScore, April 2009; Google, Forbes, BtoB, June2009; “Social media get quake reports out fast,” Los Angeles Times, January 2010; Microsoft, 2009, quoted in http://news.bbc.co.uk/2/hi/technology/7988579.stm; ABC News/Washington Post, 2009, quoted in http://www.spendonlife.com/blog/new-poll-shows-increased-id-theft-fear.

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represent the views of Vodafone. Neither Vodafone nor A.T. Kearney is responsible for the use that might be made of this paper. This paper has a global scope but most examples and illustrations focus on North American and European markets. Terminology has been standardised and may differ from regional usage. The paper begins with a brief overview of the Internet’s growth and usage trends. Next, it lays out the Internet value chain and describes each part of the value chain in terms of key players and revenue models. Finally, it provides an assessment of the industry’s market size, growth trends, profitability and competitive structure. It is not the purpose of this paper to offer recommendations, but rather to provide a consistent framework and fact base to inform public debate. With such a broad remit we may inevitably disappoint readers who would like more detail about individual markets or issues; for that reason we have provided documentation of our sources and assumptions to assist further research.

1. Summary of Findings
The number of Internet users has grown rapidly to 1.7 billion in 2009, or a quarter of the world’s population. Consumers use the Internet for an increasing range of everyday activities, from shopping and banking to sharing photos and watching TV. As a result, they spend a growing proportion of their media consumption time and wallet on the Internet. A complex value chain has developed to deliver these services, comprising global and local players with assets as diverse as content rights, communications and IT infrastructure, proprietary software and global brands. Businesses also use the Internet extensively to market and distribute their services as well as to procure and manage supply chains.
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Total Internet value chain revenues are estimated at US$1,930 billion in 2008, growing on average at 10 percent p.a. More than 60 percent derives from business-to-business activities as many organisations have embraced the Internet to market and sell their services and to manage relationships with suppliers and partners. On the consumer side, the largest categories of spend are for retail Internet access and end-user devices/ hardware. Between them, these enablers for households to access the Internet account for 44 percent of total consumer value chain revenues. Consumer Online Services, the most visible part of the Internet economy, represent a US$242 billion market, of which a substantial part relates to e-Commerce. Search engines capture more than one-third of remaining online service revenues and indeed 59 percent of online advertising revenues. Revenues for consumer Online Services are growing more than twice as fast as those for Internet access provision and more than five times faster than sales of hardware and software. Bandwidth growth has been even stronger, but online service revenues are for the most part disconnected from bandwidth consumption — in 2008 file-sharing and video-on-demand accounted for nearly three-quarters of bandwidth but only 8 percent of revenues. Our analysis shows that the most concentrated markets in the value chain are the Online Services of VoIP, gaming and search plus certain categories of hardware/software, namely games consoles, smart phones and operating systems. The online advertising network market is also highly concentrated. In all of these categories the top three players account for more than 60 percent of revenues, driven by strong network and/or scale effects. We also analysed the profitability of the largest players in all categories. While many factors

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influence a company’s profitability in a given year, we found the most concentrated categories to be among those with the highest returns on capital employed (ROCE) in the value chain, at least 20 percent in all cases. Content Rights and Connectivity, on the other hand, are less concentrated markets when measured at a global level, although local differences apply. Both of these markets also have lower ROCE (10 to 15 percent) and the market capitalisations of their largest players have been stagnant for years. The Internet has a short history characterised by rapid bursts of technological and economic development, often stimulated by the emergence of new entrants on a global scale. Whether it will continue to be so dynamic or is now of such a size and relative maturity that it begins to resemble other parts of the global economy, is beyond the scope of this paper. Certainly one could expect such differences in economic performance across the Internet

value chain to influence corporate strategic activity and regulatory decision-making in the years ahead.

2. Growth of Internet Usage
The number of Internet users globally has grown dramatically in the past 15 years (see figure 1). In 1995, there were only 16 million Internet users, equating to 0.4 percent of the world’s population. By 2009, this had risen to 1.7 billion users, corresponding to more than a quarter of the world’s population. In most West European and North American markets, Internet usage penetration now surpasses 75 percent of the population. In recent years the strongest growth has come from emerging markets. In China, the penetration rate has jumped from 2 percent in 2000 to 27 percent by the end of 2009. With 360 million people online, China has more Internet users than

Figure 1 Global Internet users and penetration rate (1995-2009)
25.6% 23.5% 20.0% 16.7% 1,574 1,319 1,018 719 513 587 817 1,093 1,734

2,600 2,400 2,200

A quarter of the world’s population is online

26% 24% 22%

World population penetration

Internet users (millions)

2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0
16 0.4% 36 0.9% 70 1.7% 3.6% 147 4.1% 248 5.8% 361 8.6% 9.4% 11.1% 12.7% 15.7%

20% 18% 16% 14% 12% 10% 8% 6% 4% 2%

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

0%

Sources: Nielsen, ITU; A.T. Kearney analysis

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the whole of Western Europe, and 60 percent more than the United States. Brazil already has more Internet users than any European country, while the Middle East has gone from 3 million to 57 million users between 2000 and 2009. Most users access the Internet via fixed-line broadband connections at home or at work. The take-up of broadband, delivered via multiple technology options but primarily via DSL connections over the original copper telephone networks, has transformed the telecommunications landscape in most countries. With plans to deploy fibre to deliver far greater bandwidth per connection, the telecommunications sector faces a major investment wave in the next decade and is currently engaged in extensive debate over the future regulatory framework and commercial model to support such investments.

More recently, mobile devices have become a key means to access the Internet, driven by the availability and increasing affordability of smartphones as well as high-speed data modems and USB “dongles” that provide Internet access for laptop computers. Total shipments for smartphones, for instance, are projected to grow from 54 million in 2005 to 289 million in 2013.2 Time spent online is also growing substantially, to some extent at the expense of traditional media. A recent study conducted in Germany, for instance, projected that the Internet’s share of media consumption time would increase from 4 percent in 2000 to 24 percent in 2015. This, however, does not come solely at the expense of other media. Total media consumption time grew by nearly 50 percent between 2000 and 2009 to an average of 10.3 hours per day. There is a growing

Figure 2 Internet share of consumers’ time and wallet

EXAMPLE: Germany

Share of time by media1 (2000-2015e)
(hours/day/person)
7.2
20% 4%

Share of wallet by media (2000-2015e)
(US$ billion)
10.3
23% 2% 21%

8.3
23% 3% 29%

9.6
23% 2% 24%

71

75

99

134

Others2 Magazines Radio
7% 6% 23% 5% 5% 20% 58% 47% 40%

34%

Others2 Magazines Radio TV

37%

4% 4% 17%

30% 34% 36% 12% 21%

29%

TV

8% 6% 23%

42% 29% 16%

Internet3

24%

Internet

4%

5%

2000

2005

2010e

2015e

2000

2005

2010e

2015e

Notes: 1Includes simultaneous media consumption 2 Books, films, newspapers, offline-video games and video 3 Internet advertising and access spending
2

Sources: PwC, SevenOne Media, ARD/ZDF online study; A.T. Kearney analysis

Credit Suisse, June 2009

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trend of consuming multiple media at the same time—for instance, browsing the Internet while watching TV. With increasing share of time, the Internet is inevitably also capturing an increasing share of consumer and advertiser spend—from 5 percent in 2000 to 42 percent of total by 2015 in Germany, potentially twice as much as TV and Radio combined. This trend is likely to be repeated for other European markets (see figure 2). Internet usage is expanding to a broader range of services and becoming central to everyday lives. In the United States, 56 percent of people reported having bought a product online in 2009 compared with just 27 percent in 2000; 42 percent bank online, compared to 10 percent in 2000; 28 percent use social networking sites, in contrast with only 5 percent in 2000.

Internet usage patterns have evolved rapidly, as illustrated by consumers’ preferred websites. Of the top 15 websites in the United States in 1999, measured by unique visitors, only four remained in this league table by 2009 (see figure 3). Most of the top 11 websites have been launched fairly recently and include sites such as Google, Facebook, eBay and Apple iTunes. Search and Social Networking are two examples of services where market leadership has changed rapidly. In 1999, Google captured only 4 percent of global search revenues. Today Google has two-thirds of the market, while 1999 leader Yahoo!’s share has shrunk from 29 percent to 7 percent. In social networking, Facebook did not exist in 2003. Five years later, it held 23 percent of the market, while 2003 market leader Xanga is no longer among the top five players.

Figure 3 Top 15 Internet websites (1999 versus 2009)

U.S. top 15 sites 1999
Web property 1. AOL sites 2. Microsoft sites 3. Yahoo sites 4. Lycos 5. Go Network 6. GeoCities1 7. The Excite Network 8. Time Warner Online 9. Blue Mountain Arts 10. AltaVista 11. Amazon 12. Xoom 13. Snap 14. Real Networks 15. CNET
= No longer operating = No longer exists as an independent entity

U.S. top 15 sites 2009
Genre Portal Portal Portal Search Portal Web hosting Portal Media e-Cards Search e-Commerce Web hosting Search Media player Media Web property 1. Google sites 2. Yahoo sites 3. Microsoft sites 4. AOL sites 5. Facebook 6. Ask Network 7. Fox Interactive Media 8. Amazon 9. Wikimedia Foundation 10. eBay 11. Turner Network 12. CBS Interactive 13. Apple Inc. 14. Glam Media 15. Answers.com UVs (m) 164 158 133 99 97 88 83 70 69 67 63 59 58 56 55 Genre Search Portal Portal Portal Social network Search Media/social network e-Commerce Reference e-Commerce Media Media Music Lifestyle Reference

UVs (m)
2

46 32 31 29 21 19 17 13 12 11 10 9 9 8 8

Note: 1Now only available in Japan 2 The Unique Viewers (UV) metric enables a clearer comparison of different types of websites than the more commonly referenced Page Views metric Sources: ComScore, A.T. Kearney analysis

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3. Overview of the Internet Value Chain
The Internet ecosystem is complex and involves multiple activities and players. We break down the Internet value chain into five main markets: Content Rights, Online Services, Enabling Technology/Services, Connectivity and User Interface (devices and applications). Figure 4 shows the main strategic segments within each market and the different service categories within those segments, together with the logos of some of the larger players. A number of industry players operate in two or more segments of the value chain. This can be powerful in terms of creating a seamless customer experience but can also be used to take full advantage of assets such as technology, brands and customer relationships in order to strengthen competitive positioning.

Content Rights owners are typically media companies such as Warner Brothers, the BBC or Electronic Arts providing their content for a share of revenues and/or license fees. Content Rights owners typically retain 50 to 70 percent of the revenues generated by the online service provider that makes the content accessible to Internet users. For instance, iTunes shares approximately 70 percent of revenues earned on each music purchase with the music majors.3 In some cases, Content Rights owners provide their own Online Services, such as the BBC iPlayer service. Of course, there is still considerable illegal or unauthorised use of content on the Internet for which there is no payment made. Online Services Online Services correspond to the range of services accessed by Internet users and are, as a result, very diverse. For simplification, we have grouped Online Services into five main segments:4 Communications. Includes all forms of communications among Internet users, including voice (VoIP), social networking, email and instant messaging. Leading providers of such services include Skype (part of eBay), Facebook and Hotmail (part of Microsoft). With the exception of VoIP, these services are invariably provided freeof-charge and funded by advertising revenues. General/vertical content destinations. This segment includes general content portals (Yahoo!) and more targeted services such as dating websites, general news/consumer publishing or special interest content websites on a diverse range of topics from wine to politics. Revenues are mostly generated through advertising, although some websites charge for access to their services (for example, dating websites and FT.com).

Description of the Key Markets in the Internet Value Chain
Content Rights Much Internet content is user-generated, for example, an individual’s page on a social networking site or a “tweet” message on Twitter. Such content typically does not involve remuneration to content creators, although they may well retain copyright or some degree of privacy protection over how their content is used by others. The Content Rights market quantified in our subsequent analysis corresponds to the provisioning of content to online service providers on a commercial basis. Examples of such content include music, filmed entertainment, games, news or the content of books and magazines.
3 4

Content Rights are often more complex than described here: an artist may own rights to different elements of a composition and receive royalties out of the revenues collected by the media company. In subsequent analyses we also refer to the main categories of service within these segments where market characteristics are distinct.

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Figure 4 Overview of the Internet value chain

ILLUSTRATIVE

Content rights1
Media rights owners • • • • • • Video Audio Books Gaming Adult content Editorial content
EMI Blizzard BBC

Online services2
Communications
Skype Hotmail Vonage Facebook

Enabling technology services3
Support technology • Web-hosting • Web-design/development • Content management
NTT/Verio Limelight Group Rackspace Akamai

Connectivity
Core network
AT&T British Telecom NTT France Telecom

User interface
Applications • Software • Media players • Internet browsers
McAfee Symantec RealNetworks Firefox

General/vertical content
Yahoo! Financial Times Wikipedia match.com

TimeWarner Harper Collins

Search
Google Bing Baidu Ask.com

Billing and payments • Online billing and payment system providers
PayPal Chase Paymentech First Data Google Checkout

Interchange
Level 3 XO Communications Communications

Retail Internet access
AT&T SingTel United Internet NTT Vodafone Tiscali Road Runner Free

Devices • • • •

User

Entertainment User-generated content • Text • Images • Voice • Video
YouTube Last.fm Xbox Live iTunes

Transactions eBay Expedia Amazon Boursorama

Advertising • Online ad agencies • Online ad networks/ exchanges • Third party ad servers • Ratings/analytics services
WPP Double Click Razorfish Nielsen

PCs Smart phones Game consoles Other internet access hardware • Operating systems
Dell Microsoft Nokia Source: A.T. Kearney analysis Nintendo Apple

Notes: 1Content rights abbreviated to CR in subsequent value chains 2 See online services categories list in methodology for details 3 Enabling technology/services abbreviated to ETS in subsequent value chains

Search. This segment consists primarily of web search engines such as Google or Baidu, as well as local/national directories such as Yell in the United Kingdom or Pages Jaunes in France. Revenues are primarily generated from advertising, with sophisticated models such as auctioned keyword references or pay-per-click having established themselves in recent years. Entertainment. This comprises websites focused on audio-visual entertainment, such as downloads of digital content (iTunes), music and video streaming/online radio (YouTube, last.fm), IPTV, gaming (Xbox Live), gambling (PartyPoker) or adult content. Revenues are generated almost equally from advertising and payments from end-users. e-Commerce. Many websites sell non-digital

products and services. The largest service categories include e-Retail (Amazon), e-Travel (Expedia) and online brokerage (Boursorama.com). Both bricks-and-mortar and pure-play online players are active in this segment. The e-Commerce site operator will collect payment from the customer and retain a margin, with the remainder passed on to the manufacturer or service provider. Online costs are typically much lower than for traditional retailing so that prices are often, although not always, lower. This has triggered substantial growth and a displacement of volumes from traditional retail to e-Commerce for items such as books. Revenues generated by Online Services therefore originate from a combination of advertising, paid-for access to content and services, and e-Commerce transaction fees.
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Enabling Technology/Services Enabling Technology/Services are generally invisible to the end-user, but are essential for the technical delivery of web content and the generation of revenues. Highly fragmented, these services fall into three broad segments: support technology, billing and payments and advertising services. Support technology refers to a set of technical services provided to online service providers and includes website design and development, web hosting and technical service platforms (such as content management platforms). Akamai, for

Revenues for consumer Online Services are growing more than

twice as fast as Internet access provision and more than five ware and software. times faster than sales of hard-

example, provides content delivery services through its network of servers that improve the speed and reliability of the connection and manage the network load efficiently on behalf of online service providers. Billing and payments comprise all payment platforms used to process monetary transactions made by consumers on the Internet—to pay for accessing specific services (such as music downloads) or to conduct online e-Commerce transactions. Beyond payment processing services
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INTERNET VALUE CHAIN ECONOMICS

provided by banks and payment processors such as First Data, there are also pure-play online payment service providers such as PayPal (part of eBay) and Google Check-Out. Advertising services providers are fundamental to revenue generation for most online service providers. This segment includes four categories: • Advertising agencies that provide a range of services to their clients, including media campaign planning, ad inventory acquisition for online advertising campaigns, and creative services to design and produce online advertising. They charge commissions based on the total volume of advertising spend and, in the case of large multi-service agencies such as OMD and WPP, online advertising is simply part of their portfolio of client services, albeit a growing part that requires specific skills. • Dedicated online advertising networks and exchanges such as Doubleclick (part of Google). Ad networks are a technical and payment clearing house for advertising space. They both acquire advertising space on behalf of media buyers and advertisers and sell ad inventory on behalf of Internet websites. They also provide the technical platforms that facilitate the placement of display ads on websites. In some cases, such as Advertising.com (owned by AOL), ad networks will acquire and resell ad inventory with a mark-up. • Third-party ad serving providers that host and distribute online ads. This is also often performed by the advertising agency that provides the creative services. • Ratings and analytics service providers that pro-

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vide Internet user and usage metrics. Advertisers have the option to buy advertising space either through ad networks, through their regular advertising agency or directly from the website/ content publisher. Connectivity Connectivity refers to Internet access services provided by telecommunications network operators, whether fixed or wireless. Telecommunications markets vary in their structure based on regulatory and competitive dynamics, particularly with regard to the “access layer,” colloquially known as the “last mile.” Many customers will arrange their Internet access service via their home telecommunications provider, but cable TV companies, independent resellers or service providers and wireless operators provide highly competitive offers in terms of network speed and pricing. These services are typically provided on the basis of a monthly subscription fee, which in some instances can include the fixed-line subscription fee and bundled voice calls and TV subscriptions. As usage volumes grow exponentially for some heavy users, there is debate on the future revenue model, with options including volume-based pricing (benefitting occasional users) or models where the online service provider pays for the customer connectivity to ensure a particular quality of service that matches its content offering. Also involved in providing connectivity are core network operators that provide the so-called “highways” of Internet traffic transport. Core network operators tend to be remunerated based on the capacity they provide to the access providers. They connect the access network nodes to the “super-exchanges” of Internet traffic, which route global Internet traffic based on technical standards defined by the Internet Corporation for

Assigned Names and Numbers (ICANN). Major core network providers exchange traffic with each other on the basis of “peering,” whereby each covers its own costs for installing and operating equipment that interconnects with others. Many providers also procure interconnection on the basis of IP transit, since this is more cost effective at lower traffic volumes. Both core network and interchange operators tend to be part of large, integrated telecoms operators such as Verizon or BT, but there are specialist companies such as Level 3 or XO. User Interface The User Interface is an essential part of the Internet value chain, involving both devices (such as PCs, game consoles and mobile phones) and the related software (such as operating systems, web browsers, media players and games) used to render services to end-users. Key players include hardware manufacturers such as Dell, Nintendo, Apple and Nokia, as well as software providers such Microsoft, Real Media and McAfee. Revenues generated from the User Interface mainly derive from the end-user’s acquisition of the device, which often includes pre-installed software. Subscription models are increasingly common for some applications, such as anti-virus security software. In some cases, software is provided free-of-charge (for example via Internet browsers and media players) — as providers seek to maximize their user base and generate revenues from advertising. In wireless markets, it has been common for the connectivity provider to supply the device on a subsidised basis and recover the cost through ongoing subscription revenues. In some markets there have been trials with laptop computers provided on a similar basis. The replacement cycle for devices from PCs to wireless phones has been very short, with
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Figure 5 Revenues generated by the Internet industry

Internet revenues by source/nature
(2008 in US$ billion)
Content rights
1,927
34

Online services

1,198

1,195

19

Enabling technology and services Connectivity User interface

61 325

956

732
242 61 262 151

16

309

62 158

Total
Source: A.T. Kearney analysis

Business

Consumer

a virtuous cycle from the perspective of the players in this segment, as new applications drove a need for stronger device functionality (for example, chip processing speeds) which encouraged customers to upgrade. In the economic downturn, however, many corporate customers sought to slow down replacement cycles for their computing infrastructure. The subsidised model in wireless markets has also become increasingly strained as operators question the profitability of customers acquired on this basis.

4. Market Size and Growth
Internet Market Size
Total revenues generated in the Internet value chain amounted to US$1,930 billion according to our estimates for the year 2008 (see figure 5). Revenues
5

generated from consumer services, the main focus of this paper, amounted to US$732 billion. Revenues from business services were substantially higher at US$1,195 billion. Eighty percent of these revenues derive from the Online Services market and by far the biggest category here is B2B e-Commerce, accounting for 86 percent of the revenues for Online Services (see figure 6). The Internet has brought substantial efficiency gains to the way in which businesses deal commercially with one another, through electronic data interchange (EDI) services, which offer greater speed and traceability than offline transactions. This has resulted in the rapid replacement of offline transactions with web-based transactions — in 2007 around half of e-Commerce transaction volume between businesses in the United States was already taking place through the Internet.5 The analysis in Figures 5 and 6 omits the actual value of the goods and services and related fulfilment costs for B2B e-Commerce. After e-Commerce, the next biggest service category in B2B Online Services is online information services, a US$71 billion market for the provision of professional data on subjects such as finance, healthcare and law. Providers include the likes of Thomson Reuters and Reed Elsevier. Other major Online Services categories are the provision of professional online e-Learning services and Internet communication services, the latter incorporating professional (or corporate) VoIP, email, instant messaging, video-conferencing and machine-to-machine communications. The Content Rights, Connectivity and User Interface B2B markets largely share the same categories as the consumer market. In the User Interface market, however, it is worth noting that user-paid software and other Internet hardware categories are significantly larger for businesses

The United States Census website.

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Figure 6 Revenues generated by the Internet — business-to-business (2008)
# = market size in US$ billion1

CR
8 SaaS/MFT4 19 Communications

Online services
27 Corporate e-Learning2 71 Information services

Connectivity
19 Core network interchange

User interface
12 Applications 5 Oper. systems 14 Smart phones

19 B2B content

49 Other Internet hardware

831 e-Commerce

43 Retail Internet access

78 PCs

$19 $956 $62 $158

Total market = $1,195 billion
Notes: 1All market sizes are based on gross revenues. Revenues generated from other companies in the value chain are not distinguished from those from companies outside the value chain; 2 Includes professional e-book sales 3 Includes VoIP, email, instant messaging, video conferencing, machine-to-machine communication 4 Software as a service, managed file transfer Source: A.T. Kearney analysis

than for consumers. The B2B user-paid software market was worth US$12 billion in 2008, compared to just US$2 billion for the parallel B2C markets. This includes, for example, corporate security and networking applications. The Internet hardware market was worth US$49 billion in 2008, compared to US$7 billion for the parallel B2C market and incorporates the likes of enterprise storage, Ethernet and enterprise routing hardware. The remainder of this paper focuses on the B2C market. Revenues generated by consumers (B2C) are focused on Connectivity (US$262 billion), User

Interface (US$151 billion) and e-Commerce (US$146 billion), which covers e-Retail, e-Travel and e-Brokerage services (see figure 7 on page 12). In other words, a typical household will spend most of its “Internet budget” on the access device (such as a PC with software) and the access connection (such as a broadband subscription), as well as paying substantial sums per year as margin on their e-Commerce purchases. As before, this analysis omits the actual value of the goods and services and related fulfilment costs, so, for instance, the wholesale price of a book sold by a publishing house to an e-Retailer such as Amazon
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Figure 7 Revenues generated by the Internet — consumer
# = market size in US$ billion1

CR
3 Editorial

Online services3
4 Communication 13 General/vertical content destinations

Enabling technology/ services 12 Support tech.

Connectivity

User interface
2 Apps. 7 Oper. systems

2 Adult

34 Search 42 Entertainment

80 Core network/ interchange

13 Game consoles 27 Smart phones 7 Other Internet hardware

21 Online billing and payments

4 Games

7 Audio/video/books

78 e-Retail

49 e-Travel

19 e-Brokerage

16 Ad agencies

12 Online ad services2

182 Retail internet access4

95 PCs

$16 $242 $61 $262 $151

Total market = $732 billion
Notes: 1All market sizes are based on gross revenues. Revenues generated from other companies in the value chain are Source: A.T. Kearney analysis not distinguished from those from companies outside the value chain; 2 Includes ad networks/exchanges, 3rd party servers, ratings/analytics services 3 Online services includes $3 billion revenues for other website types not covered by the categories we have defined. This is excluded from subsequent analysis. 4 In determining the value of Retail Internet Access we have made assumptions about the directly attributable portion of monthly “bundled” subscription fees paid to connectivity providers —in some markets regulation makes specific distinctions on this point

is excluded and only the gross margin earned by Amazon is included.6 Online Services represent perhaps the most visible part of the industry to the general public, but of the US$242 billion in revenues most are related to e-Commerce while Search and Entertainment generates US$76 billion—10 percent of total value chain revenues. Even highprofile players such as Skype, Facebook and YouTube generate less than a half a billion dollars in revenues each, despite substantial user numbers. As Figure 8 illustrates, more than 75 percent
6

of the revenues from online advertising and userpaid content and services are concentrated in search and the largest entertainment categories, namely gambling, gaming and adult. Advertising (mainly Search-related) generates over US$58 billion, or 60 percent of total online search revenues, while the remaining 40 percent comes from payments by Internet users. The ratio of advertising revenue to end-user payments in the Online Services market is similar to the ratio seen in more traditional media such as consumer publishing.

Approach based on An Economic Map of the Internet (MIT 2002).

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Figure 8 Breakdown of consumer online services revenues, 2008 (excluding e-Commerce)

Internet B2C revenues by source
(2008 in US$ billion)
Content rights Online services, user-paid Online services, advertiser-paid e-Commerce1
732
16 (2%) 38 (5%) 58 (8%)

Revenues breakdown2
(2008 in US$ billion)
Others Communications Online dating Consumer publishing Global portals
96
3 4 2 7 4

58
4 (6%) 2 (3%) 7 (13%) 2 (4%)

Others Communications Consumer publishing Global portals

146 (20%)

Enabling technology and services

61 (8%)

Search/directory

34

Connectivity

262 (36%)

VoD/MoD Gambling IPTV Music/video/book sales (digital) Adult sites

2 6 5 6 11

34 (59%)

Search/directory

User interface

151 (21%)

2 (3%)

Gaming

12

3 (6%) 3 (5%)

VoD/MoD Adult sites Gaming

B2C revenues
Notes: 1Includes e-Retail, e-Travel, e-Brokerage 2 Excludes e-commerce (e-Retail, e-Travel, e-Brokerage)

Online services, user- and advertiser-paid

Online services, advertiser-paid
Source: A.T. Kearney analysis

A comparison between global Internet traffic volume (as measured in petabytes7) and the generation of Internet revenues suggests a significant disconnect (see figure 9 on page 14). File sharing, including both legal and illegal downloads and uploads, generates 54 percent of total Internet traffic but only 2 percent of total revenues. Videoand music-on-demand services generated 18 percent of traffic but only 6 percent of revenues. This might explain the concerns raised by a number of
7 8

Internet Service Providers (ISPs, operating in the Retail Internet Access segment of the market), as traffic transportation costs account for more than 40 percent of their costs yet Internet traffic growth does not, under current pricing models, translate into incremental revenues.8

Internet Growth Perspectives
A.T. Kearney has reviewed the growth trends in each market, strategic segment and service

One petabyte is equal to 1,000,000 gigabytes. This has led to a number of disputes between ISPs and providers of online services, particularly media services. For example, in 2009 the BBC voiced concern that BT was limiting Internet download speeds during peak times, and that this was affecting the user experience of the BBC’s iPlayer video-on-demand service.

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Figure 9 Online traffic versus online revenues in the consumer Internet value chain (2008)
6,100 PB
1% 2%

Gaming1/gambling Communications Other online services2

$242 billion
7% 1% 7%

22%

Gaming1/gambling Communications General/vertical content sites Search

14%

IPTV VoD/MoD

3% 18%

File sharing and VoD
• Generates 73% of all consumer traffic… • …but only 8% of consumer revenues File sharing/digital downloads
54%

60%

e-Retail, e-Travel, e-Brokerage

2% 6% 2%

IPTV VoD/MoD3 Digital music/video/book sales

Traffic
Notes: 1Includes video and casual gaming 2 Includes all general/vertical content, search and e-Commerce online services 3 Includes adult

Revenue
Sources: Cisco, Gartner, IAB, IDC, eMarketer, Business Insights, JP Morgan, Natixis, PwC, A.T. Kearney analysis

In October 2009 a report by Arbor Networks revealed more up-to-date Internet traffic analysis showing a relative decline in P2P file-sharing and significant growth in streaming video from sites such as Hulu.com or YouTube. The disconnect between traffic and revenues, however, remains constant.

category in the Internet value chain and collated growth forecasts from multiple sources (see Appendix on page 22 for details). It is challenging to make long-term forecasts, but for the next three years, we expect Internet revenues to grow at 10 percent p.a. but with substantial differences across the industry value chain. Figure 10 represents our growth estimates, with the darker-shaded categories of the value chain being those with the strongest growth trajectory. Online Services is one of the most dynamic markets in the Internet value chain, with a growth rate of 16 percent per annum—driven by migration of advertising spend to online formats and
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INTERNET VALUE CHAIN ECONOMICS

increased success in charging end-users for access to audio-visual entertainment services as opposed to illegal downloading. Growth of Connectivity services is set to be moderate at approximately 6 percent p.a., representing a mix of robust growth in emerging markets and in wireless access but a major slow-down of broadband Internet access penetration growth in developed countries and intense pricing pressure. As discussed earlier, the User Interface market should experience the slowest growth at 3 percent p.a. following a period of strong device penetration growth (for example, PCs and game consoles). New devices, such as e-Books, may well provide new growth impetus.

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Figure 10 Growth perspectives of the consumer Internet industry (2008-2013 in US$ billions)
CAGR (2008-2013) 30%

CR
Portals

Online services
Social networking

Enabling technology/ services
VoIP Dating

Connectivity

User interface
Operating systems
Applications

Directory

Web search Music/ video/ book sales (digital)

Web hosting, design and development

Content mgmt.

Consumer publishing

Core network/ interchange

Game consoles

Smart phones

Gaming

Adult

VoD/MoD

Gambling

IPTV

Online billing and payments

Content rights

e-Brokerage

Ad agencies

e-Retail

e-Travel

Online ad services1

Retail internet access

PCs2

$16 24%

$242 16%

$61 13%

$262 6%

$151 3%

2008 market size 2008-2013 CAGR

Total Internet value chain CAGR = 10%
Notes: *Size of box indicates relative market size (2008) 1 Includes ad networks/exchanges, 3rd party servers, ratings/analytics services 2 Includes other Internet hardware Source: A.T. Kearney analysis

5. Industry Structure and Economics
Structure and Concentration of the Internet Value Chain
The Internet value chain comprises some segments and categories that are global and others that are more local in nature. PCs and operating systems are inherently global businesses, due to the standardised nature of these products and the very high economies of scale. Businesses such as e-Commerce and Connectivity are much more local in nature—

although some players might operate in multiple countries (for example, eBay or Vodafone). Viewed at the global level, the Internet value chain seems highly fragmented, with a few notable exceptions. For categories such as operating systems, smartphones, search, games consoles/ services, music and video, the top three market players account for more than 40 percent of the global market and, in some cases, more than 80 percent. This is due to the inherently global nature of these activities and the high economies of scale and/or network effects.
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Figure 11 provides a graphic representation of the degree of concentration at a global level of the Internet value chain categories; the darker-shaded categories have higher concentration. e-Commerce appears particularly fragmented at a global level. This is due to the local nature of these activities and specialization of industry players by type of service. Although fragmented when considered at a global level across all retail types, e-Commerce is highly concentrated in some specific areas, that is, at a national level and at a product category level. For example, Amazon has a 53 percent share of the U.S. online book market, which is projected to grow at a CAGR of 44 percent between 2008 and 2013.9

In Connectivity, concentration at a global level for Network Access is low as this is a fundamentally local business. Market concentration at a country level may be strong, given local economies of scale and the legacy of monopoly infrastructure providers. There are however significant differences across countries. In 2008, the five largest UK ISPs accounted for more than 91 percent of the Consumer market (following a wave of consolidation) while the five biggest U.S. ISPs had a combined market share of 56 percent.

Profitability in the Internet Value Chain
A.T. Kearney further attempted to calculate the profitability of the larger players across the value

Figure 11 Market concentration of the consumer Internet industry (2008)
Cumulative market share of top 3 players (at global level) 80%

CR
Portals

Online services
Social networking

Enabling technology/ services
VoIP Dating

Connectivity

User interface
Operating systems
Applications

Directory

Web search Music/ video/ book sales (digital)

Web hosting, design and development

Content mgmt.

Consumer publishing

Core network/ interchange

Game consoles

Smart phones

Gaming

Adult

VoD/MoD

Gambling

IPTV

Online billing and payments

Content rights

e-Brokerage

Notes: *Size of box indicates relative market size (2008) 1 Includes ad networks/exchanges, 3rd party servers, ratings/analytics services 2 Includes other Internet hardware
9

Ad agencies

e-Retail

e-Travel

Online ad services1

Retail internet access

PCs2

Source: A.T. Kearney analysis

Global Entertainment and Media Outlook: 2009-2013, PWC.

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chain. Figure 12 represents our estimates, with the darker-shaded categories having the highest returns (measured as Return on Capital Employed, ROCE). Higher ROCEs (20 percent+) can be observed in User Interface (such as operating systems, PCs, smartphones and games consoles) and selected Online Services (such as e-Commerce, search, gaming, gambling and adult services). Returns in Connectivity and Enabling Technology/Services appear significantly lower (10 to15 percent). This is likely due to higher capital intensity, more fragmented competition and in some cases specific regulation of prices and/or margins, as in the case of telecoms services in many countries. Consumer publishing demon-

strates returns that are likely below the cost of capital — the problems of this market in responding to the challenge of “free” content have been well documented. Beyond the mainstream market leaders, the Internet offers multiple niche positioning options — some of which appear particularly profitable. For instance, online nutrition company Nutrisystem delivers a ROCE of nearly 80 percent; the company offers customized online nutrition programs and delivers ready-made meals that can be ordered online.

Economics of the Internet
Economic theory would suggest that the highest

Figure 12 Returns on capital employed for market leaders in the consumer Internet industry (2008)
Average ROCE3 30%

CR
Portals

Online services
Social networking

Enabling technology/ services
VoIP Dating

Connectivity

User interface
Operating systems
Applications

Directory

Web search Music/ video/ book sales (digital)

Web hosting, design and development

Content mgmt.

Consumer publishing

Core network/ interchange

Game consoles

Smart phones

Gaming

Adult

VoD/MoD

Gambling

IPTV

Online billing and payments

Content rights

e-Brokerage

14%

21%

Ad agencies

e-Retail

e-Travel

13%

Online ad services1

Retail internet access

PCs2

11%

25%

2008 ROCE

Notes: *Size of box indicates relative market size (2008) 1 Includes ad networks/exchanges, 3rd party servers, ratings/analytics services 2 Includes other Internet hardware 3 ROCE is based on top 3 players by market share in each category

Source: A.T. Kearney analysis

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returns should be earned in categories with high market concentration. Such concentration may be due to high economies of scale and strong network effects (including customer switching costs). Our analysis seems to confirm this for a number of categories, including operating systems, games consoles and smartphones (see figure 13). Categories with low to moderate network effects and economies of scale are expected to deliver modest returns. For example, this is the case for general interest portals and web hosting/design. Some service categories do not deliver returns in line with what economic theory would suggest.

Social networking delivers low returns despite strong network effects. This might result from the emerging and fast growing nature of these services and from challenges to date in monetizing usage. Internet access service providers also deliver low returns, despite high scale effects. Possible explanations might include the highly capital intensive nature of this industry, strong competition, regulation and limited opportunities to differentiate beyond price given legacy technology platforms. Some categories of Online Services may appear fragmented at a global value chain level but actually involve concentrations in national or regional

Figure 13 Network effects and economies of scale for selected consumer Internet strategic categories
Illustrative
Dating
High

Social networking Ad networks Digital music/ video sales Web search

Operating systems Game consoles Smart phones

Gambling

Gaming Portals

Network effects/ customer switching costs

Medium

e-Commerce3 Portals Ad agencies

Content rights
Low

Online billing/ payments Internet access PCs
High

Web hosting/ design

Low

Medium

Economies of scale1
Notes: 1Low: low capex, low operating economies of scale; Medium: low capex, high operating economies of scale; High: high capex, high operating economies of scale 2 Relative weighted average ROCE of top 3 players (where possible) 3 Includes e-Retail and e-Travel

Relative ROCE:2

High >20%

Medium 10-20%

Low 15 percent) for these services—perhaps due to strong customer willingness to pay.

Future Outlook
At a highly aggregated level, the Internet value chain offers a strong growth outlook (10 percent p.a.) and good returns for market leaders (>10 percent and in some cases much higher).

Yet, as this paper has shown, it is important to understand differences between service categories. Some categories deliver low returns and face decelerating growth perspectives — for example, web hosting and Internet access provisioning. They may see attempts to consolidate or expand into other parts of the value chain: there are some cases of telecoms companies investing in devices or in content, for instance. Figure 14 shows our estimates of future growth and current returns. In a number of smaller categories such as social networking, returns are expected to increase

Figure 14 Forecast growth versus returns of the consumer Internet industry by category
45% VoIP (1) IPTV (5) Media rights (15) Dating (2) Adult (11) 75% VoD (1) Digital video sales (1)

30%

Market concentration
80%

Digital music sales (4)

Content management (1) Social networks (3)

e-Retail (72)

Market CAGR (2008-2013)

e-Brokerage (19) Internet access (164)

Billing/ payments (21) Direc(11) Ad networks tories (5) Ad agencies (16) Web search (30)

Gambling (6) Smart phones (27)

Video gaming (9) e-Travel (49)

Consumer publishing (7)

Software (2)

Web hosting (10) Global portals (4)

PCs (95)

Game consoles (13) Operating systems (6) 40%

0% 0%

Average ROCE
Notes: *Size of bubble denotes relative market size 2008 (value in brackets in US$ billions); all categories over $10 billion have same bubble size; bubble border thickness denotes relative barriers to entry, through network effects or economies of scale/capital intensity 1 Based on combined market share of top 3 players Source: A.T. Kearney analysis

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substantially as market leaders benefit from greater scale effects and diminishing needs for start-up investment. However, the value chain is dynamic and a number of market leaders in 2010 could in theory be out of business by 2015. Differences in growth perspectives and returns largely explain diverging market capitalization gains over the last six years (see figure 15). Connectivity and Content Rights have failed to create significant shareholder value—largely due to sluggish market growth prospects and relatively low returns. Online Services and User Interface have delivered the strongest market capitalization growth—due both to strong growth prospects and high returns. Although more impacted by the stock market downturn in 2008/2009, the rebound in these markets has been very strong.

Concluding Remarks
This paper has shown some clear trends in terms of the economic performance of the various markets in the Internet value chain. Online Services and some categories of hardware and software at the User Interface show high concentration, rapid growth and high returns, which are reflected in the market capitalisation of their leading players. Content Rights and Connectivity are less concentrated globally and earn returns around 10 to 15 percent, but their market capitalisations have stagnated as investors weigh high capital requirements against continued margin pressure. Strategic moves along the value chain may be expected as players react to these economic trends. Understanding these trends in such a dynamic part of the global economy is a key challenge for the companies involved, for investors and for policymakers.

Figure 15 Evolution of market capitalisation by value chain market (base 100 in 2004)

500

User interface5

400

Online services2
300

200

Enabling technology/ services3

100

Connectivity4 Content rights1

0

2004
1

2005

2006

2007

2008

2009

2010
Sources: Bloomberg, A.T. Kearney analysis

Notes: Average for Disney, NewsCorp, Time Warner ,Warner Music Group, Vivendi and Electronic Arts 2 Average for Amazon, Google, Yahoo!, eBay, Baidu, Expedia and Partygaming 3 Average for Akamai, CyberAgent, Google, Valueclick, Verisign and WPP 4 Average for AT&T, Vodafone, NTT, British Telecom, Deutsche Telecom and France Telecom 5 Average for Microsoft, Apple, Dell, Acer, Nokia and McAfee

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Authors
Mark Page is a partner and global leader of the firm’s communications, media and high-tech practice. Based in the London office, he can be reached at mark.page@atkearney.com. Laurent Viviez is a principal in the firm’s communications, media and high-tech practice. Based in the London office, he can be reached at laurent.viviez@atkearney.com. Christophe Firth is a consultant based in the Dubai office. He can be reached at christophe.firth@atkearney.com.

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Appendix: Report Methodology and Sources of Information
Value Chain Definition
The Internet value chain includes all activities that exist as a direct result of Internet usage. The Internet value chain includes five markets and 15 strategic segments, as described in section 3. Suppliers to segments have only been described when they are specific to the Internet. For example, we did not isolate call center providers or insurance brokers providing services to e-Commerce players, but have included web hosting. Each segment was also further broken down into more detailed service categories—47 consumer categories and 20 business cate-gories. We assessed separately revenues generated by consumers and businesses— given the specifics of business services. These include services such as B2B e-Commerce and exchange platforms, online information services (for example Reuters), and paid-for hosted applications such as email servers, Software as a Service and videoconferencing.

classifieds, email direct marketing and in-game online advertising. Advertising revenues are calculated on a net advertising value basis (source: IDC). Online Services revenues from end-users include subscriptions, pay-per-use services and digital goods purchases.

ROCE Analysis
ROCE has been used as a key financial metric to evaluate the profitability of companies involved in the Internet value chain. The ROCE calculation used is the company’s EBIT divided by its Capital Employed. Capital Employed is defined as Total Assets less Current Liabilities. Where ROCE is calculated at segment or category level, we have taken an average for the top 3 players in the category (which report financials), weighted by their 2008 Revenues. In segments where there are no pure players, we have had to apply the overall returns of the leading players in that category or select second-tier pure players. ROCE is calculated using Bloomberg data and annual reports. Focusing on the top 3 does of course exclude the effect of failed companies which may have experienced negative returns in any given year, but we believe that it captures the long term profitability characteristics of the segment for successful players.

Market Sizing Analysis
All market sizes are based on gross revenues, except where otherwise stated. Revenues generated from other companies in the value chain (for example, through commissions, fees, sales or advertising) are not distinguished from those generated from companies outside the value chain. In other words, this is not a “value-add” analysis for the Internet economy and there are overlaps among revenue categories. For example, revenues from Content Rights overlap with revenues from Online Services. For all Online Services categories, we have calculated revenues generated from advertising and from end-users. Advertising covers all formats—that is, search, display, lead generation,
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Market Competition and Concentration Analysis
To provide a view of the level of competition in each category, we evaluated the combined market share of the three largest companies, at global level. The HHI index system is a commonly used measure of market concentration. Due to the global scope of our analysis and the nature of the industry, a full HHI indexing would, however, be impossible to conduct with high accuracy.

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Therefore, we avoided using this methodology. We do however believe that the results of an HHI analysis would be in line with our current approach, in terms of providing a picture of the relative level of concentration across Internet value chain categories.

Market Definitions
The definition and market sizing methodology for all service categories are provided here. We only elaborate on the market sizing methodology for cases requiring a specific explanation and not based on an established public source of information.

Content Rights
Segment
Media rights owners

Methodology/Description
• Market size is based on the percentage of revenues made by Online Services that is paid to Content Rights owners, either as: — Revenues from digital product sales after commission — Content acquisition or license cost • Online Services categories in scope are: VoD, MoD, IPTV, video gaming, casual games, filmed entertainment sales, digital music sales, electronic book sales, global portals, consumer publishing, adult content • For each category of Online Services we estimated the percentage of total online revenues that would be subject to a revenue share with the corresponding Content Rights owners—based on publically available information and interviews with key industry stakeholders • Revenue received by user-generated content owners is not included in the analysis—but is negligible as is user generated content that is rarely remunerated

User-generated content
Source: A.T. Kearney analysis

Online Services
Segment Category Methodology/Description
VoD (videoEntertainment • Websites providing audio-visual content on-demand through a streaming service, funded by either ads Enabling Technology/Services on-demand) or subscription. Excludes adult content (see below).

Segment
Billing and payments Advertising

Category MoD (musicon-demand) Billing and payments IPTV
Video gaming Online ad agencies Online ad networks/ exchanges/ other games Casual services Online ad servers Gambling Ratings/ analytics services Adult content

• Methodology/Description on-demand through a streaming service, funded by either ads Websites providing audio content or subscription • Consists of payment processing for online transactions • • Market sizing is based on total B2C an IP connection Television services delivered through e-Commerce transaction value plus user-paid Online Services multiplied by an estimated average transaction processing fee • Websites and applications providing the ability to play console or PC games on the Internet, usually with • Companies providing an interactive streaming service and acquire online ad inventory for advertisers other gamers, through services to plan online campaigns • • Companies that design, produce, host and serve onlineand game software (through a physical disk or End users are generally required to purchase a console ads download) in order to play • • Companies providing intermediary online advertising servicessale of in-game virtual items Includes subscription revenue, in-game online advertising and to advertisers • • Includes with casual that acquire ad inventory from websitesanalysis to advertisers, platforms for buying and Combined companies games under “gaming” for parts of the to resell selling inventory, or tools to optimise online advertising effectiveness • • All market size numbers are gross revenues users through an interactive streaming service Websites providing Internet-hosted games to end • End users are not required to purchase a game or gaming device in order to play • • Companies offering gaming under “gaming”ads parts of the analysis Combined with video technology that places for on websites • Includes third-party ad serving only. Excludes ad serving performed by interactive ad agencies. • Includes websites providing all types of online gambling services, including betting, casino and other • Companies offering data and analytics on Internet user and usage metrics gambling services • Websites providing adult content • • Companies that offer services that allow online and download digitalthe flow of content through the Internet Websites providing the ability to either purchase services to optimise filmed entertainment products, or(primarily content delivery networks) rent physical filmed entertainment products. Excluded from e-Retail

Support technology

Content Video sales/ management rental (digital)

Web sales Musicdesign and • • Companies createthe ability to purchase and download digital music products Websites providing and code Internet pages development (digital) • Excluded from e-Retail Web hosting Book sales (digital)
Source: A.T. Kearney analysis General/vertical Consumer

• • Companies that provide a service allowing individuals/organisations to store their websites on their servers Websites providing the ability to purchase and download electronic books and make them available on the Internet • Excluded from e-Retail • Websites operated by newspapers and magazines, usually with similar branding and content • Revenues include advertising only • The market for paid content on consumer publishing sites remains negligible although many publishers are considering how to change this • Websites offering match-making and communication services focusing on developing romantic relationships INTERNET VALUE CHAIN ECONOMICS | A.T. Kearney • Selected General Interest Portal and website operators with a global scope, including Yahoo!, MSN, AOL, IAC and their subsidiaries

content sites

publishing

Online dating Global Portals

23

• End users are generally required to purchase a console and game software (through a physical disk or download) in order to play • Includes subscription revenue, in-game online advertising and sale of in-game virtual items • Combined with casual games under “gaming” for parts of the analysis Casual games • Websites providing Internet-hosted games to end users through an interactive streaming service • End users are not required to purchase a game or gaming device in order to play • Combined with video gaming under “gaming” for parts of the analysis • Includes websites providing all types of online gambling services, including betting, casino and other gambling services • Websites providing adult content • Websites providing the ability to either purchase and download digital filmed entertainment products, or rent physical filmed entertainment products. Excluded from e-Retail • Websites providing the ability to purchase and download digital music products • Excluded from e-Retail • Excluded from e-Retail Methodology/Description • • • • • • • • • • • • • • • • • • • • Websites providing the ability to purchase and download electronic books Websites providing by newspapers and magazines, usually with similar branding and contenteither ads operated audio-visual content on-demand through a streaming service, funded by or subscription. Excludes adult content (see below). Revenues include advertising only The market for paid content on consumer publishing sites remains negligible although many publishers are Websites providing change this on-demand through a streaming service, funded by either ads considering how to audio content or subscription Websites offering match-making and communication services focusing on developing romantic relationships Television services delivered through an IP connection Selected General Interest Portal and website operators with a global scope, including Yahoo!, MSN, AOL, IAC Websitessubsidiaries and their and applications providing the ability to play console or PC games on the Internet, usually with other gamers, includes an interactive streaming service types including webmail and instant messaging Market sizing through revenues from all branded product Endexcludes Casual Games and search revenues, which aregame software (through a physical disk or but users are generally required to purchase a console and captured elsewhere download) in order to play Includes subscription revenue, in-game online advertising and sale of in-game virtual items Websites providing categorised, searchable lists of organisations—typically consists of “Yellow Pages” Combined with casual games under “gaming” for parts of the analysis publishers’ websites Websites providing Internet-hosted games to end users through an interactive streaming service Search engines providing the ability to find information/other websites on the Internet End users are not required to purchase a game or gaming device in order to play Combinedprimarily focused on facilitating person-to-person communications through a variety of channels Websites with video gaming under “gaming” for parts of the analysis including one-to-one (e.g., in-site delayed and instant messaging) and one-to-many formats Includes websites providing all types of online gambling services, including betting, casino and other gambling services voice communication transmission services over IP networks Companies providing Only includes third-party VoIP (i.e., VoIP based on bespoke applications downloaded by end-users from a website) Websites VoIP services operated by telecom operators Excludes providing adult content

Gambling Adult content Video sales/ rental (digital) (digital) Online Services (continued) Music sales Book sales (digital) Category VoD (videoConsumer on-demand) publishing MoD (musicon-demand) Online dating IPTV Global Portals Video gaming

Segment
Entertainment General/vertical content sites

Search

Directories Casual games Web search

Communications

Social networking Gambling VoIP Adult content

Transactions (e-Commerce)

Video sales/ e-Brokerage rental (digital) e-Retail Music sales (digital) Book sales e-Travel (digital)

• Websites providing the ability to either purchase and download digital filmed entertainment products, buy and sell financial products on the Internet or rent physical filmed entertainment products. Excluded from e-Retail • Websites selling goods/services over the Internet; includes marketplaces and auction sites • Websites providing the abilitytransaction value download digital music products sold and fulfilment Revenues are based on total to purchase and less direct cost of goods/services • Excluded from e-Retail The percentage to be subtracted is an estimate based on company reports for a selection of leading operators • • • • • • Websites providing the ability to purchase and the Internet travel booking services on download electronic books Excluded frombased on total transaction value less direct cost of goods/services sold and fulfilment Revenues are e-Retail The percentage to be subtracted is an estimate based on company reports for a selection of leading operators Websites operated by newspapers and magazines, usually with similar branding and content Revenues include advertising only The market for paid content on consumer publishing sites remains negligible although many publishers are considering how to change this

publishing content Kearney Source: A.T. sites analysis

General/vertical

Consumer

Online dating Global Portals

• Websites offering match-making and communication services focusing on developing romantic relationships

• Selected General Interest Enabling Technology/Services their subsidiaries Portal and website operators with a global scope, including Yahoo!, MSN, AOL, IAC and

Segment
Billing Search and payments Advertising Communications

Category
Billing and Directories payments Web search Online ad agencies Social networking Online ad networks/ VoIP exchanges/ other services Online ad e-Brokerage servers e-Retail Ratings/ analytics services e-Travel Content management development Web hosting

but excludes Casual Games and Methodology/Description search revenues, which are captured elsewhere

• Market sizing includes revenues from all branded product types including webmail and instant messaging

Consists providing categorised, searchable lists of organisations—typically consists of “Yellow Pages” •• Websitesof payment processing for online transactions • publishers’ websites on total B2C e-Commerce transaction value plus user-paid Online Services multiplied Market sizing is based by an estimated average transaction processing fee • Search engines providing the ability to find information/other websites on the Internet • Companies providing services to plan online campaigns and acquire online ad inventory for advertisers Companies that design, produce, host and serve online ads •• Websites primarily focused on facilitating person-to-person communications through a variety of channels including one-to-one (e.g., in-site delayed and instant messaging) and one-to-many formats • Companies providing intermediary online advertising services to advertisers Includes companies voice communication transmission services over IP networks •• Companies providing that acquire ad inventory from websites to resell to advertisers, platforms for buying and selling inventory, or tools to (i.e., VoIP based advertising effectiveness • Only includes third-party VoIP optimise online on bespoke applications downloaded by end-users from a website) All market size numbers are gross revenues •• Excludes VoIP services operated by telecom operators Companies offering technology buy and sell financial products on the Internet •• Websites providing the ability tothat places ads on websites • Includes third-party ad serving only. Excludes ad serving performed by interactive ad agencies. • Websites selling goods/services over the Internet; includes marketplaces and auction sites Companies offering on total analytics on Internet direct cost of goods/services sold and fulfilment •• Revenues are baseddata andtransaction value lessuser and usage metrics • The percentage to be subtracted is an estimate based on company reports for a selection of leading operators • Websites providing travel booking services on the Internet Companies that offer services that allow online services cost of goods/services sold and fulfilment •• Revenues are based on total transaction value less directto optimise the flow of content through the Internet (primarily content delivery networks) • The percentage to be subtracted is an estimate based on company reports for a selection of leading operators • Companies create and code Internet pages • Companies that provide a service allowing individuals/organisations to store their websites on their servers and make them available on the Internet

Transactions (e-Commerce)

Support technology

Web Source: A.T. Kearney analysis design and

Source: A.T. Kearney analysis

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Connectivity
Segment
Core network

Category
Core network

Methodology/Description
• Companies that own and operate the core telecommunications network, providing wholesale services to Retail Access Providers (which may be a division of the same company as the core network provider, but typically with some degree of regulatory separation) • Operators providing the “super-exchanges” of Internet traffic between core network operators • There are limited standalone/independent interchange operators, besides Level 3 Communications and XO Communications, which are both U.S. operators • In the majority of other major markets, Interchange is provided by large network operators • Companies providing access to the Internet, typically known as ISPs • Includes both fixed and mobile Internet access; excludes charges for voice calls, TV and fixed line rental • For the market concentration analysis, we took the leading players in three major markets (U.S., Japan and France) and evaluated their share of the total global market. This is notwithstanding the fact that retail access providers largely operate on a local basis.

Interchange

Interchange

Retail Internet access

Retail Internet access

Source: A.T. Kearney analysis

User Interface
Segment
Devices

Category
Games consoles Operating systems PCs

Methodology/Description
• Personal gaming devices and software with the ability to connect to the Internet • Based on total worldwide sales multiplied by the percentage of gamers who play online • Based on total worldwide sales multiplied by the percentage of PCs bought by consumers (as opposed to businesses), multiplied by the estimated percentage of consumer PC time spent on the Internet • We assume for simplicity equal average purchase price for consumers and businesses • Based on total worldwide PC sales, multiplied by the percentage of PCs bought by consumers (as opposed to businesses), multiplied by the estimated percentage of consumer PC time spent on the Internet • We assume equal average purchase price for consumers and businesses • Mobile handsets offering Internet access • Based on total worldwide smartphone sales, multiplied by the percentage of smartphones bought by consumers (businesses excluded) • We assume equal average price for consumers and businesses • Peripherals allowing other devices to connect to the Internet and enabling usage of online services (e.g., modems, routers and webcams) • Other applications providing tasks relating to Internet usage, including endpoint, messaging, web and IAM software sales multiplied by the percentage of sales to consumers (as opposed to businesses) • For this percentage we took the same percentage split as for Internet access hardware

Smartphones

Other Internet access hardware Applications* Applications

*Also includes Internet browsers and media players, however these have generally not been provided on a paid-for, stand-alone basis Source: A.T. Kearney analysis

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Business-to-Business
The additional clarifications in the chart below only relate to those B2B categories that we felt required additional explanation of methodology

and assumptions not covered in the overall report methodology, or where our approach is different to the equivalent category in the consumer Internet economy.

Segment
Content Rights

Category
Content Rights

Methodology/Description
• Market size is based on the percentage of revenues made by Online Services paid to Content Rights owners, either as: — Revenues from digital product sales after commission — Content acquisition or license cost • The categories in scope are: corporate e-Learning, information services and professional digital book sales • For each category we estimated the percentage of total online revenues that would be subject to a revenue share with the corresponding Content Rights owners • Includes revenues from business VoIP (58 percent), email (17 percent), instant messaging (2 percent), video conferencing (11 percent) and machine-to-machine communication (12 percent) • Web-based enterprise education and training programmes • Includes professional digital book downloads • Commercial transactions between businesses over the Internet, generally through electronic data interchange • The approach and assumptions taken are for consumer B2B, i.e., transaction volume less cost of goods sold and fulfilment costs • Online business information services estimated based on percentage of sales that are online for a basket of information services genres (e.g., legal, tax, healthcare) • Includes advertising revenues from digital trade magazines (accounting for less than 3 percent of total for this category) • Online revenues from businesses from Software-as-a-Service products and from professional Managed File Transfer services • Peripherals allowing other devices to connect to the Internet and enabling usage of Online Services (e.g., modems, routers and webcams) • Business hardware includes enterprise video conferencing, Ethernet, enterprise storage and routing

Online Services

Communications Corporate e-Learning e-Commerce

Information services

SaaS/MFT Devices Other Internet hardware

Source: A.T. Kearney analysis

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A.T. Kearney

Sources of Information
Market sizing and profitability estimates in this report are based on a large set of recognized sources of information—both primary and secondary. Primary research includes interviews with experts in the field of online media and the Internet value chain, including both A.T. Kearney and external experts. We thank interviewees for their time and openness in supporting this research paper. The data collected from financial statements and press releases by companies in the Internet value chain has been primarily used to estimate total market size and growth, market concentration levels and ROCE for each category. For market sizing, ROCE and market concentration analyses, we used 2008 data where possible. At the time of writing, this is the latest year for which full-year company financial data was widely available. For market growth estimates, we used a five-year forecast covering the 2008-2013 timeframe.

Secondary research covers a broad range of publicly available research resources. Many market size and growth forecasts are from Telecoms/ Media/Technology industry research reports such as PwC’s Global Media & Entertainment Outlook, and general industry and category-specific forecasts are from research companies such as Forrester, Gartner, Screen Digest, Business Insights and Ovum. We also used relevant industry broker reports. For Internet traffic and usage data, we used sources such as IDC, ComScore Media Metrix, Nielsen Netratings, Hitwise, Zenith, Bloomberg, OneSource and Reuters Knowledge. In addition to industry-specific reports, we have also drawn on general economic/macro research reports, including reports by the OECD, ITU, Pew, IAB, U.S. Department of Commerce and Economist Intelligence Unit. Most exhibits include a reference to the primary sources used but some are composites of multiple sources, together with A.T. Kearney assumptions and are therefore sourced as “A.T. Kearney analysis.”

INTERNET VALUE CHAIN ECONOMICS

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A.T. Kearney

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