Verizon could learn a thing or two from Comcast about how to make most of its new cash cow

Verizon Communications announced yesterday that it would pay US$4.4 billion to acquire AOL, a company that once had so much financial leverage, promise and ambition that it could afford to buy Time Warner for about $164 billion in 2001.

To put it lightly, the synergies anticipated for that combined company did not arise, and Time Warner spun it off in 2009 after AOL lost billions in value.

Will Verizon have more luck?

The acquisition seems to make plenty of sense. Verizon has lots of earnings that it has retained over the years and the ability to borrow billions. AOL gives Verizon access to advanced technology for selling ads and delivering high-quality web video.

That’s important because Verizon understands its biggest revenue sources are stagnating. Local and long-distance telephone service carried via copper wire generates declining revenues and profits. Verizon also understands that it must confront the possibility that basic wireless telephone service, its single biggest revenue source, has reached maturity.

Moving up the vertical “food chain” into content helps the company diversify and generate new sources of revenue from both advertisers and subscribers.

Could AOL become Verizon’s new cash cow to compensate for any declines in revenue in its core businesses?

Bear in mind that a few years after splitting from AT&T in 1984, Verizon briefly dabbled in developing new revenue streams by producing content itself. That effort failed miserably in part because Verizon didn’t hire staff skilled in content creation and management.

By combining third-party and self-generated content, Verizon’s latest acquisition stands a better chance at succeeding – a lesson already learned by Comcast, the nation’s largest cable TV and broadband provider.

Traders react to the merger news.Reuters

Lessons from Comcast

While Comcast has a woeful record in customer service, the company is notable for successfully integrating content distribution with content generation. It has vertically integrated up and down the food chain of content creation, syndication, distribution and delivery to consumers.

Comcast will of course try to squeeze every last dollar it can from subscribers as a cable television operator with a national market share exceeding 30%. But it understands that should the cable model deteriorate, it must diversify into many other types of content creation and technologies for distributing it.

Most recently, Comcast acquired NBCUniversal in 2013 as part of this strategy. But by then, it had already built up a sizable inventory of content through ownership interests in many cable programming networks and regional sports networks.

Facing the prospect of declining subscriptions to its legacy cable service, Comcast is pursuing a strategy with many prongs. The company wants to increase – or minimize reductions – in average revenue per user by enhancing the value proposition in a cable subscription. It does this by promoting “on demand” access to content anytime, anywhere, via any device and in any delivery format.

Comcast also wants to acquire more market share through acquisitions, making it an even more formidable content access negotiator and able to push for even higher subscription fees.

That strategy foundered last month after regulatory concerns over its market power forced it to abandon its proposal to acquire Time Warner Cable. The Federal Communications Commission and the Justice Department had legitimate concerns about one company controlling nearly 40% of both the legacy video delivery market (cable television) and the emerging broadband market (that offers a substitute for cord cutters).

Comcast’s purchase of NBCUniversal gave it a ton of content to deliver to its customers.Comcast building via www.shutterstock.com

Controlling content is key

In a nutshell, Comcast embraces change, even as it pushes the legal and regulatory envelope for permissible market domination in old media.

By controlling access to “must see” video content, Comcast can tap multiple sources of revenues, even if consumer eyeballs migrate from old to new media. Thus, it can welcome new links between consumers and content rather than fearing new technologies as vehicles for piracy and revenue siphoning.

Comcast rightly considers the demise of linear “appointment television” – in which content is only available at a designated time – as more of an opportunity for profit than a financial threat.

Increasingly consumers have no patience for rationed and media-specific access to content. That’s what propelled Netflix, for example, to make entire seasons of TV shows such as House of Cards available for “binge watching” instead of the traditional week-by-week allocation. More companies are following suit.

Comcast and other companies making the most of changing tastes know that consumer stickiness – how much time someone spends consuming media and absorbing advertising – can grow faster and higher if it provides on demand alternatives to the traditional distribution model.

AOL can do the same for Verizon

And that’s what Verizon hopes to get out of its purchase of AOL, allowing it to operate a powerful and desirable media and advertising platform.

Economists use the term double-sided markets to identify instances where an intermediary, like Verizon, provides services downstream to retail broadband subscribers, but also upstream to other carriers and sources of content.

Only a small number of companies such as Verizon and Comcast have the financial resources and geographical footprint to create a substantial broadband platform. Because of a concentrated industry and converging media, the FCC and other national regulatory authorities have established [open internet access rules]– aka net neutrality – designed to prevent platform operators from exploiting their broadband platform in ways that harm consumers and competitors.

Verizon’s acquisition of AOL can help bolster its platform by providing compelling content, better ways to link advertisers and consumers and offering a trusted brand for accessing content via four available screens: television sets, computer monitors, smartphones and tablets.

Unlike the trouble Comcast had convincing regulators that the Time Warner acquisition would not harm consumers, Verizon should have better luck framing its AOL purchase as a win for customers. Its deal involves vertical integration that can enhance consumers' perception of value from services previously available from two separate companies, rather than Comcast’s more horizontal kind that would have eliminated competition in the industry.

Rather than merely buying out a competitor and adding market share, Verizon will acquire a presence in competitive markets it knows it should enter.

Maybe this time it will welcome the new talent.

Robert Milner Frieden currently receives no funding from any company, institute, foundation or other organization. On previous occasions he has provided consultancy services primarily for international organizations such as the World Bank.