In trading some e-mails with Jim Crowe recently, he was nice enough to spend some time to answer questions about Level 3’s CDN business for publishing here on the blog. While Level 3 has been pretty quiet in regards to their CDN business and the customers they have been winning, make no mistake that they plan to be a serious competitor. And I’m not just repeating the company line. I see it from talking to customers, learning of new contract wins and by seeing all of the pieces of the CDN ecosystem they are finishing putting in place.

While Level 3 still has some work left to complete before they make the hard push into the market, even reading their Q2 Content Delivery Network Newsletter gives you a good indication of just how much they have gotten done. Their CDN is now running Flash Media Server 3 (FMS3), they added CDN footprint in Asia, they finished the buildout and launch of their origin storage offering, they added the ability to limit the download speeds for progressive files, added byte-range request functionality (which is seeking into a file even if it has not fully downloaded or stored on the Level 3 network), added geo-intelligence rules to block access to media and enabled reverse proxy ingest amongst other things. And shortly, they plan to roll out detailed URL-level reporting, support for Silverlight HD, enable better customer self-servicing options, implement live WM push functionality, improve their live reporting features and add the ability for customers to move content from hot to cold storage.

And if you look around, you’ll see that they are already pushing out their new CDN messaging. On their new recently launched website, the main message on their home page is "Connecting Content Creators to Content Consumers" and talking about their content ecosystem strategy. A new Flash based presentation on their website entitled "From Creation to Consumption", really lays out the strategy Level 3 is taking, and it’s a smart one. Don’t just push bits, figure out how to help customers create, ingest, store, manage, track and deliver the content. It’s a good presentation and come Q4 of this year, you’ll start to hear a lot more details about Level 3’s CDN offering. And come Q1 of 2009, I expect Level 3 will become a serious player in the CDN market.

The following were questions I asked Jim specific for posting on the blog:

Question: While Level 3’s CDN business does not contribute much to your overall revenue today, what impact do you see it having on revenue 2-3 years out? How big of a business can CDN become for Level 3? 

Jim: We anticipate that the CDN business will become a major revenue source for Level 3 over the medium term. We expect the delineation between our Internet Transit business and our CDN business to blur in the fairly near term. At the very least, we expect our CDN business standalone to compare in size to our Internet transit business within the next few years. 

Question: At what point do the economics of scale really begin to kick in for Level 3 in regards to owning the network and having a cost advantage for the CDN services? Many telcos say it is cheaper to own the network, specific to CDN, but can you quantify yet just how much cheaper it really is?

Jim: We benefited from the economic advantage of owning a network from the time we entered the business – we will enjoy our cost advantage from the first bit carried to the last. Consider that our network (all layers) has been operating at scale for some years now and we don’t need to wait for CDN traffic to grow materially to enjoy that advantage. 

Two things are useful in trying to quantify that; most CDN providers break out, as a percentage of their overall costs, what they spend on network services (usually comprised of collocation, power and bandwidth). That portion of their total cost is the differentiating element. The advantage to us comes from the difference between the retail rates they pay, on a recurring basis, and our internal costs. See the answer to a following question for a more detailed discussion of CDN economics.

Question: As you know, many CDNs are entering the market and focusing only on price, even if they say they aren’t. Since your costs should be lower, will you come to market anytime soon with a really cheap price, undercutting everyone else, so that you can grab market share faster. While others are trying that model and will lose in the long run, you own the network, so can you win on price and still make money, or at least break even? 

Jim: We will certainly be very competitive on price. However, we have two other major advantages over most of the new entrants; scale and quality. We expect that many of the newer entrants will struggle to achieve a sustainable business model and, at the same time, provide the large and rapidly growing capacity that larger object (i.e., video) CDNs require. The customers we talk to are increasingly concerned about a provider’s ability to scale – today and more importantly tomorrow. We have already answered the question of our ability to scale.  With regards to quality, we are use to building and operating very large IP networks. We know how to operate them while keeping the performance and availability levels very high. All of the independent performance measures on our traditional services as well as our CDN places our products amongst the best performing in the industry.

Question: When does Level 3 begin to really attack the market with more marketing and sales specifically around the CDN product, without bundling it into all of the other products and services Level 3 offers?

Jim: Making a full range of optical and IP services remains core to our strategy. This approach allows us to meet the complete needs of media and entertainment companies who generally purchase a range of services from CDN to waves and sometimes dark fiber for data center interconnection and other facilities. 

While we have an advantage in selling to a large, existing customer base, we also have sales people actively seeking and closing new customers, some of whom may only purchase CDN. Because we have a portfolio of services to sell, we can leverage our ability to sell CDN and Internet transit to those customers that need both. We can also provide our Vyvx Broadcast customers with the ability to encode, deliver and store content. Based on the customer’s solution needs, we can bundle a host of services that we believe no other CDN provider is able to do today. We will continue to increase both the sales people selling and the marketing effort to raise the profile. 

Question: To date, from what I know, most of your CDN business has come from your current customers for other services. When will Level 3 focus on going after the pure CDN customers who have no other needs like transit or colocation?

Jim: Clearly you want to sell as many products as possible, but there is a lot of just pure CDN business out there today. We have paid particular attention to our existing customers since we have many long-standing relationships and because many of them had been asking us to enter the CDN space. We also target new customers who we believe will value the scale and scope of our offerings. Funcom is a recent example of such a new customer.

Question: A lot of people want to compare the decline in IP transit pricing to CDN pricing. Since it is not an apples to apples comparison for most and since most CDNs don’t own the network and you do, what insight do you have on this?

Jim: We divide the cost of a CDN into four primary elements: the cost to develop and deploy technologies such as intelligent traffic management and server cluster load management; IP/optical transport (i.e., bandwidth); the cost of CPU/storage in server clusters; and the cost to develop, acquire and protect intellectual property. Of these, we expect bandwidth and CPU/storage costs to dominate with the former the largest element of long run incremental cost. Underlying bandwidth costs have been falling quite rapidly, which have enabled a decline in IP/optical transport pricing. CPU and storage costs have a long and generally well-understood price performance improvement rate. These price performance dynamics are a fundamental reason that it increasingly more cost efficient to transport larger objects such as video over CDN networks versus other channels such as optical disc/physical distribution. For a more detailed discussion of these fundamental trends, readers can refer to the “August Investor Presentation” which can be found in the Investor Relations, Presentations and Events section of the Level 3 website.

Question: Can you say how much money you will put in the network this year specific to the CDN product, not including any previous acquisitions?

Jim: I can’t comment on that specifically as we do not break out our financials to that level of detail; however, we continue to make significant investments in our platform. We have expanded into Asia and continue to make capacity augments on all three platforms (streaming, storage, and caching) in North America and Europe. In addition, we have been investing in the infrastructure within our Level 3 colocation space where we locate our CDN nodes so that we can do “just in time” capacity deployments to uniquely serve the growth needs of our customers.   

The From Creation to Consumption presentation that we spoke of really is at the heart of what we are trying to achieve and why we are different from other CDN providers you comment on. We are trying to simplify the distribution chain associated with using an IP network for the delivery of rich media content. For this part of the market we believe that, over time, the distinction between IP Transit and CDN goes away. We will simply talk about Internet delivery of content. It is all about efficiently moving bits increasingly dominated by video and other rich media.

Historically, Microsoft’s Windows Media technologies have always dominated the enterprise market for multiple reasons, the biggest being that the WM Player was bundled into the OS and the server is cheap to deploy. And while I think Microsoft still has the majority share of the enterprise market, Adobe continues to get more aggressive in targeting IT decision makers inside enterprise organizations.

With Adobe making the licensing costs for FMS3 a lot cheaper than they use to be, and the fact that live Flash is now considered stable in FMS3, I am beginning to hear from more enterprise customers who are now evaluating Flash. Previously, a year or so ago, I saw very few enterprise companies willing to even consider Flash for streaming inside their Intranet. And while Adobe has a long way to go before it displaces Windows Media anytime soon with the Fortune 500, it’s a clear sign that Adobe is trying to hit Microsoft where it hurts. The enterprise market has always been one that Microsoft has dominated and that other video formats have not tried to penetrate since RealNetworks stopped getting the majority of their revenue from server licenses almost seven years ago.

Another sign of this push by Adobe is the number of articles I see about video in the enterprise that quote Adobe or talk about Flash. (see: Streaming Media In The Enterprise) In the past, you rarely saw Adobe talking about the enterprise market or saw them quoted in enterprise focused editorial coverage. Seems that is starting to change.

While most people always talk about Adobe and Microsoft going head to head for all online video, I don’t think they really do. Microsoft has always been the winner for video that was live, needed to be downloaded, played on devices or needed DRM. And Adobe has always been the winner for video that was used for advertising, media and entertainment content, true cross platform for Mac users and content that require embedding and custom design. The new version of FMS3 is getting some traction to challenge Microsoft for live content and Microsoft is trying to challenge Adobe in other areas with Silverlight.

But Adobe starting to go after enterprise video is new and shows signs that they are really taking the gloves off. It’s too early to know if Adobe can displace or eat into Microsoft’s
share of the enterprise market, but it’s something to keep a close eye
on.

I am happy to announce that the keynote lineup for the Streaming Media West show is now complete. Miles Beckett and Greg Goodfried, the creators of lonelygirl15 and KateModern and co-founders of the social entertainment company EQAL, have been added as keynote speakers on Thursday, September 25.

The keynote lineup is now complete and consists of:

• Werner Vogels, CTO, Amazon.com
• Jordan Hoffner, Director of Content Partnerships, YouTube
• Albert Cheng, Executive VP, Digital Media, Disney ABC Television Group
• Anthony Wood, Founder, CEO, Roku
• Miles Beckett, Co-Founder, CEO, EQAL
• Greg Goodfried, Co-Founder, President, COO, EQAL

Streaming Media West will take place September 23-25 in San Jose and all keynotes are FREE and open to anyone who registers before August 22nd for a free exhibition pass. In addition, press registration is now open and all bloggers and other media are invited to register.

On Wednesday August 20th, I will be hosting my first Frost & Sullivan Analyst Briefing on the CDN market. Each month, Frost & Sullivan analysts provide free briefings on a variety of topics in the Information & Communication Technologies (ICT) industry and this month I will be covering the latest trends and data from the CDN market.

This webinar will also highlight data from our new report we will be releasing next month entitled "World Content Delivery Networks Market". The report will provide revenue and demand forecasts for CDN solution providers and peer-to-peer based solutions broken out geographically in different regional markets: Americas, EMEA, and Asia Pacific.

Along with audience Q&A, these points will also be discussed:

• New CDN players in the market
• Recent acquisitions and VC funding
• Size of the market opportunity
• Impact telcos may have in the industry
• The role P2P and hybrid networks may play
• Growth drivers and barriers in the market

You can register for this free webinar on the Frost & Sullivan website and can submit questions to me via e-mail in advance. If there is a topic you want to see me cover, let me know. The webinar starts at 11am EDT and will last about an hour, or as long as you have questions.

I am going to do as many of these free webinars as possible on various topics surrounding the online video space, not just CDN. At Frost & Sullivan, we have many reports coming up on the online video industry including: World Video Server Market, World Video Encoding Market, World Streaming Platforms Market, World Enterprise Content Management Market, World Digital Rights Management Market, World Digital Media Storage Market and World IPTV Server Market amongst others. If you’d like a complete list of all future reports, send me an e-mail.

Yesterday, on Limelight Networks Q2 earnings call, various segments of their business was talked about on a high level that is worth digging deeper into. For starters, one of the biggest questions Wall Street seems to be asking is why did Akamai have a weak Q2 for CDN and Limelight had a strong one? The reason is not pricing pressure, lack of traffic growth or any of the other reasons people want to give. The bottom line is that Limelight simply had a good sales quarter, were aggressive in the market and won some business from Akamai. In quarters past, Akamai has had good quarters while Limelight’s have been bad. That’s the way it works and the winner will be the one who shows consistency with sales. It takes more than one or two quarters to declare a real shift and change in the market landscape.

Based on what both companies reported, Limelight’s CDN traffic does seem to be growing faster than Akamai’s. Notice I didn’t say is larger than, as we don’t know, but simply growing faster. While not discussed on the call, all of the Stage6.com traffic that Limelight lost when Stage6.com closed down, has already been made up by Limelight with new traffic. That’s something to think about considering that Stage6.com was one of the largest traffic sites on the web, doing close to 20 million unique visitors a month when it was shut down. Limelight has replaced all of that lost traffic with new traffic, in only 4 months time, which is a good sign of traffic growth. Of course to be successful, and more importantly profitable, you need more than traffic growth, you need revenue growth. But if you can grow traffic and not have any pricing pressure, which I didn’t see Limelight having in the last quarter, that’s the fastest way to increase revenue.

Another interesting thing not mentioned on the call yesterday is that on the second Tuesday of every month, Microsoft delivers software security updates. Limelight delivers more than half of that traffic for those updates and yesterday, Microsoft released 11 security updates that addressed vulnerabilities in Microsoft Windows, Microsoft Office, and Internet Explorer. That means Limelight’s network was delivering a huge amount of traffic for software updates and the Olympics, all at the same time.

The most interesting thing Limelight said on the call, with very little details, is that they would spend more in the second half of the year to build out their network for business they had won, but traffic they would have to take away from competitors or from in-house. While that seemed to confuse many on Wall Street, it makes a lot of sense if you really follow the CDN market. While Limelight won’t talk about the NFL business that I have confirmed they have won, it’s a great example of a customer who’s business that have won, but so far, have only been committed to be given half the traffic. The other half is to be delivered by Akamai. Without coming out and saying it, Limelight is challenging Akamai head on to take all of that business and show customers it is going to ramp up the capacity of their network to a whole new level by the end of the year.

In addition, this buildout makes Limelight a much stronger acquisition target by the telcos in six months time. What telco wants to acquire a CDN who they then have to put a bunch of money into to have the network ready for the next phase of video growth? By Limelight spending the money now, in six months time they will have built out their network for round two and will be a more valuable acquisition target.

To those who are new to the online video industry, it may seem like the content delivery market has been around for only a few years. But amazingly, 2008 marks the 13th year since some of the first content delivery networks (CDNs)—such as Sandpiper and Real Broadcast Networks—began offering streaming media services on the internet. In that time frame, the video delivery market has gone through enormous changes, both from a technology standpoint and assorted business standpoints, including how these services are priced, packaged, productized, and marketed.

Now that the service is evolving and the process of delivering bits has become somewhat of a commodity, people in the industry are just starting to talk about all of the other pieces in the content ecosystem. Today, most CDNs are still focused only on moving bits across the internet, while many content owners are struggling to figure out all of the other pieces in the workflow process that truly enable them to monetize their content. Delivering bits is not the complex part. Content owners are wrestling with the entire ecosystem workflow of content creation, capture, ingestion, transcoding, management, authentication, syndication, storage, delivery, and reporting, among other possible steps.

That being said, video delivery networks still play a vital role in the industry and will continue to do so down the road. Today, almost no company builds out its own video delivery network, as most CDNs can do it far more economically and efficiently than a content publisher can, especially when capacity and global reach are crucial.

As CDNs evolve, so does the term. Today, there is still no clear definition agreed upon by the industry that determines which companies will be classified as a CDN and which won’t. The term is very vague and continues to have a very broad definition as more types of content outside of video—such as applications—are delivered across CDNs. Everyone seems to have a different answer as to what makes a company a CDN and what kind of infrastructure CDNs are required to have in place in order to use the term.

Even with that confusion, the video delivery market is hot. In the past 6 months alone, the content delivery market specific to video has seen some enormous growth in the number of new vendors in the market, the amount of venture capital raised, and the expectations many people have regarding what the video market will grow into down the road. We’ve seen telcos enter the market and lawsuits over patents, and many hybrid or P2P-only networks have entered the fray. There are more than 50 video delivery networks now in the industry (see www.cdnlist.com), including those that are P2P-based, and the vast majority of them are competing for the same business in a market that is still small in the U.S.

While many reports in the industry have talked about how the size of the CDN market is much more than a billion dollars, none of those reports break out video-only revenue, which is the fastest growing segment of content delivery and takes up the most bits on any network. Based on my calculations of vendors’ revenue, the market size for outsourced video delivery services in the U.S. was $450 million to $500 million last year and has the potential to grow to about $800 million this year (see www.cdnmarket.com).

At the same time, in the past 18 months, more than 16 video delivery vendors, including P2P-based providers, have raised over $300 million in capital. CDNetworks, EdgeCast Networks, Panther Express, GridNetworks, Highwinds Network Group, Velocix, ITIVA, Move Networks, Pando Networks, Conviva (formerly Rinera), BitTorrent, ChinaCache, RawFlow, Oversi Networks and BitGravity combined raised $285.35 million in 2007 and 2008, and that number does not take into account other CDNs that have already raised money but have not yet made it public or those that are out in the market raising another round. When all is said and done, I expect close to another $100 million will be raised in the next 12 months. Combine this much money being raised with a market that’s not as big as some think and one has to worry that, in the next 18 months, the number of video delivery networks in the industry will fall considerably. The market can’t support 50 providers, and not every company will be acquired and make back their investors’ money.

History has a way of repeating itself, and we have gone through this before. In 2000, before the bubble burst, we had nearly 50 CDN providers in the market. Two years later, we had less than 10. Five years later, we’re back to 50, but for how long? At some point, investors are going to want to see some return on their money, and with fewer video delivery networks focusing on doing more than just delivering bits, it’s going to be hard to get acquired unless they can show a lot of revenue, which most don’t have.

While all this is going on inside the industry, on the outside, customers who are trying to choose the right video delivery network for their needs are more confused than ever. Thirteen years on, there are still no standards for online video and no agreed-upon way to fairly compare one vendor against another for the many different levels of services. In addition, while video delivery pricing continues to drop each year (see www.cdnpricing.com), it’s no longer falling at the rates we have seen in years past. All the while, consumers are watching more online video content more frequently, at higher bitrates, for longer periods of time, and on more devices. More than ever, CDNs are a crucial piece of the puzzle in helping this industry grow to the next level.

When it comes right down to it, the entire CDN market hinges on the ability of all CDNs to be able to use the economics of scale to operate their networks more efficiently. They need to spend less money to deliver more content with fewer resources and less infrastructure so they can reduce pricing to drive more consumption while still trying to earn a profit. Today, most CDNs are still losing money and spending a lot on capital expenditures, all while trying to stand out in a very crowded market.

Continue reading at StreamingMedia.com >>>

In the past 18 months, CDN and P2P based delivery vendors have raised over $300 million to build out and deploy content delivery services. So it should be no surprise to hear that BitGravity announced last week that it had raised $2.5 million from Allen and Company and Blake Krikorian, the co-founder and CEO of Sling Media

Adding up all the investments that CDNetworks, EdgeCast, Panther Express, Grid Networks, Highwinds,
Velocix, Itiva, Move Networks, Pando Networks, Conviva, BitTorrent,
ChinaCache, Rawflow, Oversi and BitGravity have gotten, and it totals $285.35 million. In addition to these sixteen providers, Kontki, SimpleCDN, Vusion and EdgeStream have all raised undisclosed amounts as well which puts the total amount of money raised into the CDN space well over $325 million. And if we think of AT&T’s CDN offering as a startup, which they basically are, with their $75 million investment into their network this year, that puts the total amount of money raised to over $400 million in the past 18 months.

In addition, while BitGravity is the latest to raise money, they won’t be the last. There are at least three to four new CDNs in the U.S. and Asia who are gearing up to enter the CDN market and have already raised, or are in the process of raising money. I am amazed that companies continue to be able to raise money for a new CDN business when there are already over 50 CDN providers and the market is not big enough, and won’t grow fast enough to support them all.

The CDN market is going to be in for a world of hurt in 18-24 months, and most of these CDNs are not going to get acquired or bought out at all, let alone at the kind of revenue multiple investors are dreaming of.