Part I Jan 2010 - Can airlines power ancillary revenue with digital media and better WiFi platforms?

Alford Strategic
Part I - January 2010
Development

What can digital entertainment, WiFi,
and mobile mean for airlines?

Alford Strategic Development LinkedIn | (206) 734-7450 | www.maketravelbetter.com 1

Introduction

Convergence of mobile technology and airline WiFi installations with digital entertainment’s fast growth could mean
significant ancillary revenue opportunity for airlines and WiFi providers…

• Airline WiFi will serve 400 - 500 million annual US airline passengers by 2012

• 300% - 400% larger than COMBINED projected iPad, Kindle, Xbox, Wii, PS3, and Netflix user bases

• US airlines could drive $3-5 Billion via revshare and customer acquisition partnerships with digital media firms

• …but charging travelers for WiFi cuts the head off the market

• “The 60-hour Cycle” - use knowledge of the itinerary to deliver impulse-buy content, entertainment, and
location-based services via mobile device, laptop, or IFE screen – from door-to-door roundtrip

• “Think Outside the Flight” - Mobile enables ~25 touchpoints – each way


Airline WiFi and digital entertainment growth

Airline WiFi installations are growing quickly…

• 400M – 500M WiFi-enabled passengers by 2012 is on
scale of top websites’ traffic

US digital content sales - $US bn
Movie / Video Music eBooks Games
$40.1B
Digital entertainment markets could reach $40 Billion by 2014
8.8

$27.5B
• travelers are high impulse book, movie, and music consumers 6.3
$21.3B 5.0

4.6 8.6
$15.8B 4.8
$11.1B 3.3 7.0
4.6
$6.3B 2.1 5.9
4.2 16.4
$3.9B 1.0 4.9
1.9 10.9
0.7
0.1 0.3 3.8 7.3
2.6 3.0 4.2
0.5 1.1 2.2

2008 2009 2010 2011 2012 2013 2014


Alignment of forces

Even 6 months ago, this market did not exist…

…now forces are aligning to enable airlines to capitalize on fierce competition in digital entertainment

Netflix, Amazon, Apple, Google battle
Airlines need new revenue channels
each other, publishers and studios

• 2009 = $11 B loss; 2010 ~ $3 B loss • Fierce competition for “living room”
share and market power
• Baggage and other fees make money, ~ 500 million passengers
but passengers don’t like them drive $1B to $5B digital • Customer acquisition is critical focus
entertainment revenue

Digital media partners can
Huge WiFi investment, but fee- win captive market Mobile technology and adoption
based model shrinks the market competitors cannot access create large opportunity next 3 yrs

• $100,000+ install cost per plane • Mobile growth and device convergence
• Travelers don’t want to pay WiFi fees • Location-based marketing extends
merchandising around flight


Who will own the content platform?

Aircell and Row44 are strong WiFi technology partners…

…but airlines need world-class digital media and web / mobile merchandising partners to own the content, merchandising
and marketing platforms…

Content, merchandising,
and marketing platform
Airline-built?
Studios Aircell?
In-flight WiFi
and Row 44?
service
publishers Netflix?
Amazon?
YouTube?
Apple?


“Think outside the flight” to drive revenue and engagement

The 60-hour Cycle

Think outside the flight…travelers are high impulse-buy targets for roughly 30 hours each way

• Mobile enables 25 round-trip touchpoints:

• Market actively to drive revenue, don’t wait until passengers are in their seats

• Defray in-flight data costs by driving travelers to download content before boarding

Text-offer movie Scan 2D code for Deliver eBook Flight delay? Offer Enjoy The Economist
for the flight exclusive offers coupon before free movie at $1 free on-board. Offer trial
customer buys at cost vs. $200 subscription on landing
Hudson News flight voucher


Standard revshare vs alternative opportunity

Capitalizing on these forces could generate $1 - $3+ Billion by 2012

Airline ecosystem digital media sales - $US bn
download / rental only download + referral / subscription
Revshare models based on in-flight movie rentals, eBook sales, and $5.4B
more could generate $1 Billion by 2012
$4.4B

$3.2B

But as just one alternative idea… $1.9B
$1.5B $1.6B
$1.3B
$0.8B $0.9B
…offering movie subscription trials to convert travelers to recurring $0.4B

“living room” customers could generate over $3 Billion by 2012
2010 2011 2012 2013 2014


Conventional revenue share approach

A conventional revenue share or affiliate model for movie, eBook and music download rentals can be profitable…
…but studio licensing and publisher royalties will take most of the income from airlines

Digital Entertainment Content “GoGo Video-to-Go”
Ecosystem service

Traveler rents $5 movie
on one flight

Airline income $1

or Partner income $1

Studio income $3


Customer acquisition / Referral approach

A customer acquisition model could deliver much more revenue to airlines, partners, and studios than a one-time in-flight
rental…don’t just settle for a conventional in-flight rental revenue share model

• As just one example, offer a free movie if traveler takes a free trial subscription for Netflix, registers for Amazon, etc

• Anecdotally, ~70-80% of travelers asked prefer the free movie / free trial option over paying for a rental

Digital Entertainment Content
cloud-based distribution
or

Traveler gets free movie by
choosing free trial

Airline income $12 - $16 referral

Partner income $120 annual subscription

Studio income $18 annual licensing fees

…note for digital partners - lock competitors out…airline contracts with WiFi providers are 10-year terms


Customer acquisition / Referral approach

The fierce digital media battle for “living room share” is driven by customer acquisition…

Netflix aggressively cornered game Amazon wants to be Apple using iPhone and iPad to drive digital
console and television streaming market relevant beyond eBooks video and eBooks after dominating music

…and airlines can offer a tremendous customer base and potential customer acquisition channel…

Annual WiFi pax vs hardware / subscriber bases
Game console Netflix subs Kindle iPad WiFi pax

Millions
476M
Compare ~400 million WiFi passengers in 2012 to: 463M
403M

• iPad and Kindle install base of 20-27 million units 320M

• Netflix subscriber base of 17-20 million
154M

• Xbox, Wii and PS3 install bases of ~40+ million households 11M
15M
21M
26M
7M 16M 20M
2M 11M
0M 16M 7M 17M 19M 22M 24M
0M
3M 15M
0M
1M 12M
10M 35M 39M 41M 41M 41M
19M 28M

2008 2009 2010 2011 2012 2013 2014


Why now?

WiFi providers need to replace a deteriorating revenue model just as installation capital costs take off…

• As with broader trends, passengers don’t want to pay for WiFi, and charging for it shrinks the potential media market

• WiFi providers are developing partnerships, but opportunity exists to create a better consumer experience

39M
124M
Quarterly passengers with WiFi access 107M108M
102M

82M 83M 86M
77M 78M
21M
47M 47M
39M

21M
9M
7M 7M 9M
0M

0M 0M Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 11 12 12 12 12 13

Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010

JetBlue tests BetaBlue Row 44 partners with:
(with Amazon, Yahoo) • SkyMall, HSN

Virgin America creates Aircell announces:
regarded RED in-flight • Gogo Video-to-Go
entertainment
Continental tests:
• LiveTV


Disrupt the traditional IFE content value chain

A new approach leveraging cloud-based digital services could disrupt the labor-intensive in-flight entertainment value chain

• Could save the airline industry ~ $150 Million

• Rule-of-thumb costs of $75 - $80 per flight for licensing and film services

• IFE serves ~ 20% of flights and is used to drive premium fares, but not direct revenue

Traditional value chain

Cost = $150 M content and content ship
Movie Airport plane Plane IFE Ovhd or seat-
No revenue Studios film services and storage load facilities server back screens

Future value chain

Ovhd or seat-
Cost = $5 M back screens
Movie DECE content Plane IFE
WiFi service
revenue opp herein Studios platform server
Mobile


Summary – General factors to consider

From an airline perspective From a digital media partner perspective

• WiFi fees are less sustainable and drop usage significantly, missing • Airlines likely will want a one-stop solution
out on potential digital entertainment revenue
• Amazon can package all digital categories and its incredible
• Digital merchandising is high-margin and has the Earnings value of retail capability in an on-board and mobile solution
a much greater volume of air fares
• Aggregate passengers
• IFE has been a cost center, but money can be made
• Lock competitors out; don’t get locked out
• Airline markets could be a key battleground in digital entertainment
• Customer acquisition channel is potentially much larger than
• Amazon can package all digital categories and retail Netflix’s console deals
capability in an on-board and mobile solution
• Sheer size of the passenger base can influence markets, studio and
• Netflix leads the movie category, but offers no others publisher leverage, and M&A activity

• Subscription-referral model could be much more lucrative • Netflix subscriber growth is a key driver of its 30x PE multiple
and $4 Billion market value
• Netflix offering standard $16 affiliate referral
• Amazon, Apple and YouTube have great general customer
• Lifetime value of subscription is significantly greater; leverage bases, but assuming Netflix is a subject of M&A interest:
huge passenger base in negotiations
• If Netflix drives 4 million subscribers, its valuation could
increase significantly

• If Amazon takes those 4 million customers, Netflix
acquisition pricing could be lower


Appendices

Appendices

Digital entertainment industry overview

• Amazon, Netflix, Apple, Google comparison

• Movies

• eBooks

• Music

• Games

• Unit sale economics

Airline WiFi service provider summary


Appendix – Potential partner comparison

Four players are best-positioned, but have key differences in what they provide and how they can benefit from air markets

Amazon Netflix Apple Google

Digital Media • Mass niche - all categories • Movie subscription category killer • Mass niche - all categories • Scanning large eBook library but
positioning engaged in civil actions
• eBook leader with strong Kindle • No hardware platform • Music dominance with strong
hardware platform hardware and iTunes distribution • Testing movie product via YouTube
• Direct retail streaming and
• New movie product coming? streaming distribution partner • New eBook platform coming?

General • Capital base and customer base • The movie rental brand • “sexy” brand and design talent • Always a threat due to capital base,
strengths search base, and innovative culture
• Precedent for strategic patience • Single focus – no distractions • Large digital cust base via iTunes
• Cloudfront streaming service • 12 M subscribers, growing fast • iPhone base • Android operating system could be
used to drive mobile content
• Recommendation engine • Console deals lock out competitors • Airline market bias – exclusive iPod
jack in new Panasonic IFE systems
• Recommendation engine

How they can • Lock out Apple and Netflix • Lock out Amazon and Apple • Lock out Amazon and Netflix • Lock out Amazon and Apple
benefit from
• Drive Kindle in competitive market • May be greater cust acquisition • iTunes movie / video trails Netflix • Lock out Bing and Yahoo search
Air markets
channel than console deals
• Gain music share in mature market • Drive eBook business for iPad • Launch pad for YouTube movie
• Leverage vs studios re licensing rentals
• Launch pad for movie product? • Leverage vs studios, publishers,
and “day and date” schedules
and labels • Drive eBook business
• Greater cust acquisition channel
• M&A pricing leverage if considering
than Netflix console deals • Mobile search and location-based
being acquired
search opportunity
• Leverage vs studios, publishers
• Engage mobile consumer in
• Movie subscriber growth creates addition to home-based
M&A leverage if eyeing NFLX
• Publishers may approve “airline
window” to offer new eBooks


Appendix – Digital Movie / Video overview

US movie sales & rentals - $US bn
The market is just forming, and positioning for customer acquisition
digital movies physical format
and profitability is paramount. Expectations have increased with: $30B

• Streaming technology advancement and cost reductions $25B

$20B $9.0
• DECE’s common file format and Digital Rights Locker
$12.0
$15B $15.0
• Increased competition and partnerships to stream to home- $21.7 $20.7 $19.7 $17.7
networked HDTV’s, Blu-ray players, game consoles, and PCs $10B
$16.4
$5B $10.9
• Netflix’s aggressive positioning as retailer and distributor $7.3
$2.2 $4.2
$0B $0.5 $1.1
• Apple’s aggressive iPad promotion 2008 2009 2010 2011 2012 2013 2014

• Mobile video, processing and storage technology following
classic (maybe faster) advancement cycles

Competitive characteristics
• Netflix overwhelmed Blockbuster and has a strong singular
focus, but not a large capital base

• It must drive customer acquisition, reduce churn and
streaming costs, and navigate studio licensing demands

• Netflix may be a necessary acquisition candidate

• Apple’s iPad launching successfully

• Amazon have significant financial muscle and content, but is
not on the radar in significant way

• YouTube has significant Google muscle and is testing movie
downloads, but continues to face revenue challenges


Appendix – Digital eBooks overview

US digital and physical book sales - $US bn
The eBook market is tremendously dynamic, with Amazon, Barnes & digital retail physical retail
$40B
Noble, Apple, Sony, the Big 6 publishers, Google, and disruptive
publishing startups like Smashwords vying for influence.
$30B
• Kindle is Amazon’s bestselling item, and Amazon is holding to its
$33.2
disruptive pricing strategy and walled-garden approach $20B $35.2 $34.5 $33.8
$38.0 $36.7 $36.0
• Google is still engaged in anti-trust and legal licensing issues to
scan older texts and develop its online service $10B

• It is opposed by almost everyone else in the market $0.1 $0.3 $1.0 $2.1 $3.3 $4.6 $6.3
$0B

• Smashwords is building a publishing service aimed at disrupting 2008 2009 2010 2011 2012 2013 2014

traditional publisher economic models – Amazon followed suit

• Magazine and newspaper publishers are forging on their own, led
by Hearst’s FirstPaper, to produce eReaders and content display

As expected, Amazon’s success continues to attract competition in both
content and eReader-oriented hardware

• Apple launched its iPad and is arranging content deals

• Barnes & Noble’s Nook platform got a lot of holiday buzz, though
results are unclear

• Traditional publishers are threatening a new “day and date” release
window, similar to movie studios, to protect hardcover margins


Appendix – Digital Music overview

US digital music sales - $US bn
US Digital music will equal physical sales in 2010, generating about digital music physical format
$12B
$3.8 Billion and rising to about $7 Billion by 2013. Physical format
sales have dropped from $13 Billion in 1999. $10B
$2.0

• Though Apple has dominated the explosive growth, the $8B $2.3
$8.6
$2.7
industry has attracted stiff competition and innovation $3.2
$6B $3.8 $7.0
$5.5 $4.6 $5.9
• Amazon, despite its strengths, carries just 8 – 10% share $4B $4.9
$3.8
• Major barriers are record labels themselves, milking CD sales $2B $2.6 $3.0
and slow to adjust licensing requirements to truly enable new
$0B
distribution paradigms
2008 2009 2010 2011 2012 2013 2014

• Labels demanded significant upfront payments – and equity
stakes - from promising streaming music start-ups, many of
which failed partly as a result

• On the other hand, Pandora now claims a base of 40 million
registered users and Spotify is growing rapidly

• How profitable they are is a big question

As well as Apple’s dominance, this is becoming a dynamic
market of paid downloads vs ad-sponsored streaming and
consumer-facing business vs record-label inflexibility.

By leveraging airline passenger populations, opportunity exists
to build power with labels to drive profitability.


Appendix – Digital Games overview

US digital game sales - $US bn
Pyramid Research claims the global casual digital gaming market digital games
$10B
will rise to $18 billion by 2014 from $6.9 billion in 2008.
$8B
However, little data exists to verify this or determine which content
platforms or game publishers are driving the business. $6B

Often anecdotal evidence of potential opportunity includes: $8.8
$4B

• In the US, digital game sales allegedly topped $1 Billion in $4.6 $4.8 $5.0
$2B $4.2
2009, and the iPhone game market may have been
$1.9
accountable for $250 Million of it $0.7
$0B
2008 2009 2010 2011 2012 2013 2014
• 250 million people are active social gamers, up from 100
million just several months ago in April

• VC firms have poured money into companies such as Zynga,
Playdom, which received $40 Million from Kleiner Perkins.

• EA acquired Playfish for $400 Million

• Virtual gaming goods are widespread outside the US, and may
now generate $1 billion in the US, up 100% from 2008, as
sales and gifts grow on Facebook, etc.

The burning platform might be to use casual game distribution
as a complementary product offering to drive deals with airlines
and share in the other major categories.


About Alford Strategic Development

About Jonathan Alford

With 16+ years of experience in consumer and business travel, hospitality, and retail, Jonathan’s work
centers on dual principles of driving a better traveler experience and advancing travel industry/company
economic models.

Recent focus includes creating visionary product and platform strategies for global corporate travel firms,
leveraging new mobile/tablet platform capabilities and themes of "consumerization" to improve traveler
experience, drive economic value to offset rising travel costs, and deliver enhanced duty of care to
mitigate travel risks as emerging economies shift.

Recognized thought leadership influencing disruption of airline industry WiFi and digital entertainment
(manifested in current advancements in both in-flight and "outside the flight" experience) and promoting
voice recognition technology impact in mobile travel search and itinerary management.

Jonathan was awarded an Olympic Order of Excellence for executive program and Games-wide
operations management at the 2002 Winter Olympics, judged best-managed Games in history.

He is a graduate of The Johnson School at Cornell University and the University of Virginia.


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