First, consumer entertainment needs are well-defined and much understood.  A device which is premised as an entertainment solution stands a better chance of actually making into the mass-market household than a data-centric device.  After all, when was the last time you saw a group of people wait in line all night to get the latest version of a router?

Second, it can be reasonably asserted that in the very near future most American consumers will be able to select from at least two residential broadband providers.  At minimum, most consumers will be able to choose between cable and some version of DSL. 

Third, it is our belief that the market for residential gateways (at least in the next five years) will be driven by the service provider, not the consumer.  RGs remain too sophisticated for the average consumer to install, and given that many of the services supported by an RG will not be delivered for two to three years, there exists no compelling need for the consumer to rush out to an electronics store and purchase one.

Service providers, on the other hand, have a genuine interest in deploying RGs right now.  In order to secure the residential premise against future competitors, service providers must deploy devices that are as sticky as possible (i.e., give the consumer a reason not to jump ship to another service provider).  Combine this imperative with a desire to reduce future truck rolls and enable remote upgrades and management and it becomes easy to see why many service providers are beginning to deploy RGs right now.

For example, several DSL providers currently offer residential gateways to their new customers as an option to the standard broadband modem, often at a rate lower than the retail price.  EarthLink recently announced a partnership with 2Wire to offer new DSL subscribers the option of selecting either the HomePortal 100 or 100W when setting up their service[1].  The HomePortal 100 and 100W traditionally retail at around $199.95 and $359.95, respectively.  If purchased when purchasing EarthLink DSL service, the 100 and 100W sell at $149.95 and $299.95, respectively.  These are one-time up-front costs, but a monthly service charge of $9.95 (in addition to basic broadband connectivity) is required to enable the home networking features of the HomePortal series.

A similar model is used by Telocity/Hughes Electronics’ DirecTV Broadband.  Telocity’s VelocityPort™ is a standard part of its DSL value package, and is sent to new subscribers at a cost of $24.95 (which covers shipping and handling).  There are no additional charges to receive the gateway, but to enable its enhanced features (such as home networking, firewall security, virus protection, and spam filtering) requires an additional $9.95/month.

EarthLink’s marginally discounted consumer distribution model may work, but it leaves the consumer bearing most of the cost of the residential gateway up-front.  It remains to be seen if consumers will be attracted to this model, although I suspect the discount will have to be deepened in order to move a lot of RGs.

Telocity’s subsidized model is attractive, but the long-term validity of fully subsidizing high-end electronics has only been validated in the cable space.  Such a strategy requires more up-front investment for companies that are already operating with razor-thin margins. For most DSL providers, it will be very difficult to fully subsidize residential gateways for the long-term.

 Let’s juxtapose the DSL RG distribution model with that of the cable broadband providers.  It has been a long-standing (and profitable) feature of cable service models that the devices placed within the consumer homes are fully subsidized; in exchange, of course, for a service commitment of some specified length.  Currently, mid-level set-top boxes have an end-user value of between $350-$500, while high-end set-tops (set-top RGs) tend to run between $500-$600.  (It should be noted that most MSOs believe that the average price of set-top RGs will drop to below $500 very soon.)  These costs are not passed on directly to the end-user, but indirectly recouped via the sale of services. 

How successful has this model of distribution been?  Recent estimates suggest that there were almost 15 million set-top boxes deployed in the U.S. as of year-end 2000[2].  In terms of set-top RGs, our latest forecasts suggests that by the end of 2001 there will be close to 5 million set-top residential gateways deployed in U.S. households, accounting for almost 57% of the cumulative 2001 U.S. residential gateway market.  Scientific Atlanta, one of the largest players in the set-top space, recently told Parks Associates that almost one-fourth of its 2001 set-top production will be Explorer 4000 and 8000, both classified by Parks Associates as set-top RGs.  Numerous multi-service operators (MSOs) have announced relationships with Scientific Atlanta, Pace Microsystems, and Motorola to distribute record numbers of advanced digital set-top RGs in the next few years.

Why will this method of distribution work equally well for set-top residential gateways?  Look at it from the consumer’s perspective, through the eyes of Joe and Josephine Six-Pack.  Their DSL provider can offer them broadband service at $49.95 per month (e.g., EarthLink), and in order to receive home networking support they have to pay a one-time fee of (often) more than $100, a monthly fee of $9.95, and sign a contract for twelve or more months. 

But their cable provider offers them broadband service at $44.95 (e.g., AT&T), and gives them a free set-top box that can enable digital cable and data service, and supports multiple home networking technologies.  No extra fee for the box, but they do have to sign a contract for a specified length of time. 

To some this will appear as on oversimplification.  Yes, much depends upon installation costs and the reputation of the service providers in question.  But to the average American consumer who does not have a sophisticated knowledge of residential technology, who compares options based upon the actual costs for services and equipment received, it would appear to be a no-brainer.  All things being equal, the mass-market consumer is more likely to gravitate toward an entertainment-based solution that has a less expensive monthly rate and offers a fully subsidized device.

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