JUNE 8, 2009 • The future of distribution is online. Across a spectrum of entertainment industries and services, a growing number of businesses are reaching consumers via online distribution rather than through old-fashioned brick-and-mortar storefronts. Of course, retailing is not on its way out, but indicators are strong that a lot of consumers will predominantly turn to the Web for their entertainment in the years ahead.

Online distribution for the PC has been around for years, but mainly it has been for basic casual games with a very small file size. Emerging industries like casual gaming and free-to-play exist almost entirely on the Internet. Companies like RealNetworks, PopCap and SPIL Games are quite profitable distributing content online.

However, the biggest sign of change is that increasingly large games, that have gigabytes of data, are being offered for digital distribution – most notably via Valve Software’s Steam service. Furthermore, the three console manufacturers are working hard at expanding their downloadable content download offerings. The new PSP Go even eliminates the physical disc by doing away with a UMD drive to focus on delivery of content via digital distribution.

At this year’s GDC, OnLive presented its ambitious online Games-on-Demand service, which is similar to the traditional cable service model. Finally, in the emerging Brazilian game market, a company called Tectoy has launched its Zeebo console, which allows customers to download content from major publishing labels. Clearly, digital distribution is not just the wave of the future, but a growing part of today’s business. This means it is time to look under the hood and more closely examine the costs associated with digital distribution.

As entertainment moves online, a critical question is the cost of delivery. In some cases, publishers attract millions of people to their site. Hosting all that content and traffic quickly becomes an expensive part of the business model. Even at a few dimes per user, successes like Nexon’s MapleStory, which counts 92 million worldwide subscribers, can run up quite a bill.

The low conversion rates (3-5%) that are typical for most online game play means companies have to host content for 20 users to obtain one paying customer. This tells us that online distribution is not as “free” as it seems at first. Just because it circumvents a lot of the capital expenses that apply to traditional retailing, the massive traffic needed to make a profit online can weight heavily on a company’s cost structure.

In addition, the gaming industry has begun expanding its customer base by focusing on emerging markets. The so-called BRIC countries (Brazil, Russia, India and China) are coming online, presenting a significant potential for audience expansion. But many of the players looking to capitalize on broadband roll-out find that advertisers are not as charmed by these new audiences.

Succinctly, online ad spending, traditionally the financial backbone of many online game companies, is currently insufficient to carry the cost of expanding into these markets. This makes the cost of server hosting a thorn in any CFO’s eye. Reducing this expense will prove of paramount importance.

The traditional names in game hosting offer content delivery services that run anywhere from $0.29 (Akamai) to $0.066 (Amazon S3) to even $0.017 (SimpleCDN). Currently, the average cost for a single user’s download of a typical free-to-play title at $0.091.

One of the companies that is aggressively moving into this space is Pando Networks. Established in 2004, Pando initially focused on a free consumer service, launched in the summer of 2006, designed to move large media files such as pictures and videos. As people spend more money on sophisticated consumer electronics, Pando figured, their need to send their output via email would increase dramatically. To help facilitate this, Pando created a small application, based on the same principles as the better-known, but often illegally used, Bit-Torrent service. By using a swarm, instead of one-on-one server to host connection, downloads are not just faster, but can also be paused and resumed at a later time. By early 2009, more than 28 million end-users had installed the Pando-client.

In early 2006, Intel Capital led a second round of funding with BRM and Wheatley Partners, resulting in $7 million of financing for Pando. Based in New York City, Pando Networks is led by CEO Robert Levitan, who previously co-founded iVillage (which was acquired by NBC). According to Levitan, although Pando does not give out specific information on its customer segments, the “vast majority (85%-plus) of all new installs are for game customers.”

Recently, Pando has started looking at the media and entertainment companies that distribute content online. In 2008 Pando released a service aimed at commercial content owners and distributors. The goal is to ensure companies can provide low cost and efficient delivery of entertainment content to the consumer.

The Pando Content Delivery Cloud is a suite of software and services that allows companies to digitally distribute software with a very large file size. One of the main attractions of the service is a comparatively low cost of delivery. However, the service also boasts some performance features that help increase the completion rate (the number of people that start and then successfully finish a download). For example, using Pando, a user can stop a download in progress and resume it at a later date. Of course, Pando offers a robust set of tracking tools that help companies monitor their downloads.

Pando’s success indicates that content providers are beginning to pay attention to online distribution cost. With a growing audience using the Internet for entertainment, a healthy bottom line depends on getting content to customers in the cheapest way possible. Yes, there exists a wonderful potential to reach millions of Internet users. But to monetize this into a relevant revenue stream, one is well advised to watch the cost of life online.