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Alongside deep penetration of fast internet, brilliant innovations in technology – from video compression to LTE – have enabled the rapid and disruptive emergence of OTT services in the world’s Developed Markets. The transfer of value brought about as incumbent products wither and are either diminished or replaced by new OTT substitutes has been acute and often merciless. Just ask the telcos how much of their revenue faucet from SMS has been dialed-down by chat apps;  the increase in mobile data revenue attributable to chat apps like Viber and Skype has not offset the loss in direct SMS revenue even when one considers how new revenue streams such user authentication by SMS has sprouted only with the growth of OTT services.

The ultimate hegemony of OTT services in the market is solidified not only by rationalization of cost and waste and the development of new features and functions around core product utility, but finally by enhanced customer satisfaction and increased product or category usage. The growth of OTT video in the US for example has served to increase average daily time a person spends watching video although the actual time spend consuming  traditional long form video or linear channels via broadcast technologies is rapidly declining.

One dark side of the evolution however is that value is not only rapidly and irreversibly transferred, net value can actually be reduced in the process, assuming that one believes that ultimately only net profit can drive true long-term value.

The other dark side of OTT evolution can be seen in the net effect on employment –  when a single telco would have to employ nearly a small army to manage and deliver its SMS business, for a long time there were only 20 employees at Whatsapp (that said, digital marketing and software engineering skill sets are in ever greater need around the world;  the labor market invariably adjusts, though the reactive speed of “human bandwidth” in the wake of rapid shifts in value often creates economic casualties.)

What does this all mean for Emerging Markets?

The confluence of smart device penetration (thank-you to the Chinese manufacturers of quasi-smart phones and Western reverse logistics companies that resell container loads of old gen smart devices in Asian markets), faster internet (minimum enabling speeds, really) and more purchasing power in many Emerging Market populations means that OTT Services are now a real industry here- and as equally a disruptive factor in ASEAN markets as they have been in the West.

Disruption is disruption, but the manifestation, snapback, and control forces in ASEAN markets that are put into play around continuity are very different than are found in Western markets.

Business model and industry evolution in the Developed Markets, especially when driven by technology, ultimately finds its way to Developing Markets.  That is not new.   But what is new is the blazing speed at which the OTT Service evolution is happening in ASEAN, and the weakness of the usual levers to control it.     What took 10 years in the West – say from the unsuccessful commercial launch of Joost in 2006 with its P2PTV technology to distribute content to Mozilla-based desktop players under its CoreAVC H.264 video decoder to the wide adoption of video services like Netflix and its advanced adaptive encoding deployed in a global CDN- is happening in less than a quarter of that time in many key Emerging Markets.

Any product or service delivered via internet protocol technology is by definition a global business, thus internet OTT businesses and all the good and bad they bring, are now front and center in ASEAN.  There are more daily Tweets coming from Jakarta than out of New York City – despite substantially lower internet speeds and lower data and smart device penetration rates.

Danger, Will Robinson…

Its really no surprise that The Ministry of Communications and Informatics (MOCI) in Indonesia issued Circular Letter No. 3/2016 dated 31 March 2016 on the “Delivery of Application and/or Content Services through Internet,” e.g. the regulation of OTT Services.

The OTT Circular Letter clearly states that the purpose of the action is to alert all OTT Service Providers- domestic and foreign – and incumbent Telecommunication Operators that they need to prepare themselves to comply with what might be a very challenging and sweeping regulation currently being prepared by MOCI.

Let’s have a look at the circular itself, and what it likely means.

 

Key Points

The following are the key points of the OTT Circular Letter:

Product Definitions

The OTT Circular Letter defines OTT internet products and services as the provision of applications and/or content services through the internet:

  • OTT Application services: the utilization of telecommunications services via internet protocol based telecommunications networks that enable communication services in the form of short messages (texts), voice calls, video calls, online conversations (chatting), financial and commercial transactions, data storage and collection, gaming, social networking and media, and all derivatives of these services.
  • OTT Content services: the provision of all digital information forms consisting of text, sounds, images, animations, music, videos, films, and games or any combination thereof, including in from of streaming or downloads, by utilizing telecommunications services via internet protocol based telecommunications networks.

The above definitions, while not unconventional, are broad.  It is purposely so in order to cast a wider control net over virtually anything delivered to a consumer or business using internet protocol technology.   When the government means to regulate OTT, they mean to capture anything and everything in the category.

OTT Service Providers

The OTT Circular provides that OTT Service Providers are deemed to include any Indonesian, or foreign, individual and business entity, importantly either in the form of a legal entity or otherwise.   This enables the Ministry and evolving legal framework to exert legal control over the services themselves rather than simply over entities or individuals that may be foreign domiciled and unable to be reached.

Further, Circular Letter also provides that OTT Services can be legally delivered by a foreign individual or a business entity only if a Badan Usaha Tetap – which our legal team tells us means “PE” (Permanent Establishment)- is established in Indonesia in accordance with the prevailing tax laws and regulations.

OTT Service Providers Obligations

The Circular provides that all OTT Service Providers, which are now currently operating in the ASEAN-equivalent of the Wild-Wild-West by virtue of operating outside a specific legal and tax framework, must comply with Indonesian laws and regulations on monopolies and unfair competition, trade, consumer protection, intellectual property rights, broadcasting, advertisement, pornography, anti-terrorism, and taxation.

Additionally, OTT Service Providers must also:

  • comply with all data protection laws and regulations;
  • conduct content filtering in accordance with the prevailing laws and regulations;
  • conduct censorship activities in accordance with the prevailing laws and regulations;
  • use the Indonesia’s National Payment Gateway;
  • use an Indonesian-generated internet protocol number;
  • guarantee access to lawful interception and evidence collection for the prosecution or investigation of criminal cases by the relevant authorities in accordance with the prevailing laws and regulations; and
  • provide information, service guidelines, T&Cs, and all manuals regarding the use of the services in the Indonesian language in accordance with the prevailing laws and regulations.

OTT Service Providers are prohibited from providing services with contents which:

  • contradicts with the State Ideology (Pancasila) and the Indonesian Constitution (UUD 1945); and threatens the unity of the Republic of Indonesia;
  • incites conflicts between ethnicities, religions, races and inter-groups (SARA), and degrading, harassing, and/or blaspheming religious values;
  • encourages the public to (i) conduct unlawful or violence acts; (ii) abuse narcotics, psychotropic and other addictive substances; (iii) degrade human dignity and morality, (iv) violate decency and pornography, (v) gamble, (vi) conduct insulting, defamatory, extortion or threatening behavior, hate speech; and (vii) violate intellectual property rights; and/or
  • contradicts with the laws and regulations.

Oceans Eleven may indeed be right out the window. I’m not sure a Hollywood movie or TV show other than perhaps Bambi will meet the guidelines without a great deal of editing, though I am encouraged with the government’s overt and aggressive words regarding pirated content and services that blatantly violate copyright.   It is hard to speculate whether or not that is a long-term and enforced view.

Preliminary Analysis

Not only was this expected, it is to be expected.   The usual themes underpin the attention now being given to OTT Services –  objection to perceived extraction of wealth, control over culturally objectionable ideas reaching into the country, protection of slower moving and slower-to-develop local OTT businesses, protection of employment and thus social stability, and (of course) local business enrichment and market control alongside government tax revenue.    Indonesia isn’t the only emerging market to begin to look extensively at OTT Services – Vietnam is likewise moving along parallel paths, and China has done so for several years.

So in some ways, this is snap-back to the rapid acceleration of foreign company pole position in key OTT categories as Indonesia is clearly intent on regulating OTT products and services.  Foreign domiciled OTT service providers in particular- whether delivering their products from overseas servers or on-shore servers – have cause for concern and for an immediate evaluation of their Indonesia GTM approach and business structure.   This will likely include all the global category leaders such as Netflix which was recently blocked in Indonesia without warning or singularly clear explanation.

Providers may need to move onshore somehow, and will accordingly be taxed onshore;  there may be significant emerging partnerships with local established Indonesia conglomerates on the horizon where foreign investment regulations restrict establishing a company or where deltas in taxation levels dictate restructuring and partnering.

It is very likely that the upcoming OTT Regulation will require all foreign OTT Service Providers (which make their services available in and generate revenues from Indonesia, regardless if their servers are located onshore or abroad) to have a local presence in Indonesia either by  partnership with a local conglomerate, or by establishing a PMA company (the latter if foreign investment regulations permit based on the product category).  There is a strong possibility that local data center requirements will be enacted, especially as the Government is the largest incumbent network and services provider (i.e. Telkom and Telkomsel).

Unfortunately, a great deal is still unclear:

(a)   whether foreign OTT Service Providers that have already established an Indonesian company but do not fully provide all services that the offshore companies are providing into Indonesia, will still be required to set up a PE in Indonesia
(b)   the applicable sanctions and whether there will be any grace period for OTT Service Providers to comply once the OTT Regulation is issued – e.g. whether MOCI will give itself more expansive power to block entire services, applications, and sites (and not just rely on its current power to block negative content) – which will by definition spill over to Apple and Google
(c)   whether the Indonesian National Payment Gateway requirement means the Indonesia’s National Payment Gateway or any Indonesian payment gateway
(d)   how MOCI intends to deal with OTT Service Providers that may not be able to establish an Indonesian subsidiary (given foreign investment regulations) – which then potentially results in higher tax – or whether it will push in the forthcoming Negative List to have a specific category for OTT Service Providers
(e)   how this will all be monitored (e.g. as regards ascertaining revenues for tax purposes), what the reporting requirements will be, etc. – while certain matters can be monitored through the Indonesia’s National Payment Gateway and also telco carrier billing, clearly not all payments modes (e.g. credit cards) can easily be monitored
(f)    whether the OTT Service Providers will be considered as Electronic Systems Operators under Government Regulation No. 82/1012, and for many who may collect data complying onshore with the requirements under this Government Regulation and more generally the Electronic Information and Transactions Law.

Money Flows & Tax

There is still no specific tax regulation for OTT Service Providers.  But if they are in the end required to establish PE to legally serve the market rather than serve it via a PMA company, the tax implications are substantial.

Under the Indonesian tax law, a PE is considered as a corporate resident taxpayer and will have to comply with all applicable Indonesian tax regulations, including the requirement to register itself as a taxpayer in Indonesia by obtaining a tax identification number (NPWP). A PE will then be subject to Indonesian income tax on profits attributable to the PE at a tax rate that is higher than the rate that applies to resident corporate taxpayers. In general, a PE is subject to a 40-45% corporate income tax (25% corporate tax plus 20% branch profit tax of the after-tax profit, with certain modestly reduced rates under relevant tax treaties.)

If the PE delivers taxable goods and/or taxable services within the customs area, the PE is also obliged to be registered as a taxable entrepreneur for VAT purposes.

Given the depth of existing penetration of some of these foreign owned and delivered OTT services, “Ka-ching! goes the cash register…”

Nearly all foreign OTT Providers today are getting a complete free ride.  For significant foreign entities delivering anything over the Internet – read: Netflix, iFlix, Viber, LinkedIn, Daily Motion, Facebook, Twitter, Snapchat, and an endless list of high-brand value services – and even smaller, lesser known entities and their brands such as USKOOP and others owned in part by ALTUS Digital Capital- this should be a wake-up call that there is not going to be any free rides ahead.

One must bear in mind that this is all happening alongside a “new Indonesia” that is relaxing requirements on establishing local companies and supporting foreign investment.    Foreign industry needs to engage MOCI and other relevant authorities in constructive dialog, recognizing that in the midst of the muck is clear opportunity to build a clearer and deeper relationship with Indonesia.    There is opportunity galore in all of this for companies and services that can fit their operating structure and GTM into the emerging framework, especially those that can partner with local Indonesian companies.   ALTUS Digital Capital has a core philosophy that success in ASEAN market digitalization rests in part on strong partnerships and partnering skills and a willingness to share the upside- never has this winning strategy been more apparent than in both the challenges and opportunities in emerging OTT Service regulation in Indonesia.

Indonesia is going to remain the place where everyone wants to be but no one can easily get into – except of course those nimble and flexible few who know the secrets and carry the right point-of-view.

 

 

 

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