About the Death of the Set-Top…

Today's early morning announcement that Cisco is selling off its set-top unit to Technicolor begs the age-old question: Are we looking at the death of the set-top business?

With Cisco Systems Inc. (Nasdaq: CSCO) out of the market, Arris Group Inc. (Nasdaq: ARRS) swallowing up its largest competitors, and even smaller vendors consolidating to remain viable, it's tempting to suggest that set-tops are slowly going away. There's more evidence to support that conclusion too. In 2014, pay-TV set-top shipments contracted for the first time in a dozen years. (See Pay-TV STB Revenues Plunge .)

What the news really means, however, is not that the set-top business is going away, but that priorities -- and margins -- are shifting.

Set-tops entered their glory period a decade ago with the arrival of digital video recorders. At the time, Motorola and Scientific Atlanta sat on top of the vendor heap, selling higher-margin DVRs in bulk first to cable companies, and then to the major US telco TV players Verizon Communications Inc. (NYSE: VZ) and AT&T Inc. (NYSE: T). The need for on-board storage and greater processing power meant that the two set-top kingpins could charge more money for their TV boxes even while they maintained a virtual duopoly in the market. (The latter bit because of the complexity of content security systems -- see Who Will Own Cable's Content Security?)

It wasn't long, though, before the landscape changed. Video streaming entered the picture, CableCARD technology promised to open up the market to new retail players, and smart TVs joined the game with their own video app ecosystems. Still, traditional set-tops kept selling, and there were even some record years in the business through the end of the decade.

What finally tipped the market was not a rush of new TVs and set-top vendors -- many of those came and went -- but advances in software and networking that made it possible to move more and more TV functionality up into the cloud.

Cisco saw the writing on the wall. The decision to sell its set-top division to Technicolor (Euronext Paris: TCH; NYSE: TCH) is just the latest move in a series of shifts away from dedicated hardware -- a difficult but calculated strategy in the face of network virtualization. Arris hasn't ignored the signs either. Beyond bulking up with the acquisition of Motorola, and entering into an agreement to purchase Pace plc , Arris has also hedged its bets by acquiring ActiveVideo in a joint venture with Charter Communications Inc. ActiveVideo is a leader in set-top virtualization with its CloudTV platform that delivers web-based video services to virtually any device. (See Cisco Sells STB Unit to Technicolor for $604M, Arris to Acquire Pace for $2.1B and Arris, Charter Nab ActiveVideo for $135M.)

But if all of this sounds like an argument against set-tops, it's not. Set-tops aren't going away. They may continue to shrink in size, like Google (Nasdaq: GOOG)'s Chromecast and newer hockey-puck-sized set-tops from Arris, but there are still reasons to keep some TV functions out of the cloud and not in high-end flat-screen displays that only get replaced once a decade.

In order to optimize TV services, there will continue to be interplay between content and features that are hosted in the cloud, and those that reside at the edge, in a local network. Speed, latency and offline storage: these are all reasons why there's still a business in set-tops, even if it's one that demands greater vendor scale and delivers lower per-box margins.

Set-tops aren't dying. They're entering a new life cycle phase. It may not be as lucrative as the heyday period in the mid- to late-2000s, but it's not the end either. Set-tops will keep chugging along.

— Mari Silbey, Senior Editor, Cable/Video, Light Reading