Roku (NASDAQ:ROKU) revealed a surprising decline in its player revenue when it reported its fourth-quarter earnings results. The average price per player fell 14% year over year, but that was partially offset by an 8% increase in unit sales in the fourth quarter. Lower pricing led to a significant drop in gross margin -- which came in at 9.5% versus 14.3% a year ago.
Roku is getting squeezed by competition from the likes of Amazon.com (NASDAQ:AMZN) and Alphabet's (NASDAQ:GOOGL) Google, which are selling streaming players at or below cost to increase engagement on their streaming platforms. Roku's platform business has grown into a formidable piece of its business as well, which is why the company was comfortable lowering prices.
But Roku stands to benefit even more if it can continue the momentum in its software-licensing efforts. Roku was the operating system in 20% of smart TVs sold in the United States last year. That's up from about 12.5% at the end of 2016. Roku will expand its software licensing to more manufacturers and device types this year, and it plans to rely on licensing to expand internationally.
Those factors are why licensing is the company's biggest focus of 2018.
Owning the television experience
The biggest advantage of licensing software to television manufacturers is that the Roku home screen is automatically the first thing users see when they turn on their television. While that hasn't resulted in an increase in streaming hours, it presents a unique advertising opportunity for Roku. Think about how Amazon monetizes its Kindle tablets by showing users an ad when they first turn on their devices.
Roku TVs offers Roku capabilities it doesn't otherwise have from its player units -- specifically, it can access a lot more user data.
Last April, Roku introduced Automatic Content Recognition (ACR), which detects what you're watching. With the operating system built into the television, Roku can show a pop-up menu to stream that same content from the beginning of the episode or series and see fewer commercials while you're at it.
ACR also provides Roku data on what ads its users have seen. That enables it to measure the incremental reach of its advertising platform, and it could eventually allow it to target ads based on which ads users have or haven't already seen.
That's an advantage Roku can hold over practically every other digital advertising giant, even Google. Owning the television experience should result in higher engagement and better user monetization over the long run.
Roku-powered international growth
Roku also offers a licensing program for streaming players that is the primary catalyst for international growth. It has deals with Sky in the U.K. and Telstra in Australia, which basically create souped-up cable boxes using Roku's software. Given that these boxes come directly from pay-TV operators and control live TV viewing as well as streaming video, they could eventually have similar capabilities to Roku TV.
The most important factor here, is that licensing software is a more efficient path to international growth than selling players itself. Roku doesn't have to deal with the logistics of getting its devices into stores in foreign countries and marketing them to a whole new demographic, which adds overhead to its operations.
While Roku may lose some of its branding power through licensing, the cost is minimal compared with the savings it can see from marketing and distribution. After all, Roku's big moneymaker is its platform business.
Expanding software to more devices
In 2018, Roku is thinking beyond the television. The company is jumping on board with the smart-speaker trend and licensing software to manufacturers to compete with Amazon's Echo devices and Google's Home lineup. Roku Connect will allow manufacturers to make smart speakers that integrate with Roku's video streaming devices, creating what Roku is calling a "home entertainment network."
Expanding beyond the TV creates a way for Roku to lock users into its platform by creating an ecosystem. It also offers an opportunity to bring in new customers.
Smart-speaker users are proving to be extremely loyal. Seventy-five percent of Echo owners said their next smart speaker will be another Echo. Sixty-nine percent of Google Home users said the same about Google Home. That's because users can create a network of speakers that can communicate with each other and provide an optimal experience. That benefits Amazon and Google, which already have a big head start in the space. But there's still plenty of room to grow, according to estimates.
Developing an ecosystem of multiple devices in a home that communicate with one another represents a great opportunity for Roku to create loyal and engaged users. Combined with plans to license its software to more TV and set-top-box manufacturers and distributors domestically and internationally, Roku's efforts to license its software ought to quickly overshadow its player business in 2018.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Amazon. The Motley Fool owns shares of and recommends Alphabet (A shares) and Amazon. The Motley Fool has a disclosure policy.