The Future of TV

Kicking Television

Kicking Television (Photo credit: dhammza)

Laura Martin and Dan Medina of Needham & Company, a branch of an investment banking and asset management firm have issued an analysis on  the Future of TV. There has been a lot of other reporting about this report, most of which zeroed in on the fact that ESPN would need to charge $30 in an a la carte environment. I’ve written several other blogs about the a la carte issue and instead want to highlight some of the interesting facts from the report.

They say that TV is a bargain and that the average family spends 30 cents per hour to watch TV. This is based upon an average cost of $75 for a cable subscription and a family watching TV eight hours per day. I think they miss two points with this. The price of cable has grown much faster than inflation and there are now more and more homes who feel they can’t afford the cost of the subscription. If cable rates keep climbing 6% per year, in only five years this same subscription is going to cost over $100 per month. Also, there are many households who do not watch TV eight hours per day. It is these two groups that are leaving the cable system, the first reluctantly and the second because it no longer feels like a bargain.

TV content is expensive to produce. The four main broadcast networks (ABC, CBS, FOX and NBC) spend an average of $2.5 million to create a prime time hour of programming. To contrast, all of the other 130 or so cable networks spend an average of about $100,000 per hour. But there are new rivals now producing programming. There are a number of companies now producing content for the web and this is expected to grow rapidly. For example, YouTube is spending about $100 million, NetFlix $200 million, Hulu $500 million. And both AOL and Yahoo have created web ‘channels’.

They say that about 80% of content never pays for itself. The TV world is driven by hits since they draw the bulk of the advertising revenue. But hits are ephemeral and unpredictable. The broadcast networks have been geared for decades to product hits and it’s obvious that even with the money that they spend that it’s very hard to do. But the top shows garner the lion’s share of ad revenues. To show the power of hits, the top 1% of movie hits account for 18% of movie rentals / views.

They recognize that TV viewing is shifting in a digital age. They cite the following statistics:

  • 72% of viewers watch content only on a TV set.
  • 11% watch content only on some digital medium such as computer, pad or smartphone.
  • 17% of viewers watch some content in both ways.
  • 61% of TV watchers now use the Internet while watching TV and 10 – 25% of those viewers go to the website of the show being watched (depends upon the network being watched).
  • 29% of the viewers who use the web while watching TV are on Facebook.

The report estimates that over 1 million jobs are dependent upon the TV sector. These are mostly middle class jobs and include cable TV installers, customer service reps, people who work in various roles at the networks. Comcast alone has 126,000 employees. By contrast the new companies trying to make money from web content have very few employees. Hulu has 420 employees, YouTube has 650 and NetFlix has 2,348. The report thinks that most of the traditional cable TV jobs are at risk if we move to an a la carte system.

The public companies in the TV sector have about $400 billion in market cap (investable securities). The report estimates that at least half of that market cap would disappear under a la carte programming. They warn that even having the government looking at a la carte programming puts these investments at risk.

These are just a few of the many facts cited in the report, which is why I have included link to the full report for anybody who wants to read more. Oh, and at the end of the report they recommend buying CBS and AOL stock. If you buy them and it doesn’t work out, you didn’t hear it here.

Should You Carry OTT Programming?

Every cable provider today needs to consider carrying Over-the-Top (OTT) channels on their cable system. OTT programming is content that is available on the web and includes such things as Hulu and Netflix. There are a number of reasons to consider this:

  • I have discussed the phenomenon of cord-cutters in other blog posts. The large organizations that track cable customers report that a lot of customers are dropping traditional cable. Nielson reported that at least one million people dropped traditional cable last year and that number is expected to increase. The cable industry appears to be at the same place that the telephone industry was ten years ago and everybody expects more and more people to drop cable TV every year much as has happened to land line telephones. To the extent that you can give customers easy access to OTT programming on your cable system you may convince some of them not to leave your system.
  • There are a lot of customers buying OTT boxes, which are devices that let them watch OTT programming on their TVs and also on other devices using WiFi such as pads and smartphones. These are devices like Apple TV, Roku, Boxee and Playstation.  Once a customer has an alternative box in their home sitting next to your settop box they have mentally started the process of dropping you. If you can give customers easy access to the OTT programming they want you will have lowered their incentive to buy an alternate box.
  • You can use OTT programming to develop new products. Nobody makes much money today with cable TV. You can create a new bundle of programming by combining OTT, the basic network channels and local programming that can be more profitable than the large packages you sell of many channels. I will discuss this more below.

There are a number of ways to get OTT programming onto your cable system. You can gather the OTT program sources yourself and put them onto open channels on your system. There are devices available that will let you create a channel out of web content. For instance, you can create a channel that would have buttons for the most popular web content.

But an easier way is to use somebody who has already done that aggregation. There are several vendors who have packaged OTT channels together to make a ‘channel line-up’. Probably the best of these right now is a company called AIOTV (All-in-One TV). This is available on the web to anybody, but they also have a version of their programming that is designed to be used as a web channel.

AIOTV will supply the feed to you for free to get onto your cable system. They sell nationwide advertising and they insert ads at the beginning of each show that a customer watches. If you put them onto your cable system they will send you a small revenue sharing check each month for carrying their ads. It’s not a lot, and the revenue is not the primary reason to do this, but it’s still nice to get a check.

The other nice feature of AIOTV is that their platform gives you an easy way to create additional web channels of your own. There innumerable ways for you to use this capability and you could add additional web content to your line-up that is not already on AIOTV. However, the best use of this capability is to use it to create local programming. You can use AIOTV or other platforms to create a channel for every school, church, non-profit or other entity in your area. The programming would be up to the entities who have channels and they can use it to put items of interest to your community onto your cable system. For example, this is the easiest and lowest cost way to get things like little league games and high-school sports onto your network.

With AIOTV or some similar provider you can create some sense out of local programming. The platform gives you a way to create a traditional looking channel line-up so that people can find the local channels they want. Each local channel supplier also has the ability to operate their channel so that it is continuous feed or on-demand.

Local programming is a way to get and keep customers on your cable network. Other communities that broadcast a lot of local content say that this becomes one of the more popular things on their network. People want to watch local sports and graduation ceremonies and other local events. Most cable systems today carry local city-council meetings, but there is a lot more events of local interest in every community.

Finally, you can use OTT and local programming to create a new product. For example, every cable provider has a basic product that consists of the broadcast networks such as ABC and NBC along with a few other channels. You can create a pretty robust package that includes your basic line-up, OTT programming and local programming. Priced at something like $20 per month this would be the most profitable product on your cable system. Today most companies are lucky if they break even with the larger cable packages after paying for all of the programming.

This kind of line-up offers customers a ton of programming including web access to many of the most popular shows they watched on traditional cable. I have anecdotally spoken to several people who have dropped traditional cable for a Roku or Apple TV box and they say that they don’t feel like they have suffered any big drop-off in options. If you can add live network TV and local programming to this mix you have a robust line-up that many of your customers are going to see as an attractive alternative.

I think that cable systems are on the verge of pricing a lot of customers out of being able to afford their services. Expanded basic packages are now $60 to $70 per month in most markets and continue to increase in price every year. So consider a preemptive strike and give your customers a pre-packaged lower cost alternative rather than waiting on them to go find this on their own.

A la Carte Programming and Sports

ESPN, Fox Sports, Comcast SportsNet, and regional sports networks like the Big Ten Network must all be lobbying hard against a la carte cable programming ever becoming a reality. Their business model relies on the practice where all cable subscribers must pay for sports even if they never watch it. Sports programming has become a significant chunk of what customers pay each month for cable TV and the rates charged for sports networks are growing at the fastest pace.

It’s not hard to see why sports programming is so expensive because the sports networks pay a lot of money to obtain exclusive sports content. Let’s look at ESPN as an example. It was reported in financial news that ESPN will pay over $3.5 billion in 2013 for sports programming.  That includes $1.1 billion to the NFL, $600 million to the NBA, $610 million for football bowl games, $360 million to major league baseball, $240 million for ACC sports, and many other smaller deals.

And the amounts that are being paid keep rising. It’s been reported that in 2014 the fee for the NFL will jump to $1.9 billion and for baseball to $700 million. The network just announced an eleven year deal for $770 million to broadcast the U.S. Open Tennis Tournament. And ESPN will be launching a new network for Southwest Conference Football in 2014 and the details of the amounts to be paid have not been announced, but one has to imagine they are huge.

How much does this all cost consumers? Not all cable companies pay the same amounts for ESPN since there are individual contracts with each cable company that span different periods of times. I’ve seen recent articles that say that the average monthly cost charged today for cable companies for ESPN is $5.13 per household, with additional monthly fees of $0.68 for ESPN2, $0.18 for ESPNNEWS and $0.18 for ESPNU. For 2013 those fees total to over $7.3 billion. A household getting all four of these channels would be paying $74 per year just to ESPN. And if they have a cable provider that carries all four of those channels there is a good chance they are also paying for other sports networks like FoxSports, Comcast SportsNet, the NFL channel, the golf channel, the Tennis channel and a bunch of others. And the fees paid for sports aren’t even always obvious since there is a substantial fee for the Olympics buried in the fees for carrying the NBC channels. It’s probably not a bad guess to think that the average cable household is already paying over $100 per year today for sports coverage.

And the fees are continuing to climb at a rate far faster than inflation. It’s been reported that a recent deal signed by Time Warner Cable has them paying almost $7.50 for ESPN by 2018 with a built-in annual 6.5% rate increase after that. This would put the cost of ESPN over $8 per household per month by the end of the decade, or almost $100 per year.

As I have written in the past, the whole cable industry is starting to see subscribership fray around the edges. It was just reported by Variety last week that all cable companies combined lost about 80,000 customers for the 12 months ending March 31, 2013. That doesn’t sound like a lot, but just a few years ago cable subscribers were growing by several million per year. Industry experts predict the number of cable subscribers will begin dropping more each year, much like what happened with landline telephones over the last decade. There are a lot of reasons for this including cord cutters who are dropping cable for programming on the web, and young households who just aren’t signing up for cable. But one contributing reason is rate fatigue, meaning that households are finding the rates for cable to be more than they are willing to pay.

So why would the sports programmers be sweating a change to a la carte programming? It sounds like a really good idea for customers to be able to buy just the programming they want. What sports lover would not love to ditch Lifetime Movies, and what sports hating household would not want to stop paying for ESPN?

The answer is simple math. If a la carte programming is introduced then buying what you want will be too expensive. Let’s just look at ESPN as an example. Let’s say ESPN went to a la carte programming so that only households who wanted it would buy it. The amount that ESPN would charge on a standalone basis would depend upon how many households they think would be willing to write a check for ESPN. Let’s look at the math. This assumes that the cable company would mark-up the channel by 30%. These are the resulting monthly subscription rates:

Willing To Buy              Rate Today            Rate in 2020

50%                                    $15                           $20

30%                                    $26                           $33

15%                                    $51                           $67

This table must scare the hell out of ESPN. We already know what a la carte looks like. HBO is sold a la carte and is in 30 million homes, or 30% of the US market for around $15. I look at this table and find it hard to think that 30% of homes would pay $26 monthly for just the four ESPN channels. There is probably no price point on this table that looks realistic in the market, and so the reality is that if ESPN was to be sold on an a la carte basis that they would have to cut their rates, meaning that they would have to cut the payments they are making to the various sports. And that would have a profound impact on the sports industry. For example, universities in the major conferences now rely on cable revenues to support their teams and one can imagine massive cutbacks in college sports if the TV revenues decline. Television fees are the main factor behind the huge salaries paid by professional sports.

And this same math is going to be the same for every other sports network – and as far as that goes, for every cable network. If a la carte programming comes to pass and people buy only what they want, they are going to end up paying as much as they do today for a smaller number of channels. Today’s regime of averaging the cost of hundreds of networks across 100 million cable subscribers has resulted in the wide variety of programming available to a cable household. It is my prediction that under a la carte programming that many of the networks we watch today would fold because they could not find enough buyers individually to support them. And maybe that is what should happen. Certainly, if the cable industry starts seeing total subscribers dropping by millions per year this will happen eventually anyway. There just won’t be enough money to support all of the networks. I can’t see any future where the amount of monies paid by ESPN and other sports networks to obtain programming rights doesn’t go down. It’s just a matter of math and time.

Will There Be a Tipping Point in the Cable Industry?

The Tipping Point: How Little Things Can Make ...

The Tipping Point: How Little Things Can Make a Big Difference (Photo credit: Wikipedia)

This is not a book review, but a few years ago I read a book called The Tipping Point: How Little Things Can Make a Big Difference by Malcom Gladwell. This booked looked at examples of tipping points – when minor events reach a level which triggers a more significant change. In the book he looked at a number of popular culture events such as how Hush Puppy shoes went from being something worn by New York hipsters to being in every mall in America in a short period of time. It was a thought-provoking book that looked in particular at how certain types of people are able to effect much bigger changes in the world than ought to be expected.

What made me think back on this book is that I have been thinking a lot lately about the cable TV industry. There are a ton of those ‘minor’ events happening in the industry and I have talked about some of them in my blog before. And I have been thinking about whether these small trends can accumulate together to fundamentally change the industry or if it will just change more slowly over time. I’ve been trying to think about what it might take for the whole industry to reach a tipping point.

We have a parallel to what might happen with cable TV service by looking back at what happened to home telephone service. Fifteen years ago about 98% of households had a traditional home telephone. But then Vonage and other VoIP carriers came along a little over a decade ago and whittled into the home phone market. But the VoIP carriers collectively did not do that great and after a couple of years in the business had captured only about 3% of the total market. But then other factors began hitting the industry. For instance, companies like Skype arose allowing people to make calls over the Internet without even using a phone. But the number one factor that has killed many home telephones has been the meteoric rise of cell phones. In looking back I think the landline phone industry really started losing lines when the cellular industry introduced family plans and all of the members of a family could have a cell phone.

In a study done in the first half of 2012, the Center for Disease Control asked many questions including ones about telephone usage. They found that the number of households with landline phones has dropped below 65%. In looking at the statistics in that study I conclude that the landline telephone industry never reached a tipping point. The industry certainly declined over a fairly long period of time and will almost certainly continue to do so. But there has been no tipping point such as was seen in the music store business which went mostly bust within just a few years after iTunes got popular. And so I ask myself if there will be a tipping point with the cable TV industry or if it will instead go into a long steady decline like the landline telephone business?

There are a number of factors that are affecting the cable TV industry, and most of them are relatively new. Some of these include:

  • Over-the-top video where programming is available on the web instead of by a traditional cable TV subscription.
  • Cord-cutting. Neilson has estimated that there are now 5 million homes in the US that don’t watch any form of TV and that this number grew by 1 million last year.
  • Cord-nevers. These are young households who get their entertainment from cell phones, pads and other methods and who do not sign-up for traditional cable TV packages when they start a new household.
  • Rate fatigue. The ever climbing cable bills that are pricing cable service out of the range of many households. This leads some customers to leave cable but others to downgrade to smaller packages.
  • Ever increasing programming costs. To a significant degree the cable TV rate increases are being driving by the programmers who charge more each year to cable operators for carrying their content.
  • Tons of companies competing for cable’s customers like NetFlix, Hulu, Amazon Prime and many others. And to some degrees the broadcast networks are helping them by making programming available on the web soon after it is aired live.
  • Companies like Aereo making it easier for customers to watch TV on any device.
  • Really simple devices like Roku, Apple TV, Playstation and many others making it easier for the non-technical household to get alternate programming onto the TV.
  • Unique programming being created just for the web. NetFlix and others are now developing programming directly for the web. There is also a movement to pick up popular shows that get cancelled and to continue them on the web.

There are a few experts that believe that the cable industry will be able to hold its own, even with all of these trends going on. But there are a lot more experts who are positive that the industry will decline, but the predictions of how fast vary from a slow decline like telephone service up to predictions of a fiery crash like what happened to CD stores due to iTunes. And there is ample evidence that the decline has begun. I saw a statistic that said that in 2012 the cable industry as a whole added a net of 50,000 new customers, wherein past years that would have been millions. And there is evidence that every one of the above trends is hurting the industry.

And there is more disruption to come. Wireless connections have gotten faster making it easier to watch TV while on the go. John McCain just introduced a bill that would promote (but not guarantee) a la carte programming. Comcast just increased their cable modem speeds nationwide. It just becomes easier and easier for a household to elect something other than the traditional cable TV packages.

Like many I certainly foresee an industry that is going to lose customers at a faster and faster pace over time. But I just don’t know if all of these little factors can somehow produce a tipping point for the whole industry. With that said, I believe that the effect of these changes will differ by market and I expect that there will be companies and markets that reach a tipping point long before the whole industry does.

Cable TV Trends

There are a number of trends affecting the cable TV industry that all add up to an industry that is going to be seeing big changes over the next decade. These are what I see as the biggest trends affecting the industry:

  • Cord Cutters. The number of people who are completely dropping cable is growing and the speed of that drop is accelerating. I have seen several different recent estimate that 5 million households will have completely dropped all cable service by the end of 2013. And only the cable providers know how many other million households that have cut back on the size of the package they buy rather than drop service totally. I anecdotally know many people, myself included, who have gone from the big cable packages to something less – in my case I now have only the basic package of about 20 channels.
  • Higher Programming Costs. Programming costs have been rising steadily for the last decade and until the last few years were climbing between 6% and 7% per year. Costs have climbed even faster in recent years due to the high fees being demanded by local network channels in each market (ABC, NBC, CBS and Fox). Local network programming was free for cable companies until a few years ago, but now they paying as much as $1 per month per customer for each major network channel. Many contracts between cable providers and programmers are for multiple years and those contracts show the price increases are going to continue to come.
  • Even Higher Rate Increases. The large cable companies have increased rates around 7% per year for many years. The programmers have usually blamed the size of the increases on increased programming costs, but until the recent increases in local network programming the increases were generally about twice what was needed to cover programming cost increases. If the rate increases continue at that level, then a $70 package today will cost $129 in ten years. Prices are already at a point that are forcing households off the network.
  • Very Solid Cable Modem Business. To a large degree the cable companies have won the war with DSL. However, they have stiff competition from Verizon and FiOS on fiber. There is limited competition outside the Verizon footprint, but with Google building fiber in Kansas City and having announced Austin and Provo there is going to be more competition for the residential business.

What do these trends add up to? I see them resulting in the following:

  • Ever decreasing cable customer base. The most dire trend for the industry is that young people are not interested in traditional cable, and as that demographic ages the percentage of households wanting cable is going to drop faster and faster. Add to this the households dropping due to never-ending price increases and most experts see cable subscribership going down the same path as landline telephones. Subscribers are dropping somewhat slowly now, but every prediction I have seen believes the rate of disconnects will accelerate over time.
  • Cable Providers Become Data Companies. As cable penetration decreases the cable companies will become more and more reliant on selling data. This is going to lead them over time to maximize their networks for providing bandwidth for data rather than cable TV. And I predict it also means that they will start raising data prices over time, something that we just started seeing in the last year. There is not much profit in selling cable packages and the cable companies could be more profitable selling data eventually (assuming they are in markets where they don’t have stiff competition).
  • Winnowing of Cable Networks. As the industry loses subscribers and as people downgrade from larger packages to smaller ones, the demand for some of the networks is going to diminish. One way for cable companies to control costs is going to be to whittle away at their line-up, and that is not that hard to do with 300+ channels on many cable systems. So some of the marginal networks are going to either die or greatly reduce the fees they charge if they want to stay in business.

There is one change that might affect the industry that could upset these trends, and that is a la carte programming.  There are a lot of barriers to make that happen, but cable companies might get new life if they are able to sell only those channels that people want to watch. It’s certainly possible that they could sell a package of 20 channels to a family at an affordable price and make more profit than they do today with the large expensive packages. But this is going to require a major change in an industry that is currently controlled by the programmers and not by the cable companies.