The Industry

Programmers Have the Power

huluIt was announced late last month that Time Warner is negotiating to buy a 25% share in Hulu. This would make them equal partners with Comcast, Disney, and Fox in ownership of the OTT service. I think this potential transaction highlights the very complicated dynamics in the industry between programmers and OTT companies.

It’s obvious that the programmers love Netflix, the largest OTT provider, but they also fear them to some extent. On the plus side, from the programmers’ perspective, the four companies (include Time Warner) currently get about $650 million per year just from Netflix to pay for selling rights to various programming, mostly older TV series, to Netflix. This is obviously a significant source of revenue.

But there is also a lot of unease in the industry since OTT providers, and Netflix in particular, are influencing people to demand alternate programming. And while the programmers have lost some money from cord cutters, the real threat to them is skinny bundles. While the revenue the programmers get from Netflix is good money, it is dwarfed by the revenues that come from traditional cable packages. I have never seen that exact number, but by looking at my clients I am going to guess that the average paid by cable companies per customer for programming is probably around $45 per month, not including premium movie channels. That would equate to more than $50 billion per year paid for programming.

The big threat from skinny bundles is that the cable companies will sell small packages of only the most popular programming. The owners of the most popular channels will do okay, but today the real money for a programmer comes from forcing cable companies to carry their entire large suite of channels. If skinny bundles get popular enough they are going to whack the revenue streams from the less popular channels in each programmer’s portfolio. And that means huge potential losses in revenue, far greater than what they will collect from OTT and skinny bundle providers.

There is talk in the industry that the major programmers might start withholding their best content from Netflix. Reed Hamilton from Netflix has voiced this concern many times and this is probably the reason that Netflix is spending so much money to create its own content.

The four programmers could instead funnel all of their own content to Hulu, and in effect pay themselves by hopefully drawing more paying customers to Hulu. The surveys I have seen have shown that a large percentage of viewers are becoming loyal to shows and not to networks, and so giving Hulu exclusive rights to content certainly sounds like a plausible strategy.

The above discussion makes me realize how much power the programmers still have in the industry. While these four programmers couldn’t destroy Netflix, they could probably hobble them. As Bill Gates said, content is king, and that certainly applies in this arm-wrestling match between programmers and service providers. Since there are only a handful of programmers, they collectively have the ability to pick winners and losers in the industry.

Since content is king one has to wonder how long a small group of programmers can keep their current power? Not only is Netflix creating popular content, but there other new content creators like YouTube and Amazon entering the fray and joining companies like HBO and AMC that are becoming mini-powerhouses on their own.

I find it unlikely that the programmers would just cut Netflix or anybody else dead from all of the content, which would seem to be an open invitation to an antitrust investigation. But they can withhold some content, raise the rates on other content and make it harder for companies like Netflix to continue to eat away at their revenue streams.

I have no idea where any of this is going to go. But my guess is that if we could look forward a decade from now that there will be major shifts in the industry. There are going to be some current programmers that wane and other new ones who will enter the market. But as a whole, no matter who the programmers are, they are still going to be in the driver’s seat.

The Industry

Small Cable Systems Failing

The American Cable Association (ACA) recently asked the FCC to look at the issue of why small cable systems are shutting down. The ACA represents small cable systems nationwide. Using data from the National Cable Television Cooperative (NCTC), the ACA says that 1,169 cable systems have shut their doors since 2008. In 2014 there were 91 cable systems that closed and in 2013 there were 133 systems.

The ACA says that the primary reason that these small cable systems have closed is programming costs, and I’m sure that has to be a major reason. The other reason is probably due to competition from satellite providers, which is also tangentially related to programming costs.

I am guessing that many of the systems that are closing are small bandwidth systems that don’t carry the 200 – 300 channels that people associate with urban cable systems. There are numerous rural systems that carry smaller channel line-ups from 30 to 100 channels. They tend to carry the most popular stations and so their customers are generally happy with them.

There is one programming issue that I think particularly discriminates against smaller systems. While I can’t cite specific numbers due to various NDAs, there are programmers that price programming in a way that kills the small operators. For instance, the programmers often make the large systems take all of the channels they offer in an all-or-nothing deal. But they price this in such a way that all of the ‘cost’ to the cable system is allocated to one or two primary channels in the suite with the rest being added for free or for a very low cost. This means that a small system that takes only a few channels from a programmer might pay as much for the programming as a large cable operator that carries everything from that same programmer.

While it is probably impossible for the FCC to regulate the programmers, I think it is probably within their purview to say that the practice of forcing systems to take every channel is discriminatory. If they could do that they could probably also insist that the programmers fairly allocate the fees among the many channels in their package. That would allow the small systems to save a lot of money on programming and to stay competitive against satellite providers.

The satellite providers are definitely hurting the small systems. The satellite companies are large enough that they can buy programming for a little cheaper than a small system. But this is only a minor edge because even the big companies don’t get much of a discount on programming. The real advantage the satellite companies have is that they don’t have to maintain a fleet of technicians in trucks. That is a true competitive advantage and the small systems can’t compete with that while paying more for programming than they ought to.

The other issue that small cable systems face is not related to programming. A lot of these smaller systems are low bandwidth, meaning that they have only enough bandwidth to carry the smaller cable lineup they offer. This means they cannot offer cable modem service, which is the one huge advantages that larger cable companies have. Even if the small systems were able to increase their bandwidth somehow, these older systems often would require a major rebuild of the coaxial plant in order to handle larger bandwidth. It would mean replacing and moving power taps and amplifiers, and in some cases even replacing the coaxial cable.

To some extent a number of these systems were doomed to fail when the rest of the industry shifted to make all of their profits from cable modems and voice. Without that extra margin these small companies are competing with only a cable product against satellite providers who can offer more channels for a lower price. And these small systems have the same issues with cord cutting and a general loss of cable customers that everybody is seeing. That is a recipe for failure and I’m not sure that the FCC ought to prop up systems that are doomed to fail almost by definition.

But there are many other cable providers that would benefit and thrive if the programming issues can be made fairer. If the FCC really wants to help out cable providers of all sizes and of all technologies they will give cable providers the chance to offer smaller packages of programming to match what the OTT guys are doing. This will benefit fiber systems as much as coaxial systems and can put some balance back into the relationship between programmers and providers.

The Industry

Cord Cutting Might Finally be Here

Recently, Wall Street has been hammering media stocks due to the fact that most of them have reported falling US subscribers. That makes me ask a question I have asked several times before: are we finally seeing the impact of cord cutting? Most cable companies just released 2nd quarter 2015 cable subscriber numbers and except for Verizon FiOS, all of the other large cable providers lost cable customers for the quarter, as follows:

  • DirectTV               -133,000
  • Dish                        -81,000
  • Comcast                 -69,000
  • Time Warner         -45,000
  • Suddenlink            -44,000
  • Charter                  -33,000
  • AT&T                      -22,000
  • CableOne              -21,000
  • Cablevision           -16,000
  • MediaCom            – 3,000

Just for this group of companies that’s a loss of 423,000 cable customers. And the numbers are actually worse. For instance, the Dish numbers might be as high as a loss of 187,000 because they are now netting the gains from Sling TV into the reported today. And Cox is not in these numbers since it’s privately held. The total losses above are something greater than 530,000 for the quarter.

Then you have to consider the fact that historically cable companies would have captured a significant share of new households. With the improved economy there will probably be at least 1 million new households added to US housing this year, and cable would normally have added about 200,000 customers each quarter from these new potential customers. That brings total net losses compared to historic trends to over 700,000 in a quarter.

The large cable companies have been losing customers for several years now. For a while these losses were offset by increases in satellite customers. More recently there was nearly a one-for-one between the losses experienced by the cable companies and the gains of the telcos, mainly AT&T and Verizon. But in this latest quarter Verizon gained only 26,000 and AT&T lost nearly that many, so that sector is no longer growing.

The second quarter is traditionally one of the poorest performing quarters of the year. For example, the cable industry as a whole suffers when campuses shut down for the summer, although those losses generally net out to gains again in the fall. And so it’s unlikely that these losses are going to annualize to the 2 million customers you might expect from these figures. But for the first time there is going to be a significant loss of cable customers for the year.

The cable companies almost all reported improved revenues. Even though they lost a lot of cable customers, the group as a whole gained 377,000 new data customers. Further, the cable companies had significant cable rate increases (although they also had significant increases in programming costs).

But it’s not hard to see how these kinds of losses affect the programmers. Take ESPN – it’s been reported that they charge cable companies more than $5.50 per customer per month. At that rate the loss of 530,000 paying customers annualizes to almost $35 million per year in lost revenues. And if you look at the historic trend including new housing units their loss is even greater than what they traditionally could have expected.

Not reported in the above numbers is the impact of cord shaving. It’s been anecdotally reported that there are a lot of customers cutting back to smaller TV packages, meaning that they are paying for fewer channels. The channels in the premium tiers have to be losing revenue at a significantly higher rate than the basic channels that everybody gets. But the cord shaver numbers are hard to come by and are not reported in cable company press releases.

ESPN is part of Disney which is a very large corporation with diversified revenues, and $35 million lower revenues gets lost in the rounding on their corporate books. But Wall Street is looking at the long term trend and is worried about programmers in general.

Finally, there is another industry measure that may have also spooked Wall Street. Nielsen recently released trends in TV viewing time. Since 2010 viewing hours per week have dropped for all age groups, but particularly for younger viewers. Viewing by 50-64 year old was down 1%, 35-49 year olds down 10%, 25-34 year olds down 23% and 18-24 year olds down a whopping 32%. That speaks tons about the dropping trend for future advertising revenues, which are aimed more heavily at young viewers.

It’s no wonder that Wall Street is punishing the media companies when they are losing revenues from both subscribers and advertising. Many of the programmers are selling enough new content overseas to make up for the US losses, but analysts are obviously worried that this trend is going to quicken in the same manner it did for landline telephones. This could get ugly fairly quickly.

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