Why the Big Programming Cost Increases?

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I recently talked to several clients who are expecting an increase in cable TV programming costs of between 8.5% and 9% for next year. They are able to forecast this because most of the contracts for programming cover at least three years of baked-in rate increases.

Every one of these clients is bleeding cable customers. We hear about how the big cable companies are experiencing impact from cord cutting. Last year the big companies altogether lost about 1.7 million customers, which is a little less than 2% of their customer base. But my small clients seem to be losing cable customers at a much faster pace. Cord cutting is obviously a real phenomenon and I’ve seen recent estimates that the big companies are expected to lose around 1.9 million customers this year. But while the big companies are losing customers at a steady pace, smaller cable operators are seeing a much bigger impact.

I think there are a number of reasons that small cable providers are suffering more.

  • Most of my small clients don’t pay the same billing games as the big cable companies. The big companies have created a number of ‘fees’ such as a local programming fee or a sports fee to disguise the real cost of cable. Many customers think these fees are taxes of some sort and they believe that the base price of cable shown on their bill is the actual price they are paying. That lower number is the one that they use when comparing to other alternatives.
  • The big companies are also far more aggressive with their bundling. They work hard to force customers into bundles and they penalize customers for leaving a bundle. Customers often don’t know what they pay for any specific product in a bundle and when they try to drop one product the full bundle savings are applied to that product. Even when small companies have bundles they don’t create a huge financial disincentive to leave the bundle.
  • Big companies are willing to give ‘special’ pricing to keep customers. They tend to give special pricing discounts aimed at new customers to anybody else who is willing to wade through the customer service minefield to ask for it. I think since smaller companies often don’t advertise ‘special’ prices they are far less likely to even be asked to reduce rates.
  • My smaller clients are generally more rural than the big companies, and as such they face far stiffer competition from the satellite companies. Both of the satellite providers now have a ‘skinny’ bundle that a lot of customers are finding attractive.

Why are the programmers raising rates so aggressively when it’s clear that the price of cable service is the number one driver of cord cutting? I have several ideas why they might be doing this:

  • These are all publicly traded companies and to some degree they don’t have a choice. Over 90% of cable channels are bleeding customers much faster than the rate of cord cutting. This shows that many customers are cord shaving and downgrading to smaller, less expensive packages. The programmers are compelled to increase profits, and with declining sales they can only compensate by raising programming rates. That sounds insane because it sounds like the beginning of a classic death spiral. But you must remember that any large publicly traded company that performs poorly is subject to being purchased by somebody else who will then force profits back up again. Our dreadful quarterly profit driven economy is forcing the programmers into a path that is not in anybody’s best interest.
  • They are all chasing hit shows. There are now a lot more companies like Netflix and Amazon creating unique programming, which adds to the pressure on the programmers. The financial rewards from producing even one hit show is gigantic, so they all keep spending money trying to find that next big hit, and raising rates to cover the cost of producing content.
  • Another theory is that the current rate increases are their last hurrah. They can see where the industry is headed. I saw an interview with the head of programming for FOX and he said that he expects that the company is going to have to ultimately collapse most of its many channels as they keep losing customers. And so perhaps these rate increases are the chance for making big profits for a few more years before the wheels come off. It seems that end is coming anyway, so maybe raising rates now is a way to milk every last penny out of a fading industry.

Programming content is certainly never going to go away. But companies like Netflix and Amazon are showing that there are reasonable alternatives to the huge TV bundles. I just wish I knew what to tell my clients. The most common question I seem to be getting these days is, “Should I even be in the cable business any longer?” I’m starting to think that the answer for many of these businesses is no – or it will be no within a few short years.

Keeping Up with Programming Costs

I saw a presentation recently that compared skinny bundles with traditional cable TV. One of the things mentioned in the presentation was how much the the cost of programming and the average cable rates have increased over time. I was asked recently if a cable provider should always pass on the increases in programming costs into rate increases. I know my clients have different views on the issue.

First a few numbers. The presenter said that programming costs have grown on average from $26.65 per customer per month in 2010 to $43.20 in 2016. That’s around a $16 increase and a growth rate of more than 9% per year, and that comports with what I’ve seen at my clients. But the overall numbers seem low and I’m guessing these numbers represent just the typical expanded basic package. Cable companies in general have three tiers – basic, expanded basic and premium. A lot of my clients today have programming costs that are well over $50 rather than $42.

This same presentation also showed that the average cable revenue per customer climbed from $65.90 in 2009 to $83.60 in 2016. That’s an annual 3.5% increase in rates, but it also generates a $16 increase in revenues from 2010 to 2016. I know most of my clients have had larger rate increases than this. I’m guessing the cited figures don’t reflect that the larger cable companies have significantly increased other rates such as settop box fees during this same time period. But generally the numbers cited show an industry that on average has raised rates to match the increases in programming costs. But if rates are only increased to match programming then they don’t cover any increases in the other costs of operating a cable business, such as keeping a headend up to date as well as the general inflation from operating a company.

This is an issue that my smaller clients wrestle with every year. Just two years ago I had a number of clients that saw an overall programming cost increase of more than 15% in a single year. A lot of them have seen costs go up even more than the 9% shown in the above numbers. Programming costs are driving cable rate increases that are far in excess of inflation over while average household wages over this same time frame have stagnated and grown only a tiny amount.

Small cable operators now face the dilemma that if they pass on a large programming cost they know they will lose customers. A lot of my clients operate robust broadband networks, making it a lot easier for households to elect to cut the cord. If they raise rates they are guaranteed to lose customers, and if they don’t raise rates then they directly eat into operating margins.

A company can get into real trouble by not raising rates. I had one client that had only small rate increases over a number of years and even skipped a few years without a rate increase. They compared their rates to surrounding communities and were surprised to find that their rates were nearly 40% lower than in nearby towns. I’ve seen a lot of similar situations and there are a number of small cable providers with rates that are 20% and 30% lower than surrounding communities.

Municipal operators and cooperatives have a particularly hard time with this issue because decisions are not made strictly based on the numbers. Many municipal cable companies require City Council approval of rate increases – and it’s not hard to picture politicians that want to vote against rate increases. But cooperative boards can act similarly if they think there are enough profits from other parts of the company to cover the cable rate increases. This is never an easy decision and I know a number of commercial cable providers that sometimes decide to eat some of the programming cost increases.

There is no easy answer to this question these days because nobody knows the elasticity of cable demand – meaning the degree to which customers will react negatively to a rate increase. For many years demand elasticity was low and a company could raise rates with a pretty good assurance that they would lose only a few customers. They’d suffer a spate of complaint calls when they raised rates, but almost everybody paid the increases.

But that’s no longer true. I think most small cable companies are afraid of that day when a rate increase drives a lot of their customers to find alternatives. There is a general wisdom in the industry that nobody makes money at cable, and on a fully-allocated cost basis that is almost always the case. But almost every small cable operator still has a positive margin on cable. And that means that a company suffers a real loss every time they lose a customer. The bottom line is that it’s a crap shoot these days. We all know that the day is going to come when most customers will refuse to pay the higher cable rates. But it’s anybody’s guess when that day will come.

Fighting Against the Cost of Programming

Numismatics_and_Notaphily_iconToday I want to talk about the cost of programming from the perspective of a small cable provider. In the cable world, any company without many millions of cable customers is considered small because they have no effective negotiating power against the programmers.

For decades most small cable systems have purchased a lot of their programming with rates negotiated by the National Cable Television Cooperative (NCTC). There are currently 850 member of this cooperative. Altogether the NCTC group represents the second biggest pile of cable customers after Comcast. It’s hard to know the exact number of customers they represent because a few of the larger cable companies like Cox and MediaCom have joined and then left the cooperative over the last few years. At one point I heard the number 20 million subscribers bandied around the industry but it’s probably smaller now.

Not all programmers will work with NCTC and some require cable providers of any size to sign a contract directly with them. But NCTC represents a significant portion of the channels used by cable systems. Within that negotiated pile of content members must still sign a contract with each programmer and are free to sign the NCTC contract, negotiate directly with the programmer, or else sign no contract if they don’t want to carry a given programmer.

Back in 2014 there was a big furor among small cable companies when the Viacom group asked for a huge rate increase, reported to be over 60%. Viacom includes channels like MTV, VH1, Nickelodeon, Comedy Central, Spike, BET, and other music channels. At the time about 60 NCTC members, representing about 900,000 subscribers, decided that they could not afford to pay the higher rates and so dropped the Viacom channels from their cable systems.

We are seeing a similar battle brewing today as AMC is asking for a huge increase in rates with NCTC. I’ve not seen the new proposed rates, but have seen news articles describing this as a 379% rate increase over the term of the new contract, which is probably for five years. AMC includes the channels AMC, We tv, IFC, and Sundance TV. Additionally the new contract also covers BBC America and BBC World News, which are 50% owned by AMC.

How can a programmer ask for such a big increase? Programmers are very attuned to the Nielsen ratings which constantly track the number of people that watch each network. The general concept used by programmers is that their network is worth at least as much as other networks that get the same number of eyeballs, very similar to the way that a professional baseball player sets his worth by comparing his statistics to his peers.

AMC’s popularity has exploded in the last few years as it changed from a channel showing old movies to one which now carries very popular original programming like Mad Men, Breaking Bad, and The Walking Dead. This has raised their Nielsen rating and the network wants to charge more due to being a lot more popular.

The whole programmer industry owes a debt of gratitude to ESPN which was the first network to constantly and significantly increase their fees over the years. Every time that ESPN signed a new deal to carry programming for a sports league they then raised their prices to cover the new fees they were paying to those leagues.

But in doing so ESPN was setting an industry pricing standard against which other networks can be measured. We saw this happen with retransmission agreements with the major broadcast networks that have grown from zero to several dollars each per customer per month over the last decade. And we’ve seen popular channels ask for more as they get more viewers. The funny thing is, though, that when a network loses viewers they never seem to drop their rates.

Caught in the middle of all of this are the service providers that offer cable TV. They keep seeing bigger and bigger increases each year in programming costs and some are reporting overall programming costs growing by at least  15% per year. They are left with little choice but to raise rates, which puts many of them into a poor position compared to the satellite providers. And with each rate increase comes more customer impetus to cut the cord or at least cut back on the programming they purchase.

It’s been my experience that few of my small clients that carry cable have been bold enough to pass on all programming cost increases, and so their margins on cable keep shrinking. On a fully allocated cost basis many of them are underwater with the cable product. And sadly, as is shown by the recent AMC rate demands, there is no end in sight for continued huge increases in programing costs. It’s a lousy time to be a small cable provider, that’s for sure.

Why Isn’t There a Cable Headend in the Cloud?

dish-731375I saw an article earlier this year that said that some smaller triple-play providers have decided to get out of the cable business. Specifically the article mentioned Ringgold Telephone Company in Georgia and BTC Broadband in Oklahoma. The article said that small companies have abandoned over 53,000 customers over the last five years, with most of this being recent.

I’m not surprised by this. I have a lot of small clients in the cable business and I don’t think any of them are making money with the cable product. There are a myriad of outlays involved such as programming, capital, technical and customer service staff and software like middleware and encryption  And all of these costs are climbing with programming increasing much faster than inflation. And there is pressure to keep up with the never-ending new features that come along every year like TV everywhere or massive DVR recorders. I have a hard time seeing any cable company that doesn’t have thousands of customers covering these costs.

But small cable providers are often in a bind because they operate in rural areas and compete head-to-head with a larger cable company. They feel that if they don’t offer cable that they might not survive. But it is getting harder and harder for a company who doesn’t have stiff competition to justify carrying a product line that doesn’t support itself.

I’ve written several blogs talking about how software defined networking is going to change the telecom industry. It is now possible to create one cable TV head-end, one cell site headend or one voice switch that can serve millions of customers. This makes me ask the question: why isn’t somebody offering cable TV from the cloud.

There are big companies that already are doing  headend consolidation for their own customers. For instance, it’s reported that AT&T supports all of its cable customers from two headends. A company like AT&T could use those headends to provide wholesale cable connections to any service provider that can find a data pipe to connect to AT&T – be that a rural telephone company, a college campus or the owner of large apartment complexes.

This wholesale business model would swap the cost of owning and operating a headend for transport. A company buying wholesale cable would not need a headend, which can still cost well over a million dollars, nor technical staff to run it. In place of headend investment and expense they would pay for the bandwidth to connect to the wholesale headend.

As the price of transport continues to drop this idea becomes more and more practical. Many of my clients are already buying gigabit data backbones for less than what they paid a few years ago for 100 Mbps connections. The only drawback for some service providers is that they live too far of the primary fiber networks to be able to buy cheap bandwidth, but the wholesale model could work for anybody else with access to reasonably priced bandwidth.

The wholesale concept could be taken even further. One of the more expensive costs of providing cable service these days is settop boxes. A normal settop box costs over $100, one with a big DVR can cost over $300 and the average house needs two or three boxes. The cost of cloud memory storage has gotten so cheap that it’s now time to move the DVR function into the cloud. Rather than put an expensive box into somebody’s house to record TV shows it makes more sense to store video in the cloud where a terabit of storage now costs pennies. Putting cable in the cloud also offers interesting possibilities for customers. I’ve heard that in Europe that some of the cable providers give customers the ability to look backwards a week for all programming and watch anything that has been previously broadcast. This means that they store a rolling week of content in memory and provide DVR service of a sort to all customers.

The ideal cloud-based cable headend would offer line-ups made up of any mix of the channels that it carries. It would offer built in cloud DVR storage and the middleware to use it. I think that within a decade of hitting the market that such a product would eliminate the need for small headends in the country. This would shift video to become a service rather than a facility-based product.

There would still be details to work out, as there is in any wholesale product. Which party would comply with regulations? Who would get the programming contracts? But these are fairly mundane details that can be negotiated or offered in various options.

It is my hope that some company that already owns one of the big headends sees the wisdom in such a business plan. Over a decade, anybody who does this right could probably add millions of cable lines to their headend, improving their own profitability and spreading their costs over more customers. AT&T, are you listening?

 

The Total Sports Programming Bill

footballThe average cable bill in the US is now somewhere between $75 and $80 per month (depends on who measures it). Nobody can say for sure how much of that average cable bill that is needed to pay for sports programming, but we know it’s huge. There are a number of reasons why it’s hard to get at the true cost of sports programming. First the deals with sports teams are often private since the sports teams and the companies buying rights to the content are often closely-help corporations. Further, cable companies sign a mountain of non-disclosure statements that prohibit them from talking about what they pay for a given network.

Anybody who buys a big channel lineup has a tremendous amount of sports programming available today. I currently count 35 national sports networks in the US. This includes the ESPN family of networks as well as the Fox Sports networks. But there are also networks that carry tennis, golf, horse racing, skiing and fishing. There are the national networks that carry college football such as the Big 10 network, the SEC Network and the PAC-12 network. The major professional sports of baseball, basketball and football each have their own channels. In addition to these 35 channels, there are 50 regional sports networks that carry mostly local professional sports and college sports not represented on other networks.

In addition to all of this there are sports costs buried within the cost of many non-sports network. Certainly when you pay for CBS you are paying for some of the deals they have made for the NFL, college football and basketball, tennis, golf and auto racing. With NBC you are also paying for the Olympics, which alone have a monthly cost of over 80 cents per cable customer in the US. When you buy TBS you’re paying for the Atlanta Braves. And local stations everywhere carry local college sports.

There were some hearings earlier this year in Congress that looked at the high cost of cable TV. There were a variety of estimates put forth for the cost of sports programming that ranged from a low of $21 per household per month up to an estimate that sports represents nearly half of programming costs. I think the answer is somewhere in between.

One of the problems with sports programming is not just the proliferation of networks, it’s the fact that sports programming costs are increasing much faster than the cost of other programming. It’s a vicious circle where companies bid for the rights to get sports content with the assumption that they’ll be able to pass it all on to the public. And for the most part they have been able to do this.

But consider the deal made for the Los Angeles Dodgers. The Dodgers were able to negotiate a new 25-year programming deal that increased the team’s TV revenue from $39 million to $335 million per year. That’s an 860% increase. It’s a great deal for the Dodgers certainly. Some of the smaller market baseball clubs don’t have total revenues greater than $300 million per year. But this turns out to have not been a good deal for the newly formed SportsNetLA. This company is owned partially by Time Warner Cable. The network wants cable companies in the area to pay them between $4 and $5 per customer per month to air the Dodgers, and all except Time Warner have declined to do so.

It’s obvious this is driven largely by greed. Every time the existing carriage rights end for a given sport there are generally multiple parties bidding up the price for the new rights to content. There is a lot of incestuous behavior in this part of the industry since cable companies like Time Warner and Comcast own significant rights to sports that they pass on to their own subscribers without negotiations.

It’s been estimated that about 30% of households actively watch sports of some kind. But even that number is aggressively high because the majority of that 30% favor one or two sports and not the wide range of programming we are all paying for. It’s been estimated that maybe 4% to 5% of households are the total sports fanatics who watch it all. Doing a little math shows that if the 30% were asked to pay for all of the sports programming the cost would be $85 per household per month. And if the 5% had to pay for it all the cost would be $500 per sports fanatic household per month. It’s obvious that households who care nothing for sports are subsiding this lucrative industry.

At some point in the near future this model is going to break, because the cost of programming is rising far faster than inflation, driven in large part by sports programming. Nobody knows what the magic number is, but there is going to come a point where the average home is just going to say no to the monthly cable bill. One doesn’t have to look very far in the future and the average cable bill in ten years is going to be $150 and within fifteen years it will be $200. I am guessing that long before those numbers that a whole lot of households are going to opt out of paying for sports and other programming that they don’t even watch.