Can Small Cable Companies Survive?

Today I ask if a small provider can be profitable and succeed with a cable TV product. This was prompted by the news that Cable One, one of the traditional mid-sized cable companies, is bleeding cable customers. For those not familiar with the company they are headquartered in Phoenix, AZ and operate cable systems in 19 states with the biggest pockets of customers in Idaho, Mississippi and Texas.

The company just reported that for the 12 months ending on March 31 that they had lost 12.7% of their cable customers and dropped below 300,000 total cable customers. Just a few years ago the company would not have cracked the top ten cable companies in the country in size, but with all of the consolidation in the industry they are now at the bottom of that list.

While most of my clients would consider anybody on the list of top ten cable companies to be large, I wonder if anybody smaller than the few really giant cable companies can maintain a profitable and viable cable product in today’s environment?

Cable One’s drop in cable customers was precipitated by several factors. One that is very familiar to small cable operators is that Cable One decided in 2015 to drop the Viacom suite of channels from their system. Small cable operators all remember when Viacom announced huge and unprecedented rate increases of over 60% for the suite of channels that include MTV, Comedy Central, BET and a number of other channels. A number of my clients also decided to drop Viacom rather than pay for the huge increases in programming.

Cable One also shares another characteristic with smaller companies in that they are too small to unilaterally negotiate alternate piles of programming to sell as skinny bundles. So they and other small companies are likely to see customers abandoning them for smaller line-ups from Sling TV and other purveyors of smaller on-line line-ups.

Finally, Cable One is seeing the same cord cutting as everybody else. While only a fraction of their customer losses can be blamed on cord cutting, it is now a real phenomenon and all cable companies can expect to routinely lose a larger number of customer every year to Netflix and others.

The giant cable companies are not immune from these same market influences. The giants like Comcast and Charter are also seeing big increases in programming costs. Recent Comcast financials show that the company saw a 13% increase in programming cost over the prior year (although some of that increase was paid to their own programming subsidiaries).

It looks like the giant cable companies will be able to offset losses in cable margins with new sources of revenues. Comcast has launched a cellular product and Charter recently announced becoming a partner in that business. I’ve written several blogs of all of the ways that Comcast is still growing their business – almost all which smaller companies are unable to duplicate.

A big dilemma for small cable companies is that the TV product still drives positive margins. While every small cable provider I know moans that they lose money on the cable product, the revenues generated from cable TV still exceed the cost of programming and almost every company I know would suffer at the bottom line if they killed the TV product line.

It has to be troubling for programmers to see cable companies struggling this hard. If somebody the size of Cable One is in crisis then the market for the programmers is quickly shrinking to only serving the handful of giant cable companies. The consolidation of cable providers might give enough market power to the huge cable companies to fight back against big rate increases. For instance, Charter recently announced that they were demoting a number of Viacom channels to higher tiers, meaning that the channels would not automatically be included in the packages that all customers get and that payments to Viacom will decrease.

It’s hard to think of another industry that is trying so hard collectively to drive away their customer base. But all of the big companies in the sector – the cable providers and programmers – are publicly traded companies that face huge pressure to keep increasing earnings. As customers disappear the programmers raise rates higher to make up for the losses, which then drives more customers out of the cable market. It doesn’t take sophisticated trending to foresee a day coming in the next decade where cable products will become too expensive for most homes. We are watching a slow train wreck which the industry seems to have no will or ability to stop.

It also doesn’t take a crystal ball to foresee when cable will turn into a true loser for small cable operators. I already know of a dozen telcos that have backed out of the cable business and over the next decade this is likely to turn into a flood as companies back away from a dying product line.

The Changing Face of Advertising

advertiseherebillboardmedThere has been talk for a number of years of advertising dollars shifting from television to the Internet, and it looks like maybe this is finally starting to happen. Consider the recent advertising revenues from Viacom and Facebook.

Viacom is one of a handful of the big programmers and owns such channels as Comedy Central, MTV, and Nickelodeon (along with Paramount Pictures). This has always made Viacom one of the powerhouses in attracting advertisers along with other large programmers like Disney, Fox, Comcast, Warner Brothers, and a few others. Viacom’s ad revenues in the first quarter of this year were $1.123 B, down slightly from $1.172 B a year ago.

But Facebook’s ad revenues were $5.201 B for the first quarter of this year, up from $3.317 B a year ago. It’s pretty obvious that the big web companies are starting to win the advertising battle. For all of 2015 the total advertising for television was $80.4 B, down slightly from $82.0 B in 2014. But in 2015 the advertising revenues for just Facebook and Google had grown to $84.5 B and is still growing rapidly.

This is not particularly surprising since ratings for television as a whole are plummeting. People are watching traditional television less and are watching more and more video on the web. It seems like the battle between television advertising and web advertising has passed a milestone and that web advertising is now dominant for the first time. I have no idea how fast (or by how much) television advertising will fall, but it looks inevitable that it will.

What does this trend mean to small cable providers? I think it matters a lot because advertising revenue is a major source of revenue for programmers. To the extent that advertising revenues drop for them there is going to be more pressure for them to raise programming rates to cable companies even faster to make up for the revenue difference.

But that could lead into a classic death spiral. Rapidly rising cable TV rates is one of the major factors in driving people towards alternate programming. Many cord cutters and cord shavers cite the cost of traditional cable as a big reason they are looking for alternatives. The more that programmers raise rates, the more eyeballs they are going to lose, and one assumes the more revenue they will lose.

Programmers are also starting to get some pushback from small cable operators. There are a handful of smaller cable systems with less than a million customers in total that have dropped Viacom completely in the last year due to the unreasonable rate increases the company is demanding. I have a number of small cable clients who – when they do the math – realize that they are either losing money on cable or are getting close to the time when they will lose money. Once a company gets to that point then dropping programming is a natural response. It’s better to cut costs and lose customers when you are losing money rather than to keep shoveling money out the door to the programmers.

The programmers are also facing an FCC that is leaning more and more towards giving customers more choices in programming. You can see this in the recent NPRM for settop box reform where they want the cable companies to include ‘channel slots’ for alternate programming like Netflix. The FCC has yet to act on the open docket that is looking at the rights of companies to put content onto the Internet – but it’s clear that the FCC favors consumer choice.

And all of the big cable companies are now implementing or looking to implement skinny bundles. These are smaller packages of just the channels that people want to watch, at a much lower cost to consumers than the big traditional packages. The cable companies want to get off the treadmill of paying huge amounts for programming, and skinny bundles reduce and reset the bar. The cable companies also want to offer an alternative to people to stop them from totally dropping the cable company.

It’s a tough time to be a cable company because margins on the cable product keep tumbling. But it’s starting to also be a rough time for the programmers. Probably the best thing that can happen to the programmers is for Wall Street to lower their stock price to reset the expectations for earnings performance. At that point maybe the whole industry can take a pause and see if they can salvage what is looking like a slowly sinking ship.

Fighting Back Against the Programmers

comcast-truck-cmcsa-cmcsk_largeSome of the biggest cable providers are finally fighting back against the high cost of programming. Programmers have been aggressively increasing the costs of buying their contentfor over a decade, and the cable companies have been passing on those cost increases to their customers. My clients report programming costs have increased historically at 7% to 9% per year and say that it’s been even higher the last few years.

The first big provider to take an exception to programmers was Verizon. Last April they moved ESPN from the basic to the digital line-up. For them this meant a significant savings. If a network is carried in the basic line-up then a cable company must pay the programming fees for every cable customer. But if a program is shifted to the digital tier then the programming fees only apply to customers that buy the higher-priced digital tier. The percentage of customers that buy digital tiers varies widely, but most cable companies have between 40% and 60% of customers electing the higher tiers.

So if Verizon had a 50% penetration of digital tiers, then moving ESPN to the higher tier would have cut their ESPN bill in half. Some programmers try to make up for this sort of shift by charging more for the same network if it’s carried in the digital tier instead of the basic tier.

Comcast just joined the same fray. Earlier this month they moved Spike, CMT, and POP (the TV Guide Channel) into the digital tiers. Viacom instantly complained about that and there is certainly going to be a lawsuit over the issue. Viacom says that their contracts require those channels to be carried in the basic tiers.

And that highlights another reason why cable rates keep rising. The programming contracts have tightened up over the last decade and programmers now demand to be carried in lower tiers as part of renewing a contract. They also often demand very specific channel placement, which is why you don’t see a lot of differences between cable line-ups in different markets.

This insistence that programming be carried in the basic tier (which maximizes the revenue of the programmer) has gotten out of hand. I helped a client set up a new cable system just a few years ago and the programming contracts insisted on 85 channels being in the basic tier. A decade earlier the basic tier generally had no more than 60 channels, but more and more networks are being jammed into the more expensive placement.

Cable companies have been complaining about this for years and I can recall several pleadings to the FCC asking them to stop the practice. But the FCC hasn’t tackled the programmers yet and so nothing ever came of this.

A company the size of Comcast might be able to beat this in court. I would imagine that this was something that was forced down their throat and that they fought this during contract negotiations. But from what I’ve seen the programmers are completely unwilling to negotiate and their programming contracts are mostly take-it-or-leave-it. At some point it’s not a negotiation when one side won’t budge.

Companies smaller than Comcast have no ability to take this on other than to decide to omit certain programming from their line-up. I reported in another blog how small cable companies had dropped the whole Viacom line-up after a huge rate increase in 2013. This removed the Viacom channels from over 600,000 homes.

So maybe Comcast and Verizon can shove a small wedge into the leverage currently held by the programmers. If the FCC won’t take on this issue (and I’m not sure they have a legal way to do so), then it’s going to take these big public fights between the cable companies and the programmers to change the paradigm.

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.

What if Nobody Wants to Sell Video?

television-sony-en-casa-de-mis-padresSome of the largest cable companies in the country have begun to de-emphasize cable TV as a product and it makes me wonder if smaller companies should consider the same strategy. It’s been clear to everybody in the industry that margins on cable have dropped, so the question that every cable provider should ask is how hard should you work to maintain cable customers or introduce any new innovations in your cable products?

The largest company that is downplaying cable TV is Cable ONE. Earlier this year Cable ONE’s CEO James Dolan told investors that cable had accounted for 64% of his profits in 2005, but by 2018 he expects that to drop to under 30 percent. Like many other cable companies, the lost margins on cable have been replaced by sales of broadband products.

Cable ONE has gone farther than most cable companies in de-emphasizing cable. For example, they and Suddenlink decided to drop the Viacom suite of cable networks when the programmer asked for a giant rate increase last year. This decision has cost these companies cable subscribers, and Cable One lost over 100,000 cable customers in the year after the decision, but the companies see this as a good long-term strategy.

If you are a small ISP and offer cable then your situation has to be a lot direr than Cable ONE’s. I have one small client who dropped their cable offering altogether earlier this year and they were surprised to find out how positively it affected them. They went from having a room full of busy customer service reps to having almost no inbound calls. It turns out that cable drove almost all of the inquiries and complaints to the company.

This tells me that it’s likely that offering cable is costing a small company a lot more than they realize. By the time you factor in the true amount of customer service time and truck rolls that are associated with the cable product it’s very likely that for small companies cable is completely under water.

The cable companies still have one major advantage that gives them a lot of flexibility. In the majority of the markets in the US the cable companies have no real competition with their data products and they have captured the lion’s share of the market. The latest statistics I’ve seen show that less than 10% of the homes in the country have access to fiber, and a lot of that is Verizon FiOS which is no longer expanding. In most markets the cable companies are still competing against DSL – a battle they have largely won.

For a while the telcos were rapidly expanding broadband products based upon paired-copper DSL, like AT&T U-verse, and were capturing a lot of data customers. But a lot of homes are starting to find that a data pipe that delivers around 40 Mbps of data, and which must be shared between cable and data products, is not fast enough for them. This might be the primary reason that AT&T bought DirecTV, to take pressure off their huge embedded base of U-verse customers by moving cable back to the satellites.

There is a lot of press about the growth in fiber-to-the-home. CenturyLink says they will pass 700,000 homes with fiber by the end of the year. AT&T is announcing new markets almost weekly for their new fiber product. And Google is steadily but slowly building fiber to new cities. But even if all of this fiber activity raises the national fiber passings to 20% of homes the cable companies will still be in the driver’s seat in most markets.

The larger cable companies are being proactive in order to preserve their large market broadband penetration rates. They have almost all announced that they are embracing DOCSIS 3.1 and will be significantly increasing data speeds in markets ahead of any fiber builds. Until now fiber roll-outs have had great success when entering markets where they are selling gigabit fiber against a 15 – 30 Mbps cable product. But fiber’s success is not going to be so automatic if cable companies can counter gigabit fiber with a lower-priced 250 Mbps or faster data product.

To come back around to my original point, it’s clear that data is becoming everything for cable companies. Analysts have been wondering for a few years how the large cable packages might eventually unravel. There has been a lot of speculation that cord-cutters and OTT programming will chip away at the business. But the death of the traditional cable packages might instead come when the cable companies all stop caring about cable TV. At that point they will have regained the balance of power against the programmers.

Those Insane Programmers

MTVThere is currently a dispute going on between a programmer and a bunch of cable companies that illustrates the nearly insane greed in the cable industry. I say the greed is insane because it seems like the programmers want to hasten their own demise.

The programmer is Viacom and they own channels like MTV, Nickelodeon, Spike and Comedy Central. The dispute is with the National Cable Television Cooperative (NCTC) which represents 890 of the smaller cable companies in the country. That’s just about everybody who isn’t large.

The current contract between Viacom and NCTC expires on March 31. None of us know the exact numbers, but a NCTC spokesperson says that Viacom wants a rate increase that is 40 times the rate of inflation. That itself may be an inflated claim, but in 2012 Viacom asked for a 30% rate increase from DirectTV. When DirectTV refused to pay, Viacom pulled their channels off the air for DirectTV until the issue was settled.

And Viacom is still today asking for huge fee increases. If Viacom was the only programmer doing this we could say that they are extra greedy. But the fact is that all of the programmers are doing the same thing. Every programmer is increasing fees to cable systems at rates far above inflation. The cost to cable providers for programming has climbed over 7% per year for nearly a decade, and in recent years I know some systems that have seen increases over 10%. Cable companies have no choice but to pass these increases on to customers and so we keep seeing big rate increases year after year.

But we are now at a time when customers are getting tired of the price of big cable packages and when a significant percentage of customers are thinking about abandoning cable. To keep pushing these big increases make no market sense. Just do the math to see how insane this is. For a customer paying $50 per month today, these increases will increase their rates to $70 in five years and $98 in ten years. Somebody paying $70 today will see rates of $138 dollars in ten years.

This can’t be sustained. It seems as if programmers like Viacom are making the risky bet that people will not cut the cord and find an alternative to the big cable packages. But every one of my smaller cable clients is losing customers, and at a faster and faster pace. They hear the stories every day of people who are fed up with the big monthly bill and who decide that they can get by with rabbit ears, NetFlix and AmazonPrime.

I’ve heard the idea that once most people drop cable that all of the networks will just go a la carte and sell to people over the Internet. But that is naïve and there are only a small handful of channels that have enough appeal to survive in an a la carte world. It’s likely that people will pay a monthly fee to get ESPN or Disney and maybe even Comedy Central. But probably 90% of the channels on cable systems will die if the big cable model breaks.

So why are Viacom and the other programmers being so greedy? One can chalk part of it up to the large company mentality that all that matters is the earnings next quarter. But one can also blame amazing arrogance in that they believe that the people of the US will keep paying huge fees to watch them. Are there really that many households where Nick at Nite is so important to people that they will pay $100 monthly in order to watch it? As OTT programming gets better, I foresee a day in the not too distant future when customers will bail on cable companies in droves. And then the hubris of the programmers will be fully exposed. The programmers are pushing hard to speed up the day when they will fail. If that is not insane, what is?