Quick Thoughts: The Revolution will NOT be Televised

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–          The clouds around channelized TV are building – MSOs are pushing back on network fees, networks are playing hardball while looking on-line, and on-line players are getting aggressive.

–          VZ will look to pay networks based on viewership; Cablevision is suing Viacom to get out of bundling; and DISH’s ad-skipping Hopper DVR has CBS hopping mad.

–          ABC’s new live streaming service will require an MSO subscription … for now; Fox and Disney are apparently fighting over Hulu; The 2011 NFL TV deals raised the total yearly fees by 66% to $5B.

–          Meanwhile, Aereo isn’t going away; Boxee’s cloud DVR will store network content; Netflix’s new shows have the buzz; and Amazon, Google and Microsoft are big time content buyers.

By definition, a death by a thousand cuts does not come quickly, but in the case of channelized television, the pace of the minor wounds has picked up and the accumulated damage is starting to become more apparent. On one front, multichannel distributors – i.e. cable operators, telephone companies, and satellite TV players – are coming to the realization that they may not be able to pass ever higher content fees onto their customers, given that the average U.S. monthly video bill of $90 is already taking more than 2% of the discretionary income of a typical household. On another front, media companies are grappling with falling ratings for flagship networks, ad market pressures, and rapidly rising rights fees for marquis sports programming, by continuing to bid up rights fees, while playing hardball with distributors and flirting with their own on-line strategies. Meanwhile, the Internet crowd has the pedal to the medal, finding technical ways to circumvent the cable industry hammerlock on popular programming, while opening their wallets to content owners and creative talent in search of their own original hits.

Cablevision’s anti-bundling lawsuit against Viacom is particularly amusing. On one hand, Cablevision has a point in its assertion that the bundling arrangements, by which Viacom and the other media titans insist that distributers take all of their channels rather than just the popular ones, leads to higher service prices and hurts consumers. The irony is that the Dolan family, which controls Cablevision, also owns a controlling stake in AMC Networks, which plies the exact same bundling strategy in its own negotiations with other distributers. Indeed, Dish Network raised AMC’s insistence that it take the low rated IFC and WE tv as the primary irritant in acrimonious stand-off between the two companies last year.

Seeming hypocrisy aside, Cablevision’s Viacom suit merely brings an issue felt by all television system operators to the front burner. Verizon, America’s 6th largest pay TV provider, is proposing to pay networks on a sliding scale based on their number of viewers, as captured by the carrier’s own digital set-tops.. Time Warner Cable CEO Glenn Britt raised the same point with a more blunt solution, dropping Current TV and Ovation from its line-up on New Year’s Day, and singling out low rated networks Hallmark, IFC, Lifetime, NHL Network, Style Network, and WE tv as at risk of the same.

 Exh1

Of course, Cablevision, Verizon and Time Warner Cable are all steering clear of the elephant in the room – sports channels, such as ESPN or regional sports nets, demand and receive enormous fee premiums relative to the actual audience that they command, premiums that have rising rapidly with every contract negotiation. In 2011, ESPN, CBS, Fox, and NBC signed new deals to carry NFL games through 2022 for an aggregated total of $5 billion per year, a 66% bump up vs. the previous deal (Exhibit 1). At some point, the squabbling over the few cents per month per subscriber paid for IFC will bubble over into Disney’s inevitable demand for a healthy increase in the $5 per month per sub that operators pay for ESPN. With stagnant American household discretionary budgets and rising claims from health care and education costs, MSOs are understandably nervous about testing the elasticity of demand much further.

Dish Networks has found an entirely different way to %$@& off the networks with its controversial Hopper DVR. Unlike normal DVRs, which force the user to actually use the remote to fast forward through the commercials, Hopper will do it automatically. Moreover, Hopper can record 6 channels simultaneously, and has enough capacity to hold more than a week’s worth of programming from all 6 channels, essentially turning the multichannel content into an on-demand service without commercials. For the broadcast nets, which rely on advertising for more than 90% of their revenue, the ad-skipping box is a nightmare. Not surprisingly, CBS has filed a lawsuit questioning Hopper’s legality, going so far as pressuring its subsidiary CNET to withhold a CES best in show award for the product.

Hopper is not the only technical assault on broadcast network hegemony. Aereo, the Barry Diller funded start-up, has installed tens of thousands of individual antennae in a warehouse on a hill in Brooklyn, and is using them to provide user-specific streams of broadcast network telecasts to consumers over the Internet. By Aereo’s reckoning, legal precedent does NOT prohibit steaming over-the-air signals, as long as each individual user is assigned a dedicated antenna. Of course the lawsuits are flying, but the networks failed to win a preliminary injunction and Aereo is expanding its service, which includes a cloud-based DVR function, to cover almost all major US markets by the end of 2013. Obviously, the ability to buy access to all of the over-the-air networks, including the big four and their hefty sports coverage, for as little as $8 a month is a considerable spur to households thinking of cutting the cord on their $90 a month cable bill.

Boxee TV requires that you have your own over-the-air antenna, but seamlessly combines those channels with a wide variety of web-based content, and includes an essentially unlimited capacity cloud-based DVR service. Programs can be recorded off of the broadcast signal and digitally stored for viewing anywhere. For households that get good reception from their antennae, Boxee is an intriguing alternative to cable, and an interesting model of where Aereo might go next.

If the threat were just Hopper, Aereo and Boxee, the channelized powers-that-be might be justified in complacency, but there is obviously a lot more brewing from companies with far greater resources. While there is still no real news on the Bigfoot-esque Apple Television, and Google’s scattered set-top-box efforts have been a bit of an industry punch line, both mobile giants bring technical chops and serious brand power to the game. Microsoft brings it a huge step further, leveraging the 76 million Xbox households, amongst them, 46 million Xbox Live on-line subscribers, to deliver programming content along with the games. Xbox is already the number one delivery vehicle for Netflix to the television, and has the most robust line up of video content partners in the alternative set-top field.

Exh2

As these boxes light the way for on-line video to make it to the living room television, the quality of on-line content keeps making quantum leaps (Exhibit 2). Netflix is using its data-driven insight of its viewers’ tastes and habits to gin up a slate of high profile original programs. The web-based subscription service’s “House of Cards” is on its way to joining The Sopranos, Mad Men, Breaking Bad, and Homeland, in the pantheon of “must-see” cultural phenomena, with drooling press reports over this spring’s return of the cult comedy classic “Arrested Development” hinting at further elevation of Netflix’s industry status. Meanwhile, Amazon and Google’s YouTube are plowing hundreds of millions of dollars of their own to establish original programming cred, with Yahoo, AoL and others casting their lot with originals as well. Last year, these companies participated in on-line “upfront” sales presentations to advertisers, timed to coincide with the traditional “upfronts” used by television networks to pitch their new programming and sign early advertising commitments for the coming season. The success of last year’s events has attracted an even bigger crowd to the 2013 on-line upfronts next month, with print media stalwarts The New York Times, The Wall Street Journal, Conde Nast, and Time Warner’s orphan magazine unit looking to bolster their own video bona fides with advertisers. All of this activity is attracting money – 2013 US on-line video advertising spending is expected to push $5B, up more than 40% from 2012, and a real rival for the $65B projected to be spent on traditional television ads. It seems impossible that the growth in on-line video isn’t re-directing some funds that might have otherwise been spent with the networks.

Exh3

To this, the network owning media companies are starting to say “if you can’t beat ‘em, join ‘em”. All of the major networks offer free streaming of, at least, some of their programming from their own sites or through services like Hulu, which is the subject of a spirited battle for control by two of its owners, Disney and NewsCorp, if media reports are to be believed. CBS, which is the only one of the big four networks without a stake in Hulu, has been the most aggressive in getting its content on-line via its own site, its TV.Com subsidiary, and through licensing agreements with independent video streaming players. As of mid 2012, CBS was already making 7% of its revenues from its various on-line activities, a percentage that is undoubtedly rising given the company’s aggressiveness in pursuing new monetization strategies. Recently, it was reported that Disney-owned ABC would introduce an app that would allow viewers to live-stream its programming to portable devices, a bold step to grab a valuable slice of the rapidly growing audience for video on these platforms (Exhibit 3). While the initial implementation will require viewers to be verified subscribers to a multi-channel service, that requirement is unilaterally imposed by Disney and could be loosened should future conditions warrant it.

So 2013 won’t be the year that the bottom drops out of television. Cord cutting will be modest. The hours spent watching channelized TV will tick downward and the average audience will shrink a little bit. TV ad sales will be slightly disappointing. Programming contracts that come up for re-negotiation will be a bit more contentious, and the pressure on the whole system to pay for the big increases in sports rights fees will be a tad more apparent. Excuses will be made and bullish recommendations reiterated. In the end, we will be that much closer to accumulating those one thousand cuts.

For our full research notes, please visit our published research site.

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