Cable TV Model Not Just Unpopular But Unsustainable

Cable TV Model Not Just Unpopular But Unsustainable

Imagine making this elevator pitch to sell an investor on your startup.

We’re developing a video delivery service that provides literally hundreds of channels. Sure we’ll carry the big networks, but mostly what we’ll be offering are niche outlets that only a tiny fraction of our customers will want to watch. Our subscription prices will include rental fees for low-cost hardware like modems, set-top boxes and remote controls. We also plan to build in annual rate hikes that outpace inflation by about, say 400%. And for good measure, our arrangement with the creators of the content we distribute will ensure that every couple of years we’ll be locked in contentious and public renegotiation rights that interrupt service for our customers. If all goes as described, we should be able to consistently deliver customer satisfaction levels that rank among the lowest of any industry.

To call this a flawed business model is an understatement, but in essence that’s how today’s cable TV industry operates. Nationwide, the average pay TV bill (excluding internet and phone service) was $86 in 2011 and is expected to reach $123 by 2015, based on estimates by the NPD Group. With consumer income and spending remaining relatively flat, industry analysts agree that the current business model is not sustainable in the long term. Yet despite widespread customer complaints over price hikes and channel bundling, the cable industry still manages to hold on to a nationwide customer base of about 56 million video subscribers, more than their satellite (34 million subscribers) and telco (10 million subscribers) rivals combined, according to a recent report from SNL Kagan.

But how did we get to this point, where a company like Time Warner Cable Time Warner Cable can score at the bottom of this year’s American Consumer Satisfaction Index yet still report revenue growth?

Consumer advocates point to the wave of mergers and consolidation that followed the relaxing of media cross-ownership with the Telecommunications Act of 1996. The Act was promoted to the public as a way to foster competition, allowing telephone companies to offer TV service and cable operators to deliver phone service, for example. What has followed, however, has been a series of FCC FCC rulings approving mergers as well as allowing ownership of multiple media outlets in the same market by a single company. The result is that today, most of the country’s biggest broadcast and cable networks as well as movie studios – all content creators – are owned by just six companies: Comcast Comcast, Walt Disney Walt Disney, Viacom Viacom, CBS, News Corp and Time Warner Inc. Several of these companies own local TV stations in key media markets. And Comcast is also the largest cable provider in the country.

Rising Prices

Let’s take a look at customer complaint number one: rising cable subscription prices. While the FCC reports that customer rates have been increasing by about 6% annually – the current inflation rate, by comparison is 1.5% – cable companies counter that their programming costs have been rising by as much as 10% in recent contract renewals with media companies. A growing portion of these increases are coming in the form of retransmission fees paid to local broadcast stations. When Congress passed the 1992 Cable Act, local broadcast stations were for the first time allowed to charge cable distributors for airing their content – the same content available then and now for free, to anyone with an antenna.

With retransmission fees – essentially found money – making local TV stations attractive investments, media giants have bought them them in significant numbers, further strengthening their leverage in fee negotiations. A media company owning local stations in several big media markets, for example can demand a higher fee from a cable distributor. It’s no surprise then that these fees are a huge profit generator for local broadcast stations, their parent companies and the networks themselves which take a healthy 50% cut. SNL Kagan estimates revenue of roughly $3 billion in retransmission fees this year and predicts that will surpass the $6 billion mark by 2018. With numbers like those it’s little wonder the networks have asked the U.S. Supreme Court to hear arguments against Barry Diller-backed upstart, Aereo which is bypassing the fees altogether.

Seeking to maintain their profit margins in the face of rising programming costs, cable companies have combined customer rate increases with cost-cutting moves in customer service, says David J. Heger, Senior Equity Analyst at Edward Jones. “Companies are seeking efficiencies like online chats and knowledge bases which reduce calls to customer service agents. In addition,” he notes “Internet access charges have been going up and thus far there’s been very little pushback from consumers.”

Price hikes and reductions in customer service can only go so far though before customers start to leave in significant numbers. As it is, the cable TV industry has seen quarterly declines in video subscribers over the last several years. So far, the majority of these losses are turning up as gains for satellite and telco distributors rather than for cord cutting options like streaming video on demand (VOD) services. But industry analysts note that growth is flat for the pay TV sector (cable, satellite and telco) as a whole, and few see it improving in the long term. Indeed the prospects for customers being able to lower their cable bills are slim.

Channel Bundling

Advocacy groups like Consumers Union have long pushed for an à la carte solution, in which customers can pick and choose which channels they want to pay for. Senator John McCain has even proposed recent legislation to that end (with muted support in Congress it should be noted). The populist appeal of such a move is obvious. Under the current model, a high value channel like ESPN costs $5.54 per subscriber according to SNL Kagan. The rub is that you’re paying that rate whether you want to watch ESPN or not.

The first problem with getting your cable company to unbundle channels, however, is that that’s exactly how they are being licensed by the media companies. Disney owns ESPN and when a cable distributor wants to carry the country’s premiere basic cable channel, Disney includes it in their own bundle of less popular channels like ESPN Classic. Disney can’t charge a per subscriber rate anywhere near as much for ESPN Classic, of course – think cents not dollars – but each additional channel Disney airs is an additional opportunity to sell advertising.

And if Disney were somehow convinced to sell ESPN in an à la carte model? With non-sports fans dropping the channel, Disney would need to charge a substantially higher per subscriber rate to maintain the same revenue from a now smaller pool of subscribers. While some of you may not shed a tear for the sports fan now paying perhaps $30 instead of $5.54, for a single channel, the same fate would befall high value channels that you do want to watch. In addition, cable companies have long argued that less popular channels would not be economically viable in an à la carte model and would simply be dropped altogether.

And if you’re wondering why a sports channel is commanding the highest fees to distributors, look no further than the huge sums ESPN pays to televise live sports. The network’s N.F.L. contract to broadcast Monday Night Football games through 2021 for example is a staggering $15.2 billion. That’s a lot of money but it’s a cost industry watchers are confident the network can absorb because of the ESPN subscriber rate everyone is paying on their monthly bill. It’s clear that under the current programming and distribution model that eliminating the bundling option is not going to lower costs to the consumer.

The Future

With companies like Google, Intel, Sony and even Apple all reportedly working on over-the-top (OTT) services that deliver live TV broadcasts via an Internet connection, it’s clear that the tech industry sees a pay TV market that is ripe for disruption. The main challenges here may very well be of the legal rather than technical variety though, as the New York Times reports that several distributors have contract clauses that discourage content providers from offering lower rates to Internet distributors or forbid the licensing of channels to them outright.

Even with the promise of an OTT live television service, however, consumer advocates like Todd O’Boyle, Program Director for The Media and Democracy Reform Initiative at Common Cause, point out that the problem can’t be solved only by innovation. “Public grass roots awareness is needed around issues like data caps and erosion of net neutrality, both of which could undermine the ability of consumers to have [OTT] video as an option.”

And let’s not lose sight of the fact that for all its acknowledged long-term problems, the existing content distribution model is today a very lucrative one for both content companies and pay TV providers. With no current alternative that comes anywhere close to this revenue stream, “Media companies want the MSO (multi-system operator) system to stay intact,” says SNL Kagan Senior Analyst, Robin Flynn. Streaming video services like Netflix and Hulu Plus, when combined with hardware like a Roku box or Apple TV can offer an increasingly attractive range of viewing options. Yet while these are growing in popularity, a majority of users are employing them in addition to a pay TV service. The number of cord cutters – those dropping cable in favor of streaming video – is still a very tiny fraction of pay TV subscribers. If you’re thinking about becoming one of them, read my detailed look at the current options to a pay TV subscription.

While it’s far from certain how this will play out in the years ahead, it’s very clear that something has to change fundamentally with the current TV model.

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