Television Ad Model Under Pressure on Two Fronts

Sep 22, 2003  •  Post A Comment

Broadcast television’s seemingly solid advertising base could soon be under siege on a local level by rival cable operators, according to one respected analyst. Another warns that on a national level, both broadcast and cable advertising revenues are threatened by personal video recorders that, while still in their infancy, are on track to become a major weapon in the battle between cable and satellite providers for subscribers.

Merrill Lynch analyst Jessica Reif Cohen asserts in a new client report that a major shift in local spot ad spending from local TV stations to local cable operators is occurring and will permanently reshape local TV economics.

She estimates that cable operators could double their $4 billion in advertising revenues over the next several years as a result of increases in the number of aggressive cable interconnects and in the number of cable networks offering to insert spot ad time, along with improvements in local viewing measurement.

That potential $4 billion to $5 billion share shift in spot advertising revenues, which could translate into an average of $55 per cable subscriber, does not include the organic marketplace growth cable operators also expect to realize in the next two years, she said.

A share shift in spot advertising of that magnitude would add 30 cents to 40 cents in incremental cash flow per share for most cable operators, or $4 to $5 per share in overall incremental value, Ms. Cohen said.

Cable’s “sizable advertising opportunity” is possible because cable now accounts for half of all U.S. TV viewing. But not even cable can afford to be sanguine, according to Bernstein Research analyst Tom Wolzien, who in a new client report contends that regulation is needed to prevent the erosion of television’s overall $60 billion advertising base by the proliferation of commercial-skipping PVR devices.

Although there are barely 1 million PVR devices in U.S. TV households today, most of them courtesy of TiVo, Mr. Wolzien warns that massive deployment of PVR technology is on the way as satellite and cable operators use it in their battle for subscribers. News Corp. Chairman Rupert Murdoch recently said he would like to see a free PVR in the home of every DirecTV subscriber once he assumes a 34 percent controlling interest in the dominant satellite provider early next year, although the company later said no such plans are in place. Rival EchoStar recently put ReplayTV into its set-top boxes as a way to counter cable providers’ growing embrace of video-on-demand.

“We’re talking about preserving the very financial foundation of ad-supported television,” Mr. Wolzien said in an interview. “This whole thing is sneaking up on the industry much faster than anyone realizes.”

Just a year ago, many mainstream television executives were openly declaring PVR technology null and void because of its flagrant TV ad-skipping capabilities. But PVRs have since become a driving force behind new consumer-command technology that is changing the way we produce, use and sell media.

“Satellite and cable operators have little understanding of the long-term consequences of the $3 billion to $5 billion in annual advertising revenue that may be lost later in this decade by the zapping of TV advertising. And the only way to replace those lost ad revenues will be to increase the subscriber fees that are already considered to be too high,” Mr. Wolzien said in his report.

Although Mr. Wolzien’s call for regulation may seem strangely timed given the current brouhaha over media deregulation, the former NBC executive, who has patented many of his own tech designs, said marketplace forces are accelerating the adoption of PVR technology.

“There will be no way to regulate this technology once it is widely offered by cable and satellite providers to their more than 83 million subscriber households and consumers consider such ad-skipping options to be a God-given right,” Mr. Wolzien said. Although widespread adoption could be at least five years away, any erosion of ad revenues could have a devastating impact on media company profits and stock prices.

The best way to regulate such technology may be with software in the playback devices that prevents the skipping of ads, in much the way Microsoft’s Windows Media Player does for The Walt Disney Co.’s new ESPN Motion service. Such software also could be coded to prevent content piracy, to assist in copyright protection and other digital rights management and even to allow for the insertion of a different set of playback commercials, which could be a new source of revenues, he said.

“Ultimately, the issue might be taking the digital television standards set by the Federal Communications Commission and including provisions for content playback for any device with [ad-skipping] functionality,” Mr. Wolzien said.

The warnings issued by Mr. Wolzien and Ms. Cohen, which are supported by quantifiable trends, indicate relatively brief windows of opportunity for any effective response, as change already is well under way.

For instance, cable interconnects, which have increased five-fold in the past several years to 54 and will double by the end of 2004, will generate $1 billion in ad revenues for Comcast Corp. this year.

The number of national cable networks that allow for the insertion of spot ads has doubled in the past several years to 32, with a leader such as Cox Communications offering as many as 45 targeted national and local networks per market.

Overall, cable interconnects are on their way to covering as much as 56 percent of U.S. TV households, up from 16 percent last year.

In addition, more detailed demographic data being generated by Nielsen’s new active meters in markets accounting for 30 percent of U.S. TV homes finally puts cable networks on “equal footing” with broadcast networks, Ms. Cohen said.

Just on the basis of those hard facts, it’s easy to see the potential upside in cable’s relatively low 30 percent share of spot audiences and 14 percent share of spot advertising. Ms. Cohen contends that cable will be able to significantly close what she estimates to be a 16 percentage-point revenue gap relying on more advertising interconnects, cable networks willing to insert local spot ads and more reliable local ratings data.

Given how quickly consumers took to downloading recorded music off the Internet without paying a fee, and given ongoing economic volatility, Mr. Wolzien said media companies cannot afford to stand pat.

A 20 percent decline in advertising revenues for broadcast and cable networks would be a significant blow to media company balance sheets, he said.“Do you need any better reason to begin looking at the financial foundations that underlie the entire industry?” Mr Wolzien said.