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Cable Faces Multiple Challenges

Dec 1, 2003  •  Post A Comment

With upgraded systems now the first stop for mass-market interactivity, the cable television business in 2004 will be about much more than stemming basic subscriber losses, ramping up free cash flow and rolling out new services.
Amid today’s atmosphere of good-and-plenty, cable operators and the suppliers of cable programming are setting new precedents for pricing, distribution and overall industry economics, the impact of which will reverberate through media and entertainment circles.
It is a huge challenge and a heavy burden that is not getting nearly enough serious attention.
The long-term financial consequences of the industry converting to a largely pay-for-play model are dramatic and touch every distribution and content company. But so far, the debate about a la carte or tiered programming has been reduced to a public fee fight between The Walt Disney Co.’s ESPN and Cox Communications, complete with hostile Web site and public exchanges.
Midlevel ESPN and Cox executives met in mid-November, amid the latest exchange of accusations, to no avail, sources tell me. But their eleventh-hour negotiations late in the first quarter of 2004 will at least render some new model for tiered sports programming or an extension of basic cable carriage at hugely reduced rates. Either way, the economics of both companies and the industry at large will be impacted, perhaps negatively.
With other cable and satellite operators taking their cue from Cox, Merrill Lynch analyst Jessica Reif Cohen estimates the worst-case scenario would be for 100 percent of ESPN’s contracts to be renewed with no affiliate fee increase, which would result in a $456 million revenue and operating income downside for Disney compared with the current 20 percent annual increases it is requesting. This is a very big deal for Disney, considering that ESPN represents nearly one-third of the company’s overall operating income.
But other major media and entertainment companies that own and manage cable distribution systems and program networks are sure to find themselves in similar entanglements.
The threats by other cable operators to yank or alter any of their program offerings, despite the contracts in place, contribute to shifting more of the burden of paying for content costs to the consumer in exchange for giving users more power to access and manipulate content at will for a price.
That changing dynamic, in turn, will completely alter the advertising and subscription revenue models upon which media consumption is based. It will play out over the next five years.
So far, the discussion or examination of this critical sea change has surfaced in the context of the growing use and availability of digital video recorder technology-a controversial development from only a year ago that has since become an imminent threat. But this groundswell of change is actually being driven, collectively, by all forms of interactivity-from cable and satellite set-top boxes to wireless 3G video phones to server-based streaming media on the Internet.
Every step cable operators and content suppliers make in a new direction-in the name of competition with satellite or each other-sets a new media and entertainment standard that resets industry expectations and economics.
But at the moment, that significant reshaping of industry fundamentals is being hidden by a veil of prosperity.
The pay television universe is nearing saturation at 86 percent of U.S. homes (68 percent of which are cable and 18 percent of which are satellite). But the widespread installation and use of optical fiber transport infrastructure has, at the same time, drastically altered the type of business pay TV is-and the clout it carries, much of which has yet to be fully recognized or felt.
In fact, cable already has been transformed from a single-product, basic subscriber-based industry to a bundled service, tiered user-based industry. Despite the broad loss of basic subscribers, cable operators actually are growing their significantly more valuable nonvideo subscribers-which are typically high-speed data-only customers-faster than they are losing video subscribers. So, counting all of its varied services, cable’s overall basic subscriber rolls are actually rising.
Bernstein Research analyst Craig Moffett in a Nov. 24 report to clients estimated that the typical $3,500 to $4,000 valuation per subscriber at some cable multiple system operators is actually valued at more like $11,000 each at the high end.
This is already a reality for Cox, where, Mr. Moffett estimated, 30 percent of current subscribers will migrate from a single product to two or three bundled products, adding an average $2,000 of value per subscriber over the next five years.
In fact, Cox, whose industry-leading bundled services account for 62 percent of the company’s total revenues, will see high-value bundled subscribers grow to represent more than half of all its subscribers over the next five years. Those high-end subscribers were growing at an average annual rate of 70 percent last year for Cox.
And it isn’t just Cox. Comcast expects to see its average revenue per subscriber double over the next several years, according to analysts.
Already the triple-play subscriber, who takes telephony, data and video services, accounts for 7 percent of Cox’s users and 17 percent of its total revenues, and two-way product bundles comprise 30 percent of subs and 46 percent of revenues.
Mr. Moffett makes a riveting case in his report for how cable’s future value and income will be in the high-speed Internet and telephony services-not in its television video mainstay.
In fact, the only way video will survive in the digital age is to become a paid offering, which will dictate permanent changes on the kind of content that is produced for specific audiences willing to shoulder the cost.
It is incumbent upon the powers that be in the cable industry to recognize that they are doing so much more than managing their businesses in 2004 and beyond.
The “one-trick pony,” as Ms. Cohen called it, that was cable’s peddling of television channels-off a backbone of rising deregulated rates and household penetration-has given way to a pallet of new businesses and emerging economics built on a backbone of interactivity. And there is nothing about it that is routine.
Let the forward thinking begin.