Evolution of the Industry

Dec 1, 2003  •  Post A Comment

Englewood, Colo.-The zenith of the Western Show’s reputation as a news-making event came Dec. 2, 1992. On that Wednesday in Anaheim, Calif.-a typically balmy December morning in Southern California-John Malone, president and CEO of Tele-Communications Inc., then the largest cable operator in the country, said at a press conference that it was now possible, through compression technology, to get 10 digital channels for every analog channel. Thus, he explained, if a cable system carried 50 channels, with compression there could now be 500 channels. Furthermore, Mr. Malone expounded on how many of these new channels would be interactive.
The next day Mr. Malone’s vision was on the front page of The New York Times, and soon his scenario of 500 channels entered the lexicon.
Mr. Malone is now chairman of Liberty Media. Through Liberty’s full or partial ownership of such cable networks as Court TV, Starz! Encore, QVC, Discovery Communications and Game Show Network, among others, and its major stakes in News Corp. and Time Warner, Mr. Malone continues to be a major media player.
The one thing Mr. Malone is probably as well known for as his media savvy is his reluctance to sit down for interviews with the press.
However, when TelevisionWeek suggested an interview to coincide with the final Western Show, Mr. Malone graciously agreed. What follows is an edited transcript of the recent conversation between Mr. Malone and TelevisionWeek editorial director Chuck Ross, which took place at Liberty Media headquarters. Mr. Malone spoke candidly on a wide range of topics, from Liberty’s bid for Vivendi to its legal hassles with Comcast to cable’s continual battle with satellite providers. The dialogue begins with Mr. Malone’s recalling his “500 channel” remarks, which quickly leads to a discussion about his thoughts on the latest technological innovation, the digital video recorder.
TelevisionWeek: Your comments at the Western Show about the 500 channels about a decade ago garnered international headlines. Are you surprised how the cable industry has evolved in the intervening years?
John Malone: No. I guess if I’m surprised or disappointed it’s that the evolution of interactive kind of got put on the back burner because the high-speed data business became so strong. The progression in my mind at that time was lots of channels through the digital set-top, and the digital set-top would bring with it a lot of interactive services. And as you know, we even had joint ventures with Microsoft, trying to develop software. And the next technology I thought would be the high-speed data. We started @Home. And of course CableLabs started working on cable standards.
That took off initially slower than I would have thought and eventually faster than I would have thought. I always thought that that’s how the cable industry would get into telephony on that side. Voice over Internet always seemed to me to be the most cost-effective way for cable to get into telephony because it would also bring with it video-telephony conferencing and all that kind of thing. So that’s how I saw that evolving, with interactivity on the television side.
I always thought there was going to be a lot of value-and there still may be-to the consumer and for the advertiser and for the guy doing it, by providing that impulse quick-response interface. And in a sense you could cross platforms. You could jump to Internet like random access on the television side and, of course, you could jump to video on the Internet side, so that there would be a blend, or convergence, of the applications across both sides. So no, I’m not surprised at all at how cable’s evolved. I’ve always been a great believer in the full-service network and the ability of this hybrid network to be cost-effective and provide these services.
TVWeek: And do you think we’re closer now to seeing cable provide these services everywhere?
Mr. Malone: It’s spotty, in the sense that some operators are doing some things and others are doing other things. Quite a few people went down the switch-circuit line on telephony because they saw an opportunity there and they didn’t want to wait for technology. Who knows what’s right in the long run in terms of present value? But as we sit here today we’re starting to see VoIP [voice over Internet protocol] deployed. We certainly have plenty of channel capacity to do almost anything. People have servers at the headends that will have huge capability.
The one thing that we didn’t talk a lot about back then at the Western Show-but the guys who were with me on the first CableLabs tour of Japan will remember me trying to get-is pricing on a digital set-top box with a PVR [personal video recorder] in it.
TVWeek: You’re kidding. Back then?
Mr. Malone: Yeah, 12 or 13 years ago. It’s funny. It was a great trip. Brian Roberts was with me, and Bill Schleyer and Dick Green. I think there were five of us. And I twisted the [Japanese businessmen’s] tails a little bit. First of all, we wanted to know if we put a big order in for high-definition sets, just how cheap could they deliver them. And that created a lot of scrambling. They had all the guys out there with calculators. It was a fascinating display of Japanese responsiveness.
And then I think it must have been Toshiba … and I forget … it must have been Toshiba, into their … the guy that was really developing the PVR, and it was one of those ‘Gee-whiz, this is a real technological breakthrough’ things. So I wondered aloud what it would cost if we could build this capability into a digital set-top. So when you ask me if I’m surprised by what’s happened, the answer is no, because a lot of these guys, like Dick Green-not only me-were thinking about and dreaming about these things more than 10 years ago.
TVWeek: Do you have a TiVo or some sort of digital recording device?
Mr. Malone: I have it in a New York apartment, but I don’t have it at home.
TVWeek: So you’ve fooled around with it. What do you think about that technology as we move forward?
Mr. Malone: I think all of these technologies that evolve, you sit there and you try and predict their impact on business structures. It’s very hard.
TVWeek: But with Liberty’s having invested in a lot of ad-supported networks, I assume you’ve thought long and hard on this one?
Mr. Malone: Yeah. I think it will have an adverse effect on traditional entertainment, interrupted-entertainment advertising. It will cause more of the advertising to be blended into the entertainment, to the degree that we don’t have to have disruption in flow, such as, ‘Now we’re going to stop for a word from our sponsor.’ But if you think about certain channels and shows, like ‘Trading Spaces’ on Discovery’s TLC, or whatever, in fact the advertisers are just part of the whole structure.
TVWeek: But is it enough just for an advertiser to be embedded, so to speak, in a show, or is that too subtle to sell his product?
Mr. Malone: You can show a Lowe’s all the way through it and then at the end of the show you can have a message-almost like public broadcasting-this show was brought to you by Lowe’s. Nobody’s going to fast-forward through that. That’s too quick, so they are going to get the punch line.
I’m not an advertising guy, but I’ve got to believe that there’s enough brains back there on Madison Avenue to figure this out. First of all, the DVR and the elimination of advertising content isn’t going to happen with the throw of a switch. There are some commercials that are so entertaining that people will want to see them. There’s the whole business about when you’re watching a soccer match, all of the billboard advertising is still there.
I don’t know how it will evolve. I don’t think you’re talking about something going from 100 to zero. I think you’re talking about something going to from 100 to 110, or it could be 83.
I’m sure it’ll change the form, and I think it may really give interactive advertising an impetus. So that, rather than billboard advertising, or pop-up advertising on the Internet, advertising becomes much more something that the individual consume
r is interested in and wants to know more. So you tease them into it.
If you look at our biggest single asset, QVC, the entertainment is exactly the product. It is a merchandising channel, and you know, it’s amazing when they put on branded products, store sales go up. So it’s really doing good for the brand as well as good for the show as well as good for the product. So we may see more variance of that. It’s very hard to predict.
There’s one thing for sure though: If the public likes it, the DVR will proliferate. And it seems like they like it.
TVWeek: Yes, lots of people who have them say they love them and it changes their viewing, and their viewing even increases. And certainly it’s a no-brainer that if you’re watching the Tennis Channel you’re likely to be interested when a tennis product is advertised. But in this new world of DVRs, what is Procter & Gamble going to do with hawking paper towels or toilet paper? Because no one’s ever going to say ‘Boy, I really want to see a commercial for paper towels.’
Mr. Malone: But there it’s really impressions. When you walk in the supermarket and you see a brand you recognize, you go for that rather than another product. And so that’s more the kind of branding that’s bumper and that’s billboard, or whatever you want to call it. Maybe it’s in the entertainment, if you’re thinking of pure entertainment channels. One of the reasons why we didn’t aggressively go for Vivendi was that on pure entertainment networks, where advertising is basically a total interruption of flow, we were concerned about what the future held for that. Plus, we were concerned about getting beat up by Brian [Roberts] and his friends on rates.
TVWeek: And of course Brian and Comcast considered bidding themselves.
Mr. Malone: No, that never got serious. Anyway, with Starz! Encore we are non-commercially interrupted. And Discovery tries to have contextual advertising. So, for instance, they have the Travel Channel. So they try to have travel-related advertising to interest those viewers. Programmers will have to get better at that.
TVWeek: I recall years ago your telling me, when you owned part of AMC, that one of the things you really liked about the channel was that it was commercial-free, that you would have kept it that way. Now it carries a full load of commercials.
Mr. Malone: I love Chuck [Dolan], but in all honesty I don’t understand why cable operators pay him what they’re paying for a channel that is sliced and diced as heavily as AMC is when they’ve got Turner Classics without commercials, a real service to the consumer, at a much lower price. [Editor’s note: this conversation took place a few days before AMC filed a $250 million suit against Time Warner raising issues of programming and fees.]
As you know, we used to own half of AMC and we sold it for two reasons. (1.) We didn’t believe in putting commercials in, and (2.) we saw Turner coming with a non-commercial channel. So I don’t understand it. It might just be they may have such a strong brand or the distributors might have liked Katie [McEnroe] so much that they overlooked the commercials. But at some point I think the distributors got to look back at it and say ‘It’s not as much value to my customer now that it’s got commercials in it as it did when it didn’t.’
They had long-term contracts, so [you] can do it for awhile until your contracts expire. Then your distributor says, ‘Hey, wait a minute.’
TVWeek: Of course the multiple system operators can go to AMC and say, ‘Let’s renegotiate. With all these commercials this really isn’t the channel I originally was promised.’ I’d imagine some or a lot of that’s been done.
Mr. Malone: The big guys will have the power to do that. But maybe the theory at AMC is we can make concessions to the big guys, get away with much smaller concessions to the smaller guys and sweat out the terms of our contract. So they collect the same money they are now, make more advertising between now and then, and it all works out. I really don’t know. They’re not stupid people. I’m sure they’ve got it figured out.
TVWeek: You mention programming rates. You’ve long railed against ESPN’s rates and have said this is going to be a war between the operators and ESPN in this latest round.
Mr. Malone: Yes, that’s out of control. And if it was me and if I was Brian, I would draw a line in the sand and say ‘This is ridiculous.’ If your programming costs go up because you’re outfitting everybody else in the world for everything, that’s your problem, not mine. Cox is drawing a line in the sand. Brian is hiding behind Cox right now. If I’ve got to guess, and I know nothing on this, but if I had to speculate I would say that given the fact that [Rupert] Murdoch is going to have DirecTV, and he has an awful lot of sports, regional sports, and given that Brian has a lot of distribution and has several regional sports networks now-and given the fact that Brian still owns lot of stock in Cablevision that he could swap for Cablevision’s regional sports networks outside New York-it could well be that eventually you could see Comcast and News Corp. getting together and creating a sports service to replace ESPN.
TVWeek: Except that right now ESPN has a number of rights to national sports such as-
Mr. Malone: They have Sunday night football. I’m not a huge sports fan, but the only thing I watch on ESPN is Sunday night football.
TVWeek: They’ve also got the basketball deal with Turner, hockey-
Mr. Malone: There’s lots of basketball. Regional is stronger than national. So to me this may be ESPN’s Waterloo. If they push it too far, they could get to the point where everybody stands up to them, in which case the golden goose gets killed. I don’t know. They’ve been very, very, very aggressive on the rates. If you went out and asked the average household, ‘If you could have a three-dollar-lower cable bill, would you mind if you gave up ESPN?’ I would guess 85 percent of households would say, ‘You bet. Lower my bill, take it off.’ Fifteen percent who are really the sports fans would say, ‘No, I really like it.’ So it’s a political maneuvering thing, and maybe Brian or somebody says, ‘Well, we’ll carry it and whatever they charge us, that’s what we’ll charge our customers, but we won’t force our customers to pay for it.’
TVWeek: Let’s continue about rates. For many years you ran the biggest MSO in the country. Now you’re purely on the other side, as an owner of and investor in programmers. What do you think of the idea of a la carte pricing, which seems to have captured the imagination of John McCain?
Mr. Malone: If I was John McCain or the Commerce Committee, I’d be pushing for something that says, up to a certain wholesale price point, bundling is fine. When a channel becomes so expensive, when the wholesale price gets to a certain point, it should be required that it be unbundled and made a la carte. And you could tie in to that some kind of mandatory survey. You could even put the burden on the distributor who doesn’t want to carry it bundled, to go commission an independent survey. So Gallup or someone goes out and talks to customers and comes up with what I just described. And if fewer than 50 percent of the people want it at that differential price, then it must be unbundled, offered on an unbundled basis.
There’s got to be some break on this. Bundling for a 10-cent channel is critical that it be part of the mass offering. And most people would say, ‘Well, for 10 cents I don’t watch it, but maybe somebody out there does.’ But in my TCI days, I would have set a buck as the limit. When something goes north of a buck, adjusted for inflation, if there isn’t consumer demand to make it mandatory as part of the bundle, then the distributor has the option and the supplier must make it available on an a la carte basis at whatever price the distributor wants to pay. He can still charge whatever he wants, and make whatever split deal he wants, but it has to be available that way. That’s how I would have broken it. Otherwise, what you’ve really got is a tax.
Charlie Ergen is a good example here. Go talk
to Charlie and he’ll tell you that in New York he didn’t carry the Yankees. He said that he came to the conclusion that having a rate that was three bucks lower was more important to his customers, to 90 percent of the customers, than having the Yankees was to 10 percent. So he played the counter-strategy to what Hughes did with DirecTV. Hughes ended up paying three bucks for all their customers in the New York market, which was a huge amount of money for a very little, narrow, marketing edge.
The other thing we’ll see, with Rupert owning DirecTV, is much more aggressive competition, I think.
TVWeek: He’ll drop the price?
Mr. Malone: I don’t know whether it’s price. Not necessarily price. Promotion, content, technology. Rupert’s now had plenty of time to stretch his legs and get ready at the starting blocks, and I think he will be pushing technology evolution, content and be trying to develop new and promotable stuff. That’s his nature. He’s very aggressive. So Charlie’s got to be a little nervous about his market share vis-…-vis EchoStar. But as those two guys do get out there, they’re going to be stepping all over cable.
TVWeek: Satellite’s been pretty successful vis-…-vis cable. Looking forward, with Murdoch in the satellite picture, is satellite going to continue to make serious inroads on the MSOs?
Mr. Malone: Right today, of course, they’re capturing about a 105 percent of growth in video. So they’re still penetrating video. Their market share is growing rapidly. Cable is dropping.
I have satellite at home because I can’t get cable, but if I go to my son’s place in Philadelphia, he’s on the Comcast system. I look at what Comcast offers, and no way are you going to switch to satellite if you have them. The DirectTV offering is just not sufficiently compelling on the video side to offset what Brian has done in Philadelphia because he’s got virtually all the same channels, plus he’s got high definition of the locals, plus he’s got video-on-demand of the most interesting stuff. Plus he’s got high-speed data. So, no way am I interested in satellite there.
So it’s a race condition. Brian is perfectly prepared to give me a DVR, if necessary-if that’s an important thing to provide-and Brian’s got balance sheet and the technology smarts to fairly rapidly offer that same package as the satellite guys to his subscriber base. He may even be able to hold his own or even grow market shares, slowly, in terms of video. It’s such a competitive world that he’s also got to look over his shoulder at Verizon and what are they going to do with high speed data and all of that. So a company like Comcast, it’ll react quickly and keep up technologically, so is probably going to be fine, vis-…-vis satellite.
A weak cable company, a company in a low-density market, that company will continue to lose share to satellite.
TVWeek: Do you think the telephone companies, as they are partnering with the satellite guys, are getting more and more powerful?
Mr. Malone: The telephone guys are desperate to head off cable’s penetration of high-speed data. Because right behind high-speed data comes telephone-and cheap telephone-and that’s a killer for the local telcos. So it’s the best they can do. They have not been successful in doing VDSL and even their DSL is spotty, so they’ve got a hell of a problem. And the market prices of their stocks show it. This latest thing, where, if you own a telephone and a cellular phone you can offer transportability of phone numbers-that’ll help the phone companies on their hard-line service because it’s more convenient. So it’s a plus for them. The phone companies, they’re still big, they’ve still got a lot of cash flowing, they’ve got a lot of pension liabilities, so they’ve got a lot of issues. They’ve got a lot of debt. Their business is still capital-intensive and they’re losing revenue. Pricing is continuing to go down. Technology has made long distance cheaper, and cellular is taking the place of wire line for a lot of kids, for a lot of people. If the cellular service was better here it would happen faster, but, if Europe is the judge, about 15 percent of wire-line services have been disconnected. So the phone companies are really under pressure. Especially a telephone company like Qwest that gave up its cellular early and has been trying to come back-but forget it. So in the short run you can see the telephone companies out of desperation cutting DSL prices.
TVWeek: SBC in California is doing it like crazy.
Mr. Malone: And they’re starting to gain market share or recover against cable. And where cable is slow and weak they probably will be able to take a substantial market share and damage cable’s ability then to compete with satellite. Because if you’ve got DSL, maybe you go satellite instead of cable for the video. So it’s all like a race. For cable the race the last three years has been for deployment of high-speed data, and so the focus on high-speed data by the leading cable company is entirely appropriate because that’s where you lock in your long term.
TVWeek: And of course Liberty has extensive cable investments overseas.
Mr. Malone: We’re clearly the biggest player outside the U.S. in cable.
TVWeek: Your most recent dealings with a company in another country was with the French as a bidder for Vivendi Universal assets. Were you surprised [Vivendi] went with the NBC deal and didn’t go for the cash?
Mr. Malone: Not in the least. We were very close with the Vivendi guys. We were talking to them all the time. I think they always viewed us as a bidder of last resort, because we just couldn’t get to the price that they felt they wanted. They also saw us, to some degree, as tied with [Barry] Diller, and they didn’t really want to have the mud on their face of saying, ‘We take X and sold it back at 0.6X to a Diller entity.’
TVWeek: But they could have taken the cash from one of the other bidders as well.
Mr. Malone: Well, in all honesty, I think they really believed there was more value there. They always wanted the GE deal. And really, the whole name of the game was for us to hang in there as a bidder and help them get the GE deal. We would have liked to have bought it at the price we were offering, but we were at $11.1 billion, and they wanted $14 billion. We just couldn’t get there. So if they’d come back with 111/2 or maybe 12, we might have done it, but [Jean-Rene] Fourtou wanted 14. He’s a smart guy. He’s a good guy. He was very clear what he wanted from the beginning. And we just couldn’t get there. Nor could Edgar [Bronfman Jr.]. Nor could anybody. Edgar could have gotten there, but Fourtou would have had to [have] left a lot of money in it. And that didn’t make a lot of sense.
TVWeek: And I guess Marvin Davis couldn’t get there either?
Mr. Malone: I think it was the same thing. At the end of the day the guys who were going to pay cash were right in the price range we were at. Nobody could get to the 14 on a cash basis. Davis’ group, the only chance they had was if music was included, because they could put more leverage on music. If you could buy music cheap, you could afford to pay more for video and then you’d be there. But at the end of the day, NBC was the only one that had the promise of delivering to Vivendi the kind of ultimate value they were looking for. Fourtou had done a good enough job on the rest of his balance sheet that he had the luxury of taking equity and riding it.
TVWeek: Do you think you would have gone that route if you were in his shoes?
Mr. Malone: Well, it’s hard to say. If anybody can take the Vivendi assets and create extra value, it is NBC. They’re good guys. They’re smart guys. Definitely GE Capital can finance things better than anybody in the world. So if there is a gold ring in there somewhere, NBC’ll find it and Vivendi will benefit. And I think that’s what Fourtou is looking for.
TVWeek: Would you like to see Liberty do another kind of deal like that?
Mr. Malone: We’re opportunistic in that sense. We have quite a bit of liquidity, but the deals have to make sense, and there ha
s to by some synergy or logic to them. Our problem with Vivendi was there really wasn’t a lot of synergy for us in it. There was a maybe a little bit between Starz! Encore and the studio. But otherwise, we really didn’t have the right kind of synergies. Viacom would have synergies, so they probably would have been a legitimate buyer of some of the assets. NBC’s got a lot of synergies with them.
So from our point of view unless you are going to find a bargain-and there are few bargains in the world-the way you create a bargain is by having strong synergies between what you buy and what you already have. And there were times, maybe a year ago, when the market was so negative that there were bargains. But today that’s not the case. I don’t see any bargains out there. I think everything is pretty fairly fully valued, and so the only way to justify paying the market price, or a premium to the market price to buy something, is if you can create value by some combination of something you already have.
TVWeek: One last question: You were embroiled in a big, ugly lawsuit about Starz! Encore and its affiliation agreement with Comcast. That’s been settled now. Any lessons learned there?
Mr. Malone: Oh, huge lessons, huge lessons learned. I hate litigation. Especially when you are litigating with your big distributors, with people you have to do business with. We really should have sat down, really with AT&T, and worked it out. And if we hadn’t worked it out with them, at least we should have sat with Brian very early on and worked it out and been willing to take a haircut. Because the longer those things go, the worse it gets. Unless you are absolutely sure you are going to win-and you’ve got to know if you win, is it a Pyrrhic victory?
So the lesson is, try and work it out earlier. Comcast believed that the affiliation agreement that they negotiated with Starz! Encore gave them the full right to blow out the AT&T contract. And they had every reason to believe that. That’s what it said. And the way they looked at it, the deal between Starz! Encore and AT&T was an affiliation agreement. Of course the way Starz! Encore looked at it, it was not an affiliation agreement. It was deferred payment for a whole bunch of things that Encore did for TCI, including giving them a lot of money.
So what you really learn is, if it’s a duck, call it a duck. Book it as a duck and deal with it as a duck. Don’t try and turn a duck into a swan. We’ve all learned a lesson here from an accounting point of view, which is deal with these things straight up.