Does an investment banking firm know more about the television business than the rest of us? The good folks at Needham & Company, LLC, certainly want you to think so. Either that, or they just want to get their company’s name on as many blogs as possible. (Hey, here’s one more! Good job, guys!)
Needham certainly moved the needle with this report on the future of TV, which suggests that the best path forward for pay TV is to grow the cable bundle rather than shrink it. The reasoning seems to be that more channels means more content, which leads to more ad space and, thus, more money. I’ll spare you the obvious Underpants Gnomes joke here and instead focus on a few of Needham’s observations that should be questioned.
Let’s start with this one on page 20:
Despite calls for unbundling because it would give consumers more choices, our math concludes that approximately 50% of total TV ecosystem revenue would evaporate and fewer than 20 channels would survive because a la carte forces consumers to bear 100% of the cost of the channel, whereas today TV advertisers bear 50% of the cost.
This leads me to my first question:
1.) How exactly is having only 20 pay TV channels a bad thing?
Bruce Springsteen was singing 57 Channels (And Nothin’ On) back in 1992. Now we have hundreds of channels, and the vast majority of them don’t have much of an audience. What’s more, the vast majority of those hundreds of channels are owned by less than a dozen large companies — Comcast, Disney, Fox, Time Warner, Viacom, CBS, AMC, Discovery, E.W. Scripps, and Hearst. There’s your cable bundle. Ten companies control at least 90% of the channels on your pay TV dial. Why exactly do these companies need 10-20 cable channels each? Serving niches would seem to be the obvious answer, until you realize that most of that “niche programming” ends up looking like this:[youtube:http://www.youtube.com/watch?v=OQRG8YaXDK8]
That PBS parody speaks volumes about the current state of the cable bundle, which seems more than happy to feed us as much Sharknado as we can handle. Sure, Netflix is flooded with garbage as well, but it has more than enough compelling content to keep growing its customer base, and it costs a lot less than the cable bundle. That’s why Netflix has 28.62 million streaming video subscribers, roughly the same number of subscribers as Time Warner-owned HBO.
Let’s bring this back to sports, though, since sports keeps tens of millions of homes tied to the cable bundle. The author of this paper doesn’t seem bullish on the prospect of ESPN become separated from the cable bundle.
We believe that only 20 million “super-fan” homes would pay $30/month for ESPN’s group of channels. If 20 million homes pay $30/month, this is equivalent to 100 million households paying $6/month today. Therefore, we would expect demand for ESPN to fall below the critical 25 million subscriber threshold required to generate advertising revenue, implying $3 billion of lost ad revenue to the sports (and TV) ecosystem.
That leads to my second question:
2.) How exactly is Needham calculating these numbers for ESPN?
There are roughly 100 million households paying for TV. According to this Harris Interactive survey, 43% of all pay TV subscribers say they keep paying specifically to watch live sports. So where does this 20 million figure come from? That’s a huge gap between 20 million and 43 million. Who are these 23 million people who want to watch sports but wouldn’t pay for the ESPN channels as a premium service? They can’t all be hockey fans, can they?
Perhaps they wouldn’t pay $30/month for ESPN, but why would that be the price, when a service like HBO generally costs between $15 and $20 a month? And why would they pay for just ESPN, rather than a sports bundle that also includes Fox Sports 1, NBC Sports Network, and other sports channels?
Probably because those ten content companies that control the cable bundle don’t want to let that happen…
We believe that the 20 million households that are “super-sports households” would disconnect the additional $40/month for the entertainment bundle, implying a loss of approximately $10 billion in subscriber revenue to the TV ecosystem.
Of course, the flip side to this argument is that, if 20 million non-sports households decided they didn’t want or couldn’t afford the cable bundle anymore because of the rising price of sports, the TV ecosystem would lose $16.8 billion. (20 million * $70 * 12 months) This scenario wouldn’t happen overnight, but it’s not implausible in the current environment, and it grows ever more likely as online options grow more robust — something the author of this report claims to “lose sleep over”:
We worry that the consumer price/value disparity of $8/month with no commercials vs. $70/month with 14-minute commercial loads is too large and that it encourages cable subscribers to disconnect. Is Netflix a bundle of the best content on Earth that undermines the pricing power of every other distribution window? We wonder…
This is likely the main reason Hulu’s co-owners — Fox, Comcast, & Disney — are keeping Hulu Plus from blossoming into a true competitor to Netflix. They’re terrified of cannibalizing their core business. It might also be the reason this report is so bullish on TV Everywhere as a value-add proposition, although that raises other questions this report clearly wasn’t designed to tackle.
So what are we to make of this report? Is it industry propaganda designed to make us think the current pay TV model really is a much better value than an a la carte model? Or is it merely an attempt to boost the stock prices of 21st Century Fox and Yahoo, which the report encourages investors to buy on page 24? Either way, this report seems quite comfortable promoting the current pay TV bundle as a great value — a point on which nearly half the American public disagrees. The disconnect between these two opinions is striking.