Digital Economics: TV and cord cutting

This is a multipart series on digital economics. More here.

So what about the future of TV? There’s a lot of talk of “cord cutters”, people who don’t subscribe to Cable or Satellite, but get their TV from broadcast over the air and internet video. And long term that certainly makes sense. But it’s less clear exactly how we might get there, and who the winners and losers will be. Let’s take a look.

First some basics on where Cable adoption stands today:

90% of US Households pay for cable or satellite TV (103 out of 114 million US households). 90%!
Cable/Satellite TV market penetration is roughly flat, not (yet) dropping
Cord Cutters are hard to measure but maybe 2-3% of households
Cable bills right now average $86 a month and are historically rising by 6% a year.
Cable companies are pricing their services “at a price that discourages you from taking broadband only”. For example, with my data plan at Comcast I pay $57 per month for high speed internet. Then on top I pay an additional $21 to get just the local set of TV channels I could have gotten free over the air via broadcast. At $21 a month I didn’t bother to buy and install an antenna, though it would pay for itself in a year or two. The trick here is that internet access is becoming the cornerstone thing cable companies sell, and they discount everything else to keep you locked in.

Second, some points on how the TV market is structured today, many taken from this very nice NT Times article.

Cable bills are large due to bundling (which I talked about in my zero marginal cost post). To get the thing you want, say HBO’s Game of Thrones, the most pirated show on TV, you have to buy HBO year round as part of your cable bundle. But you can stomach this because in your bundle you get a bunch of other stuff that makes you feel it’s an acceptable deal. So even though in practice the value of the other stuff is worth less to you than if you could buy a la carte, you still pay up.
Now even an AMC cable hit like Breaking Bad only pulls in 3 million viewers. Yet AMC has 80 million subscribers since it comes bundled with most cable packages. So 25 times as many people pay for the AMC with their cable bundle than watch any particular AMC hit show. And in fact AMC gets 40 cents per subscriber per month, so they rake in about $30 million a month. Bundling is a good business.
Viacom had $8 billion in revenue last year with a 49% profit margin. This margin is better than Apple’s infamously high but declining 35% margins. In fact most companies have a single digit profit margin percentage on revenue. Bundling combined with cable’s near monopoly on internet access allows them to print money.
The bundling model explains why people who think HBO is stupid not to sell Game of Thrones a la carte are wrong, at least from a tactical business perspective. HBO bundled inside cable is pulling in far more revenue than a la carte ever could. In fact the way it works today is “HBO Go”, the HBO streaming service, is exclusive only to people who already buy HBO via cable. So not only is HBO not allowing you to buy Game of Thrones a la carte, but it doesn’t even allow you to buy HBO outside of a cable subscription. This is true even though it already has the streaming service product “HBO Go” on the market. One reason for this is “channel conflict” as they say in economics – the cable companies would go crazy fighting with HBO if they had to compete with an internet version not exclusive to cable. But another reason this hasn’t changed is that cable rakes in far more than a pure internet play would, at least for now. One clarification here is that Game of Thrones does eventually come out for a la carte download, but is timed the same as the DVD release dates. Which are about a year after original broadcast. Older shows are available for download because from a license point of view everyone treats them the same as the DVD model which is already worked out.
Finally, we’ve talked a lot about TV shows, but one of the main pillars of cable is actually sports. Sports are perfect for the internet age because they are extremely valuable in real time, but pirated digital copies after the fact are nearly worthless. Sports have antipiracy built in. But it turns out that ESPN, from an economics point of view, is actually quite similar to HBO. In particular, you pay for a bundle even though all you really want to watch is a particular team in a particular sport. So in practice sports have the same bundling economics as other cable TV, it’s just that they have stronger innate protections against pirating, which may help them charge a bit more long term.

So with that background, where are things headed?

Cord cutting is coming, but much more slowly than internet wishful thinkers will be happy with. It could take another decade to go from the current 3% of cord cutters up to say a 30% number. The cable companies already price their high speed internet to subsidize their cable TV bundles, so unless the mobile companies jump in on wireless broadband, it will be very hard to kill cable’s lock on customers. They’ll just price the TV portion of their bundle low enough to keep it going.
Incremental cord cutting will have to start destroying the cable business model before we see a company like HBO make HBO Go available to non-cable subscribers. That’s how it happened in music, you first destroy the old model’s profitability. Only then does it make sense to convert to the new (less profitable) model. HBO and cable are in no hurry to move from their cushy 39% margins to internet streaming 10% or less margins. Every cable customer is worth multiples times what an internet customer is worth. So every year they delay the transition is another year of gravy. And when the shift happens, cable companies and production companies like HBO will see their stock price tank as they are pushed into a much lower margin distribution channel. Like I said, it might take a decade.
Even though it will take a long time for show offerings to come directly to the internet, it’s likely to be a rather sudden transition when it finally does happen. Why? Because the companies behind the shows already have products like HBO Go they could flip on today if they want internet only customers. ESPN is similar. These people aren’t dumb, they know what’s coming and are getting ready. They just want to eek out a few more years of high profits. But once the conflict between show providers and cable companies turns into a war, every content provider will be forced to jump. Note that even then, HBO is likely to still want to bundle their product, so they may continue to hold a very high price point for a la carte hits like Game of Thrones or delay their availability to encourage you to pay for a subscription to the full HBO Go bundle. Bundling won’t go away, but at least you’ll be able to get bundles outside of the cable system.
Cable and Satellite TV will be around for a long time even in the age of cord cutting. A good analogy is that phone land lines are a generational thing, where 50% of early 20’s people don’t have land lines but 95% of people 65 and older have them. Most people who’ve always bought cable will continue to do so, and it will take decades for the demographic wave to move through.
Who are winners and losers? The only sure thing is the whole TV ecosystem will make far less money with unbundling. But all the main players may stick around and live on. For example, Comcast already offers “xfinity”, which is a streaming way to see your Comcast cable shows on your tablet or phone. For now you can get this only if you already have a cable subscription of course, but at a technology level it’s not that different from Netflix. Comcast could easily morph into a Netflix style provider to cord cutters, plus continue to subsidize this with monopoly internet access and do well enough. It’s obviously their intent at this point. In fact, Netflix could be bought by Viacom for that matter. Amazon also has big intentions in streaming video as well. So it’s unlikely any of the current players will implode, though their fortunes will shift.
What about even more disruptive technology like the long rumored Apple TV? My take on these types of new systems is they’ll consist of two parts. First a box like you already have today, so Apple TV, Hulu, Roku, Tivo, Playstation, or high end Blu Ray player/DVR. Second a controller app running on your handheld touchscreen device, which will run on your existing phone or tablet or in some cases on a dedicated touchscreen android remote. With the exception of a “we make everything company” like Samsung, I don’t think we’ll see companies like Apple or Hulu or Tivo make lower margin TV monitors themselves. How it’ll work is you’ll use your handheld touchscreen device to voice search (this is key) or type search for a show, say Mad Men or even something on YouTube. Then you’ll see where you can get it: Amazon, Apple, Cable DVR, Netflix, YouTube, Vimeo, etc. And with a touch you start watching. And you’ll be able to do cool things like flick a channel showing on your handheld across to the big TV screen. The downside is this does nothing on the content side. Companies like AMC and HBO will still have the same business model conflicts and restrictions as before, though undoubtedly companies like Apple or Amazon will try to get special deals. The point here is these new TV user interfaces may speed up cord cutting by being easier to use, but in reality they’ll just be super cool remote controls.
Finally, cord cutting will end the “golden age” of TV we’re living in now. Currently critical and popular cable successes like Mad Men, Game of Thrones, Breaking Bad, etc., subsidize the larger cable ecosystem with 39% margins. This pays for lots of failed experiments, which is what you need to produce a critical and popular hit TV show that’ll stand the test of time. And when that money goes, the “hollow middle” will creep in. The few hit shows will be even bigger hits, but the revenue from the failures will be nothing. It’s a bit ironic that many of the people screaming most to make shows like Game of Thrones available a la carte online don’t realize that when they get their wish they’ll destroy the economic model behind the shows they love.