After Streaming Kills Cable, Where Will the Content Come From?

Mutually assured survival

To echo a familiar refrain, consumers are mad as hell and not about to take it from cable companies anymore! Networks are dinosaurs who think the big asteroid in the sky called Netflix is their god, but it’s coming to kill them all! The next Walking Dead is already on YouTube!

But here’s the reality: Netflix is not going to kill cable. Nor is Amazon Prime. Nor is the mythical Apple TV. Because if they do, they will essentially be sawing off the limb on which they have built their businesses: content funded by the very cable model against which they offer an alluring alternative. And wow, is it ever funded—programming is expensive, as you may have heard.

Cord cutting may be on the rise, but it’s nowhere near the level of an existential threat to the cable industry, despite the hype. Nielsen’s fourth-quarter cross-platform report counted more than 5 million “zero-TV” households in 2012, up from just over 2 million as recently as 2007. Those are small numbers given the 110 million TV household universe.

That said, cable operators (or MVPDs, for multichannel video programming distributors) and the networks they carry are dragging each other kicking and screaming toward the rich seam of multiplatform video distribution that Netflix and Amazon are already mining as fast as they can. To be sure, there’s a new economic model for content coming, but it’s big enough to allow all parties to survive, perhaps even thrive.

Here’s how: The linear programmer’s dream for Netflix and its ilk has always been that it becomes a back end—a kind of syndication market for cable programming, which until now has simply vanished into the ether after nominal DVD sales. That would enable programmers to keep their precious dual-revenue stream model (advertising and subscriber fees) with this third additive option, too.

If, as the doomsayers predict, consumers abandon cable en masse, the ecosystem will become so damaged that high-profile programming becomes impossible to fund. And no company with a stake in the entertainment business wants to contemplate that kind of disaster.

A MUTUAL NEED
There are no ratings numbers for Netflix, but its relationship with cable is definitely symbiotic. “New viewers are finding [our] shows on a digital service, catching up on prior seasons and then tuning into AMC for new seasons in greater numbers, many for the first time,” Josh Sapan, president and CEO of AMC Networks, told investors last May after the net’s flagship shows The Walking Dead and Mad Men each saw huge ratings gains in the wake of the decision to stream previous seasons on Netflix. Presumably, that means Netflix viewers would be pretty upset if they couldn’t watch Walking Dead a season late, too.

The feeling of mutual need is reciprocal. Netflix CEO Reed Hastings last week tipped his hat to the industry on which his business is feeding. Though Hastings calls the linear TV model “ripe for replacement” in an 11-page manifesto, even he doesn’t think Netflix will be the only game in town. “TV Everywhere will provide a smooth economic transition for existing networks,” he predicts. “The same consumer who today finds it worthwhile to pay for a linear TV package will likely pay for a ‘linear plus apps’ package.”

Hastings, too, agrees that the trouble with traditional MVPDs is lack of convenience, and other networks have demonstrated their agreement with that thesis while pointedly stepping on Netflix’s toes.

FX announced at its upfront this year the rollout of FXNow, a complementary authenticated digital service à la HBO GO that includes a section called Movie Bin. The catch: FX has negotiated exclusive windows on its movie content. So while it will certainly be happy to provide episodes of Archer to Netflix, it will also be taking away, for example, Thor from its digital rival. (Windowing wars were a huge deal when HBO was in its ascendancy and competitors like Starz were trying to challenge it; they appear to be on track for a return engagement.)

It’s easy for Hastings to sound so magnanimous. Separately last week, Netflix announced on an earnings call that it had passed Time Warner powerhouse HBO in subscriber numbers for a total of 36 million U.S. customers (it was big news when the service passed 10 million subscribers in 2009). The company’s stock jumps every time it makes a move. Netflix announced last month it had streamed 4 billion hours of video and its share price spiked 3 percent; when it announced the latest customer base, the stock topped $200.

Many see Netflix and services like it (Amazon Instant Video, for example) as the land of milk and honey for the angry hordes ready to flee tyranny—that is, paying an average $160 a month for cable’s triple-play offering. Netflix declined to comment for this story, but Hastings has in the past described the model for the cable industry as “managed disappointment,” adding that his company is happy to take advantage of customer dissatisfaction.

Amazon, too, is trying innovative approaches to programming, including content creation. “Amazon released 14 original pilots; which series end up coming from those will be driven in part by what reception they get from consumers,” says Shawn DuBravac, chief economist and director of research at the Consumer Electronics Association. “When and if they watch them, if they pass them around to their friends—all that information can be captured and analyzed.” It is, DuBravac says, “a more mathematical” approach than the traditional network model.

THE ALTERNATIVE
Networks aren’t blind to that kind of appeal, but there’s other math to be considered. TV programmers understand the strengths of alternatives to traditional cable—they’re easy to use, filled with content and available on any device you’d care to name—but find themselves powerless to match its lateral reach, because their content relies heavily on ad support, and advertisers are used to buying Nielsen GRPs, for which there is no direct equivalent on digital platforms.

“The real issue is that we’re deploying multichannel video services on devices that the industry doesn’t make” or own a stake in, says Jeremy Legg, Turner Entertainment’s svp of business development and multiplatform distribution. Legg has worked with the cable industry’s greatest hope to compete with digital streaming on a level footing: TV Everywhere.

TV Everywhere isn’t one particular service. Rather, it’s more of a rallying cry—a call to all networks and MVPDs to put their content into a VOD package just as friendly and intuitive as Netflix, with more big-ticket programs and movies, and full ad support. Ads are, admittedly, a sticking point. It’s much harder to measure digital viewing than TV viewing, and it’s hard to make sure shows are being watched by someone who actually pays the cable bill. “Historically, whether you were talking about linear video on demand or other services, the set-top box was authenticating people—and you can’t stick a set-top box on an iPad or a mobile phone or anything else,” says Legg. “The industry has to make authentication just as seamless on devices it doesn’t make as it is on devices it does.” 

That has been difficult, to put it mildly. For a while, not all content creators were on board with TV Everywhere. Some saw services like Netflix, which pay hefty license fees, as an easy way to double dip on content costs. They got license fees from Netflix, CPMs from advertisers and carriage fees from MVPDs.

But that strategy, several network insiders told Adweek (none would comment on the record), is not viable in the long term. If a show is available on an $8-per-month service and it sits near enough in time to the same window when it is available on cable, then cable will obviously lose, because consumers will come to believe that all their favorite shows can be made for $8 a month—which, of course, they cannot. “Netflix’s monthly fee is how much it would cost to make one really great channel,” one exec said. One popular network, ESPN, accounts for more than $5 of your cable bill. 

Of course, subscriber fees are a whole new can of worms. Briefly, they’re the portion of a cable bill that goes directly to the networks, and they’re always going up. MVPDs are quick to point out that rising cable bills can be traced to increased sub fees, but John Bergmayer, senior staff attorney at consumer advocacy group Public Knowledge, makes the point that “content companies are only able to charge those prices because they know the price will get passed on to cable customers, because the consumers don’t have another choice.” Cable companies have divided the country up into little fiefdoms where there’s usually only one provider, so consumers upset about exploding bills are stuck. “When you don’t face competition,” Bergmayer says, “there’s really no incentive to be efficient.”

So for TV Everywhere, networks have to provide the incentive to roll out new and better equipment and higher end digital services. The growing presence of TV Everywhere “is essentially part of the consideration set of doing a carriage renewal in the industry,” as Legg explains. “I don’t think it’s coincidental that we’re seeing these around the announcements of carriage renewals.” The price of that, of course, may be that there’s a less pronounced rise in carriage fees for a few rounds of negotiations.

Content fees are a concern for digital-only providers, too. Those dumping money into Netflix stock probably aren’t taking a close look at the company’s SEC filings. Revenue in 2012 was a whopping $3.6 billion, while net income stood at just $17 million. One reason for that disparity is the ballooning costs of all-important content agreements, itemized in the fine print of Netflix’s annual report: As of Dec. 31, 2012, Netflix’s obligations to its licensors was comprised of $1.3 billion itemized on the balance sheet as “current content liabilities,” $1.1 billion designated “non-current content liabilities” and $3.2 billion in “obligations that are not reflected on the Consolidated Balance Sheets as they do not yet meet the criteria for asset recognition.”

And those costs are going way, way up because rights holders are getting warier about the long-term consequences of providing consumers with a cheaper and more convenient way to consume ad-free video. The industry isn’t interested in bringing carriage prices down—not yet, at least—or in removing advertising, so it is focusing on convenience. And that’s what TV Everywhere has been about.

BEWARE THE STATUS QUO
There is some justification for the cavalier attitude toward ad interruptions and rising costs. The U.S. economy, as one programming vet notes, just bottomed out as badly as it has in decades, and yet the video industry barely blinked. Cable is one of the last things consumers cut when tightening their belts.

Pat McDonough, Nielsen’s svp of insights analysis and policy, concludes that consumers are simply adjusting to ad-supported DVR usage with surprisingly little fuss. “They’re adopting the VOD with fast-forward disabled,” she says. “That’s kind of their expectation for programming—I watch TV, I watch commercials.”

The deal breaker, networks believe, is the level of ease. Just as iTunes proved that one could compete with free in the music world, TV Everywhere initiatives are setting out to show their checkmate move will be a cable package allowing consumers unlimited access to recent episodes of their favorite programs. One reason that dream may not have been realized on a cable box is that MVPDs have been so slow to adopt them, because they perceive the networks’ demands for more service as leverage in carriage negotiations, rather than a call to unite in the face of an existential threat.

The MVPDs are playing ball—though rarely without prodding. The growing presence of TV Everywhere “is essentially part of the consideration set of doing a carriage renewal in the industry,” Legg says. “I don’t think it’s coincidental that we’re seeing these around the announcements of carriage renewals.” The price of that, of course, may be that there’s a less pronounced rise in carriage fees for a few rounds of negotiations.

Something has to give, because some MVPDs are responding to the effects of churn. For example, despite massive profits ($2.15 billion in 2012), Time Warner Cable’s COO Rob Marcus told Bloomberg last week that the company plans to provide “fewer channels and fewer features” to consumers in an effort to squeeze more profits from its shrinking number of consumers (11.9 million in Q1, down 119,000 versus Q4 of last year).

That kind of reaction to adversity will no doubt only serve to drive more subscribers into the waiting arms of the Netflixes and Amazons of the world. Should that come to pass, everyone loses.