More than 40 years after Ted Turner started the first basic-cable network (WTBS in 1976) and nearly 35 years after McKinsey consultant Roger Werner coined the good idea to charge distributors for carriage (ESPN in 1983), pay TV programmers are faced with a new dilemma.
Do they jump to the fast money from subscription video-on-demand pioneers Netflix, Hulu and Amazon Prime Video? Or do they stick with a financial model that has sustained the business almost since its beginning, hoping the monthly affiliate fee and linear ad fees hold firm?
What’s been shocking to most cable programming veterans is how quickly these services have morphed into such big competitive beasts. In 2010, when asked about Netflix, Time Warner CEO Jeff Bewkes famously said: “It’s a little bit like, is the Albanian army going to take over the world? I don’t think so.”
Now for many analysts, SVOD is quickly emerging as the dominant model in the pay TV business. While pay TV networks have watched their subscriber bases erode over the past three years — at an average of 2% to 3% per year — Netflix has grown by leaps and bounds. By March 31, Netflix was expected to reach 50 million domestic subscribers, a milestone it hit in just nine years. In contrast, it took the cable and satellite TV business 15 years to reach the same point.
NETFLIX RISING
Netflix’s ascent has been fueled by a new approach to the TV business: One that’s commercial-free, on-demand and loaded with original content. Netflix has never been afraid to spend, and it’s expected to raise its overall content budget from $6.5 billion in 2016 to $8.3 billion this year, more than doubling that expense line to $17.5 billion by 2030, according to Sanford Bernstein media analyst Todd Juenger.
In a recent note to clients, Juenger estimated Netflix would finish this year with 53.9 million U.S. subscribers, growing to 60.8 million by 2020 and to 77.4 million by 2030.
Netflix is becoming a force outside of the U.S., too. Juenger estimated the service will reach nearly 61 million international subscribers in 2017, rising to 214.1 million in 2030. And that’s not taking into account the largest potential SVOD market of them all — China.
Netflix is just the largest member of a new class of SVOD service providers. Amazon Prime Video is estimated to be a distant No. 2 with 50 million subscribers worldwide, followed by Hulu with 12 million customers. Hulu later this year is expected to launch a new over-the-top service called Hulu Live, complete with SVOD and linear networks, for under $40 per month. Google’s YouTube in February announced a new OTT service, YouTube TV, which the company has said it intends to launch “soon.”
All of this has prompted some analysts to sound the alarm for conventional pay TV networks, warning that TV’s business model is rapidly shifting toward on-demand. Juenger has been one of the sharpest critics of traditional networks, warning Viacom and other programmers five years ago that reliance on short-term SVOD money could erode viewership for their linear channels. That’s exactly what happened.
Now, the influential analyst sees SVOD as the next dominant model for packaging and presenting pay video service. SVOD, he said, is tailored to today’s content viewer in that it is on-demand, easy to access and search, inexpensive and either has limited advertising or is completely commercial-free. That combination, coupled with what Juenger called overpriced conventional networks — which have enjoyed margins of 30% to 40% for decades — and traditional linear, one-to-all simultaneous distribution could be headed for the scrap heap.
“The only reason TV networks even exist in their current form is the distribution technology required the organization of content into a simultaneously distributed, scheduled stream,” Juenger wrote in his recent report. “If broadband had existed in the 1950s, we doubt TV would have evolved the way it did.”
There are some obvious holes in the theory that could help preserve the current model. For starters, SVOD doesn’t (yet) offer sports or live events, which could keep broadcasters and pay TV networks going for a few years. And though younger viewers aren’t watching TV as their parents did, they still haven’t completely gotten up from the couch.
CASH-FUELED INERTIA
A shift to dominance by the SVOD model also won’t happen immediately, as there’s too much money at stake. Advertisers spend billions of dollars each year for the broad reach that TV gives them; distributors pay billions in affiliate fees to carry those networks; and millions of people still sit down each night in front of their TV sets to watch everything from nightly news programs and sports to comedies and dramas from general entertainment networks.
But even if migration takes years, TV-watching trends are undeniably changing, especially among younger viewers. Just as their parents migrated from four broadcast networks to hundreds of niche channels and sports networks, younger viewers are watching on the go, on different devices and on-demand. You can bet every network executive worth his or her salt is grappling with how to keep them watching.
Pivotal Research Group senior research analyst, advertising Brian Wieser agreed that the landscape is changing, but added that any shift toward the SVOD model would be gradual.
“Over a multi-decade period, it’s possible,” Wieser said in an interview. “I don’t think it will change that quickly.”
Wieser noted that sports programming is a big factor, as is the fact that most SVOD customers also have a monthly pay TV subscription. He noted several studies reporting that SVOD customers on average watch about 70% as much TV as non-SVOD customers.
“Its not like they’ve abandoned it,” Wieser said of traditional linear and nonlinear network programming. “But there is possibly a significant share of entertainment programming becoming accessed through SVOD services.”
That, too, depends on several factors. Netflix, Amazon and Hulu could triple their original content spends and theoretically triple their customer share, Wieser said. But that only works to a point.
“The math won’t work for them at some point,” Wieser said. “Incumbent networks are not giving up investing in original content anytime soon.”
And those networks are spending. According to Juenger, NBCUniversal and The Walt Disney Co.’s broadcast and cable networks each almost doubled Netflix’s content spend in 2016 — $11.2 billion for each of the programmers, versus $6.5 billion for Netflix. But the SVOD pioneer has been increasing spending at an accelerated rate — 27% annually since 2012, according to Juenger, versus 3.1% for NBCU and 5.7% for Disney.
Traditional TV programmers are beginning to see apocryphal signs. As more and more viewers opt for on-demand content and less so-called “appointment viewing” is happening outside of sports and one-time events, networks are modifying how they present content.
Viacom, which has seen its younger-skewing viewership move toward SVOD and nontraditional viewing environments, announced a fivepoint plan last month that will focus on six core brands, a move some analysts said is a step toward breaking up the programming bundle. Other networks have started to offer targeted OTT versions of their programming to viewers. For example, AMC has a horror-themed service called Shudder; NBCUniversal has launched a comedy-centric service called Seeso; and Turner operates FilmStruck, a service targeted at movie buffs.
While the focus may be on giving consumers what they want to watch when they want to watch it, Wieser added, that applies to linear programming as well.
“In entertainment programming, there is active viewing — which in general will not be appointment viewing — and passive viewing, which accounts for a significant share of TV consumption,” Wieser said.
Passive viewing can range from just having the TV on as background noise, watching programs while simultaneously online or on the phone, or just flipping through channels on the set.
POWER OF PASSIVE VIEWING
That last aspect — simply channel-surfing through genres — accounts for a big chunk of overall TV viewing, Wieser said.
SVOD services in turn are increasingly adding original programming that was once the bailiwick of traditional programmers. Netflix has commissioned action shows like Marvel’s Daredevil, reality competition shows like Ultimate Beastmaster, talk shows like Chelsea and cooking and lifestyle programming like Cooked and Chef’s Table. Amazon has delved into children’s programming with Wishenpoof and the stop-motion animated Tumble Leak. Hulu is debuting a big-budget drama series The Handmaid’s Tale later this month and has dipped its toes in the reality and news genres in the past.
Adding to the pressure is the decline in linear viewership, which has reduced audiences for conventional ad-supported TV since early 2014, according to Nielsen. Juenger wrote that roughly corresponds to when Netf lix began becoming easier to access on the living-room TV screen.
As a result, he estimated that primetime TV ad impressions in the so-called money demographic of adults 18-49 have dropped 18% since 2013, and are declining at a mid-to-high single digit percentage rate.
Networks are also losing subscribers to a combination of cord-cutting and so-called skinny bundles that exclude some networks from their packages. According to Nielsen’s cable-network universe estimates for April, excluding virtual multichannel video programming distributors like Sling TV and DirecTV Now, median pay TV network subscribers declined by 2.7% in the period, despite a 1.7% increase in total TV households for the month.
And as viewership declines, Netflix and Hulu are busy hammering out deals with MVPDs to make it easier to access their services. Already, Netflix and Hulu are accessible through TiVo set-tops and have reached set-top integration deals with RCN and Grande Communications, Comcast, Altice USA and others.
Comcast chairman and CEO Brian Roberts highlighted the impact of such an inclusion on the cable operator’s February earnings conference call. Speaking about 90 days after Comcast had embedded the Netflix app into its X1 platform, Roberts said 30% of all X1 customers were already accessing Netflix via the set-top.
INTEGRATION’S IMPACT
“That’s an incredibly quick take rate for something we barely have advertised,” Roberts said on the February call. “And it’s stable and working, and people love it.”
The Netflix integration had a halo effect on other on-demand services, Roberts added. In January, on-demand usage was up 35% year-over-year, the best January Comcast ever had in that metric.
UBS media analyst Doug Mitchelson said more deals like the Comcast-Netflix partnership are expected in the future, for the simple reason that they help reduce churn for both sides.
Other MVPDs are expected to join the party, which may or may not bode well for traditional programmers.
Juenger said he sees the integration of the Netflix app in set-tops, remotes and other devices as the final piece of the SVOD pioneer’s position as the “anchor tenant of the SVOD era,” getting prime shelf space in set-tops and/or video storefronts.
“Much like with shelf space on mobile apps, the space is very limited,” Juenger wrote. “Given all of Netflix’s other scale advantages, we think it’s very unlikely that Netflix will get kicked off of these devices, and there is not much room to add competitors.”
Netflix CEO Reed Hastings, on a February podcast with venture capital and tech guru Marc Andreesen, made no bones about his feelings as to the future of linear TV. On the podcast, Hastings mentioned that Netflix had shifted its $200 million-plus ad budget from linear TV to online a few years ago, mainly because they wanted to target shows to individuals. A similar fate could be in store for linear networks.
“In general, linear TV has been amazing — we’ve had it for 50 years — but it’s like the landline phone,” Hastings said on the podcast. “That was an amazing invention, too. Now it’s been replaced by mobile phones over 30 years. And linear TV, 10-20 years from now will disappear.
“Once in a while, you’ll see it in a hotel like you see a fixed-line phone, but everyone around the world will be doing Internet video, as well as Internet everything else,” Hastings said.
