Why Custom Fios Matters to ESPN
How We Got Here
Since the dawn of the television era, content providers and distributors have not only worked together to monetize the process, but also feuded over who made what. Keeping this extremely basic, the content providers, e.g. ABC, NBC, and CBS, made money in two main ways; affiliate fees and advertising.
Affiliate fees was an amount the national network would charge a local station to “carry” their signal and broadcast it to that market. Fees could vary depending several factors, most notably size of the market. Most of this money was used to fund content development and wasn’t the main revenue driver for the national networks. This is basically how the radio networks worked prior to TV and still do today.
Advertising became the key aspect of this technology, be it radio or television, because the local stations had to make money as well. Timing slots were standardized to sell advertising spots to generate revenue. If you watch your programming closely you’ll notice at certain points during the show you’ll see more national ads, like beer commercials or McDonalds, and at other times you’ll see all local ads, like plumbing services or car dealerships. The local stations can sell any ad they want in those local slots, while the national networks make their revenue off the national advertisements.
With the introduction of cable television this model didn’t change too drastically, all that changed was who provided the content. Unlike the days of only three stations on the dial, now anyone could start their own network and sell it to a provider for distribution. Within those deals, which still exist to this day, the major revenue streams are identical:
- Affiliate or Subscriber or Carriage Fees are paid to the network based off how many subscribers purchase the network via the provider.
- Advertising is sold by the network and the cable provider for revenue as well.
The main difference is that where advertising was the largest revenue stream in the past, now cable providers were charging a monthly fee to customers just to have content delivered to their home and it didn’t rely upon the customer watching it. No matter what, the cable provider would make a consistent stream of money off of each subscriber. The race was on to sign up as many subscribers as possible.
To do this they had to lure them with channels. Offerings swelled in an effort to provide more options than a competitor. This drive for size funded a whole new subset of niche channels into the marketplace as everyone tried to get in on the growth. Networks who were already successful were also able to start leveraging their affiliate fees as this competition heated up. The channels that people wanted most garnered the highest affiliate fees.
As cable providers consolidated control a second fight started to dominate as much of the bandwidth to the end user as possible. And, just like food companies develop copycat products to take up more shelf space at the supermarket in hopes you buy their box instead of the competition, networks started to consolidate and leverage their strength by packaging multiple channels together. A subscriber may only want MTV, but to offer a popular channel like MTV a cable provider had to take all of Viacom’s networks. With each network having its own affiliate fee attached, the cost to the consumer to just receive one channel she wanted started to rise exponentially.
How Does This Effect Sports
According to the FCC, in the eighteen years between 1995 and 2013, prices for expanded basic service in the US had a compound average annual growth rate of 6.1% per year, twice that of inflation. That means if cable cost a subscriber $50 in 1995, it cost $145 in 2013, all due to the swelling of channels that nobody watches, but everyone is required to receive and, importantly, pay a subscription fee.
SNL Kagan researches the cable industry and provided a study for the Wall Street Journal earlier in the year reporting on how much subscribers pay for each channel. In that article the WSJ reported that the “wholesale cost per network is expected to increase 36% by 2018.” Since we focus on sports, it should be noted that ESPN currently has the highest affiliate fees of any network, at $6.04 for the flagship channel alone. The subscriber fees are expected to raise 39% to a cost of $8.37 per month in 2018 outpacing not only standard inflation, but also the 36% average of all other networks.
Where sports really took a turn with cable sports was the invention of the TiVo in the late nineties. At the time it was difficult to record much more than a movie or a show or two on a VCR, now you could set a device to record an entire season of your favorite show to watch when you wanted to watch it. It was a boon to viewers, but a bane to networks and still is to this day.
The reason for this is the impressions an advertisement makes on an audience was only counted during the original broadcast. A network couldn’t charge for the ads watched by people who recorded the show, if they even watched the ads at all. Today they get to use a secondary figure for DVR watching, but that only lasts for a week and with the prevalence of binge watching TV shows, networks are more apt to make their money via an online app they control than cable advertising.
The lone stand out in this battle, however, is live sports. By and large, people do not record the game to watch later. (Granted, some do, but that number is so low as to basically have zero effect on the market.) Since live sports was actually watched live, and watched by the key 18-34 male demographic, it became much more valuable than other inventory networks have developed.
For instance, ESPN and USA have basically the same average viewership of around 2.5 million people. ESPN charges 627% more in affiliate fees than USA due to the value of live sports. Both are available in 100 million households, so that means ESPN is making around $7 billion a year in fees to USA’s $1 billion in fees. All for the same total audience.
With that war chest building up, ESPN has been able to fortify its presence by buying up properties that no one else can afford, including Monday Night Football, the NBA, and all or partial properties with the ACC, Big Ten, Big 12, Pac 12, and SEC, not to mention nearly every bowl game and the College Football Playoff games.
Screenshot detailing ESPN sports deal timing from 2014 Disney Investor Call
No other cable sports networks come close to sports properties that ESPN has in its portfolio, which just increases their leverage. For a cable company to take them off the guide, large areas of the United States would go without not only Monday Night Football, but also NBA and MLB games.
That power, however, is used for more than just the properties on ESPN. Disney has used it to inflate the amount of sports channels that fall under the ESPN umbrella, many of which are not watched at all. ESPN2 is the second most watched cable sports network and it is less than a third the viewership of ESPN; ESPNews and ESPNU are less than a third of ESPN2. ESPN has also launched regional networks for the SEC and Longhorn Network, both of which draw far less than ESPNU. Not only is ESPN leveraging live sports to gain higher carriage than any other cable channel, but it is also using that power to force more of its channels onto extended basic, which all have their own affiliate fees and are overvalued compared to like audiences.
Most avid sports fans are unwilling to “cut the cord” with cable due to the fact that there is simply no other place to get some games than the ESPN family of channels. However, the avid sports fan demographic of the entire cable universe is extremely small, even if they think they are big. As stated earlier, ESPN averages 2.5 million viewers, just over half of TBS’s audience. Of that audience, some are even more fractured. Here is a view of how each sports channel averaged in ratings for the past college football season:
Outside FS1, every single network who showed college football experienced a drop in viewership from the year before. For ESPN2 and Fox that drop was around 20+%. However ESPN2 charges over two times the amount in affiliate fees as FS1, for only a slightly larger audience.
And as far as audiences go, 990,000 per game or less barely competes with mediocre showings on the Food Network. Additionally, these numbers do not even include some of the lowest viewed games on the Big Ten Network, the Pac 12 Network, the SEC Network or any of the regional deals used by the ACC or Big 12. Due to this there will come a time where distributers, e.g. cable companies, will have to decide between lowering the cost of cable to keep the bulk of customers or risk losing subscribers to cater to those who watch sports.
Where is it Heading
Probably the most mentioned way to break the cable paradigm is through video streaming applications via the internet, like Hulu or Netflix. These generally cost around $10 a month, give or take, and provide content that was purchased with those funds. However, for them to work you need high speed access to the internet. High speed access the cable providers control.
When you factor this in with there being $32 billion dollars in fees with the companies who are creating the content for these apps who don’t want to lose that lucrative income, you have a situation where disruption of the system is practically impossible. All that is really changing is the avenue by which a subscriber watches content; the cost is the same for the subscriber or, potentially, even more.
Additionally, nearly every content deal out there, sports or not, includes something called “TV Anywhere”. This allows ESPN to not only play a conference football game on its cable channels, but also on its mobile app, WatchESPN, or the streaming ESPN3 that many have available on console gaming boxes. Many cable providers, like Comcast, have started paying affiliate fees to “disruptors” like Hulu to distribute their apps. That may seem counter intuitive, but it prices out the little guy or, at least, those who cannot afford to take on the big guys.
It is important to remember that cable providers exists because they own the infrastructure into your home that can be filled with data. Believing a streaming app will change the basic premise of these companies is like believing the water company is going to change because you ran the dishwasher instead of the shower. The only way change will occur to provide their subscribers what they want, e.g. the ability to control their bill and only buy the channels they are interested in watching, is if the cable companies break the network cabals and alter how they provide channels to their clients.
And this is what customers want. While having hundreds of channels may have been a status symbol in the 80s, when it is attached to a $180 monthly bill people start to wonder how much it is worth for how little they watch. According to Nielsen, while the average channels consumers received has increased from 130 in 2008 to 189 in 2013, the amount of channels they actually watched has stayed almost exactly the same. It seems no matter how many channels we pay for, we only watch about 17 on average. What if you only paid for the ones you watched?
This is where Custom Fios has the potential to be a game changer. It set up two possibilities; the ability for Verizon to provide options to their clients to manage their channels and the ability for Verizon to make even more money.
Verizon is not altruistic here. This will make them money in multiple ways. First, it is a new way for Verizon to grow their customer base and compete with TimeWarner and Comcast in their shared markets. If a customer is looking to “cut the cord” and has the choice of spending $55 with Verizon for 40 channels they want and still get the internet from Verizon they need to stream from apps or pay $180 for 200 channels and still use their apps, they may give Verizon another look. Verizon Fios currently has 4 million households up the eastern seaboard and other pockets around the nation. A 20% increase in customers, even at the lowest package, nets them an additional $660,000,000 a year and that is before you count internet, phone or equipment charges. This is about networks, but it is also a declaration of war against their rivals.
The second way is that, while the plan is less for the basic stuff, if you add up how much it costs to get everything you end up paying more than with their current triple play packages. In the reported version of Custom Fios, there is a base package of channels and seven channel groups to choose from. For the basic rate you get the base package and you can choose one other channel group. As a sports fan you could choose base and the main sports package with ESPN, ESPN2, and FS1 for the starting rate. However, most families want kid shows, or music, or food, or news, or whatever. Add three packages and you’re currently paying $85 a month just for the channels. As we mentioned earlier, you’ll still need the internet and they will likely bundle it with phone services. Verizon also charges $10 a month for every cable box and $20 a month for every home dvr. If you have a DVR and one other TV in the home, your cable bill is already $115 a month well before you buy internet speed or phone service. In short, they know their customers are still going to buy several packages because they know what you watch. The average customer probably won’t see a ton of savings on their bill, even if they feel like they have the freedom to choose what they want.
As you can imagine, ESPN is already claiming that it violates their agreements and has sued Verizon, but don’t believe for a moment that Verizon is stupid. Their contract states that ESPN’s channels need to appear on extended basic. However, extended basic in Custom Fios is anything outside the base channels. In the past nearly all of Verizon’s 4 million households had extended basic or more. However, now it will be far less certain which package each household will buy. If they are not sports fans, they don’t have to get ESPN. The question becomes how many will choose them. The financial ramification of that decision will directly affect the networks involved, even if Verizon makes the same amount.
The following chart is not official, but a quick example to show how much money is at stake. To date I’ve seen two versions of Custom Fios, one where most of ESPN channels are on one sports block and another where the main ones are on one and the lower ones are on a second. I’ve chosen to do some variation of the split option because the numbers are more dramatic.
Using best guestimates on subscription rates from companies like SNL Kagan (none of these deals are public) and estimates on how many Verizon subscribers have extended basic, ESPN makes around $425 million dollars a year off Verizon subscribers today. Looking at audience numbers, ESPN and ESPN2 have the most viewership, meaning people would keep them first. ESPNU and ESPNews are barely watched and they also have a smaller national footprint. If given the choice it is possible that most people would forgo those two channels before they cut ties with the ESPN/2.
If 60% of Verizon households kept ESPN and ESPN2, and 20% of those households (the avid sports fans) kept ESPNU and News as well, the flagship ESPN station makes just a bit less per year, but the ESPN properties make 43% less than they do today. That is extreme and worth fighting Verizon in court for years.
This is even extreme if people pay for ESPN like they watch it. The largest ESPN broadcasts net about 30% of the households in the nation for a brief period of time; think the college football playoffs or NFL games. If only those people buy the sports block Disney would be making nearly 70% less off subscription fees.
There are two other things of note here, the first being the impact it has on subscribers. I had mentioned earlier that the way Verizon designed it ensures they will still make quite a bit of money, but if consumers actually choose to remove sports packages their savings from today’s subscription averages (not the cost of the package) is $45-76 per year. Not a gigantic percentage of a yearly bill with a cable provider, which can include internet and phones, but an important change. If someone is going to cut out sports, odds are they will be cutting out other things like news or lifestyle programming, enhancing their savings.
Secondly, Verizon isn’t even the biggest provider out there. Comcast, TimeWarner, and AT&T combine for seven times the amount of subscribers that Verizon boasts. If Custom Fios actually leads to Verizon gaining subscribers, you can assume that it will be copied by all the major players in some form or another. At that point the amount of money at stake is easily in the billions and very difficult to fathom.
Due to the money being so great, the odds of this sort of disruption happening, or at least happening more quickly than you imagine, are very good. It may only take a few years for the cable providers to completely reinvent themselves under this guise of a legal battle. The main reason for this is that the transformation began years ago.
This past Spring Comcast announced that its internet subscribers now outnumber their cable subscribers for the first time ever. At the same time they increased their earnings by 10% largely due of the growth of high speed internet.
A few other items popped up in the announcement. First, they showed a decrease in cable subscribers in the quarter for the second straight year while internet subscribers increased about 400,000 in that time. Additionally, even with cable subscribers leaving, customers who took on their triple product offering grew while the customers looking to one service decreased.
In short, they lost cable customers, but gained more business for all of their services at the same time. People are trimming their network offerings, not their cable provider. Perhaps that is the key here for our changing perception. These are no longer cable companies, these are internet companies. The internet companies and they control the pipelines into our homes.
Customers buying more services while downgrading channels provides a lot of leverage for Comcast, TimeWarner, Verizon and the new AT&T/DirecTV merger to start openly changing their focus and hack apart the network strategies of the past several decades. Verizon has already cut the Weather Channel out of their line up due to people getting their weather on their phone. Wasting bandwidth on it was unnecessary. Now it is moving to find out what else is wasting their bandwidth, taking on the strongest bastion of cable programing, sports networks, and it appears to have allies.
In 2011 21.7 million young adults were tuning into TV. That audience fell by almost 20% by the end of 2014. According to the New York Post, Alan Wurtzel, NBCUniversal’s audience research chief, told them. “I’ve never seen that kind of change in behavior.” During that same time, ESPN has lost seven percent of its customer base.
This18-34 demographic is one of the most important for the networks because the bulk of advertising spending targets it. If it continues to deteriorate at that rate the nearly century old model of television in general could disappear with the Baby Boomers.
Disney is watching and will likely act quickly. CEO Bob Iger told CNBC on Monday (7/27) that:
“Five Years out I don’t see significant change. But I think eventually ESPN becomes a business that is sold directly to consumers. We’ll use their information to customize their product. I think there’s an inevitability to that, but I don’t think it is right around the corner.”
Five years from now or at least a little past. That’s all it could take before the current model of receiving television programing evaporates away. Because if ESPN, the biggest dog on the network street, is now making plans to sell content directly to consumers through a streaming app, or at least believes that doing so is inevitable, you can guarantee that they are not alone.
Apps are also a boon for the providers; they don’t have to really negotiate. In the current set up the best channels don’t win. The network conglomerates who package content providers win. The good ones pay for the bad. In the app stores the ones that survive and make money are the ones that people use. The providers make their cut regardless.
Netflix is the ESPN of the streaming market and it currently has over 60 million subscribers worldwide on its app with revenues of $6.79 Billion. Of that $4.1 billion is domestic US streaming services and their original DVD service still brings in another $650M. What is amazing is their net income is around $87 million, since they post $6.7 billion in expenses. Of that $4.1 Billion that they are earning for streaming in the US, $2.76 billion of it is spent on streaming expenses, e.g. content. The movies and shows we go there to watch.
Those are not necessarily the types of margins that Disney and ESPN are used to receiving. In addition ESPN has committed a lot of money to various sporting events for decades out, which means they’ll either need to find a way to make up the revenue or find a way to cut some less profitable weight or stop spending. It is unlikely they’ll be able to charge more than Netflix or Hulu or HBO and not end up as a niche. The market for app content is pretty well set.
That is the key question in all of this; how much are sports networks being subsidized by those who don’t watch them. If you don’t watch the History Channel, that only amounts to less than a dollar a month on your bill. But the ESPN family of channels are between $8-9 a month or basically the cost of Netflix, but for every cable subscriber in the United States. If 40-50 million people pay to watch ESPN they lose half of their revenue moving to a pay-to-view system.
However ESPN attempts to solve its revenue issue, this adjustment from cable providers to internet providers will impact the college sports world in a major way within the next decade. Some things to consider are:
- Is the money paid out to college sports artificially inflated? If you have to pay for it individually, without the majority subsidizing the viewing habits of the minority, will prices reduce and begin to reflect demand? If so, what will that do to Power Five conference media deals?
- Within college sports, the dregs of inventory just five or six years ago are now completely subsidized by the bulk of cable subscribers. Conference networks are watched by less than the numbers posted above on college football games. Much, much less. While those are the best rated college properties, they only amount to about 3% of the total yearly programming. How much will they need to charge their fan bases for the content to cover operating costs, let alone profits? Will all Big Ten/SEC alumni shell out $20-$30 a month to provide the revenues the channel makes now? Better yet, will conference networks even be feasible when having to take on the risk of subscribers?
- In five years it will be 2021. Two years after, or seven years from now, the Pac 12 takes their Tier 1 and 2 to bid. The next year the Big 12 does the same. Will those two conferences be able to adapt more quickly to the changing marketplace than the Big Ten and SEC who are both locked up past 2030? Could it also lead to a media merger of those two conferences?
- Could this change in delivery lead to the end of conferences as we know it. Would it be more efficient for all of the Power Five to pool their resources and create an app that caters to the college sports nation, instead of just a region? And, if so, will conferences be necessary?
I could probably continue these questions for days, but I’d prefer to hear from you. How do you think the changes in the delivery of sports media over the next five to ten years will effect college sports, the Power Five, or the Big 12? Send me your thoughts and we’ll explore your comments and questions more in future articles.
If you have any questions or would like some numbers discussed, contact The Number Monkey on Twitter @TheNumberMonkey or via email [email protected]
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