11 April 2012

If Cable Costs $200 in 2020 Penetrations Are a-Gonna Fall

According to a provocative study/press release from the NPD Group, the average US multichannel television subscriber paid $86 for "basic pay-TV service" and "premium-TV channels" in 2011 and that figure is going to hit $123 in 2015 and $200 in 2020. NPD Group says that pay TV monthly rates have risen an average of 6% per year while consumer incomes have remained essentially flat. Keith Nissen, research director of NPD sees this trend as "unsustainable in the long term" and concludes "Much needed structural changes to the pay-TV industry will not happen quickly or easily; however, the emerging competition between S-VOD and premium-TV suppliers might be the spark that ignites the necessary business-model transformation of the pay-TV industry".

Dos "Benjamins" para cablevisiĆ³n
Hmmm. Let's do some analysis of these figures. According to Multichannel News, the $200 is really $196 and that breaks down to $110 for basic and $86 for premium. Filling in the rest of the numbers (hat tip, Todd Spangler for doing the reporting) and looking at the growth rates, we can prepare the following table.
NPD Group Actual/Projected Average Cable Subscriber Monthly Bills with Compound Annual Growth Rates

The current 6% basic package price increases will continue forever; that's straight-line trend extension more than analysis, but not necessarily a bad place to start. Basic rates have grown faster than inflation for probably two decades now and basic penetration is now 86% per NPD's reckoning. A rational explanation would be that  consumers are must be finding value in basic cable television, particularly with the recent stagnation in household incomes. If they didn't value it, they certainly wouldn't keep buying it. If you don't believe that, you haven't seen the data of how cellphones have eroded the market for landlines.

A further rational explanation would be that the program quality of basic cable has increased dramatically by any reasonable measure. Regional sports networks have more pro games than they used to have, typically at the expense of broadcast carriage. Entertainment networks are putting greater resources into original programming and have turned out some real quality stuff (e.g., 4-time Emmy-winning Best Drama Mad Men). Up-the-dial channels like Bravo which ran older art movies and whose marquee show was Inside the Actor's Studio developed a slate of...watercooler favorites (if you must know, see this). Less commercial concepts like The Nashville Network and America's Talking gave way to the more-commercial stylings of Spike TV and MSNBC. This bounty is now spread across dozens of additional channels (Style!, Tennis!, not just one but two food networks!), almost all of which are in high definition which is not just good but necessary because 65% of households now have sets that a 15 years ago were primarily found in the high-end room at Best Buy.

Will that all continue? It sure could. More investment in programming, more channels, TV Everywhere would allow people to use their subscription in more places on more devices, maybe a technological advance like 3DTV -- all these elements could increase the value of the basic service. In fact, I think it could grow faster than 6%.

The interesting part of the NPD analysis to me is that premium programming retail pricing will increase much faster than basic, no less than 17% annually over the next 9 years. At first blush, that makes no sense at all. Basic programming is a take-it-or-leave-it bundle and that gives it a lot of pricing leverage. If you need ESPN, you need to take the whole package. Ditto for Disney Channel or MTV. We know that basic is a fairly low-churn subscription service.

Premium television, in contrast, churns all the time (HBO churns 10 of its 28 million subs annually) and the channels are often sold a la carte, not benefiting as much from being bundled with others. If HBO is too expensive, or if the season of Game of Thrones has ended, subscribers drop it. This happens all the time. [Even premium services that are not sold a la carte (e.g., Verizon packages Showtime and The Movie Channel in a third level basic tier with a dozen or so ad-supported channels, but the premium services provide most of the value of the tier) it is hard to argue that the packages in which they reside are "basic".]

The other part of premium television is transactional -- pay-per-view movies, events and things like out-of-market sports packages (e.g., NFL Sunday Ticket, MLB Extra Innings). Many of these offerings have substantial competition from over-the-top players.

The only way that premium television retail pricing will go up by 17% annual leaps (and bounds!) is if the cable operators are tapping other revenue streams (e.g., DVD purchases, movie theatre tickets) and that will only happen if the service itself becomes much more compelling that it is today. If that happens, it is more than likely that the program quality of these offerings will have increased and/or the convenience of using the service will increase (for example, the highly compelling HBO Go) or both. In short, if the average bills are going up this much, that's probably very good news for viewers of premium television.

[If NPD is considering DVR service to be part of premium television, that's another element that would support an increase in the average bill. DVR penetrations are going up even as operators have raised the prices for it. It is simply a very compelling service.]

So, at second blush 16-19% annual increases in premium television revenue still don't seem to make sense. I would be very surprised if the average bill for premium services from a multichannel provider will grow by that much over the next decade unless...the business is very different from what it is now. [Hold that thought.]

If the average bills go up that much, it also means that Netflix, Amazon, Xbox, Vudu and iTunes are not providing as much competition for the video dollar as it appears that they are currently. One notes that result would be the exact opposite of the conclusion from an earlier NPD study on the results to date in that area of the business (my earlier post on that study). It isn't impossible to imagine pay-TV service improving over the next decade, but it is pretty hard to imagine that it will improve faster than over-the-top delivery of video. [Unless the cable/telco ISPs defang OTT video via broadband caps, throttling or price increases.]

So how do we reconcile these conflicting projections? The way that I see it is that multichannel television may longer be a 90%-penetrated service, but will morph into more of a luxury good as the prices go up. There is a nugget of this point-of-view in the NPD study findings:
"In fact, 59% of pay-TV subscribers preferred having one single provider for their pay-TV services, compared with 21% who desired multiple providers, and 21% who expressed no preference. Sixty-two percent of subscribers wanted premium TV either delivered by their pay-TV provider directly, or from a service affiliated with their pay-TV provider."
The key word here is "preferred". Consumers would "prefer" to get everything from one provider (less technical hassle, fewer bills to pay, etc.), but if the cost differential is significant..."the lure of convenience may not be enough if the content is available and people can access it without going over some set broadband cap." (well put, Stacey Higginbotham in GigaOm's The cable industry isn't stupid, is it?).

This is the future that I see for multichannel television, because the cable industry is many things, but stupid is not one of them. The cable guys will choose to hold onto the high-quality, high-price segment of the market and effectively give up the lower end to alternative solutions in whatever forms those solutions may take. Right now 14% of households rely on antenna service for television. Maybe 10-20% of the multichannel households leave the increasingly spend-y pay-TV market  That's a business different from the one now, but consistent with the major driving economic factors.

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