28 February 2014

What If Aereo Prevails at SCOTUS?: Some Q & A

Would a cable operator deploy its own Aereo-style service with an antenna for each customer delivering individual streams for each from its own antenna?

Once (and if) the Aereo service is found to be legal by the Supreme Court, it would represent an attractive alternative to the operators' current options for carrying broadcast channels, which are: (1) pay higher retransmission consent fees, (2) do without popular broadcast channels, and (3) hand out antennas to customers.

It may not be the case that cable operators create their own Aereo-style service. At a recent meeting, an investor interested in retransmission consent told me something that surprised me: cable operators can't deploy an Aereo-style service without negotiating retransmission consent agreements with the broadcasters. Cable operators are considered Multichannel Video Program Distributors (MVPDs) according to the law, however, I assumed that classification applied only to their cable television services, not necessarily to other services that they might offer (e.g., online streaming video services).

Researching the topic further, I learned that cable operators are named specifically as MVPDs in the 1996 Telecommunications Act. As an MVPD, the operator gets certain benefits and takes on certain obligations, one of those obligations is that it is subject to the must carry/retransmission consent structure when dealing with local broadcast stations.

So, by a strict reading of the law, operators may not be able to offer their own Aereo-style service.
One Aereo Antenna, dime for size comparison
So Aereo is of no consequence and an Aereo victory at the Supreme Court would not change anything for cable operators?

I would not move so quickly to that assumption.

An MVPD could enter into an affiliation agreement with Aereo (or an Aereo-style provider operated by a third party) to provide access to its customers via its set-top boxes and apps. Since all modern cable boxes are capable of decoding IP video streams and their software is updated regularly, it appears that an Aereo solution could be rolled out relatively easily. Aereo becomes another app on the box, much like Pandora.

If you think this work-around is "too cute" to be viable, I suggest you read about Dish Network and its relationship with NPS.

Certainly Aereo and likely Aereo-style competitors will exist if the service is found to be legal. Cable operators already affiliate with third-party services for several online streaming video services. ESPN3 is probably the best known example with unique content.

An Array of Aereo Antennas
If Aereo is another app on the box is that really better than giving customers an antenna and telling them to switch inputs to watch the station that isn't being carried?

The Aereo solution offers several benefits versus the clearly-has-been-found-to-be-unattractive antenna option:

  • The customer does not have to pick up an antenna (at the operator's office or a store).
  • The customer does not have to switch inputs.
  • The quality of the signal received by the customer should not vary with the customer's location, the way over-the-air reception from an antenna at his or her premises would.
  • The operator does not have to maintain an inventory of antennas

Furthermore, the Aereo app could be integrated into the cable video service in a much more complete way than as a wholly separate app.

 A cable operate could offer the following to its Aereo-style affiliate:
  • bundle your service with certain cable TV packages
  • integrate your offering with the cable TV electronic program guide
  • not count bandwidth usage by customers to view your services against any bandwidth cap we may have with customers (the elimination of the network neutrality rules would allow operators to favor certain IP traffic over other traffic -- this is an obvious place that flexibility could manifest itself)
  • incorporate your service with our billing system
  • pay you a flat rate for providing us the service or share of the revenue attributable for your service or compensate you on a per-subscriber basis
The cable operator could affiliate with more than one Aereo-style provider to offer additional choices to consumers, for example, perhaps one offers no cloud DVR storage, but a lower cost.

What might be a wise plan for a cable operator?

A cable operator should launch/affiliate with an Aereo-style service well before the expiration of their current retransmission consent agreements.

  • This service is an upsell opportunity for the operator's broadband-only customers.
  • The process of integrating the Aereo-style app in the set-top box will take some time, better to start the process well before it is "mission critical".

The downside to doing things early, of course, is that it will give the broadcasters more time to plan their response, whatever that may be.

Could an Aereo-style solution replace the carriage of broadcast stations by cable systems?

The short answer is no. The cable operator is still an MVPD and still has to offer the Basic Service Tier (BST). It is a legal requirement that cable operators must sell the broadcast tier to all customers who receive video service. For example, a customer who calls up the operator and just wants HBO or the expanded basic package (i.e., the package with ESPN, CNN, Lifetime, USA) must buy the BST as well.

However, the NCTA is lobbying to change this mandatory buy-through and their argument on this is a strong one. There is no mandatory buy-through for customers of DirecTV or Dish Network.

Furthermore, PEG (public, educational and government) channels are required to be carried in the BST by law. Additionally, broadcast stations which elect "must carry" (typically the less-viewed stations in a market) are guaranteed carriage on the cable system.

To address the concerns of local franchise authorities, cable operators could still provide the PEG channels to all video customers even if they eliminated the BST. Since those channels do not carry a license fees, the cost of doing would be negligible.

How would a cable operator drop a major broadcast affiliate?

The mechanism of retransmission consent is independent of any of the issues raised by Aereo. At some point, the current retransmission consent agreement between a station and the operator will expire. The station will make an offer for a renewal, usually with an escalating per-subscriber retransmission consent license fee. The two parties negotiate. If they can't reach agreement on terms, the operator cannot carry the station. All the Aereo-style-option does is create an alternative for the cable operator that's better than its current alternatives (BATNA in the parlance of Fisher and Ury). It would likely still be more attractive for the operator to negotiate a retransmission consent agreement than not.

Sometimes there is more in the negotiation than just the retransmission consent. For example, some broadcast stations provide the right to carry their local news programs on VOD as part of a retransmission consent agreement. Without such an agreement, the cable operator would not enjoy those rights.

Could the impact of Aereo go further?

Taking the broadcast service out of the cable TV ecosystem, in addition to sidestepping retransmission consent fees, would also appear to sidestep copyright fees payable for the distribution of such signals. Copyright fees are calculated as a percentage of revenue from the tier in which the signals are carried. If we assume that the current BST costs $20, then the copyright fee an operator would pay is a percentage of that amount times 100% of subscribers.

In the event that an Aereo-style service is available on the cable system and we assume the system is currently paying about $2 in retransmission consent fees, the system could reduce its BST retail price to $18 without harming its gross margin and then would also reduce its copyright fees for the broadcast stations by 10% as well.

Furthermore, if customers do not have to buy through the BST -- which presumably at this point only has the weaker TV stations the $18 tier may not offer a good programming value -- then the number of subscribers on whom copyright fees are payable also goes down. A win all around for the cable operator on the cost side.

Alternately, the cable operator could drop the retail price of the BST, now that it is missing its strongest programming. Since the copyright fees are based on a percentage of revenue, that cost would go down even if the number of subscribers did not.

Furthermore, cable customers would have the option of affiliating directly with Aereo (or an Aereo-style service) for their broadcast stations and use the cable operator only for cable programming services. At a certain price the benefit of doing so would outweigh the hassle to the customer of having to switch inputs.

So Aereo is a big deal for broadcasters?

As one lawyer very familiar with the retransmission consent scheme and its impact on broadcasters told me: Aereo is an existential threat.

I'm not sure that I would go that far, local broadcasters were still profitable before they started generating large retransmission consent fees.

What happens on the broadcast side if Aereo wins?

The broadcasters will lobby to change the law to define Aereo as an MVPD (and as such subject to Must Carry/Retransmission Consent)

If that doesn't work, the broadcasters will threaten to move the broadcast network channels to cable. Actually, Fox's Chase Carey has done this already. There are political issues associated with that -- broadcast licenses were granted for free, political figures would not look kindly on such a move.

If the whole channels are not moved off free-to-air television, the big programming companies will do what they always do, look at where their programming investment will get the best return. If the returns in the broadcast business go down (because there is less retransmission consent money there), more programming will appear on cable channels -- continuing the trend we've seen over the last 30 years anyway (e.g., ABC's Monday Night Football is on ESPN). In Australia, there is a law requiring some sports events to be on free-to-air television.

Update (22 November 2014): DirecTV had considered setting up its own Aereo-style service.

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