War of the Worlds: Hollywood Opts Out of the 'Google Economy'
Summary
Hollywood believes large-scale broadband video distribution would only destroy proven value, fail to provide alternative value, and alter a business model that is still far from being in decline. With near-total control of the most valuable program libraries and the business models governing their distribution, a shift towards broadband media will come largely on Hollywood’s terms and at an incremental pace.
Barbarians at the Gate: Fears of a “Google-like” disruption of film and television are misplaced
Google Bad
Wall Street Journal columnist Alan Murray succinctly summarized the media industry’s resentment of Google’s business model: “The Google economy is a kind of high-tech feudal system: The peasants produce the content; Google makes the profits1.”
Another journalist framed media’s unease in the context of recent dotcom history: “…the internet is back…its potential for radical disruption is [now] married to the capacity for outlandish profits. Once again, the media village senses that the wolf is at the door. But the village suspects that this time, he’s not going away, and that he’s brought some friends. The village has been wrong before. But probably not now2.”
Google, as well as Yahoo! (Nasdaq: YHOO) and Microsoft’s (Nasdaq: MSFT) MSN, have been adept at creating value (principally advertising revenue) by re-packaging and re-presenting the content of others in search- and community-driven contexts. Having reinvented the advertising business and shifted substantial ad spending its way, Google is intent on rendering books digitally accessible (as is Microsoft), providing municipal wireless broadband, venturing into online classifieds, and has even made ominous-sounding, if fanciful, conjectures about its potential role in the television advertising market.
Combine fear and uncertainty with blogger gossip about Google job postings or secret fiber optic purchases, mix with speculation about Yahoo’s media operations in Santa Monica, add broadcaster announcements about prime-time iPod downloads, and voilà: a “trend” – broadband disruption at the front gate of media’s major citadel, with Hollywood itself cast in the role of Sunset Boulevard’s ageing Norma Desmond.
Broadband Interference
The generalized fear of broadband and its power to disrupt existing business models is far from unfounded. Futurists apply it to television roughly as follows – with more broadband-connected households than ever, programming will be made available in increasingly massive video-on-demand libraries accessed over the internet, wired or wireless, fixed or mobile.
“the last thing we’re worried about is [that] we’re going to somehow miss opportunities here…we’re talking about establishing precedents for some time to come…” – Peter Chernin, News Corp.
Like newspapers being electronically disaggregated into individual stories accessed over the web, video content will be atomized into individual programs for personalized consumption. The concept of a “channel” or broadcast day parts like “prime time”, as well as even the need for traditional distribution networks like station groups, or cable and satellite systems will disappear. And an atomized, broadband-delivered video world will lead to all manner of new forms of ‘interactive’ media supplanting today’s entertainment.
Recent news flow might lead one to believe that US television networks are either: (a) boldly experimenting with broadband media, (b) starting to panic about the internet, (c) slow-moving dinosaurs resisting broadband at every turn, or (d) seeing the coming broadband threats are about to unwind their generally coöperative relationship with cable and satellite operators in favor of an “every man for himself” distribution strategy.
We believe the answer for now is: (e) none of the above.
In past weeks there have been a series of broadband-sounding announcements from Viacom’s (NYSE: VIA) CBS, GE’s (NYSE: GE) NBC Universal, and Disney’s (NYSE: DIS) ABC publicizing various forms of new programming delivery, including to video iPods.
These offers are, deliberately, about as narrow and as far as one could get from a media disruption, despite some of the accompanying saber-rattling, carriage-fee-requiring remarks about “cable bypass” from Viacom co-president and head of CBS, Leslie Moonves.
A very limited slate of prime-time shows (not coincidentally, ones produced by the networks’ captive studios) are made available in a Video on Demand (VoD) format through existing distribution channels (cable, satellite), though ABC and NBC are offering $1.99 “vidcasts” to video iPods. In the case of cable-bypassing CBS, the VoD shows are to be distributed via Comcast (Nasdaq: CMCSA), the US’ largest cable operator, and only in markets with CBS O&Os, and only in a one-week window after initial over-the-air exhibition.
These limited, ‘non-linear’ forms of prime-time program delivery signal that broadcast networks, far from capitulating to a “trend”, intend to fully protect any incremental viewing rights enabled by new technologies (VoD or otherwise). The message to distributors – cable, satellite, or anyone else: “New technology-enabled monetization of our programming will be under our control, with our consent.”
No one, including US broadcast networks, would disagree that video content is well suited to broadband distribution. And we can expect to see accelerating innovations in both broadband-tailored content and distribution models. But dreams (or fears) of a “Google-like”, rapid upending of the television and film industry are misplaced.
What Hollywood really believes was summarized best and most directly by Peter Chernin, News Corporation’s (NYSE: NWS) President and Chief Operating Officer in their last quarterly earnings call. Speaking of Fox Television’s notable absence from the recent flurry of announcements, he observed: “the last thing we’re worried about is [that] we’re going to somehow miss opportunities here…we’re talking about establishing precedents for some time to come…”
We believe change will come largely on Hollywood’s terms and at an incremental pace, for reasons we outline and quantify below. Before doing so, one caveat or disclaimer. As with the history of telecom innovation, it is very likely that broadband media’s first high-performance examples of both business models and technology deployments will be provided outside the US.
In particular, we have in mind the UK television market which already has a mix of: high levels of TV viewing, forceful public policy, lower dependence on advertising, very high degrees of digital video penetration (including digital terrestrial service), and early adoption of interactive services, among other factors.
2006 promises to make the UK the much-watched bellwether market. Among the milestone events, the BBC is expected to move aggressively towards broadband content distribution, and BT Group (NYSE ADS: BT) is expected to enter the video services market with what promises to be a significantly differentiated television offer, unlike its US telco counterparts.
For better or worse, Hollywood dominates the global filmed entertainment business. And in markets where American products are in the minority there is almost always media concentration, and hence library control, comparable to or greater than that found in the US. This occurs via quasi-governmental entities, media oligopolies, or both. But there are also substantial local variations in media business models, and so our opinions and analysis below have only the US media market in mind.■
1 GoogleLibrary Is Great for the World, The Wall Street Journal, October, 26, 2005
2 Googlephobia, New York Magazine, December 5, 2005, John Heilemann
Rational Hollywood: Broadband is cast in a supporting role for now
Show Me The Money
The vast majority of desirable mass market video content and the business model for its distribution are still firmly under Hollywood’s control. While residential broadband penetration continues to grow, other important catalysts for a shift towards broadband media consumption, from new syndication windows, to broadband-connected televisions or their set-top boxes, to suitable home networking technology, are still on the horizon.
Hollywood can afford to plant a few seeds, monitor fledgling competitors, weigh in on still-emerging delivery technologies, but wait for broadband media opportunities to become more clearly big enough and profitable enough to warrant serious mind-share or capital.
In the meantime, Hollywood’s agenda is to realize further gains from vertical integration and use broadband in a supporting role. Broadband technology is used to reduce marketing costs and reinforce viewer involvement with existing products (enhancing advertising and syndication value). Over time, Hollywood will reassess broadband opportunity in light of three major barriers—production and distribution economics, and market size and evolution:
1. Production – broadband is far from economically viable
US television studios almost always lose money on their expensively-created content until it is resold after initial broadcast network licensing. DVD sales account for an increasing, if still small, proportion of incremental revenues and this window is likely to be the first to transition to lower-cost broadband distribution.
But the real turning point in television series profitability occurs with off-net syndication. This resale occurs in relatively large program blocks, often 110 episodes or five seasons worth, enabling “stripped” syndication in which programs are re-exhibited in the same time slot five days a week.
These off-net syndication rights, which don’t allow for broadband distribution, have often been locked up for years to come. And given the wholesale nature of the business, it is not unusual to license practically the full slate of a studio’s output for a multi-year period. A broadband carve-out for newly-available syndication rights is certainly possible, but with fees running well above $100 million for a hit one-hour drama, the existing syndication model sets an enormously high bar for replacement or separately-negotiated incremental revenues from broadband rights (Exhibit 1 – Series Economics).
“If you want to get added to the windowing scheme, you have to pay your way in …There’s no benefit to any of us doing business with those guys [i.e. Google et al] on a micro-transactional basis.”
Prime-time TV fare will not join the Google Economy because, for some time to come, widespread broadband distribution would only destroy proven value, fail to provide alternative value, and alter a business model that is still far from declining. As one network distribution executive said recently, “If you want to get added to the windowing scheme, you have to pay your way in …There’s no benefit to any of us doing business with those guys [i.e. Google et al] on a micro-transactional basis.”
Hypothetically, say Google or Yahoo! did “pay their way in” to create a broadband window. Rather than tackle the issue of a parallel window and how much it must pay to compensate for discounting the value of traditional off-net syndication, let us assume a straight-up replacement in order to shed light on the economics.
Aspiring to marquee fare, our hypothetical broadband media buyers are bidding for the domestic syndication rights for the police drama “Law & Order.” To successfully compete against cable channels, they might pay on the order of $150 million.
Having taken the show off the cable market and put it instead into broadband distribution (and hence a more ‘internet-like’ business model), they might treat that expense, at least conceptually, as part of traffic acquisition costs (TAC). Then, to match their current profitability Google or Yahoo! would have to find a way to deploy this video content (just one show, remember) to generate around $350M in advertising, subscription, or some other kind of revenues, well over a $100 million more than comparable cable syndication would be likely to generate.
In the US, significant broadband distribution of top shelf television fare is, to put it mildly, highly unlikely any time soon. What’s on the line is not just the syndication revenues themselves, but an entire business system for which broadband distribution is, as yet, unable to provide a compelling alternative or even complementary path forward.
But cheaper, independently-created or older content, less constrained by complex syndication and rights structures will gradually find its way to broadband, with still unknown demand or results. This is already happening via Time-Warner’s (NYSE: TWX) AOL unit and their planned ‘In2TV’ broadband offer, as well as early content agreements with entrepreneurial broadband video distributors such as Akimbo, Brightcove, and Maven Networks.
2. Distribution – broadband plays a supporting role
Beginning in the early ‘90s, the US television market has been increasingly deregulated and, partially as a consequence, more vertically integrated. With the disappearance of regulatory restrictions, most notably ‘Fin-Syn’, media companies have integrated their production and broadcast businesses, created new forms of distribution (DVD sell-through, captive cable channels), and managed advertising sales and program windowing to optimize returns across this integrated portfolio3.
As exploitation of integration synergies continues and entertainment-related business models further converge, distinctions between “broadcast” and “cable”, for example, become less meaningful4. The much publicized decline in broadcast network ad sales in the “upfront” (i.e. forward) market – which accounts for over 80% of inventory – means a lot less when NBC Universal, for example, in addition to studio assets owns or controls Bravo, Telemundo, mun2TV, USA, SciFi, MSNBC, and CNBC.
Controlling cable channels is an industry-wide strategic response of diversifying away from network television’s gradual, secular decline (Exhibit 2 – Share of US Upfront Market) and squeezing further scope and scale economies across production and broader range of programming outlets. And Tier 1 cable operators, most notably Comcast, are pursuing similar strategies of diversifying across content ownership, programming outlets, advertising, as well as their infrastructure businesses of video distribution, high-speed internet access and telephony.
The work of expanding such a portfolio and optimizing its revenue yield still has a good deal of remaining upside and strategic work ahead of it. This form of ‘convergence’, not the technical/broadband kind, is the front line of television competition.
The sharpening of audience measurement technologies, the packaging of media buys around more clearly measurable demographics and focused channel mix, the arrival of ad tagging and insertion systems, the more efficient aggregation of fragmented advertising inventory in regional interconnect systems, and the value-added services potential of digital terrestrial television – all of these provide a full agenda with plenty of profit-enhancing opportunities before addressing broadband as a mainstream delivery medium.
For now, broadband media has a well-defined and growing role in Hollywood, and it is to play a supporting role in the business model convergence agenda, not the other way round. Broadband creates additional ways to involve, sustain and build viewership, thus increasing the value of the core products themselves, including broadcast advertising. For example, a broadcaster may wish to:
- further monetize proven viewer demographics by adding an interactive component to a targeted media buy (above average CPMs for, say, visits and/or click-throughs at Fox’s ‘American Idol’ website)
- sustain broadcast advertising value by using web-based presence to draw in additional viewers or further involve existing ones (‘American Idol’ voting, discussion groups)
- reinforce and build additional value for future monetization (DVD sell-through and/or program syndication) of captive studio programs by increasing viewer involvement through web-based and mobile interaction (Fox’s ‘24’, for example)
Reflected in, for example, recent News Corp. internet-related acquisitions, the effect of Google’s success has been to sharpen interest in adding another portfolio element – internet presence and advertising as a complement to, not as a disruptive replacement for Hollywood’s core business.
3 Financial Interest and Syndication rules expired in the early ‘90s, unleashing a major shift in the economics of filmed and television entertainment, starting with consolidation of TV production. Fin-Syn had previously restricted broadcast networks from having a financial interest in programs beyond first-run exhibition, and prohibited the creation of domestic syndication arms.
4 At this point, it is hard to tell what effect Carl Icahn’s on-going “break up the company” campaign will have on one of the integrated giants, Time-Warner. Viacom’s proposed split, while largely separating broadcast and cable assets appears to be geared at preserving CBS’ production economies.
3. Market Evolution – a niche for some time to come
The final and perhaps most limiting characteristic of broadband media as a mainstream opportunity is that it is too small, and is unlikely to compare favorably even to television’s existing niche audience outlets for quite some time. The combined effects of special-interest channels (e.g. FoodTV), conventionally-delivered on-demand programming (e.g. cable or satellite VoD), and DVRs (channel disaggregation, time shifting) leave comparatively little room for separately-sourced programs which happen to be delivered as IP packets over broadband connections.
Our view of broadband media’s addressable market is that is must account for three factors:
- adequate bandwidth
- propensity to consume broadband media
- network-attached televisions
First, bandwidth. Despite generous growth in at least downstream bandwidth, principally led by cable’s high-speed internet services, we believe it is likely that the US median bandwidth per broadband household will stay flat, or even decline. This is because as the market matures, new subscriber additions are principally at the “value” end of the broadband offers.
broadband media…is unlikely to compare favorably even to television’s existing niche audience outlets for quite some time
While offers with headline speeds in the tens or even hundreds of megabits are also likely, consumer need for this level of performance is very limited in the medium term. As broadband connectivity continues to be commoditized, performance levels will be tiered, and consumers will purchase according to price/performance requirements. Some time in the future, it is likely that broadband media may become the application which drives upgrades of broadband connectivity.
In the meantime, roughly 60% of today’s broadband households have ‘adequate’ bandwidth (say, 3Mbps downstream as the minimum) for imagined broadband media offers, with this percentage possibly declining to below 50% in the next five years or so, as broadband penetration into late-adopting households continues. Then, as broadband media becomes a known, desired consumer service, and as DSL (the main source of low-end broadband connectivity) improves, median household bandwidth will turn upward again.
Second, propensity to consume broadband media. Since this market doesn’t exist, this is basically anyone’s guess, but as with any new product category, the idea that more than say, 30% of potential qualified consumers will adopt it in less than five years, is quite extreme. So let us posit a generous starting point of 20% of broadband households with adequate bandwidth will consume broadband media, and let it grow upward from there.
Third, ‘network-attached’ televisions. This is a proxy for being able to watch broadband media, sourced independently from “walled garden” cable or satellite content (even if via those operators’ set-top boxes), on an actual television in your living room, not on a computer or handheld device. There are certainly a large number of technical enablers on their way, beyond today’s awkward offers such as Microsoft’s Media Center, adding an independent “broadband antenna” to the living room TV. TiVo’s recent announcements of broadband content delivery are a small step in that direction, for example, and this capability is the very definition of entrepreneurial broadband television services such as Akimbo.
But for the near- to medium-term, cable or satellite set-tops will dominate the “last inch” of connecting televisions to digital content. Given the fledgling and awkward state of video-enabling home networking technology, we would doubt that even 5% of today’s qualified broadband households have what it takes to directly display network-delivered broadband media on their primary televisions.
Even with what we believe to be generous assumptions, applying these three limitations to define an addressable broadband media market results in some pretty small numbers (see Exhibit 3 – Broadband Media Households). By comparison, the US’ largest cable operator (Comcast) and largest direct broadcast satellite service (DirecTV – NYSE: DTV) together have in excess of 35 million subscribers.
As a point of reference, we also display estimated US Telco TV subscribers – that is, households subscribing to the new generation of phone company television services, not their satellite resale offer. With slight discounting to AT&T (NYSE: T) and Verizon’s (NYSE: VZ) announced expectations (since they have already slipped), we assume these offers demonstrate some market success in 2008, leading to additional investment and growing to around 25 million homes passed and 15% penetration by 2010. This penetration level is representative of any third-player undifferentiated offer, and is a typical market share for overbuilders in existing cable markets.
If Telco TV is in fact able to match or exceed the number of network-connected television broadband households, this gives US phone companies a very significant and potentially disruptive opportunity to move to a next-phase differentiated video offer, transforming a me-too offer into one of the leading edges of the broadband media insurgency. We will return to discuss this point a bit later.■
A Confounding Revolution: How we will know it is coming and how to keep score
Interactive Headache
Interviewed several months ago by, of all people, long-time friend and nemesis Michael Eisner, IAC/InterActiveCorp (Nasdaq: IACI) CEO Barry Diller described the complexity of the broadband media challenge this way: “In this interactive, internet world, I mean, you have a headache twenty minutes into the day… Films and television, [are] not a business that, so to speak, confounds you – you’re telling stories. But this is. …we’re in a revolution, we’re absolutely in a radical revolution.”
The seeds of a broadband media revolution are already being sown by entrepreneurs unknown and well-known. We have shown why neither Hollywood nor its cable and satellite distribution networks are likely to spark or give much early encouragement to that revolution. Not surprisingly, they have well-functioning business models with much at stake when the revolution takes hold. So where might change come from, and how is it likely to proceed?
Early video wins are likely to share two characteristics: they will check as many boxes as possible in our ‘NewTV’ wish list below (Exhibit 4 – NewTV Wish List) and, through experimentation, successfully match niche audiences or communities with types of programming, just as television does today.
Let’s imagine you are pitching a new, surefire approach to broadband media distribution – you just need something to distribute and are far from having the resources of, say a Mark Cuban, to build both an independent production company and an independent programming and movie distributor.
To put it more bluntly, you will have to redistribute content developed for television until such time as you can develop your own, or a broadband content renaissance arrives. Your value proposition to consumers is about immediacy, convenience, choice, and price, not cool new shows unavailable elsewhere.
A bit more disappointing news – despite wanting to break out of traditional media concepts you will probably have to package what you offer in something very analogous to a “channel” in today’s television world. This is because (a) without some thematic organization and brand, you will (like ineffective web sites in today’s internet) simply disappear into the noise, and (b) you will very likely need a fixed subscription fee as part of your revenue model for you to stand a chance of becoming economically viable.
So, you will go to library owners and pitch your business plan, at minimum convincing them that by renting their programs to you their net revenues will be higher by adding you as a distributor than not (see “Incremental Revenue”, “Low/No Cannibalization”) and that their content will be protected from theft (see “Content Protection”).
If your entrepreneurial venture plans to rely on ad revenue, you will need to persuade both library owners and potential advertisers that your financial projections are based on targeted, demographically-valuable reach (see “Contextual Sponsorship”, “Exclusivity”), perhaps even with the potential for national scale comparable to traditional media (see “Breakout HH reach”). Finally, for certain classes of content (independent films, for example), you may need to demonstrate your distribution method appropriately showcases, or at least does not degrade, the viewing experience (see “Optimized Viewing”, “TV Endpoint”).
As to which libraries and types of programming, we’ve ruled out more than token access to marquee programming at any stage of the syndication pipeline. This leaves three broad approaches, lifted from today’s television world, which can be used individually or in combination to match potential audiences and programs:
- special-interest based: aggregate a collection of themed programming, often low-cost material that has already run through cable channel syndication and/or is independently marketed
- demographically-defined: reverse engineer a possibly eclectic programming line-up from a set of desirable demographics with a high propensity towards broadband usage but low involvement with traditional television (the pitch meeting might go: “it’s G4 meets SpikeTV, with a FoxNews sensibility”)
- ‘We Media’: roughly, a video equivalent of blogging in which audience involvement and viewer-created content (“VC2”, as it is known on the recently-launched ‘Current TV’ channel) creates both an interactive feel and low-programming costs. This two-way characteristic, for which broadband innovation is ideally suited, is either used as an enhancing differentiator or becomes a central, defining element of the programming.
Keeping Score
Barry Diller is probably right that “we’re absolutely in a radical revolution”, if for no other reason than he is Barry Diller. But how can media, internet, or telecom company strategists separate competitively-important news from noise, and what should investors look for in determining future company prospects?
The list will always change, and probably the most significant events are entirely unforeseen. But the scorecard should focus on anticipating and identifying events signaling meaningful economic developments. Some examples:
- Have major independent program developers (e.g. Crown Media, Playboy Enterprises, etc.) made significant library syndication commitments in a broadband-related format? What is the depth of the library under license? How does this deal complement or compete with “linear” exhibition?
- Is Big Media adding significant depth to broadband-available libraries, on what terms, for what distributors, across the board or by genre?
- Are ads or interstitials being inserted in broadband content? Who are the advertisers? Are these barter, in-kind promotional, or cash deals? What audience measurement and reporting, if any, is being employed?
- Is licensed or syndicated broadband-media delivery being linked to a paid-search or internet community model, and if so, how?
- Is anyone developing new broadband-specific content supply (either by re-purposing, similar to wireless carrier ‘mobisodes’, or with net new production)? What are the reported production costs, who is financing them and how (brand sponsorship, product placement, etc.)?
- Is there any evidence of broadband-related restructuring of rights and windows in lower-profile (cancelled series, cable channel originals, etc.) syndication deals?
- Is there any adoption of “programmer neutral”, open devices which can conveniently display broadband content directly on televisions (e.g. TiVo Series2, etc.)?
- Is one of broadband media’s potential advantages – à la carte consumption – being eroded by the rise of less-tiered and/or lower-priced subscription services from cable or satellite?
- How are broadcast networks planning on using ancillary spectrum at their O&Os once digital terrestrial television is launched?
Afterword: TelcoTV
Earlier, in discussing the potential size of an independent broadband media market (Exhibit 3 – Broadband Media Households) we made passing reference to Telco TV’s potential leg up and said we would return to that topic later.
US telcos have four fundamental problems with their TV offers:
- undifferentiated clones of satellite service (i.e. “bargain” cable)
- uneconomic based on programming costs alone
- no access to advertising revenues (no subscribers = no audience to sell) at the very moment in the industry when cable operators are booking double-digit advertising growth and ad insertion technology has the potential to raise CPMs by 50-100%.
- timing – drivers of price competition are likely to increase, just as (and partially in consequence of) Telco TV comes to market: e.g. emergence of “value” tiers or quasi-à la carte channel line-ups, no-frills competitors, digital terrestrial service
But telcos also have two valuable advantages: First, a direct path for broadband content to the living room television, not through “Windows Media Centers” or a “Slingbox” or other marginal attachment methods. Second, with no subscribers and high programming costs, telcos do not share cable and satellite’s vested interest in “going along” with the Hollywood business model.
The checklist (Exhibit 4 – NewTV Wish List) and scorecard immediately above are, among other things, a partial framework for how US telcos might differentiate their me-too video offers at comparatively low incremental cost and establish a modicum of market power in the programming supply chain. Instead of focusing on yesterday’s definition of multi-channel television service, a stripped-down offer, supplemented by broadband-enabled library innovation may be Telco’s best long-term bet for a sustainable video business.■
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