On Cable TV disruption…

Last year gave us a lot of big moves in the television industry. Time Warner agreed to sell itself to AT&T; Disney announced its acquisition of 21st Century Fox; and Netflix announced plans to spend $8 billion to increase its library of original content.

All this action can appear desperate and poorly thought through but these deals actually make sense and they show that these companies have seen the future of television and are preparing for it. I care about all of this because I watch an unconscionable amount of TV and as such I'm interested in anything that will affect my bingeing habits. To decode what is actually going on, I will go through the historic structure of the TV industry, how changes in technology and customer behavior have affected this structure, and how the big players are gearing up for this new paradigm.

The Industry Status Quo

The above graphic shows the channel of distribution from content creators to consumers. The flow worked something like this:

• Studios, like NBC Universal and CBS, anticipate what scripts will attract a substantial viewership (the longer the content translates with audiences the better). These Studios usually bear significant costs in producing content.
• Networks, like TNT and IFC, with a finite amount of programming slots, buy the rights to broadcast this content to their customers. There is some integration between networks and studios because the bigger studios like Disney (which operates through its ABC studios subsidiary) have their own networks to serve different customer segments. For example, ABC Family for younger and family viewers and ESPN for sports enthusiasts.
• Cable providers, like Comcast and AT&T, group networks into bundles based on their understanding of the different customer segments in a market. For example, AT&T, through DirecTV, offers a SPORT PACK package because premium sport content is more valuable to the sport enthusiast market segment than other customer segments.
• Customers shop around for the best cable option for them and watch away.

This flow persisted largely because of the significant cost and expertise required to create content and the significant costs and risks borne by Cable providers to 'lay the pipes' to customers. Vertical integration was largely limited to the NBC/Comcast and Time Warner (which has since been broken up to Time Warner and Spectrum). However, development in internet infrastructure and increased penetration in the US market has encouraged companies to consolidate along the distribution channel.

What Changes Are Happening

I'll use the growth of Netflix to illustrate the changes that are happening. When Netflix started its internet streaming service, I'd say it fell across the Network and Cable Provider categories in the old model. It bought rights to content from studios and then streamed it out to customers on-demand through its 'internet pipes'. Studios viewed Netflix as a collaborator and another source of income — another channel they can license their content; Cable Providers viewed them as a competitor albeit a distant one; market analysts saw them as a technology company; and customers viewed them as a complementary service to their cable subscription. Netflix then took a bet on producing content — like House of Cards; experienced early success and then doubled down on this move, investing substantially to increase its library of original content. Netflix's decision to create their own content provided them with a more stable content library and a stronger bargaining position when negotiating licensing rights with Studios. This, however, changed the perception of Netflix in the market. Studios now view Netflix as both a collaborator and a competitor; Cable providers now view Netflix as a direct competitor and threat to their business; market analysts see Netflix as a media and technology company; and an increasing number of customers view Netflix as their primary source of entertainment because of the steady flow of new content.

I think the growth of Netflix illustrates the broader changes happening in the cable TV industry. Thanks to the growth and development of the internet, it is now possible for a media company to be integrated along the channel of distribution. The success of HBO's HBO Now offering and the continuous growth of Amazon's Prime Video are also proof of this.

How The Players Are Adapting

From the deals mentioned earlier on in this post, it looks like the bigger companies recognize the changing industry landscape and are making moves to adapt. The most interesting of these, to me, are from AT&T and Disney.

In the old structure of the cable TV market, AT&T was a Cable provider. In 2015, they acquired the satellite service provider, DirectTV, creating the largest pay TV provider in the US (and the world). As mentioned earlier in the post, AT&T have also acquired Time Warner (pending regulatory approval) — parent company of Warner Bros Studios, HBO and other Networks. Should this deal go through, AT&T will be a major player in all stages of the channel of distribution — from the creation of content to its delivery to customers.

Disney's is a similar story. They are one of the biggest studios and their intellectual property and ability to create 'hit' content is unparalleled. They also own long term broadcasting rights to the most lucrative sporting events for advertising through their ESPN subsidiary. Their proposed acquisition of 21st Century Fox and its regional sports networks, will widen the gap between them and other studios and give them unprecedented bargaining power with Cable providers and middlemen — like Netflix. Disney could also go direct to customers with streaming services for its TV content library (as they have announced they will do by 2019) and to broadcast its sports content. I think Disney is in a stronger position for the future than anyone else (even Netflix), because they have the largest library of content and can take this content directly to customers, thanks to the internet.

What Does This All Mean For Companies?

This means different things for the big companies like Disney and for the smaller companies along the distribution channel. The bigger companies can now own everything from content creation to the customer relationship. This entails a lot of risk but they can face this challenge by bolstering their content creation process. In this new world, the ability to create relevant and commercially successful content is the differentiator between leader and also-ran.

The outlook is not as good for smaller players who don't have as large a content library or are unable to take the risks of being vertically integrated. They will have to consolidate, innovate very rapidly to compete or operate in a niche position.

What Does This All Mean For Customers?

And now to the most important person in all of this, the customer. After all is said and done, I think there's good and bad news.

As an optimist, I'll start off with the good news. Customers will have more choice of quality content than ever before. Producers, no longer constrained by programming slots, will churn out an unprecedented amount of quality content and customers will be the better for it. Also, customers have near complete control over their viewing habits because of the on-demand nature of internet streaming services.

The bad news is that prices will go up and access to all the new quality content will be nearly impossible. Prices will go up because the cost of producing content increases with an increase in the quality of the content (it cost $10 million an episode to make an episode in season 6 of Game of Thrones) and the risks these companies are exposed to increases. The TV companies of the future will be dependent on consistent growth in customer base and customer retention which are difficult to achieve without lock-in contracts and a constant flow of new content. These high prices will mean access to all this quality content is impossible unless the companies can collaborate and figure out a new kind of bundle for this new paradigm.