Tuesday, April 28, 2015
Oxford Dictionary definitions:
Tier: “a row or level of a structure, typically one of a series of rows placed one above the other and successively receding or diminishing in size”Package: “combine (various products) for sale as one unit”
Given the rapidly evolving media landscape, multi-year programming contracts (usually 5+ years in length) are incredibly complex documents that attempt to plan for unforeseeable changes throughout the industry. Making matters even more complicated is the fact that the exact terms of programmer contracts are highly confidential, with most industry participants only talking publicly in generalities.
What We Believe to Know
Most cable network programmers have agreements with MVPDs that require their basic cable channels (think ESPN to FX to USA) to be carried (and paid for) in 85%-90% of an MVPDs subscriber base. This still enables MVPDs to offer smaller bundles that have a bare minimum of channels, such as broadband-focused offerings with broadcast television and HBO or Showtime. This allows MVPDs to offer cheaper, more limited bundles without jeopardizing the subscriptions fees that cable networks require to sustain their business and the consumer reach to attract advertisers.
Interestingly, Disney appears to have an additional programming clause, at least with Verizon, that forbids ESPN and ESPN 2 specifically, from being offered as a tier.
Enter Verizon’s Custom TV
Last week, Verizon FIOS began actively marketing a new offering, entitled Custom TV with a multi-platform ad campaign using the slogan “FIOS Gives You Choice” (link). Disney, Fox and NBC have all raised concerns about Verizon’s new offer focused on how the packaging of channels does not appear to be consistent with their existing programming contracts. However, only Disney has filed a lawsuit against Verizon (via WSJ, link) aimed at stopping Verizon from packaging ESPN/ESPN2 in the current manner.
We suspect nobody in the cable network industry likes Verizon’s Custom TV offer as it’s a bit too close to the world of a la carte for an industry reliant on the “fat” bundle of networks, most of which any given consumer never watches. Yet, until Custom TV gets to a level of subscribers that violates the penetration clauses of cable network contracts, we suspect there is little that cable networks can do.
The issue with Disney that prompted a lawsuit centers on the definition/interpretation of the word “tier.” Verizon clearly put a lot of legal analytics into the structure of its new “Custom TV” packaging, with a clear focus on building one’s own base package vs. offering a single base tier and then adding others tiers on top. In fact, there is no single, standard base tier for Verizon’s Custom TV offering. While there is a base set of channels, subscribers to Custom TV get to choose two of seven channel packs as part of their base package. In turn, consumers can effectively create 1 of 21 distinct base packages under the current Custom TV structure. If a user chooses the sports pack as one of their 2 packs, ESPN and ESPN2 would be part of that subscriber’s base package. Consumers who want more content added into their base package simply pay for each additional channel pack. The legal question is whether this is different enough from a base package plus a tier.
- The ability for ESPN/ESPN2 to be in a subscriber’s “base package,” should the consumer select it as one of their two included channel packs, does make it hard to see Custom TV as discreet tiering of ESPN/ESPN2, however this will clearly be for a court to determine.
What About Consumers?
The challenge for Disney and the rest of the cable network industry is that they are pitted directly against the consumer. Programmers are doing everything they can to slow the pace of technology. Programmers have impaired recently launched virtual MVPDs (link) and have made TV Everywhere feel like TV Nowhere (link) with an exceedingly painful advertising experience (link). Programmers need the bundle to survive and structure their contracts to force large number of channels onto consumers, even if they only want a few channels. Programmers focus on the price/value of the overall large bundle and that many smaller networks wouldn’t exist or never would have gotten off the ground if not for the large channel bundles. Yet, in a world where Netflix has exceeded 40 million subscribers at a sub-$10/month price point with subscribers watching over 2 hours of content/day (link), the price/value of multichannel television looks increasingly less compelling to consumers young and old.
Courts will clearly settle the near-term dispute between Disney and Verizon, but the larger question is whether Congress or the FCC will be provoked to revisit the current state of video bundles. Historically, there has been little interest from the FCC and Congress to mandate a la carte programming, limit bundling practices and reform retrans (given that retransmission consent is often tied to carriage of cable networks, for which it was never intended by Congress). Could the FCC or Congress be forced off the sidelines, if Verizon is legally forced to discontinue its offering and increase subscribers’ video prices or remove ESPN/ESPN2 from consumers who believe they are paying for the channels as part of their Custom TV base package?
Bottom Line: With the multichannel ecosystem increasingly mature and media companies uncomfortable with the shift from TV to digital/mobile, tensions between programmers and distributors are rising to new heights, which should concern investors throughout the sector.
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