Tuesday, October 22, 2013

Bundling vs. A La Carte in TV Markets - History

Yesterday, I provided some insights from economic theory of information in terms of when bundling can be preferable to "a la carte" marketing of TV channels and networks by multichannel video distributors.  The essence was that bundling is actually the optimal strategy for the context of early cable systems and consumers, and has some ancillary social benefits as well.  "A la carte" offerings (in economics terms single-use pricing), may work well in other conditions, and the TV marketplace and distribution technology is moving towards those conditions.

Today I want to explore that transition through a historical look at TV market economics, and how that has shifted over time.  Tomorrow I'll look at what going to a la carte will mean for today's networks/channels, multichannel distributors, and TV consumers, from a business/economics perspective.  To start, let's look at how networks generate revenues from a historical perspective.

  In the U.S., the predominant revenue source for stations, networks, and distributors comes from a mix of audience-based sources.  For broadcast stations and networks, the primary revenue source comes from advertising, and the amount of revenues an advertisement generates is based on the audience attracted.  Historically, broadcast stations who were network affiliates were also paid a fee for carrying network programming, but the amount was, again, based largely on the station's potential audience.  Early cable systems were basically redistributors of TV station signals, and the cable system's revenues were tied to the number of subscribers it could attract (i.e. audience size). 
  When cable networks and channels emerged, they followed one of two basic business models - looking for advertising for revenues, or a subscription-based approach.  The subscription model, Pay TV, used a strategy of offering new, and high-value, content not otherwise available to TV viewers in the market, and revenues were directly audience-based (i.e., the number of subscribers).  Ad-supported cable networks were miniatures of the broadcast network business model, with revenues based on their ability to attract and retain audiences.  These soon discovered that having a focused programming strategy (call it targeting, filling a niche, or branding) gave them a competitive advantage over broadcast networks for the audience segments that valued that type of content more highly.  The broadcast networks offered such content occasionally, but the cable network could be a place where viewers could find it all of the time.  Targeting also had an advantage in the sense that advertising on niche networks were more valuable for those advertisers who wanted to reach that audience segment.  Now there are a few cable networks where the revenues come from sources other than subscription fees or advertising (PBS, C-SPAN, shopping channels, religious networks), but those are still indirectly audience-based in the sense that the funding is based on their programming being able to reach an audience. Bundling allowed cable systems to combine and aggregate the niche audiences by taking advantage of the different mix of high-value networks across audience segments.  Bundling increased the value of, and demand for, the bundled mix of networks, allowing cable systems to increase both subscription fees and the number of subscribers.

Revenues are only one side of the business model - the other are the costs of operation.  For broadcast stations, networks (broadcast and cable), and cable systems, there are two basic costs - the cost of the programming and content, and the cost of distributing that cost to audiences.  The distribution costs for stations is tied to transmission capability, and increasing signal reach is costly.  For networks, they need to find a mix of broadcast stations and/or cable systems to distribute their content for them.  In the early stages of TV, that meant paying stations or cable systems for carriage, with the larger the potential audience pool the more valuable the distribution channel.  Distribution costs for cable systems were substantially different - cable operators face the very high fixed costs of building out the physical distribution network, with very low variable costs.  For them, the key was not building raw audience numbers, but in increasing the percentage of homes past that subscribed.  That brought the marginal costs per subscriber down to affordable levels.
  Turning back to programming costs, there is a general rule of thumb that programming costs correlate with audience popularity (i.e., are more likely to have a high value to some set of consumers).  Historically, broadcast TV markets were constrained in terms of both the number of competitors and in their ability to reach viewers in the market - so the only area open for competition within the market was in terms of the programming content offered.  Competition tended to drive programming costs up.  When cable sought entry, they needed to compete with the existing broadcasters, and the way they could was to offer signals and content that was not easily available otherwise.  In the early years, that meant paying to bring new channels, networks, and content into their market.  There was the added incentive that bringing in more valued networks and programming content increased the perceived value of the cable subscription bundle and allowed cable systems to increase subscription fees.

Things changed as technology opened markets and the newer networks began to establish their value in the TV marketplace.  As TV markets expanded in terms of viewing options, three things happened.  First, cable networks largely went niche.  They didn't have the resources to compete head-to-head with the broadcast networks for general interest programming and audiences.  Going niche let them access lower-cost programming options, yet benefit from the higher advertising value of their audience segment with some advertisers.  As multiple niche networks pulled off segments of the general interest audience, viewing of the big broadcast networks dwindled, impacting their ability to generate advertising revenue.  The third result is that some of the niche networks developed their brand identities and established their value to the point where having those networks as part of your channel bundle became essential for cable systems.  That let those channels switch from having to pay for coverage, to having cable systems pay for their network signals.  They had established such a strong expectation of value for their content among a large enough segment of audience, that carriage was mandatory.

The shift in viewing and advertising impacted revenue growth for broadcasters and networks, yet competition drove programming costs ever higher.  As a result, everyone started looking for new revenue streams - and carriage fees looked like a viable option.  However, as more stations and networks sought to take advantage of this potential revenue stream, those costs were passed on to multichannel video subscribers, increasing the costs of the bundle.  In most cases, the added revenues were not used to increase the value of the programming offered (and thus the value of the network to the viewer), but as a replacement for lost advertising revenue.  Increasing price without increasing value will inevitably reduce demand for the network, and lower demand results in smaller audiences - particularly in ever-more competitive TV markets. 
  One factor compounding this is the growth of online video options, many of which combine access to high value content with pricing models well below those available from multichannel video distributors.  Another is the fact that eventually the value of carriage fees will ultimately be captured by the owners of the content rather than its distributors (the fee depends on the ability of the copyright owner to limit access rather than any unique aspect of the distribution channel).  Finally, as competition in the marketplace advances to the point where most content is available over multiple sources and viewing options, stations, networks, and distributors are finding that having sole access to high-value content is a critical form of competitive advantage.  This is the reason why so many networks and distributors are focusing on delivering unique content (not available elsewhere), and why bidding wars are escalating for reliably high-value programming like sports and major cultural events.

From an economic perspective, what this means is that in an increasingly competitive TV marketplace, players are increasingly looking for carriage rights fees as a revenue source, and towards developing a (niche) brand that emphasizes high-value content as a way of increasing demand and value for their outlet.  The bidding wars for high-value content drive programming costs higher, and unique content increases the value of the station/network to distributors, allowing stations/networks to try to increase carriage fees collected from distributors, in part to cover the increased programming costs.
  Increasing carriage fees mean that the cost of existing bundles is increasing.  If the fee increase isn't matched by increased perceived value of the bundle, that will eventually lead to a reduced demand for the bundle.  If the multichannel distributor persists in the bundling tactic, eventually price increases will hit a point where the cost of the bundle exceeds the bundle's perceived value by a sufficient number of consumers to trigger a fall in subscriptions.  There are increasing indications that we're nearing that point in the U.S..  In particular, there's a growing awareness that the bidding wars for sports rights among a growing number of sports-niche channels is driving big jumps in carriage fees and forcing many multichannel distributors to start thinking about pulling sports networks from the basic bundle, and marketing them as a mix of mini-bundles of sports channels and/or a la carte offerings.
  Establishing a reliable brand - in other words establishing a more consistent level of expected value for content - is critical from a consumer demand perspective.  As mentioned yesterday, a key advantage of bundling for consumers is that the consumer can mitigate for highly variable and uncertain expected value for content by aggregating across multiple channels and over time.  When value is uncertain, it depresses the likelihood of purchase.  Aggregating across multiple options means that instead of wondering whether a single program or channel is worth purchasing, the consumer only needs to consider the likelihood that among the bundled options is enough value to justify the purchase.  So, if offered a la carte, the consumer's decision shifts to the question of whether they'll receive value in excess of the price they pay for that specific content or channel.  This works best when the content is known, high-value, and where such value is relatively consistent across the content offered.  That's pretty close to the goals of branding.
  Changing technologies are also enabling the other key feature needed for single-use pricing to work - the ability to collect payments and restrict access to the content/network to those purchasing. The growth in pay-per-view and video-on demand offerings from multichannel distributors amply illustrates the technological capacity to offer networks on "a la carte"basis.  The growth in niche branding and the success of many channels in building brand value among audience segments similarly demonstrates that, for some networks or channels at least, viewers may have a sufficiently developed idea of the expected value of a network and its programming options to facilitate "a la carte" purchase decisions.  The continuing evolution of the TV marketplace looks to be providing a context where single-use pricing models may be viable and practical. 

In essence, the transition from broadcast local markets for TV to global, digital, highly competitive marketplace is leading to a situation where bundling is becoming less optimal, and a la carte network marketing is becoming increasingly viable, at least for some networks and channels.  While much of the clamor for a switch is politically motivated, the reality of the current TV marketplace is that the ability of multichannel distributors to engage in "a la carte" marketing models for (some) networks is becoming increasingly practical.  Additionally, the growth in carriage rights fees is making the idea of a single basic bundle increasingly unaffordable and unsustainable as a marketing approach.  The disparity between the growing bundle price and the online video distributors' significantly lower prices is causing many TV viewers to re-evaluate their TV viewing habits and shifting their viewing preferences to lower-cost alternatives.  (A phenomenon known as cord-cutting.)

While the early technology and market structure of TV program delivery provided a viable foundation for developing and supporting bundling as a marketing and pricing strategy for cable, the evolution of the TV marketplace (and technologies) is reaching a point where a la carte marketing strategies are becoming practicable.  And for some (but by no means all) networks, a la carte marketing structure might be preferable.

But is switching to a full a la carte marketing model a good idea?  A lot of that depends on what will be the longer-term impact of a switch, particularly if competition, and programming costs, continue to escalate.  I'll address that next.

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