Headwinds Intensify as TV SPs Scramble to Regain Momentum

Peter Stern, EVP & chief strategy officer, Time Warner Cable

Peter Stern, EVP & chief strategy officer, Time Warner Cable

October 31, 2011 – The trends shaping the cross-currents in TV viewing have reached critical mass, ensuring that the year ahead will mark either the emergence of a successful new pay service paradigm for network providers or an acceleration in subscriber losses from which they’ll be hard pressed to recover.
Working in cable, telco and satellite providers’ favor is the popularity of mainstream TV and the strengthening of programmers’ commitment to maintaining their share of the premium revenue stream. Service providers’ experiments in pricing flexibility and support for universal multiscreen navigation that integrates over-the-top options and popular applications into the pay TV experience offer hope they will be able to keep and build subscriber bases with offerings better tuned to current market circumstances.

But pay TV players aren’t out of the woods yet. In light of the momentum behind the more adverse market trends, there’s an element of too-little/too-late in their strategies that tends to even the odds on their prospects. By all appearances 2012 will be a make-or-break year when it comes to premium service providers’ ability to convince Wall Street that they have a sustainable business model.

Sub Losses Continue

Latest results on pay TV subscriber numbers contained in the few third quarter financial reports available at press time reflect a continuation, albeit at a slower pace, of the sector’s Q2 subscriber losses. For example, Comcast, registering strong growth generally with a five percent increase in profits, reported it lost 105,000 pay TV subs, down from the 238,000 lost in Q2 and from the 275,000 in losses registered in Q3 2010. Time Warner Cable, registering what analysts described as a disappointing bottom-line performance, said it lost 126,000 subscribers in Q3 compared to 130,000 in Q2 and 155,000 a year earlier. Cablevision, too, reported Q3 pay TV sub losses after registering a slight gain in Q2 as a result of including Bresnan Communications numbers for the first time.

While mild cable subscriber gains in Q4 2010 and Q1 of this year had buoyed hopes that the pay TV sector as a whole was back to tracking with historic trends, which have registered cable losses to satellite and telco competitors but overall gains in pay TV subscriber totals, the Q2 numbers altered that perspective, marking the third quarter out of the previous five with a net loss for the sector.

According to SNL Kagan, the Q2 2011 net loss, at 425,000-450,000, was even higher than the 216,000 net loss in Q2 2010, which was followed by a net Q3 loss of 119,000. The jury was still out on what sector-wide results would look like for Q3, but signs weren’t good. The two leading telcos, while continuing to register subscriber increases as they had through all the down quarters, were off analysts’ expectations, with Verizon showing a net gain of 131,000, down by over 30 percent from the Q2 gain, and AT&T adding 176,000, off 13 percent from Q2 and about 45,000 below consensus expectations of analysts.

Despite the negative signals, MSO executives hailed the relatively stronger performance in Q3 as a sign that new strategies were working against the cord-cutting pressure exerted by the economy and OTT alternatives to pay TV. “We’re pleased with the stronger subscriber results in August and September,” said Time Warner Cable chairman and CEO Glenn Britt in an earnings conference call.

“This is the worst economy in a long time,” notes Sam Schwartz, executive vice president for strategy and development at Comcast Interactive Media. “You’d expect subscriptions to be bad, but the numbers are holding. People are staying home, which means they’re getting more value out of their cable subscriptions.”

As for the impact of OTT options, Schwartz says any “cord shaving” is at the edge and of little significance. “Customers who stream Netflix are the ones who buy more VOD from us,” he adds.

Indeed, the perspective on OTT has shifted dramatically over the past year, observes Jessica Reif Cohen, first vice president and managing director at Merrill Lynch. “A year ago we talked about OTT being disruptive,” Reif Cohen says. “Now it’s another window to use to enhance consumer experience.”

The impact Roku, a leading supplier of OTT TV access devices, is seeing from its service hasn’t turned out to be a significant detriment to pay TV providers, despite an escalation in viewing time per device from seven hours per week two years ago to 12 hours currently, says Charles Seiber, vice president of marketing at Roku. “Some of our customers have decided they can get enough of what they want in the way of TV entertainment from our service,” Seiber says, “but the vast majority are pay TV subscribers who haven’t changed their behavior.”

New Pricing Strategies

However, with OTT options gaining appeal as household incomes get squeezed by the downturn, some cable operators are acting to make pay TV more affordable by testing lower cost service tiers. Comcast’s “MyTV Choice,” offered in trials in Charleston, S.C., and parts of New England, proffers several options with different permutations in different markets.

In Charleston, where, unlike the other markets, subscribers don’t have to buy Internet and voice services to get the low-cost TV packages, the offering starts with a “Get Started” package of 50 plus channels for $24.95 monthly, which can be augmented with multi-channel “theme” groupings of news and information, kids, entertainment and lifestyle, and movies at $10 per cluster. “Get Started Plus,” priced at $44.95, includes ESPN and a few other top-tier channels.

Time Warner Cable has been offering “TV Essentials” packages in the $40 range in New York City and at around $30 in Northeast Ohio markets since last November with plans to expand to more markets, as yet unnamed, in the months ahead. These offerings, like Comcast’s, feature about 50 channels and don’t include many of the more popular channels such as ESPN, TNT, MSNBC, Fox News and Comedy Central. TWC doesn’t require purchase of other services but does not offer a discount for bundling Essentials with Internet or voice.

Addressing a Goldman Sachs conference in September, TWC COO Rob Marcus said the company is trying to create packages that “might be more attractive and affordable to those customers who might not be able to handle the full packages.” He added: “The numbers are still pretty small, but the results are sufficiently encouraging that we’re going to roll that out more broadly.”

This is a path TWC will be following for a long time to come, says TWC executive vice president and chief strategy officer Peter Stern. “Historically we’ve offered little diversity in pricing,” Stern says. “We have to take risks and offer smaller and more flexible packaging.” More diversity and lower costs with an emphasis on keeping it simple will likely be a focus for the next ten years, he adds.

Cable operators have Wall Street support for such strategies. “Segmentation is the way the industry is going to have to move,” says Reif Cohen.

In a recent notice to investors Sanford Bernstein analyst Craig Moffett stresses the risks for pay TV providers who fail to follow this mandate. With 86 percent of American households subscribing to TV services and the bottom 40 percent of households barely able to cover costs of basic necessities, the pay TV sector has an especially high “exposure to the bottom half” in comparison to other industries, Moffett says.

Making matters worse is the fact that subscription costs have been rising, going up between 2005 and 2009 by 29 percent on a weighted ARPU (average revenue per user) basis as the economy has deteriorated. “The disconnect between this increase and stagnant or falling incomes is striking,” Moffett writes.

The Economy-Driven OTT Threat

It’s in this light that the real threat from OTT can be seen. “No one would argue that the entertainment choices offered by Netflix are better than what’s available from cable – and neither are those offered by Hulu or YouTube,” Moffett says. “But when faced with a choice of pay TV or a third meal, will some customers choose to make do with a back catalog or off-the-run TV shows and movies? Of course they will.”

SNL Kagan predicts four percent of U.S. households, or about 4.5 million, will have replaced pay TV packages by the end of this year, up by two million from a year earlier. By the end of 2015 nearly ten percent of U.S. households will choose OTT over pay TV, the researcher says.

Falling costs of connected TVs and rising usage of those connections by purchasers are fueling the trend. The second biggest reason for new purchases of HD sets, behind the form factor and low energy benefits, is the desire for Internet connectivity, says Kurt Hoppe, director for smart TV innovation and alliances at LG Electronics USA, Inc.

“In excess of 50 percent of the people who own our connected TVs are using them to access Internet video,” Hoppe says, noting that built-in Wi-Fi or inclusion of a Wi-Fi dongle with purchase became standard with all LG connected TVs this year.

With connected-TV penetration rising rapidly, LG and other CE firms are doing everything they can to add appeal to the content options. For connected 3D TV sets this includes instigating OTT 3D initiatives which could have a significant impact on 3D TV purchasers’ viewing habits at a time when 3D content on pay TV is scarce. “We’re working with various players to bring more 3D to our devices,” Hoppe notes.

This isn’t good news for TV executives who’ve been assuming the Internet would lag behind traditional TV in bringing 3D to the masses. In June, Time Warner chairman and CEO Jeffrey Bewkes, speaking at the National Cable Show, cited 3D as a key advantage pay TV services would have over OTT. While acknowledging the industry has yet to get 3D right with respect to integration of the experience with guides and graphics, when it does cable’s “infrastructure will be the number one place to deliver that type of content,” Bewkes said. “The Internet infrastructure can’t do that and won’t for a long time.”

But, already, Adobe, with beta release of its Flash 11 player, the AIR3 multi-device development system, CS5.5 software for TV-quality production and the Stage 3D graphics rendering API, is unleashing 3D development on the Internet with rapid uptake on the part of CE manufacturers. LG says it’s courting Adobe’s developer community to use the new tools for applications and content with the aid of LG’s new Smart TV SDK (software developer kit) 2.0, due out in December.

With these tools developers will be able to put 3DTV content into 3D-optimized graphics environments, notes Sam Chang, general manager of LG’s Innovation Development Group. LG’s Smart TV technology will allow developers to “deliver a significant amount of 3D content through the Internet into consumer living rooms,” Chang says. Next year the company will also augment the 2D-to-3D conversion feature optimized for live TV and video streaming content on 2011 models of LG 3D Smart TVs with support for 2D-to-3D conversion of apps on these sets, he adds.

One of the factors likely to accelerate OTT video-oriented app development is the fact that Flash Player 11 and AIR3 are designed to break traditional platform barriers with support for Android, Apple iOS, BlackBerrry Tablet OS, MAC OS and Windows as well as connected TVs. Adding to the scale of development potential in its domain, LG has partnered with Sharp and Phillips on the forthcoming SDK to ensure that apps created for any one of those smart TV platforms will run on all the others, Hoppe notes.

Connected TVs routinely include a portfolio of programming from Netflix, VUDU, Hulu Plus, Amazon VOD, Cinema Now, professional sports leagues and other premium options. The OTT appeal is sure to increase as the connected TV set becomes the target for ever more professional producers operating outside traditional network domains, including the new professional channels Google’s YouTube is creating with “The X Factor” producer FremantleMedia, VH1 “Mob Wives” producer Electus, News Corp.’s ShineReveille and many other TV players.

The Hybrid Service Paradigm

Leveraging their strength as keepers of the premium TV jewels, service providers are scrambling to keep ahead of these developments by making sure subscribers experience the best of the OTT and pay TV worlds through universal navigation systems that bring content to multiple devices.

“We’re in the middle of an evolution toward innovating quicker,” says Comcast’s Schwartz, noting that the next-generation Xfinity service launched to 1,000 August, Ga. households in trial mode earlier this year is on schedule for rollout in other systems next year. But “it’s hard for the industry to evolve on the legacy set-tops,” he acknowledges.

While media gateways such as the Pace Micro terminal Comcast is using in Augusta are the ultimate solution, there’s an immediate need to break down the “almost Chinese wall” in navigation that currently exists between live TV, VOD and DVR-stored video in today’s linear guides, Schwartz says. This is why Comcast and other MSOs are putting a lot of emphasis on tablet- and smartphone-optimized universal navigation systems that interact with legacy set-tops.

It’s also why MSOs are viewing connected-TV manufacturers as potential allies as well as threats. “We provide set-top boxes because we have to, not because it’s a business we want to be in,” says TWC’s Stern. “We don’t make any money on set-tops. If you have a smart TV, you won’t need a set-top. We’ll be glad to walk away from that.”

The mantra for everything TWC does these days in the TV vein is the “four any’s – any content, any device, anytime, anywhere,” Stern adds. “All of our innovations are focused on that reality.”

Ultimately, cable companies’ success at creating a hybrid premium TV/OTT experience across all devices with plug-and-play convenience and universal navigation may be their best hope for sustaining subscription service revenues. In combination with more flexible pricing strategies the new service paradigm could prove a winner with a restless consumer base. But given the long road ahead to get there, the outcome is anything but assured.