March 3, 2015

Shifting Sands

Household formation metrics generally attract little attention – unless, of course, you are a homebuilder or a pay-TV industry analyst, in which case these numbers matter a great deal. As we know, during the great recession and its aftermath, US household formation was anemic. Lacking suitable employment, a good number of Millennials boomeranged home to live with their parents and home sales slowed to a crawl.

Thankfully, those days may be behind us. In 2014, US household formation rebounded strongly, up 1.6 million for the year.1 In the same year, growth in broadband subscriptions matched (or even exceeded) new household formation, though pay-TV households were flat at best.2

Other than providing cause for celebration among the parents of Millennials, what does this tell us about the future of TV? Two things.

1. Broadband is Mandatory, Pay-TV is Optional
Nobody moves into a house or apartment without immediately signing up for water, electricity, and (in some cases) natural gas. The necessity of these services is beyond question. Regardless of income level, those moving into a new residence don’t spend months mulling over whether they want to take a shower or turn on the lights. Due to their importance in the lives of human beings, such services are viewed and regulated as utilities.

More than two decades into the era of consumer Internet, home broadband services have become one of these lifeline utilities (as TDG predicted in 2004). Despite the ubiquitous presence of smartphones with mobile data plans, few can live solely on mobile Internet access for a long period of time. Most tablets are Wi-Fi only, PCs rarely feature SIM cards, and there is (so far) no flavor of connected TV device in the US that runs over a cellular network. Without broadband Internet access (which now includes Wi-Fi as a matter of course), all of our cool devices are but doorstops. Consequently, when people move into a new dwelling (regardless of age or income level), they take pains to have a broadband Internet service in place from day one.

This may surprise our youngest readers, but ‘cable TV’ used to be in this same group. It was once a central part of daily life in the US, such that people literally suffered withdrawal if they were without it for even a few days. Importantly, pay-TV used to be the way that people received daily access to news, weather, traffic, sports scores, and election results. TV was more than entertainment; it was the way people felt connected to society and aware of what was going on.

It was the summer of 1994 in Durham, North Carolina when I moved into my first apartment. At that time, there was no such thing as separate Internet service. The few people ‘going online’ did so via dial-up service provided over landline telephone infrastructure (another utility whose time has expired, but that’s another story). Like most in 1994, I unpacked and hooked up the TV set before I even thought about unpacking the dishes or silverware. TV was truly that fundamental to my life.

My, how times have changed. The Internet has totally replaced TV as society’s fundamental communications medium and is now a must-have service. Pay-TV, by contrast, has become an optional (read ‘discretionary’) service that for all intents and purposes is a source of entertainment (critical information is now more accessible and readily available online). Put another way, TV has become the social equivalent of ice cream. Sure, lots of people like it, but very few will argue that you can’t live without it.

This shift in the perceived value of television goes a long way to explain the growing divergence we are seeing between household formation numbers and pay-TV subscription numbers. There is no longer a one-to-one relationship between ‘moving in’ and signing up for pay-TV. It is no longer viewed as a utility, and the sooner the TV industry accepts this reality, the better off we’ll all be.

At the same time, caution is warranted when interpreting the new household data. Despite the fact that new household formation has not led to a corresponding increase in the number of pay-TV households, a one-time discretionary decision not to sign up for a pay-TV service does not logically entail that these consumers have sworn off pay-TV for the rest of their life. Identifying them as lifelong ‘cord haters’ assumes a false dichotomy, a binary distinction that isn’t necessarily accurate. At this moment I don’t have any ice cream in the freezer, but this doesn’t make me an ‘ice cream hater.’ A number of life events (e.g., a change in employment status, an increase/decrease in income, marriage, having children, etc.) can fundamentally alter the context in which household decisions are made. Some of these factors may cause a person to sign up for pay-TV, while others may cause a person to cancel it. This is how discretionary consumer spending works, and subscribing to a traditional pay-TV is becoming discretionary, one of many options. Get used to it.

2. US Video ARPU will Fall
The average pay-TV bill continues to increase, so how can I make the argument that video ARPU will fall? Two reasons. First, as pay-TV becomes discretionary, MVPDs need to find ways to compete with OTT services and attract households on the fence about whether to subscribe to a full bundle of channels. One of the key tools to make this happen will be low-cost ‘skinny bundles’ that offer a small set of channels for a much lower price. As we recently noted, this is also the market Sling TV is chasing with its $20/month package.3 Such packages will be essential going forward and will consequently lower video ARPU over time.

Second, the definition of ‘video ARPU’ itself must change. The traditional conception was based on a relatively simple formula: total pay-TV revenue divided by the total number of pay-TV households. This conception, however, has become simplistic. For example, the numerator doesn’t include revenue from OTT video services like Netflix, Sling TV, YouTube, and NBA League Pass. (For households subscribing to both pay-TV and OTT services, this means the existing definition actually undercounts video ARPU.) More importantly, the denominator does not include the number of households with either pay-TV or broadband service. When these households are accounted for, it becomes clear that non-pay-TV household video ARPU is actually dramatically lower than current assessments. Over-the-top services are both narrower and less expensive than traditional pay-TV, across the board.

As the number of non-pay-TV households increases, and as more consumers turn solely to OTT services, the effect will be to dilute video ARPU. Like squeezing a water balloon, attempts to halt this inevitability by increasing the prices paid by remaining pay-TV households will be largely self-defeating, as more people will simply move into the non-pay TV column. This may be heresy to some industry types, but that doesn’t make it any less true.

The TV industry has wasted an enormous amount of energy over the past decade arguing about whether the sky is falling; that cord cutting would undermine legacy pay-TV. All the while, the ground has been slowly shifting under everyone’s feet. Broadband has become a utility. Pay-TV has become a discretionary expense. And total US video ARPU is destined to fall.

Stick with TDG and stay ahead of the curve.

Joel is a Senior Advisor for TDG and serves as an advisor and Board Member to the video ecosystem and technology companies. He lives near Seattle, WA.


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