December 10, 2014

Who Pays Whom?

As 2014 winds up, it is natural to not only take a step back – to better understand key trends of 2014 – but to look forward – to envision 2015 and beyond. In this light, it is interesting to note how many of the most important industry stories in 2014 related to the once-simple question of ‘Who pays what, and to whom?’

Whether it concerned Netflix paying money to Comcast for bandwidth, or HBO announcing a direct-to-consumer service, 2014 offered ample evidence that business models across the TV ecosystem are in a state of transformation. This will become more obvious as some of 2014’s high-profile announcements turn into real-world services.

So what have we learned about TV business models in 2014, and what if anything does it tell us about the future of TV? Two thoughts…

1. Single-Revenue Streaming Models are Fast to Market
The legacy TV industry has a very complicated business model (to say the least). The mesh of paid relationships between (1) broadcasters and their affiliates; (2) content providers and TV channels; (3) pay-TV channels and the MVPDs; and (4) advertisers and all of the above (as mediated by Nielsen ratings) is enough to fill several whiteboards and then some. Economically speaking, these relationships work well for most of the established players, but they don’t exactly lend themselves to rapid adaptation and innovation. If there’s one thing the modern history of the US TV industry has taught us, it is a certainty that any significant innovation will be met by one (or more) lawsuits in which one (or more) of the existing players vehemently protest that a new innovation (if allowed) would disrupt the existing system to their detriment.

The most successful innovators in such a system are not necessarily the most technologically proficient, but rather those with simple, effective business models capable of moving faster than others. Netflix started out with a simple DVD-by-mail subscription service that leveraged some of the positive attributes of recurring credit card billing, copyright’s first sale doctrine, and prepaid postage labels into a viable business. It then moved quickly into a simple pay-for-streaming monthly subscription model that gave them a significant advantage (emphasis on ‘quickly’).

Others were more concerned about protecting their existing revenue streams then they were in competing in the new market. Even Apple, it must be noted, was so fixated on the transactional business model pioneered by iTunes that it altogether missed the subscription video model. Conversely, the pay-TV industry’s TV Everywhere initiative has taken years to get traction (despite a pretty strong value proposition to the consumer), due in part to a complex business model that took years to articulate in such a way that it met the demands of all stakeholders.

The move in 2014 by existing TV players (i.e., HBO, CBS, etc.) to announce direct-to-consumer SVOD services shows a desire to embrace a simpler-is-better mindset, but is this really the right lesson for legacy providers to learn? As many critics of my own TV-as-an-app paradigm have correctly pointed out, consumers like apps, but they won’t necessarily like having to pay $5.99/month to multiple providers for content that used to get bundled for something closer to $1. The lesson? Simple models may be easy to deploy, but the jury is still out regarding whether this provides a viable path forward for the industry as a whole.

2. Dual-Revenue Streaming Models are More Resilient
Advertising-based business models are simple to launch (no billing!) and are popular with consumers. That said, they are not so well loved by the TV industry. And note that this is not merely a US phenomenon. Why is that? Simple: producing high-quality first-run TV is expensive everywhere and advertising by itself increasingly cannot pay all of the bills.

Second, and relatedly, advertising budgets are highly volatile over the business cycle. For example, legacy free-to-air TV broadcasters across both Spain and Greece were hit extremely hard by vicious recessions. As a result, industry fights have broken out across Europe between broadcasters and pay-TV providers over retransmission rights.

Virgin Media in the UK, for example, has historically obtained distribution rights of the most popular broadcast channels (e.g., ITV and Channel 4) for free, and is not particularly excited about having to pay for them. ITV, by contrast, has made it clear that it wants (and needs) a dual-revenue stream for its most popular channel and is not afraid to involve the European Commission to make it happen. In Germany, the situation is even more bizarre (at least from a US standpoint), with broadcasters actually paying pay-TV operators to carry their content (i.e., reverse retransmission fees). Neither of these positions appears sustainable, and most developed markets will likely evolve towards some form of retransmission fees that (along with ads) provide a more sustainable funding model for traditional broadcast channels, while other channels will migrate to a pay-TV carriage fee plus advertising model.

Though the future of TV is an app, the future of the TV business model is not so simple. Be wary of moves and announcements that emphasize speed of deployment over consumer acceptance. In such cases, the most certain (and rapid) outcome is failure.

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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