Small towns, big problems

Small-market TV never was the cash cow that big-market TV has been. But industry veterans are starting to wonder if changes in the business will squeeze out the smaller-market players altogether.

Now profits in the smaller markets are being squeezed like never before by a set of factors that, taken together, exacerbate what's always been a challenging environment for broadcasting in the hinterlands. Those factors include the phaseout of network compensation, the evaporating national spot market, the costly transition to digital and, of course, the weakened economy and the dampening effect that has had on the advertising market.

In large-market television, stations that aren't making close to 50% profit margins are considered poorly managed by most Wall Street analysts. But in smaller markets, ranked 75th and beyond, profit margins that big don't exist. In fact, for many of them, profits wouldn't exist at all but for network compensation.

Indeed, margins in smaller markets are closer to 20% than 50%, says Jim Yeager, president, Benedek Broadcasting, which owns 23 stations mostly in 100-plus markets. And others say many small-market broadcasters operate with margins far smaller than 20%.

One thing more is hurting small-market broadcasters: There's increasing competition from satellite TV operators. "Satellite is doing for small markets what cable did for the big cities," says one small-market TV-station owner. "It's giving people over-the-air access to programming in areas where it isn't feasible to have cable."

It's no secret the major networks are trying to eliminate compensation payments to stations, and most small-market broadcasters say their network comp is being phased out. By the next renewal cycle, they believe it will be gone altogether.

And that's a problem because, for smaller-market operators, it's the difference between annual profit and annual loss. Cullie Tarleton, executive vice president of television at Bahakel Communications, says most, if not all, stations in markets 90 and higher depend on network compensation for any profit they make.

For many small-market stations, comp is the sole source of funding for key services like local news operations. Stephen Marks, who owns stations in three of the smallest markets—in Glendive, Mont., the nation's smallest TV market (ranked 210), as well as Billings, Mont. (169), and Alpena, Mich. (208)—says losing compensation would force him to reconsider the viability of continuing his local news operations. "Compensation underwrites my news departments," says Marks.

Others say comp, or the lack thereof, would mean the difference between affording to build digital facilities and not having the money to buy the expensive equipment.

Some broadcasters, including Bahakel's Tarleton, say smaller-market operators need FCC rule changes or they may not survive. Duopoly restrictions need to be eased for smaller broadcasters, Tarleton says, as does next year's deadline to make the switch to digital. Others agree.

And if it's a tough row to hoe out there for small-market groups like Benedek or Bahakel, it's even tougher for single-station owners.

Case in point: David Woods, who owns WCOV-TV, the Fox affiliate in 117th-ranked Montgomery, Ala., says WCOV-TV isn't going to have any profit margin this year. In fact, he says, all of the station's cash flow—and then some—this year will go to servicing bank debt and paying Fox reverse compensation tied to an advertising inventory buyback plan that was instituted two years ago.

"Thirty percent of my cash flow will go to Fox this year for the buyback fee," Woods says. And that's after the network reduced the payments this year for small-market broadcasters who were feeling the pinch of those buyback fees. Woods says he's aware of some Fox affiliates that are paying more than half of their annual cash flow to cover the buyback payments.

Small-market managers say the networks have largely turned a deaf ear to their pleas to keep compensation intact. "We've been crying at them for years and years, and they don't seem to be sympathetic," says Dan Frenzel, the manager of KXGN-TV, Mark's station in Glendive. "All the major networks will eliminate comp. The scary part is that they're now talking about starting to charge stations to carry programming."

The networks aren't just talking about it—CBS, ABC and Fox all get help from their affiliates in paying for rights to the National Football League.

None of the networks contacted wanted to comment on the record. But when asked if the networks empathize with the plight of small-market operators, one network executive replied, "Of course we care about them. They're our distribution system, and we want them to do well." Nevertheless, the executive said, all affiliates, large and small alike, have to come up with new ways to generate revenue that will ultimately replace network compensation.

But Woods credits Fox with realizing it went too far with its reverse-comp plan. This year, the network scaled back his payments by 27%, and, in the smallest markets, fees to the network were cut by 50%, he says. "They understand that maybe they put too heavy of a burden on us. They want the small-market guys to stay in the ball game."

But Frenzel wonders whether the smallest operators can do it. "It would take an awful lot of guts to continue on in small-market broadcasting," he says. "The owner of this company wants to continue on," he says of Marks. "I give him credit for trying, but I just don't see how he can."

The economy certainly isn't helping matters. TV ad spending in Montgomery was down a little more than 16% in the fourth quarter 2000 (excluding political ads) and down about 20% in the first quarter, Woods says. The second and third quarters aren't much better, and fourth quarter is pacing down "big time," he says. "If it continues, we'll probably have to restructure our bank payments," he says.

But almost invariably when you ask small-market broadcasters what keeps them up at night, the answer is footing the cost of the transition to digital. Instead of counting sheep at the night, they count the dollars they have to come up with to make the switch.

Here's where it gets ugly: The cost of converting stations in the smallest markets is only marginally less than doing so in the largest markets. The bigger markets will spend more on backup systems because they have the money to spare. But Marks says his tech advisors tell him it will cost $12 million to convert his stations in Glendive, Alpena and Billings. It would take Marks' stations combined a decade or more to generate that kind of revenue.

Has he figured how he'll fund the conversion yet? In a word, no. But he's not counting on a deadline extension because he doesn't want to risk losing his licenses, he says.

A delay is just what small-market broadcasters need, industry executives say. "I believe it is absolutely critical that markets 75-plus get some additional time," says Tarleton. He thinks that markets ranked 75 to 99 should have another year, until May 2003, to get their digital signals on the air and that stations in 100-plus markets should get another two years. Those extensions would help in several ways, he says. With any luck, the economy will be better by then, and the cost of digital equipment will drop significantly, he believes, as manufacturers produce subsequent generations of gear.

And the fact of the matter is that if you don't have your DTV equipment order in by now, it's highly questionable as to whether you'll be able to get in time for the current May 2002 deadline, TV managers say.

"When that 2002 date was set, no one fully understood and appreciated the intensity of that curve," says Tarleton. "Our corporate engineer has put two digital stations on the air (one prior to joining Bahakel), and his learning curve is pretty much flat, but I guarantee you it didn't start out that way."

NAB data shows that it took 24 years after the introduction of color television until half the sets in use were color. That leads Yeager to conclude the following: "If we're looking at even 10 to 12 years before half the sets are digital, we've got to be realistic about this whole transition. If we're looking at that kind of timetable, then we've got to have relief on must-carry and [broadcast-cable] interoperability." Otherwise, he says, "it's going to be a terrible kind of conversion."

And broadcasters believe that is the rough timetable for conversion to digital. Marks cites figures that show consumers bought 30 million TV receivers in the U.S. in 2000. And just about all of them were analog sets. "I don't see our audiences rushing out to buy digital sets—most of which need a separate tuner—until the sets that are out there now are dying," Marks adds. So it will probably be 10 years before digital receivers achieve critical mass in the marketplace, he says. If the 2006 government deadline for making the full conversion holds, "there are going to be a lot of upset constituents that suddenly find their analog TV sets no longer work," says Marks.

There's a limit to the empathy that the NAB feels for the plight of small-market stations transitioning to digital. Last month, the NAB considered and then rejected a proposal by Yeager, past NAB joint board chairman, to press the FCC for a blanket delay in the deadline (May 2002) for switching to digital for small-market stations.

Instead, the NAB is asking for a streamlined process that will let individual stations fill out a simple form to request a waiver. Commenting last week, Yeager said that, if the FCC does adopt a "liberal waiver policy" for deadline extensions, that would probably accomplish the same thing as a blanket delay.

But one or the other is essential if small-market broadcasters are going to survive the economic downturn and make a successful transition to digital, Yeager says. "This is life or death for small-market broadcasters," he says. "The question is: Do you force them literally out of the business because of an arbitrary date of May 2002?"

Despite all the problems, some smaller broadcasters hope to hang tough. "I love this business; it's my life," says Marks. But others, including some Wall Street analysts, predict a new wave of consolidation once the economy improves, as smaller players cash in their chips and let the big boys figure out how to make a windfall out of the digital money pit.