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The Economics of Indecency

Comcast and Time Warner could find that family-tier plans will hammer some networks 12/09/2005 07:00:00 PM Eastern

The cable industry is blinking. Just days after FCC Chairman Kevin Martin launched an attack on indecent programming on basic cable, major operators seem to be coming to heel, hurriedly drafting plans for special tiers of family-friendly programming,

Comcast and Time Warner Cable are hoping to head off harsh regulation that could force systems to offer all basic channels à la carte—the same way they sell pay movie channels like HBO—which could create financial havoc for both systems and networks.

The two operators spent last week talking with programmers and combing through network-affiliation contracts to see what kind of family packages they can offer. Neither company expects to finalize plans quickly but may broadly outline a family-tier plan at a new indecency hearing before the Senate Commerce Committee scheduled for Monday, Dec. 12.

“If there is, in fact, a demonstrable need for a family tier and it can be accommodated within the programming contracts that we have, then we could probably meet that,” Comcast CFO John Alchin told an investor conference last Thursday.

Programming executives worry that a family tier presents the same hazards as à la carte, or individually priced channels. Heavy tiering could leave some networks with fewer subscribers, license fees and ad sales exacerbated by greater marketing costs. The family networks could actually be the ones that suffer.

The family tier would be relatively more palatable to operators, some of whom would welcome new flexibility to juggle the most expensive basic networks into new packages with fewer subscribers. But if a small family tier is popular, it could crunch the company's average revenue per subscriber.

At the same time, Jack Valenti, retired chairman of the Motion Picture Association of America, is calling for a different way to marshal a task force to create a single ratings system for all media—including movies, TV and videogames—warning parents what kind of language and sexual content to expect before their kids watch or play.

Both efforts stem from system and programming executives' panic over the threat of à la carte. At a Senate Commerce Committee hearing Nov. 29, Martin startled media companies by reversing the commission's previous stance, saying he advocates forcing cable operators to sell networks à la carte. Industry execs say that regulatory scheme would upend the industry's core economic model.

A solid family-tier plan would likely thwart any à la carte push. Martin, powerful Senate Commerce Committee Chairman Ted Stevens (R-Alaska) and other members of Congress have said they want operators to create a package of kid-friendly programming.

Parents with conservative tastes could buy only the family tier without ever bringing channels that are more tawdry (or edgy, if you prefer) into the house.

What's a family tier? Sen. Ron Wyden (D-Ore.) lays it out in the brief Kid Friendly TV Pro­gramming Act of 2005 moving through the Senate. It would be a tier of no fewer than 15 channels with no programming “considered inappropriate for children due to obscene, indecent, profane, sexual, or gratuitous and excessively violent content.”

If an operator put networks like Nickelodeon, Disney Channel and ABC Family into a package, that wouldn't infringe on subscribers' right to see all the Nip/Tuck and Real World episodes they want on FX and MTV, he argues. But parents could easily limit what comes into their homes.

Wyden argues that cable operators already create packages for other types of programming. “Why should sports fans and movie fans be treated any different from families and children?” he asked at the recent Senate hearing.

Network executives, however, fear that the family tier would be a ghetto. Some networks require operators to put them on the most widely used package, and many charge substantially higher rates for being stuck on a tier.

A Turnoff For Some Adults

The “family-friendly” label can be a turnoff for adults who don't have young kids. Discovery Network, for example, targets primarily adults 25-54, not children. “We don't want to only be considered 'family,'” says one Discovery executive.

A tier could mean fewer subscribers, for either the networks included on the tier or those excluded. A family tier can be crafted in a variety of ways. One that Comcast and Time Warner are considering would separate a package of family channels from the larger basic tier. Parents could buy one or the other.

Homes without young kids might leap at the chance to trim their bills by leaving Disney Channel or Cartoon Network off their dial. “Are young single men going to take kids' networks?” asks Mark Rosenthal, chairman/CEO of ad-buying group Interpublic Media and former president of MTV Networks.

Another approach kicked around by cable operators is keeping family-friendly channels bundled into enhanced basic, but parents could opt to buy only the smaller package. That would help the family networks but potentially hurt any excluded network, notably MTV or FX.

While it's unclear how many subscribers a family tier would actually secure, DirecTV offers a glimpse. For several years, the DBS service offered a Family Pack of channels deemed inoffensive, such as VH1 Classic, Hallmark Channel and a pair of splinters of Discovery Channel.

Hardly anyone was interested. SEC filings indicate that Family Pack accounted for fewer than 1 million of DirecTV's 10 million subscribers in 2001. In 2002, Hallmark was so eager to escape the family-tier pigeonhole that it paid DirecTV $80 million in stock, or $11 per subscriber, to escape and get onto its more widely distributed Total Choice package.

Overlooked: Huge Marketing Costs

Hallmark Channel COO Paul FitzPatrick warned the House Commerce Committee that a family tier would “change the fundamental economics of the marketplace” for basic channels.

Disney reports a similar experience. During the late 1990s, Disney Channel allowed operators to offer the channel on separate tiers. The network has told the FCC that the penetration of tiers barely exceeded 40% of basic subscribers.

In this scenario, networks would be collecting license fees on fewer subscribers, so programmers would either face stiff losses or have to jack up their fees. Advertising losses would probably be less severe, since the heaviest viewers of family networks would be the most likely to actually buy the tier. But networks would still lose “grazers,” the occasional viewers who stop in while surfing aimlessly.

Booz Allen, the consulting firm hired last year by the National Cable & Telecommunications Association, offers one of the most extensive looks at the economic effects of both tiering and à la carte. Consider the source.

Booz Allen principal Matthew Egol says the firm did not specifically look at a family tier but classified networks into categories—including news, entertainment and sports, and “emerging niche.” The loss of viewers, he says, would cost the networks with relatively low viewership most heavily.

In the study, “emerging mass” networks (for example, ABC Family, Animal Planet, Court TV) could lose 29% of their audience. Niche networks (TV One, WE: Women's Entertainment, Speed Channel) could lose 24%. A sports network like ESPN might lose only 8% of its audience. Fewer viewers means less ad revenue.

“Emerging networks that have fought to get carriage, traditionally relied on occasional viewing to build an audience,” Egol says. “These are the ones that are at the most risk.”

The best part of the Booz Allen report is its focus on the most overlooked cost of either tiering or à la carte: marketing costs. Coaxing viewers to tune in for a half-hour is hard enough; persuading them to spend money on a tier is much harder. Pay networks like HBO spend enormous sums urging viewers to subscribe: 15%-27% of revenue. Basic networks currently spend far less: 2%-6%.

Egol estimates that a network on a tier would have to boost marketing costs to 20%-30% of revenue. I agree: Marketing costs would definitely eat into margins.

Consumers would leap at the chance to use either a family tier or à la carte to stop paying for channels they don't watch. Cable bills would be smaller, but we'd all pay a higher constitutional price. Even giant media companies shouldn't be bullied into changing their content by the threat of government regulation. That's particularly true since an anxious parent can block almost any cable channel with a few flicks of a remote control.

E-mail comments to jhiggins@reedbusiness.com

LOCATION, LOCATION
Estimated decline in audience for cable networks moved to a tier
Category Change
Emerging mass (Sci Fi, Court TV) -29%
Emerging niche (Oxygen, TV One) -24%
Older-skewing (AMC, Bravo) -19%
Younger-skewing (FX, MTV) -16%
Entertainment/sports (TBS, USA) -11%
News (CNN, Fox News) -8%
Source: Booz Allen on behalf of NCTA
March