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The Math Behind The CW

Does combining two struggling networks equal one success? 1/27/2006 07:00:00 PM Eastern

Time Warner is the largest media company, not just in the country but in the entire world. Its Warner Bros. Television dominates the TV-production industry, supplying more shows to broadcast networks than anyone. Yet, for all that clout, Time Warner executives couldn't manage to successfully program The WB for two prime time hours, six nights a week.

Viacom and its new spawn, CBS Corp., are smaller but did no better with UPN.

After a decade on the air, the networks are folding, with the pieces combined into a new channel, The CW network.

The inability of such powerful companies to make even modest channels work on the air speaks volumes about the state of TV networks. Consolidation is a classic response of companies stuck in a mature business, and every network is stuck. The broadcast networks' revenue growth averaged an unimpressive 4% over the past five years, and the next five look no better. If the ad market is slow and programmers can't chisel audience from rivals, combining operations is often the only way to squeeze some earnings growth.

“A major, major change”

Irwin Gottlieb was a little bit alarmed by the shrinking number of major broadcast networks. The CEO of Group M—who controls ad-buying firms that spend $20 billion of clients' ad dollars—suggests rewinding five years: “Would you have ever contemplated that we're going from six networks to five, instead of going from six networks to seven? We haven't taken a step back in a long time. We've always moved ahead.”

He adds, “For the first time, we are contemplating the ability to economically produce content for six networks; we are clearly questioning the ability of the [ad] market to support six networks. That's a major, major change.”

Univision and Pax would no doubt object to their exclusion from Gottlieb's network headcount. (Indeed, Univision instantly protested The CW proclaiming itself “the fifth network” since the Spanish-language network's audience already exceeds both The WB's and UPN's.) But Gottlieb's point is clear: Broadcasters' profits are imperiled, nibbled away by cable and further threatened as viewers and advertisers are distracted by the Web.

CBS and Time Warner will be 50-50 partners in The CW, but no money changes hands. Tribune Co. will surrender its 22% stake in The WB (which analysts believed was worthless, anyway) in exchange for an affiliation agreement to The CW for 16 of its old WB stations. CBS Corp. CEO Leslie Moonves says CBS' Paramount Television and Warner Bros. will co-produce programming that appears on CW.

The deal may initially look like a merger of The WB and UPN, but it's carefully crafted in a different way. The two networks are being shut down and some of their assets drawn upon to create what CBS and Time Warner tout as “the new fifth network.” That's more than mere hype. Executives believe that closing the old networks frees them of obligations to angry former WB and UPN affiliates not chosen for The CW. That's a contentious issue roiling station groups, even big ones like Fox TV Stations.

The deal is being driven by years of losses. The WB and UPN were launched for the same reason, providing a TV platform for their studio parents. Executives at Warner Bros. and UPN parent Paramount worried that loosening federal rules would have the networks developing more of their own entertainment programming or strong-arming studios for a big piece of backend sales. So The WB and UPN were started to ensure that the studios' TV factories always had a ready outlet.

But it has been an expensive outlet. Securities filings show that The WB has burned through about $600 million; Morgan Stanley media analyst Rich Bilotti estimates that UPN has lost at least $500 million. The studios have had few giant hits to make up those losses through syndication or DVD sales.

Without detailing any numbers, Moonves says, “These two networks would have closed or would have continued to stumble along.” But by cherry-picking the strongest shows—like The WB's Smallville and Gilmore Girls plus UPN's Veronica Mars and America's Next Top Model—The CW should be profitable from the start.

“You keep the best of both networks,” Moonves says. “That's a pretty good way to start a network.”

However, there is no guarantee that combining the leavings of two troubled networks will breed success.

Is cable next?

Moonves dismisses the notion that the deal is driven by maturity of the whole broadcast-network sector. These netlets aren't in decline; they never really gelled to begin with as they fought it out behind the Big Four networks.

“Five networks was probably the right number of networks all along, even way back when,” Moonves says.

Perhaps. But maybe broadcast networks are simply in the same maturity slump that's gripping TV stations. Local broadcasters are stuck with average revenue growth around 4%, and there's no end in sight. Station groups generally complain that ownership restrictions—particularly those limiting duopolies—keep them from following the natural course, consolidation.

That's the path you see in slow-growth industries around the country from department stores to telephone companies.

Could cable programming be next? Major basic networks are generally growing now, but the easiest gains are from increasing distribution and raising license fees paid by cable and DBS operators. Meanwhile, smaller networks peck away at the top 10 channels, limiting their audience and advertising growth.

Nobody likes to grow old.

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jhiggins@reedbusiness.com

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