Comcast's Chief Cost-Cutter

Burke seeks to wield his MSO's clout to restrain programming prices
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Cable programmers had better keep an eye on the Consumer Price Index. Their biggest customer, Comcast Cable President Stephen Burke, certainly is. Operators get flak for raising basic-cable rates 5%-7% a year, about three times the inflation rate. Well, Burke sees some cable-network license fees increasing five to seven times inflation, and that's not even including the 20% surge for ESPN.

Having absorbed AT&T Broadband last November, Comcast is the nation's largest multichannel video provider, with 21 million subscribers. Burke wants to use that clout, first to secure bulk discounts even greater than AT&T or Comcast was getting on its own. And he's seeking to hold future increases to the CPI.

Burke spoke with Broadcasting & Cable Deputy Editor John M. Higgins about restraining programming costs, assimilating AT&T's troubled systems and prioritizing Comcast's various broadband businesses. An edited transcript follows.

Months before you completed the AT&T Broadband takeover, you feared that incorporating the AT&T systems would be tougher than with other systems. But your first-quarter results indicate the indigestion is going fairly well.

When we did the deal with AT&T, we felt that cable was a good enough business that, with enough good people and enough time, we would improve the performance of the AT&T Broadband systems. As we moved from signing the deal to closing the deal, we became increasingly aware this was a big challenge and didn't want to set anybody's expectations at an unrealistic level.

We look at it and say you can't lose 400,000 to 500,000 cable subscribers a year and stay in business. You can't have 20% margins and expect the markets to continue to give you capital to grow and prosper. The telephone priority might have been the right thing three years ago. For us, we know one thing: We have to as quickly as possible to get the margins up to 40%. Get the entire company rebuilt and competitive from a video-first point of view—without ignoring high-speed data and telephone—before we do anything else. And stem the subscriber loss.

From 1998, we grew from 4 million subscribers to 8 million, doing five or six acquisitions along the way. Every time we've done an acquisition, we've been able to bring the systems up to Comcast performance levels within two years. Since this was bigger and there might be problems we hadn't encountered before, a three-year timetable might be the right timetable.

The good news is, we now believe it's going to be closer to the two-year timetable and we haven't seen anything in the AT&T markets that we haven't seen before. You never can have that kind of confidence until you actually operate the business for six months.

You've said you had feared giant, systemic malfunctions, but what you found is a whole series of little stuff that seems to be more correctable by putting attention to it.

That's a fair characterization. It's interesting to see people's reactions to a course of action before you've shown up. A lot of people say you have no idea of how that plant is, particularly the systems AT&T acquired from TCI. We worry about everything, so why not worry about the architecture of the ex-TCI systems. We have very limited experience with the telephone business, so we wondered whether there was some interaction between that and the core video business and the high-speed-data business that we were missing. And we had a healthy respect for the sheer size. Does something happen to a cable company if it gets too big? Does it get too big to manage?

Part of the concern with telephony was the losses.

There's $10 billion worth of video revenue and $800 million worth of phone revenues. Phone is not big enough in itself to explain 20% cash-flow margins across the board. [Comcast's margin was 41%.] The reality was, there is nothing inherent in the phone business other than the distraction and emphasis difference. Rolling out phone was such a high priority that it diverted people's attentions and priorities. It's inevitable in a big organization that people respond to the three or four highest priorities.

One element was the compensation to customer-service reps: $90 for a new telephone customer but only $10 for selling a cable customer.

It was everybody. From top to bottom. Every single person's incentives. The way financial presentations were prepared. What everyone talked about. The advertising. Everything across the board was focused on growing the phone business. The mission was achieved: AT&T Broadband added more phone customers in a shorter period of time than anyone has before.

The good news is, there is nothing wrong with the physical plant in any of the markets, whether old TCI or MediaOne. Also, the demographics and characteristics of the AT&T markets are, on the whole, marginally better than Comcast's. Comcast was built with markets like Philadelphia, Baltimore, suburban Washington, D.C., which are traditionally not high-population growth markets. AT&T has a lot of very high-growth clusters: Seattle, San Francisco, Dallas, Atlanta, Portland, Ore. The long-term growth characteristics of the AT&T systems are better.

Are the clusters better? AT&T did a better job of clustering in individual markets than anybody, including Comcast. You can't fix population growth. You can't easily fix the size of the cluster. But you can fix the physical state of the plant. There is more long-term potential in the AT&T markets than in the Comcast markets. Since penetrations were lower, there have been more defections to satellite and DSL in the AT&T clusters. There's more upside.

But the question that worried me the most: Are we going to have enough great people to do this? We found a lot of great people at AT&T Broadband who looked at the new priorities and said that they make sense. We have more employees who came from AT&T Broadband than from Comcast.

Not in the senior management positions.

I disagree. Of the top four markets, Boston and Chicago are run by ex-AT&T executives, and half of San Francisco is run by a former AT&T executive. Philadelphia is not. There is no question that there are a lot of Comcast people in the AT&T footprint, but there are also a lot of AT&T people. A lot of people look at the new priorities and say this is back to the future.

We totally understand the need to reemphasize the video business. We love decentralizing the decision-making. Now, when someone is in Seattle, they say we're not doing a national price for digital. We're setting the price we think is right for Seattle. We're marketing it the way we think it should be marketed.

We were expecting to find people a little more reserved, a little more wait-and-see. We're finding people excited.

You've got programmers pretty rattled over license fees. What are you telling them now?

What we've been doing since the close is looking at the deals AT&T had and the rights that Comcast had and enforcing the rights in those deals. We're not ripping up contracts. We're not doing a one-size-fits-all. Where contracts expired, we've renegotiated and gotten agreements. With the notable exception of Starz!, where we've tried to clarify our rights proactively [Comcast has sued to essentially void AT&T's costly contract with Starz!], we think the discussions are going quite well. There are discussions going on behind closed doors, not in the press.

If you look at where the business is today, programming is a $4 billion cost. It's more than we spend on all the salaries for all our people, 55,000 people. It's the single biggest cost we have, and it is a cost that is going up in double-digit percentages. Here is a business operating in an environment where people are talking about deflation or no inflation or inflation of 1% or 2%, where programming costs are going up 13%-15%. It would be one thing if the programming costs were going up 13%-15% and cable operators were getting more for the 13%-15%. There was a time 5, 10, 15 years ago when costs were going up, but you were also getting a lot more original programming, you were getting a lot more sports rights, you were getting a lot more ratings, for your dollar. But cable ratings on a channel-by-channel basis are declining.

So look out over the next five years. If we don't as an industry get our programming costs under control, it is possible that, five years from now, our programming costs could be twice what they are today. And the ratings on a channel-by-channel basis could be significantly less than they are today. So any business where you are paying more and getting less has got a fundamental problem. It would be one thing if it was a line on our P&L that was relatively insignificant. But it is so big that it is out of whack.

What I would suggest is, we are prepared to do deals with anybody that wants to do deals, but the deals ought to mirror inflation. They ought to mirror what is going on in the rest of the world. The model that has been set up is not necessarily a rational model. It is a model that has worked beautifully over the last 20 years. But to have people assume that they are going to get 5%, 7%, 10%, let alone 15% increases when inflation is going to be 1% and when we're not getting any more and when ratings are declining for some cable channels 5%-10% a year, there is no logic to it.

So, after you cherry-pick the best of Comcast and AT&T's existing deals, you want even bigger volume discounts than AT&T was getting as the largest operator.

As the contracts expire, we are going to be sitting down with people. The first point is that size does matter in this business. It always has, and it is not unreasonable for us to ask for a better rate for 21 million subscribers than the rate we got for 8 million or AT&T got for 13. But we plan on doing this on a company-by-company basis, a contract-by-contract basis. We'll try to do it in a win-win way. There are a lot of new technologies: video-on-demand, high-definition television. There are a lot of different ways that we can get programming attractive to our customers and get a series of new business models that work for both sides. But we will be doing that on a company-by-company basis, when the contracts expire, and we'll be doing it behind closed doors.

But your goal is to get about 10% off what AT&T, the most favored of favored nations, would have been getting.

What we've told people so far is that our goal, our projection, is that we are going to reduce our programming costs in 2003 by $270 million. So that's 6%-7% down from $4 billion. But that comes mechanically; we believe we are entitled to that. Where we go in the next round I don't know. We don't have a goal for 2004, and, if we did, I would certainly not tell you. But it just doesn't strike me as fair that a programmer should expect to get annual rate increases compounding over time. Industry leaders who have never liked public fights are now feeling they have no recourse but to take it public. We don't want to do that. We would prefer to do this behind closed doors, but I think we have a responsibility to our shareholders to question why we are paying 5% or 7% or 10% more and getting less for it. It doesn't seem right.

And you're not talking about just sports here.

It's a big, hot point. But everything I just said I'm talking not about sports but networks' built-in assumption that, "OK, we want an extra penny or two per sub each. The fact is that, in a company our size, a penny is $2 million a year."

So if I am an A&E Networks or an MTV Networks, what license-fee growth should I be putting into my five-year plans?

It is different for every single company, but the base should be lower than the base was for either AT&T or Comcast, and the increase off that base should be more like inflation than some other number. By the way, we'd be totally prepared to take a risk on inflation, and, if inflation goes to, say, 10%, we'll pay the inflation. But I just think it is unreasonable for people to expect to get increases that are way beyond inflation if we are in this kind of an environment.

Of course, it's the steady increases that created the cable programming industry. It allowed networks to plan and invest heavily in programming.

No question. But the business is now mature. If the cable industry does a wonderful job, we are going to grow subscribers 1%. When the cable industry was adding 3 million to 5 million subscribers a year, a lot of that growth came because people were creating the CNNs or HBOs and A&Es. Those were being funded, and new program rights were being acquired. Things like the NFL rights' going to ESPN were additions to the product that fueled growth and success of the cable business.

It is now a mature business, and there is one level of investment spending when you are in the growth stage and another when you are in the mature stage. You realize that further investment is not going to grow your revenues. It's just going to increase your costs and put pressure on pricing. Our customers aren't going to stand for us passing on double-digit [percentage] rate increases. They're not going to stand for it.

But sports is a big lightning rod right now.

We obviously understand the importance of sports. We are in the regional-sports business. Before AT&T came along, 50% of our footprint carried a Comcast Sports Net. We did that because we understand the importance of sports to the overall equation and we like the branding and everything else. There are pros and cons for tiering sports and what's going on in New York. That is an example of a breakdown. We would prefer not to have breakdowns, but it would be interesting to see how New York works out. I do know one thing: You can't keep compounding these big numbers and not have further breakdowns.

You're avoiding the letters E-S-P-N in this conversation. All your peers are publicly hot about ESPN. I am sure you would be more than welcome to testify next to Cox CEO Jim Robbins before Congress.

We would prefer to talk to Disney and ESPN as business people behind closed doors. When we have something to tell you, we'll tell you.

You're going through the same process with Disney that you're going through with every other programmer in terms of rationalizing the two contracts?

No comment.

The other dispute between operators and programmers is what to do with VOD. Networks think operators should charge, but you're giving a lot away.

Here's our view on VOD and, for that matter, high-definition television. You want as many people as possible to use the time-shifting functionality that we can provide. You want people to use the product, value the product, and remain loyal customers and not go elsewhere.

Because VOD and high-def are things DBS cannot as readily offer.

Yes. Our strategy is to give people as much product as we can, make it as attractive as we can, and not charge for most of that product with the goal in mind to make sure that they use it. If you go home at night and you have the ability to see Tom Brokaw at 8:30 or the fourth quarter of the Sixers game that you missed at no additional cost, your proclivity to use that functionality is going to be much higher than if we charge you 50 cents for each. What we've done in Philadelphia and what we're rolling out to the rest of the country is a product that has over a 1,000 hours of free programming.

The way to think about it is that there are three categories of programming. One you pay for, the traditional, recent movies on demand for $4 or so. The second category would be, if you're already paying for HBO or Showtime, you would get them on demand for free. The third category would be all the product that we provide at no charge.

In Philadelphia—we've been at this now for about six months—over 50% of our customers use time-shifting, and over 30% have used it in the last four weeks. To us, those are the most important numbers. We are trying to drive them as high as we can. About 800,000 people have digital boxes in the Philly area, so 400,000 people has done this. We've found that their digital-cable churn is dramatically lower and they rate their experience with the company higher. If we were doing traditional movies on demand, the 400,000 would be a fraction of that number, and the impact on our competitiveness versus satellite would be a fraction.

No surprise. If you give it away, more people use it than if you charge. But you went to a better business school than I did.

Understand we're not giving it away for free. These are people who are buying basic cable, they're buying digital, and, in the case of in the case of SVOD, they're buying a premium channel. We're not giving it away for free, and the programmers are not giving it to us for free. What we've said to programmers is that this technology is coming whether you want it to come or not come. It's either coming through a network-based time-shifting solution, which we call free video-on-demand, or it's coming from TiVo and other DVRs. Either way, the majority of people in the United States are going to have access to time-shifting programming over the next three to five years.

The programmers from whom we're asking content are programmers who already are getting paid a lot of money for their content. They're getting paid for their analog content, for their digital content, for their premium content. So a programmer has a few ways to make out well if they give VOD programming to Comcast at no charge.

So you think networks should see providing VOD programming like providing a West Coast feed.

Yes, that's a good analogy. And don't forget, when we ask someone for VOD programming, they're already an analog provider and a digital provider. If our digital penetration grows, Scripps is going to make more money from their digital product. In addition, we let anybody who provides content keep the ads in. The third thing is, it is a cross-promotional opportunity; it is a shelf-space thing.

Look at the experience at NBC in Philadelphia. I think the fact that NBC news is on free on demand and thousands of people are using that every month is helping [NBC's owned and operated station] WCAU(TV). If you want to watch broadcast-network news in Philadelphia at 8:30, you have one choice, and that's Tom Brokaw. That's got to be good for that franchise, and I think it's good for the Biography franchise, and it's good for Comedy Central and all the other channels who are giving us the product. Some programmers instantly understand that this a new technology.

How much do you believe the ultimate potential outcome of this could be to shatter one of the great underpinnings of the television business, which is the schedule.

If you go forward five years, there is going to be a very significant percentage of people who have time-shifted VOD through network storage and tens of millions of people who have DVRs. The research I've seen says that, when you have a DVR, half of your viewing is not live, is not scheduled viewing.

People have underestimated the impact of this shift because VOD has been a long time coming. TiVo has 350,000 customers. The number is about to accelerate because cable companies are going to get behind it in a very big way. Look at us. A year ago, we probably had 2 million subscribers who had video-on-demand. End of this year, it will be 10 million. End of next year, it will be 80 million, or 90% of 22 million. At the same time, cable companies are getting increasingly excited about DVRs. Satellite is already excited about DVRs.

EchoStar's Charlie Ergen is actually the biggest DVR producer in the country. DBS is heavily pushing this, and cable is nowhere.

Watch Time Warner. There is a chance that Time Warner will have more DVRs deployed than TiVo within the next 12 months

Why haven't you had DVRs even at a premium price just available to your customers, just to blunt DBS?

I think the top priority for us is video-on-demand. But you'll see Comcast put a lot of effort behind DVRs. We've already launched DVRs in Washington, D.C. By the end of the year, when Motorola has a deployable DVR solution, we are going to launch it very broadly.

And that steps ahead of expansion in telephone?

Good question. I think, in the next 18 months, there are a number of other priorities that come ahead of telephone. One of the messages we are trying to send to our employees and to Wall Street is that our goal by the end of 2004 is to get the company operating at a level that I would call optimized. We'd like to get the margins up close to 40%. We'd like to get the company entirely rebuilt.

That's good because it is going to take us about 18 months to get our existing switch-service telephone business running more efficiently so that we feel comfortable expanding it in all markets. We are currently expanding in Boston and St. Paul, but some of the other markets are just not at a level of operating efficiency where we feel comfortable expanding it. Also, we are waiting for IP phone [Internet-protocol telephone] to get to a point where it is scalable because, long term, we believe that is a better technology.

Should HDTV be a pay product?

It's a little bit like SVOD. What are you trying to do? Are you trying to make $5 or $10 dollars a month? Or are you trying to encourage as many people as possible in your footprint to use Comcast to get their high-def services? It's the latter.

We would rather get as much high-def programming as possible and a fee for the equipment, about $5 a month right now. We believe high-def is hitting an inflection point. We are rolling out 2,500 high-definition boxes a week, we are in less than half of our footprint, and we are not advertising it. This is a product, and it's growing.

So that, of course, means that it is so valuable that you'd be happy to pay the broadcasters for their HDTV feeds?

No. Here's the real question. The entire TV industry is going to shift to high-def cameras and equipment the way the industry shifted from black-and-white to color. So is there going to be a transition where there is incremental cost? Yes.

The fact of the matter is that we went out and bought a high-def truck to do games in Philadelphia and Baltimore/ Washington. We know what that cost is and what the uptick is. There are going to be two or three years where cable channels have that cost uptick, but, long term, there is going to be no incremental cost for providing high-definition programming. So I don't think it's in anybody's interest to have an incremental charge for high-def programming.

And the FCC has been very clear. Chairman Michael Powell said he wants high-definition programming as broadly disseminated as possible and there should be no additional charge when it is provided to cable operators. So I don't think it could be any more clear that it already is.

The financial markets are treating Comcast a lot better lately. You're up 23% this year, almost double from your low last year.

Yes, but everything is relative. I've heard [CEO] Brian [Roberts] say many times that there's never been a time where we were more confident in our business than today. But it's not fully reflected.

Look, the 5 million high-speed-data customers could grow to 10 million in the next three or four years. And the value of a high speed-data customer is not that different from the value of a cable customer. With a lot of investment in the plant and a lot of hard work, it is almost like our company has grown by 50% just by high-speed alone just in the last five years. I don't think valuations are reflecting that. If you look at our company, we are going to grow our cash flow from $5 billion last year to $6.2 billion-$6.3 billion this year, about 25%. But our multiple is 10 times that. If you look at historical growth rates and our growth rate, that doesn't seem to make sense.

These things go through cycles; there is only so much that we can affect. We are trying to run the business the best we possibly can, and, when we look out over the next few years, we think our business is in great shape and eventually our valuations will follow.

What's your appetite for programming acquisitions? Your name comes up with every "for sale" sign but Vivendi's.

Right now, we have no appetite to do anything but fix AT&T. We just had Thanksgiving dinner and you're asking us if we want a turkey sandwich.

What about more startups like the black network you're doing with Radio One's Alfred Liggins?

Historically, we've created value on the content side either by being there at birth—which is the case with QVC, G4 and Radio One—or buying one that isn't fully distributed, such as when E! went from 30 million subscribers to 75 million.

I think the past is a guide to the future. We will continue to look for ways to make rather than buy, not buy something that is fully priced.

You personally are at the top of every headhunter's list to run some other media company, with the most persistent speculation being Disney.

I can't imagine a company with a better future than this one. I couldn't imagine having more fun with anyone else.

But a lot of guys also enjoy running the show, and, unless you get a gene transplant, you're never going to run Comcast: You're not family.

This is a pretty big show. Brian is the CEO and my boss. What I like to do and what he likes to do are more complementary than in conflict. What really turns me on is working with a team of people and trying to figure out how to get the job done. Brian lets me do that and lets me feel like I have tremendous amount of latitude to do the right thing.

But you strike me as a guy who wouldn't mind being CEO.

If Brian came to me and said let's trade jobs, and Ralph [Roberts] would approve it, I wouldn't do it. We would be worse off. I like to do what I do, not what he does.

What is it that you see him doing?

He has as much deal-making experience as anybody I can think off. That's partly because we're in a business of deals. The AT&T deal, there were dozens of people involved in it, but that was Brian's deal from beginning to end. It was fun to watch him orchestrate that. He's better at that than I am.

What I like to do is make sure we have the right people in place, the right plan, and make the trains run on time. I think being CEO is overrated.

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