Junk-Food Suit Gives Nick Bellyache

Public-interest group's demands strike at network's money machine

What a time for Cyma Zarghami to start her new job.

Three weeks after she took over as head of Viacom's MTV Networks Kids & Family Group, the Center for Science in the Public Interest (CSPI) notified Nickelodeon that it will sue over the network's role in fattening up America's kids. The advocacy group wants to keep food manufacturers from using the network and its adorable characters to market junk food to children, which, of course, is big business for Nick.

The attack planned by CSPI strikes at the heart of Nickelodeon's financial success: its dominance of the kids advertising market combined with an extraordinarily profitable merchandising business. Licensing its characters to other companies, most notably to food manufacturers, is a key element of Nickelodeon's financial strength, helping make it even more profitable than sibling channel MTV.

Zarghami moved up to take over some of the turf surrendered by ex-Nickelodeon Networks Group President Herb Scannell, who greeted the new year by resigning and clearing out his office. Word of Scannell's unhappiness began circulating in December, shortly after the appointment of Michael Wolfe as president of MTV Networks.

Zarghami, a career Nick executive, ran Nickelodeon's U.S. cable networks for a decade. Now she adds the company's digital businesses, a theme-park unit and Nickelodeon magazine. She doesn't have all of Scannell's old portfolio, though. Classic-TV network TV Land has been handed over to Comedy Central President Doug Herzog, a favorite child at MTVN. Herzog had earlier snagged Scannell's wobbling, male-targeted network Spike.

A smaller portfolio is offset by Zarghami's position as the head of a full business unit, reporting to MTVN Chairman Judy McGrath, an important sign in the highly charged politics of MTV Networks.

Says Zarghami, “I've been invited to the grownup table, which is both exciting and scary to me.”

Nickelodeon not only dominates the kids audience but, on a total-day basis, is also the largest cable network among viewers of all ages, a slot the network has held for a decade. The Kids & Family division's sales are expected to approach $2 billion this year, growing by nearly 10%, according to Morgan Stanley media analyst Richard Bilotti. Operating cash flow runs approximately $1 billion. “Nick still basically owns its genres,” Bilotti says.

Even so, Zarghami faces significant challenges. Nick's ratings last year were flat in key demos, kids by day and adults 25-54 at night. Disney Channel and Cartoon Network seem to alternate hitting Nick the hardest. (“Last year was Disney's turn; 2004 belonged to Cartoon Network,” says one executive at Turner Broadcasting Systems, lamenting Cartoon's decline in some key demos during 2005.)

Nickelodeon's biggest challenge is the kids ad market, which is currently in a funk. First, the two biggest ad categories—toys and movies—have been slow. Further, Nickelodeon is a primary target in the fight against childhood obesity, which attacks food manufacturers for targeting kids with ads for markedly unhealthy food. Nickelodeon, which sells at least half the TV commercials aimed at kids, is the one place all those manufactures come to pitch their wares.

Food advertising accounts for around 20% of Nickelodeon's $1 billion in annual advertising revenue. The network has already been pinched as Kraft Foods cutback its $90 million budget for advertising to children, anxious to avoid government regulation or lawsuits like the one hitting Nick.

The CSPI suit, to be filed in Massachusetts under that state's aggressive consumer-protection laws, seeks to ban the marketing of food of “poor nutritional quality” to children under 8. Under the law, plaintiffs are required to give a 30-day notice to defendants before filing a suit.

The CSPI Wednesday gave Nick and Kellogg notice that they will be sued under the state's laws. That could severely limit use of kids cartoon characters like SpongeBob on Pop-Tarts and sugar-laden cereal.

The CSPI claims that Nick and Kellogg have each inflicted $1 billion in damages by harming the health of children who overeat. (The group doesn't say when it plans to sue their parents).

The campaign against marketing to kids attacks Nickelodeon's powerful weapon. The licensing of characters generates about $200 million of the division's $1.8 billion in annual revenue. It's nearly all profit because very little expense is attached to it. Cranking out cartoons, developing new ones and selling ads is expensive. Collecting checks from Kraft for Dora the Explorer Fruit Snacks isn't.

Merchandising may be Scannell's most important legacy at Nick. His predecessor, Gerry Laybourne, was much more cautious about licensing Nick's characters. Scannell chased the merchandising business aggressively, striking gold with Rugrats, Blue's Clues and the amazing SpongeBob SquarePants, which became popular with both kids and adults.

Merchandising is a major reason Nickelodeon outperforms MTV where it counts: the bottom line. Bilotti believes MTV generates a 52% margin on operating cash flow, a profit so fat it should drive broadcast-network executives to tears. Nickelodeon's is even higher: a massive 61%.

Zarghami says the network has heard its critics and is trying to respond. The network is part of media- and food-industry initiatives encouraging kids to get outside and run around, and eat healthier food. Its characters are licensed to marketers of vegetables and other food.

“You can't turn the business upside down overnight,” Zarghami says. “The real rational answer is start to affect change, start to move the needle in the other direction.”

E-mail comments to jhiggins@reedbusiness.com