C7 and Change at the Upfronts - Brian Wieser-Pivotal Research (Members-Only Report)

REPORT INCLUDING DISCLOSURES CAN BE FOUND HERE: Madison and Wall 4-11-14.pdf

Little has changed so far to alter our confidence in this model, and we continue to believe that volumes negotiated in the upfront might range from -2% to 0% (we wouldn't put too much weight in industry expectations for volumes until much closer to the time that actual negotiations get underway in late May, as most marketers won't know themselves how much they are willing to allocate to the 2014-15 season until the last minute). In our model, this translates into a 7% CPM increase for the leading broadcast network's prime time inventory. This would be slightly below the average 8.5% increase that network TV has realized over the past 35 years (which equates to a 16 fold increase in pricing per thousand impressions over that time period, incidentally, during which time network TV upfront commitments grew six times larger).

Alongside our model, we have also noted that changes in pricing (which advertisers and agencies care about because it highlights the relative value they receive for a given budget) don't tell us much about revenue change (which investors should care about) in any one year. Changing mixes of advertisers with differing cost bases (different advertisers have different benchmark rates for identical units of inventory), shifts of budgets between upfront and scatter negotiations (each with varying pricing dynamics), changes in numbers of commercial units or uses of promotional inventory by networks and other factors all conspire to limit the degree to which reported pricing impacts revenues. Of course, in the long-run, networks benefit from pricing power, and so in any given year higher prices are certainly better than lower prices from the vantage points of the networks at least.

However, our model implicitly presumes that dynamics in the overall market for television remain unchanged, and that much about the negotiations between buyers and sellers remains as it has been over the time period that our model's underlying data depends on (which goes back to the early 1980s). For the ten+ years we have been following the Upfronts first-hand, we have heard how the conventions associated with Upfronts were antiquated and / or at risk. Only if they were actually at risk would we begin to lose confidence in our model.

Let's consider a few factors that could impact the Upfront which will be top-of-mind going into this year's negotiations:

· Digital Newfronts

· The rise of programmatic trading and its applicability to TV

· A shift from C3 to C7 as a benchmark for negotiations

The Digital Newfronts will capture a significant share of attention this year. However, attention is likely to be more plentiful than meaningful upfront budget commitments. Our skepticism doesn't ignore the changes that are happening. Measurement systems are more closely aligned between digital media and traditional TV as Nielsen's OCR becomes more widely useable (in particular on Google's YouTube and with Facebook offering OCR data to the advertisers who buy its video units, and with integration into Google's widely used buy side ad server) and measurement of viewing on tablets becomes a part of Nielsen's core panels. Media agency buying groups are increasingly organizing themselves in a manner which they and their clients will call "holistic". TV buyers have willingly accepted bundles of online video inventory associated with traditional TV programs. And digital media owners such as Yahoo are indirectly (via the press) making announcements of their intentions to invest in more premium, TV-like inventory.

However, once again, for all of the potential that digital media and digital video might offer, the biggest missing piece is the tonnage of consumption. Large brands might like the narrow targeting that digital media affords, but those which dominate TV spending need much more tonnage – reach and frequency – than online video can possibly provide. Viewing of actual content on the web still only amounts to around 3-5% of total TV consumption, and the viewing which does occur is highly concentrated among a small share of the total population; further, virtually everyone in the country remains reachable on television (and on network television in particular) over the course of a given month. Short of something profound, like Google announcing a package of sports content such as an NFL package, there is very little that advertisers can do with online video that they can't do with traditional TV today. To the extent that there are announcements of brands making commitments to Newfront-related content, the spending will likely be small in relative terms and the properties will either need to be highly bespoke to a given brand's needs or the brand (or agency) will be making the agreement at least in part for the purposes of being seen to be making an agreement.

Even genuinely popular digital media content such as the NCAA March Madness tournament captures a relatively small share of viewing relative to the traditional kind. According to our analysis of Rentrak data (and excluding out-of-home viewing, which undoubtedly amounts to much more content consumption) we estimate that there were 603 million hours of cumulative viewing on the games and related properties occurred during the tournament this year on CBS and Turner networks. By comparsion, Turner indicated in a press release this week that it served up a grand total of 15 million hours of viewing across all platforms during the tournament. While the comparison is imperfect (not least as there was non-game related content in our TV estimate), that is partially the point: conventional TV captures a substantial volume of relatively passive viewing activity, where consumers commonly watch a channel or content simply because a desired subject matter is on at a given time of convenience. Some argue that the intensity of focus and attentiveness of online video makes it more valuable; we argue that value is subjective in either environment (whether an ad to a passive consumer in a big screen environment more receptive to an ad is more valuable than an actively engaged consumer in an intensively focused environment such as the web can be has not been well-studied by the marketing research community to date).

None of this is to say that online video advertising is not going to remain a growth opportunity for digital media owners. We have come to appreciate over the years that the greatest opportunity from video is that it can replace the most premium of digital display ad buys. Publishers who want to capture high single digit CPMs are not going to be able to commonly realize such pricing from conventional banner ads, which can sometimes trade for pennies per thousand views. Video ads can appear in a wide array of places on the web, such as before a casual game plays, before text-based content is read or before an app is launched. However, relatively little of this inventory needs to be secured in advance, precisely because it is mostly commoditized and audience-driven rather than publisher-driven. To the extent that much of this inventory will be accessed programmatically and in real-time, companies such as Brightroll or TubeMogul and others focused primarily on programmatic online video advertising will fare well for the foreseeable future. But the success of video, and no less programmatically traded video on the web will not necessitate upfront or advance commitments given the degree to which that inventory can be commoditized and an advertiser can be relatively indifferent about highly precise content adjacencies. By contrast, in television advertisers will probably continue to care about those adjacencies.

The concept of programmatic trading of traditional TV will also pick up more and more noise as the year progresses, including in the context of the broadcast networks' Upfront negotiations. Already this past week NBC Universal's head of ad sales indicated at a press briefing that it was "prepared to make inventory available this year…that could include TV" on a programmatic basis. What programmatic means in this context will be the crux of the notion: automation of workflows is increasingly important as a means to helping both buyers and sellers drive pricing down, and that may very well be at the root of the term's use when a given network references programmatic TV.

Incorporating data-based tools to make requests for certain ad units or for publishers / media owners to recommend the inclusion of certain units in ad packages would be consistent with this notion, and it's possible that unsold inventory on third-tier cable networks might be made available to exchange-like environments. This would not be unlike how this inventory was made available to Google's Google TV Ads or Microsoft's Navic many years ago, before both operations were shut down. However, it is unlikely-to-the-point-of-implausible that NBC Universal or any TV network would provide premium inventory on a unit-by-unit basis or that anything like real-time bidding (or ad placement) of the nature that is occurring on the web will occur any year soon.

There is unlikely to be a compelling reason that a network owner would feel provoked into supplying inventory in this way . This is especially true when manually navigating the interests of competing interests of different buyers remains the most realistic way to maximize revenue yield at this point in time. Still, as Interpublic's Mediabrands has proven, being seen to be associated with all-things-programmatic (even when automatic is what is intended) is a great way for a media company to build a brand as a forward-looking media company to industry constituents, and no less to investors. For that reason we expect to hear more and more on this topic, even if the practical implications are very limited.

This highlights the main reason why networks have had pricing power: there are only four suppliers of inventory who can plausibly offer the widest reaching packages of inventory in television. Years of interaction have created conditions whereby each network can read its competitors intentions reasonably well, and in most years, no-one seeks to meaningfully undercut its competitors, at least to a significant degree (undercutting does happen, of course, but it doesn't seem to impact the overall health of the business as there is no race-to-the-bottom in a market of four sellers). When the networks – who can be indifferent as to which advertiser gets which unit of inventory – negotiate with six or seven (or more) different buyers, each of whom has clients who care about specific inventory and may want to prevent a competitor from getting specific inventory, the networks can manage a very strong negotiating position.

The one change that is likely to happen and potentially impact the accuracy of our model, at least in part, relates to changes in one of the benchmarks against which negotiations are commonly made, the use of C7 rather than C3 ratings. More specifically, networks presently sell demographically-based ratings against commercials that run live or unskipped on a DVR or via VOD for the first three days post live airing. Given the share of viewing that is presently occurring beyond the first three days, networks would understandably like to monetize this inventory, which otherwise does not yield the networks any revenue. Consequently, network owners have been focused on changing the base of negotiations to C7, or viewing of commercials on a live basis over a seven day period.

While advertisers generally acknowledge that they receive "free" impressions associated with their TV buys, most view it as part of the overall deal they receive, only one of dozens of elements of a TV buy, such as notions of pod positioning, the use of demographics vs. households for audience definition, the convention of buying packages rather than programs, the notion that cost bases stay with advertisers rather than agencies and many other considerations. These elements have evolved over decades of buyer and seller interaction, and don't reflect conventions that necessarily hold across countries, as every market has evolved slightly differently.

So in order for advertisers who are presently using C3 to accept C7 (and we note that not everyone even buys on C3 today), they will need to receive something back in return. Like a lower price increase than might otherwise occur, for instance. How much lower is not clear, although it probably wouldn't need to be more than a percent or so, and alternative forms of value might serve to persuade many advertisers to agree to buy on a C7 basis.

Whatever the negotiated outcomes, price changes won't tell us much about actual revenue changes as we indicated above. We have heard that some investors are concerned that a lower price increase will reduce the revenue that the broadcast networks might generate from like-for-like advertisers. However, if anything advertisers will more likely allocate incrementally more money to the broadcast networks if they buy on C7, as a buyer who agrees to C7 guarantees will view the world through a lens which shows network TV as having greater share of total TV viewing than does a buyer who views the world through a C3 or live-only lens (time-shifted viewing skews towards network TV programming, and so any shift of the currency towards time-shifted viewing will produce larger audience shares for the broadcast networks). Further, on the margins, buyers allocate actual monetary budgets between network and cable networks based to some degree on audience share levels, not on pricing alone (although weighted average CPMs paired with campaign reach and frequency expectations are other major considerations).

The incremental gains probably won't be substantial as network CPMs are still substantially higher than are those for cable, and managing a weighted average price increase for national television is going to be the primary focus for media buyers and their clients in the Upfront. This means it's only possible for a buyer to add to their network TV budget to a modest degree. Such is the consequence of a medium which is consistently able to increase its pricing power every year by seven or eight percent every year, for decades on end.

Brian Wieser is a Senior Analyst at Pivotal Research Group, where he covers securities which areimpacted by the advertising economy, including Facebook, Google, Yahoo, Interpublic, Omnicom, WPP, Publicis, Nielsen, CBS, Viacom and Discovery Communications. Brian can be reached at brian@pvtl.com.

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