Madison Avenue Speaks Out on Online Video vs. TV - Brian Wieser-Pivotal

Upfronts Still Stunt Newfronts

FULL REPORT INCLUDING DISCLOSURES CAN BE FOUND HERE: Madison and Wall 5-16-14.pdf

Each of the advertising industry, the press and the investment community are highly focused on issues around the transition of TV dollars to the web given the scale of budgets involved and the seeming potential for change to occur. The topic becomes ever-more prominent around this time of year given the active negotiations underway between different sellers and buyers of TV-based media. Few dollars that are truly intended for TV will actually go to the web in the near-term. The notion should hold at least until more significant investments in content are made, to the tune of hundreds of millions of dollars per year rather than tens of millions of dollars. This is not to say that there is not growth of online video, and it is not to deny that TV as we have known it will probably decelerate in years ahead. But the pace of change will remain very gradual while at the same time, what we consider to be video-based advertising will become increasingly ubiquitous.

Despite our notion of how the sector is evolving, we've also anticipated that public statements from agencies and advertisers about shifts of budgets from TV to the web would become increasingly prominent. However, when conveyed during a part of the year when advertisers and their agencies are establishing negotiating positions with TV networks, it's difficult not to want to deconstruct the notion. For example, a shift can represent growth what would have gone to TV if allocations to different media types would otherwise have been held constant; a shift could include budgets that are bundled with sellers of TV inventory (with networks' online video players, for example); a shift could also reflect a changing mix of client spending trends due to changes in account responsibilities. Or perhaps such figures can be taken at face value, and put in context of tens of billions of annual media spending.

But we continue to believe that any shift from TV to online video is little more than a trickle, rather than a flood. Vendors of online media want to capture TV budgets event if their properties neither look nor feel like TV, and advertisers want to convey that they are focused on where change and growth is. At the same time they genuinely want outlets that can help provide credible abilities to walk away from negotiations with traditional TV owners. But getting buyers the content they expect while providing the financial returns that media owners need is a key factor restraining more significant change. Other than a handful of significant investors in high quality content few web publishers have conveyed that they are willing to put to work what we would consider a sufficiently serious investment into the sector.

To the extent online video really does compete for TV budgets, it will most likely occur with smaller cable networks, at least unless a real hit with broad audience deliver is developed. To illustrate what it might take to compete at this level and what the rewards are at that tier, consider Crown Media (owner of The Hallmark Channel and the Hallmark Movie Channel). Crown Media captured around 1.25% of household viewing among national TV networks last year, per our analysis of Rentrak data, and generated approximately $295mm in ad revenue out of a pool of national TV advertising worth $41bn per our estimates, or 0.72% of the total. To generate this activity, Crown incurred $134mm in programming expenses. Further, we know that The Hallmark Channel itself generates 80% of its parent company's total ad revenue. On that network, 13 separate programs out of more than 200 which aired during 2013 drove half of total viewing last year. Two older programs alone (The Golden Girls and Frasier) with hundreds of episodes in their library accounted for a quarter of the network's total and 5,000 separate time periods (a near-equivalent to video on demand!). As for originals, the network launched Cedar Cove last summer with 13 original episodes and 45 distinct airings that captured 42 million household viewing hours, or 1.3% of the network's total viewing for the year (including DVR consumption).

Several observations follow from these figures, most prominently that few web-based publishers (arguably barring Netflix and Amazon and possibly Hulu) have demonstrated a willingness to invest anything like cable network-level money in content costs. A web publisher developing four flagship series with perhaps ten episodes each might be looking at a $40mm commitment if each episode cost $1mm to produce, or $20mm if costs were half of this level. However, a "library" of 20 hours of content would not likely capture anywhere near an equivalent ratio of revenues to programming costs that Crown Media does: most advertisers would struggle to make an efficient buy if they only bought inventory on a few programs given the limited reach characteristics that each might have separately or in combination.

Viewing levels such as those exhibited by Cedar Cove were sufficient to warrant another season's order. However, those levels are still low in an absolute context. For a proxy of what could be expected in terms of ad inventory production, appointment viewing (live viewing of a program that only airs a couple of times per week plus viewing via DVR) is probably pretty close. We note that on-demand access all the time on the web probably causes higher viewing (rendering TV viewing levels as potentially too low), but then again figures from traditional TV might also too high because nearly the entire population has access to traditional TV content in a conventional lean-back living room environment. We think only a minority of the population will either be willing to watch such content on a computer or otherwise set up their TVs to connect to the web.

It is essential that a web publisher have a significant volume of ad inventory to meet the needs of many advertisers. Beyond an anchor brand or two who might find a particular affinity with any one program, most marketers would only want a limited volume of inventory from a given program, as no advertiser wants their ads to hit a small number of consumers multiple times per episode. Consequently, even a successful show may not produce enough ad inventory to bring aboard many TV advertisers. This is why bundling packages of inventory including desirable originals and less desirable inventory on other programs works for both buyers and sellers in the TV world. Further, while web publishers can access other video inventory they could package with the programs they develop, the scale of consumption of appropriate properties is likely still very limited when compared with alternatives that can still be found on traditional TV at cost-effective prices (i.e. a buyer can buy deeper down the long-tail of cable networks and/or in dayparts outside of prime time on cable if they need to find any given audience).

Overall, it seems highly likely that viewing levels we would expect from a given web publisher probably won't support the costs to license content on a stand-alone basis, at least in the short-term. Lacking a sufficient volume of ancillary inventory to bundle with sales of newly greenlit shows, web publishers would probably struggle to aggregate enough revenue to cover the costs of licensing individual programs early on. From this perhaps we can better explain why most of these TV upstarts are still only taking baby steps in their move towards online video today: tens of millions of dollars of annual investment in programming are going to be insufficient to compete for meaningful TV budgets. However, those web publishers who do make this level of commitment will probably be able to build the foundation of a business that can durably capture this highly coveted pool of advertising budgets.

Many years ago we would hear from advocates for online video who argued that online video should get its "fair share" of the advertising budget. Notwithstanding that any appropriate assessment (i.e. using real, not rate card figures for ad revenues and Nielsen's, not comScore's estimates for time spent) generally indicate that online video was already capturing more than its "fair share", we have often thought: why would sellers of online video ad products want to limit themselves to a TV market?

However, the manner in which the market has evolved is demonstrating that the market for online video advertising can be increasingly unrelated to video content consumption. Online video ad units increasingly replace premium banner ads or rich media units for many advertisers. Online video can run in the middle of a text-based blog, before an app is launched, as a pre-roll before a casual game launches or, as Facebook would have it, in the middle of your News Feed. There are as many environments for video to run as there is digital media content. Clearly not all of it will be particularly valuable compared to TV units – and there are legitimate issues around whether or not a unit has value when it is auto-played, or when audio is off, when units fall "below the fold" or when units might be viewed due to non-human activity – but these efforts produce a significant volume (perhaps the majority) of online video advertising impressions.

To illustrate the degree of this evolution, video ad management platform Vindico released data earlier this month which indicated 34% of video ad impressions are delivered into a high quality video ad environment "imitating a TV-like experience". 22% of the market's impressions came from in-banner video placements that are "cleanly executed and viewable". 42% of impressions were delivered into poor quality environments, often falling below the fold or alongside inappropriate content (2% were estimated as outright fraudulent impressions). Much of the first tier of content characterized here includes user-generated content (primarily on YouTube). However, we think this inventory will also face challenges in capturing "real" TV budgets. Even if well-curated, spending on user-generated content will still represent a lower content quality than most brands will deem acceptable in helping to drive the goals that TV budgets are assigned to accomplish. Further, the mid-tier content pools wouldn't have accounted for what could be a substantial expansion of potential inventory as Facebook is only just beginning to sell video units, which means that pool of inventory will probably be growing significantly. And the poor quality issues will probably always be out there, if incrementally improved, capturing low-CPM-seeking online video budgets, but never those intended for traditional TV.

There is a more important shift between display and video ads within digital budgets presently, in our view. There have been ongoing declines in costs for like-for-like display ad inventory online. This has paired with rising budgets which create more room to spend more on digital advertising with a digital marketing goal (such as "engagement") in mind. As time progresses, a brand should generally be able to buy the same like-for-like banner inventory today for less than they bought it for previously given generally deflationary conditions for much of digital advertising. Digital media directors at marketers and the agencies they work with can deliver a preferable mix of inventory by swapping out formerly expensive display banner ads for now-expensive digital video ads. We see little to get in the way of this trend going forward.

Generally, we think that spending on high quality (and expensive) content can be intermingled with budgets for TV. But next tier of online video content will come from the aforementioned digital budgets, with different media goals, pricing benchmarks and buying tactics. Further, relatively little of this inventory needs to be secured in advance, precisely because it is mostly commoditized and audience-driven rather than publisher-driven.

Ironically, we note that web publishers might only be as likely to capture TV budgets as traditional TV owners are likely to capture online budgets over time. One trend that has yet to begin, but probably will occur relates to the allocation of online video budgets (which we view as a subset of digital advertising) into "traditional" TV environments. As ad insertion technologies improve and mesh with those used to buy online advertising today, it will be increasingly possible for digital buyers to insert into VOD or DVR-based ad units (post three or seven days of a program's original live airing), into long-tail cable networks during the whole day and into more important cable networks during non-prime dayparts. With so much TV inventory going under-monetized and yet more inventory not getting monetized at all, there is arguably more room to create value by using digital tactics to improve the yield of ad inventory on "traditional" TV than will occur on the web.

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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