Beginning with advertising, on our current estimates the national market was close to flat year over year, with total advertising probably barely better than +1% on a normalized basis (excluding local TV political advertising and incremental Olympic activity). Such figures represent decelerations, as national advertising appeared to grow by better than +3% during the first quarter while total advertising was up by around +2% at the same time. Of course, digital advertising fared quite well, likely accelerating from +16% growth in the first quarter to +18% in the second quarter. Meanwhile, national TV looks like it declined around -3% during the second quarter vs. a first quarter gain that was probably close to +3%. If correct, this second quarter decline was worse than the fourth quarter decline which we think was around -2%.
As a consequence, national TV probably lost share of the national advertising market, falling from 58% to 56%. Across the entire advertising economy, total TV appeared to be fall from 34% to 33%. Share changes of this nature have been more muted in most other quarters over the past three years, although they occurred at this scale during two quarters in 2013 – less evident then because total national advertising in its entirety was much more robust at that time – and again during the fourth quarter of 2014. Meanwhile, nationally-oriented digital advertising appears to have grown from around 21% to 25%, and total digital advertising expanded from 25% to 29% of the advertising economy during the second quarter. Overall, these trends imply that there is share shifting going on between TV (as well as other media) and digital at an aggregate level, although we think that direct shifts from TV to digital have been less pronounced than most believe. We have observed that like-for-like marketer budget allocations to TV vs. other media have been relatively stable over the past decade. Of course, if a typical TV-centric marketer were increasing their digital budget by, say, 10% while reducing their total advertising spending, it would be inevitable that TV would feel a hit. In fact, if we look at a composite of spending by a subset of 26 of the top 200 marketers who are both non-web endemic (i.e. excluding Google, Amazon, Priceline, etc.) and who have provided quarterly data on marketing or advertising spending so far during earnings season, we can see the median advertiser decelerated spending during the second quarter, and the weighted average of spending of this group on marketing related activities actually fell by -3% year over year. The rise of those Googles, Amazons and Priceline's are likely having more of an effect in driving digital advertising spending than many consider.
Will we see a rebound in total advertising, and no less in television? We can't know for certain, but it still seems likely that we will, eventually. The economy is seemingly random in its production of new, large, oligopolistic and self-referential categories of brands who differentiate themselves vs. competitors on the basis of awareness of product or brand attributes. When they show up they can bring significant new volumes of spending into the medium. We can point to factors that made this phenomenon occur more frequently in prior decades (the growing national-orientation of the US economy and consolidation within categories) but some categories become massive because of changes in the law (as with pharmaceuticals) or actions of individual companies (as with GEICO, which catalyzed growth in spending for the auto insurance category). Although a growing share of the economy is newly oriented around niche / micro-brands (who may favor paid search, social media and PR) and web endemics (who may favor paid search and performance-based digital media), new categories that will support a resumption of growth will probably return in a cyclical fashion. At least we have some elements of certainty around how advertising will play out, even if it's not particularly positive in the near-term.
By contrast, issues around affiliate fees present risks which are less about the present and more about the future, as we see it. Despite a technical capacity that has been reasonably well understood by the industry (and investors) for over a decade, true cord cutting has been very limited to date, with conventional US pay TV video subscribers stable at around 100mm over the past few years, per Pivotal Research's cable and satellite analyst, Jeff Wlodarczak. We note that there are some signs of modest cord-cutting. Actual household growth means that conventional pay TV penetration has probably fallen slightly in recent years, and a decline in excess of 1% is expected for the current quarter on a year-over-year basis. In aggregate, on estimates from Nielsen for 1Q15, 3.0mm households are broadband-only, up from 1.6mm in the year ago period. While there have always been homes who have chosen to go without pay TV services, it's probably the case that many of the new broadband only homes might, in a different era, have chosen to pay an MVPD for video services too.
Still, when compared against this 3.0mm figure, the 41mm domestic streaming subscriptions of Netflix – a key cause of cord cutting? – stands out. Similarly, Hulu is now approaching 10 million subscribers, a figure that also dwarfs the number of broadband-only homes. Looking at this from another angle, according to Nielsen, 19% of households had a multimedia device such as an Apple TV, Roku, Chromecast or other device connected to a TV. This latter figure is up vs. 15% in the year-ago period, and both represent multiples of households vs. the number of broadband-only homes. Penetration rates of these services have been high and rising without causing any meaningful drop-off in conventional pay TV subscriptions. Instead of significant disruption to the traditional ecosystem, emerging platforms appear to be complimentary rather than cannibalistic so far.
Among the reasons for this outcome is that MVPDs price video services attractively (often effectively giving it away) when a customer also needs ISP access, limiting the number of customers who even temporarily find themselves without access to conventional TV. As well, stand-alone OTT services have historically been incomplete, lacking key sports properties, live programming and many of the networks and programs that consumers most want to watch. Further, internet infrastructure is still commonly insufficient to support widespread concurrent use of OTT services, at least in terms of the volumes of video content that people are using to consuming through conventional services. And lastly, the customer service provided by incumbents – even if often viewed as sub-par – still has a role for a substantial share of the population vs. the absence of comparable service provided by upstarts. This final factor may be the feature which distinguishes incumbents over time, although not every consumer will value it.
Perhaps established OTT services and emerging virtual MVPDs will compel a larger share of the population to prioritize their video consumption through those providers in the future. While Netflix is clearly building a successful business and like-for-like consumer consumption is undoubtedly growing, one might think that if cord-cutting would follow from a service like the one it provides, we would have seen more of it by now. A launch of a virtual MVPD from Apple (if it occurs) will probably have a more significant outcome in this regard. Ditto for Sony or others who want to include "live" programming alongside access to library content via an, internet-connected interface. Regardless of the offerings that emerge, it seems unlikely that a substantial share of the population will shift video service providers, as most will probably prefer the "one stop shopping" for telecommunications services provided by existing providers. Incumbents' improvements in search interfaces and access to content through digital devices will help, too.
Overall, the proliferation of alternative packages of channels and programming probably does encourage some subscribers to shop for alternatives and incents incumbents to establish alternative packages for consumers. Many of these alternatives will be "skinnier" than those which came before, meaning that tertiary networks with limited numbers of viewers get culled from substantially more households than the number who ever fully cut the cord.
How badly will these trends hurt? It's impossible to say, but they are not necessarily negative and could be positive. Consider the following consequences of the aforementioned trends
• The primary networks to be cut in skinny bundles would seemingly include expensive sports networks. although, not everyone would want to give these networks up. Per data from Rentrak, in peak months nearly 60% of households watch some ESPN (and as many as 40% watch ESPN2; ditto for Fox Sports1). Top tier sports networks will retain substantial pricing power among most of these households, and may allow for overall affiliate fee revenue growth (although probably not at historical rates of increases). So far as even Disney noted, the actual cuts in ESPN subscriptions due to the rising availability skinny bundles has been very small
• Other networks that would be cut in skinny bundles would include marginal networks which few consumers watch and which pay their owners the least per subscriber per month, meaning a limited revenue hit, as these networks will represent a small share of group revenues. In other instances, some relatively lucrative networks may be cut from some packages, but the bigger question is to what degree programmers will have leverage to make themselves whole in terms of the total negotiation they have with MVPDs? Consumer prices may not rise as fast as revenues to programmers if MVPDs accept diminished margins from their video products in some instances. On the other hand, the percentage of subscribers who ultimately want skinny bundles may prove to be relatively small in number, and in most instances programmers will have minimum penetration rates for certain networks that should limit the degree to which packages approaching "a la carte" status take off.
• On the advertising side the impact might be slightly negative, but is probably neutral. First, advertiser budgets are relatively inelastic as relates to sports. Lower audiences (through the loss of casual viewers) would not necessarily translate into commensurately lower revenues for networks featuring sports content as a result. Advertising delivery across other types of networks won't necessarily be impacted solely because there are more OTT services and emerging MVPDs, especially as ads would generally remain attached to programs during the periods in which those programs initially air, independent of the service on which the program runs, so long as that service has advertising. And even if services do not have advertising (as with Netflix) we have seen that strength in viewing levels of non-ad supported programming has limited impact on the advertising market. Our analysis of Rentrak data also indicates than 10% of "traditional" TV viewing occurs on ad-free networks; many countries around the world have ad-free public service broadcasters capturing substantially greater shares of viewing, with limited impact on the growth of advertising in our view.
• At the same time, OTT services are willing to pay up to license content from incumbent networks' sibling studios. Given the limited impact these services seem to have on multi-channel penetration, most of these revenues may be incremental
• Emerging MVPDs will probably pay better than incumbent MVPDs, meaning that networks will generally generate more revenue per subscriber for existing top-tier networks when they license those networks to emerging MVPDs rather than incumbents. This may more-than make up for the presence of skinny bundles on those platforms.
Whether the rise of emerging services and platforms causes network owners to generate more revenue is difficult to say with much precision, and the lack of certainty among investors around how the industry evolves can understandably cause concern. No-one can know exactly what shape the industry will take and how the packages that consumers buy will look. However, we think there should be more confidence in a few big ideas.
First, consumers have generally demonstrated a sustained willingness to pay increasing amounts for video-based entertainment services and while they do not necessarily like paying more every year, consumers seem to value the variety and quality of content available. They also value the convenience that new platforms provide and the habits that older ones support, too whether they are paying intermediary OTT services or MVPDs. Second, the growing ease with which anyone can establish an OTT platform or service creates continuing potential for new direct customers who will pay today's media owners for programming, even if some of it will be duplicative in the eyes of the ultimate consumer. That business models do not necessarily need to be supported by direct consumer fees (as evidenced by Amazon's Prime service) highlights that revenue can come from new places. Third, at risk of repeating ourselves, TV advertising may be weak right now, but it is not dead. We continue to be persuaded by data that shows stable like-for-like budget allocations, advertiser spending cuts and absence of new category creations paired with rapid revenue growth at certain internet-centric companies which conspire to convey a more rapid shift than is actually occurring. And it is also worth noting that TV in its general form is still widely believed by marketers to remain a more effective brand-building tool than any alternative for advertisers dependent on reach and frequency in communicating their messages. Although more meaningful shifts may happen in the future if the Facebooks and Googles of the world license more premium content, this may change, but might also result in more revenue to the incumbent media owners who will likely produce that content.
While we can't be confident in all of the specific ways the industry will evolve nor anticipate all of the potential threats that will arise, we can at least point to the successes that the industry has had coexisting with new platforms and be confident that as new technologies emerge, so too will the ways in which media owners can grow their overall businesses in years ahead.
REPORT INCLUDING DISCLOSURES CAN BE FOUND HERE: Madison and Wall 8-7-15.pdf
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