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TV - the end of the world as we know it?

We have seen this before – companies spending big, not to advance their competitive position, just to hold their current spot. Newspapers around the world tried the strategy but many ultimately failed. In Australia, the car industry, clothing and footwear manufacturers and video stores all tried to save themselves by spending more money. They collapsed, unable to stop a king tide from drowning them in losses. And while we have yet to see the final death throes, fossil fuel retailers may have already been handed their death warrant by advancing renewable technology and battery storage.

Struggling in a corporate death spiral

Throwing good money after bad seems like the only strategy when an industry is in a ‘death spiral’ but history proves it’s often a waste of shareholders’ and lenders’ money. Of course, the alternative of accepting inevitability in a particular industry requires companies to abandon everything, including their revenue, while terminating the vast majority of their employees.


While disruption is just another buzzword for ‘change’, there is no escaping the profound impact it has on old technology, incumbent businesses and legacy revenue models. And often, the disrupters are no better off.

When a technology advances, bringing down prices, it opens new markets. Increasing customer utilisation reduces the price even further, opening up still newer markets, increasing demand, reducing the price further and so on … until of course another newer technology replaces it. Businesses caught up in the cycle must run faster just to stay in the same competitive position.

Where does it leave television?

In the television entertainment industry, video streaming technology has fragmented audiences and squeezed margins by driving down consumer prices and driving up content production costs.

Scale and globalisation are important and the largest companies in the communications industry are colliding or competing. The growth of Netflix is the best evidence of a changing dynamic in content creation and distribution.

This year, Netflix, Amazon, NBC Universal, Warner Media and CBS will collectively spend US$7 billion more than last year on content. The ‘food fight’ or ‘hail Mary passes’ in terms of creating unique scripted content is exploding with the new businesses disrupting the traditional studios by going directly to talent and bidding against each other. Viewers are demanding shorter product lifecycles and cheaper prices.

And while industry chiefs addicted to legacy affiliate fee[1] revenue suggest that content owners prefer to be aggregated in a bundle of channels and, as a result, to receive affiliate fees, they ignore the fact that viewers are ditching traditional cable and satellite packages at the new record rate of over one million per quarter.

Perhaps cable operators aren’t listening to consumers who are voting with their wallets. Just as we have already seen in the music industry, consumers don’t want to pay for an entire album - they just want to buy the songs they like. A ‘pick-and-pay’ or ‘skinny bundle’ model in television offerings, where consumers only pay for the channels they want, seems logical but the consequences for legacy revenue streams are terminal.

Recently, cable industry veteran and Liberty Media Chairman John Malone warned his industry brethren that they must morph from being bundled retailers of video services to bundled providers of interactive Over-The-Top (OTT) TV services[2] as well as devices that will inevitably be connected to the internet of things.

Most content owners do not want to launch a direct channel and be forced to win viewers one-at-a-time through an OTT TV service, and there are alternatives. They include nano piracy networks, the private networks where applications are used to stream live or recorded content to the public or a defined group of viewers. Remember what Napster did to the music industry?. Content producers may need to reconsider their current distribution models anyway. Indeed, the Diffusion Group estimates that every major TV network will offer an OTT service in just three years.

New competition with different models

The financial implications of the shift are not confined to the traditional content producers and aggregators. Netflix holds hundreds of millions of direct consumer relationships and their credit card details, but emerging competition from Apple, Facebook Watch, YouTube TV and Disney, is forcing Netflix to lower prices while spending more seeking new revenue streams overseas. In its most recent quarter, Netflix reported record negative free-cash-flow.

For example, Apple wants to develop a direct-to-consumer entertainment service beyond music. Like Netflix and Amazon, Apple has an estimated 700 million direct consumer credit card relationships. It would be relatively easy for Apple to offer a service, whether subscription based or free and supported by advertising. It is reported that Apple is having conversations with the content industry and wants to drive its ecosystem into the living room through video.

According to Variety Magazine, rising competition has meant higher salaries for actors, directors and production staff, which has increased the cost of producing a high-end drama for either cable or streaming from between US$3 million per hour in 2013 to as much as US$7 million today.

Meanwhile, younger, mobile-savvy consumers are leading the exodus from cable TV subscriptions. According to Deloitte, Gen Z, Millennials, Gen X, Baby Boomers and mature-aged consumers are all reducing their subscriptions to Pay TV. In the case of Millennials, those reporting a household subscription to Pay TV in the US has fallen from almost 75% in 2013 to approximately 50% in 2017.

Higher costs and lower subscribers (cable TV subscribers are being lost at the rate of 11,000 per day) mean business survival demands existing subscribers pay more. This can only accelerate the exodus to cheaper and more convenient alternatives, checkmating traditional operators who cannot remain in business without raising prices.

Impact on investment markets

The S&P500 Media & Entertainment index recently slid 15% from its all-time highs. Investors who are aware of the common traits seen in industry death spirals are better positioned to avoid falling for a potential value trap. Like many history-changing technologies before – think motor vehicle manufacturing or air travel - it is often the consumer that wins, not shareholders. In fact, in some industries today such as TV, the best opportunities might come from short selling.


Roger Montgomery is Chairman and Chief Investment Officer at Montgomery Investment Management. This article is general information and does not consider the circumstances of any individual.

[1] Mainstream television content development is funded by affiliate fees, which are the ‘share’ of the subscription fees paid to cable or satellite operators that are ‘rebated’ or distributed back to the content producer/owner/distributor on a per subscriber basis. By way of example, ESPN - as content owner - can negotiate high affiliate fees because, at least for now, a cable or satellite operator would appear insane offering a television bundle without ESPN included.

[2] Over-The-Top (OTT) refers to content providers that distribute streaming media as a standalone product directly to viewers over the internet, bypassing other broadcast platforms that traditionally act as a controller or distributor of such content.

December 14, 2018

Then how come Foxtel still costs me $150 a month?

December 14, 2018

A major factor not mentioned here is that fact that Netflix runs it's business at a large loss. They can only be financially sustainable if they raise their prices massively. They have been trying to form a monopoly (or similar) to help achieve this.

Disney (which now includes most of the assets of Fox, Marvel, ABC Studios, ESPN and Lucasfilm), is about to launch it's version of Netflix, Disney+, in the US. It also seems likely to take over the part of Hulu (a similar service) it doesn't already own. It seems that they and Netflix will together try to put the whole video entertainment industry into a death roll, in order to be the two left standing.

The other major English language players all have sort sort of other OTT service as well. Time will tell how many of them will pull out of Netflix like Disney has.

In Australia, Ten is now CBS, and is tied to the "All Access" OTT service. That has never been very popular in the US, though no doubt would be if CBS can organise re-merging with Viacom or at least forming a joint OTT platform with their corporate sibling.

Nine now has contracts for swaths of CBS and Disney content for it's OTT service Stan, as well as things from MGM and Starz. But how long those former two contracts can last remains to be seen.

Seven's Presto is long dead, and it has made it's OTT bed with Foxtel. But now that News Corp has sold all it's entertainment assets, the future of a Foxtel OTT service outside of news and sport (aka Kayo) is cloudy. Seven may choose to join with Disney in this area.

Regarding SBS, Foxtel now has the OTT rights to many of the non-English language dramas that SBS could once rely on. Madman has it's own similar-to-SBS OTT service. Perhaps a Madman/SBS/C4 venture will form?

The ABC has been somewhat stuffed in this space since the BBC decided to bypass them for first-run content. The BBC did have it's own OTT service in our market for a while, but axed it in favour of Foxtel and Netflix. Without the support of BBC Worldwide (which handles the rights for many non-BBC British series) and ITV Studios, the ABC won't be able to achieve sufficient scale to thrive in this space on it's own platform.

An Australian Freeview OTT service could also work. That is more-or-less what Hulu was in the beginning. It might look like a bulked up Stan. With CBS (+Viacom) joining in, it could be a winner. With the other non-Disney global players on board, who knows what it could achieve...


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