Thursday, January 8, 2009 - The Progress & Freedom Foundation Blog

Cutting the (Video) Cord Part 3: The Growing Relevance of Internet TV

Continuing the "Cutting the (Video) Cord" series started by my colleague Adam Thierer:  The WSJ had two great pieces yesterday about the increasing competitive relevance of television distributed by Internet--a trend that was at the heart of an amicus brief PFF recently filed in support of C omcast's challenge of the FCC's 30% cap on cable ownership.  The first WSJ piece declares that:

After more than a decade of disappointment, the goal of marrying television and the Internet seems finally to be picking up steam. A key factor in the push are new TV sets that have networking connections built directly into them, requiring no additional set-top boxes for getting online. Meanwhile, many consumers are finding more attractive entertainment and information choices on the Internet -- and have already set up data networks for their PCs and laptops that can also help move that content to their TV sets.

The easier it is for consumers to receive traditional television programming (in addition to other kinds of video content) distributed over the Internet on their television, the less "gatekeeper" or "bottleneck" power cable distributors have over programming.  So the Netflix-capable and Yahoo-widget-capable televisions described by the WSJ piece go a long way to increasing the substitutability of what we call Internet Video Programming Distributors (IVPDs) for Multichannel Video Programming Distributors (MVPDs), such as cable, satellite television and fiber services offered by telcos such as Verizon's FiOS.  

While such televisions are only expected to reach 14% of all TV sales by 2012, one must remember that a growing number of set-top boxes (e.g., the Roku Digitial Video Player, game consoles like the Microsoft XBox 360 and Sony PlayStation 3, and TiVo DVRs) allow users to users to receive IVPD programming on their existing televisions.  

As we argued in our amicus brief, the immense competitive importance of IVPDs lies not in the potential for some users to "cut the cord" to cable and other MVPDs (though that will surely happen), but in the immediate impact IVPDs have as an alternative distribution channel for programmers.  In the pending D.C. Circuit case, we argue that both the FCC's 30% cap, issued in December 2007, and the underlying portions of the 1992 Cable Act authorizing such a cap should be struck down as unconstitutional because the ready availability of IVPDs as an alternative distribution channel means that cable no longer has the "special characteristic" of gatekeeper/bottleneck power that would justify imposing such a unique burden on the audience size of cable operators.  (Of course, Direct Broadcast Satellite and Telco Fiber are also eating away at cable's share of the MVPD marketplace.)

The second WSJ piece, an op/ed, illustrates beautifully how cable operators are already losing "market power" (or at least negotiating leverage) in a very tangible way:  they're having to pay more for programming.  Specifically, the Journal describes how Viacom plaid chicken with Time Warner--and won. 

 The Viacom network had threatened to pull its 19 channels, including Nickelodeon with its "Dora the Explorer" and "SpongeBob SquarePants" cartoons, from the 13 million subscribers to the Time Warner Cable system....

The game of chicken included Viacom advertisements that unless Time Warner Cable agreed to pay more, it would pull the channels, encouraging viewers to call to say they wanted their MTV and other Viacom channels. One ad asked, "Why is Dora crying?" Time Warner countered that consumers would pay more if its costs rose. Bernstein Research analyst Michael Nathanson noted that neither party could afford "mutually assured destruction." Viacom needs to find more subscription revenue as advertising revenues soften, while Time Warner Cable has to worry about satellite and telecom competitors.

New media was the new factor. Many popular Viacom shows are widely available on the Web, including on its own sites. When it looked as if Comedy Central would be pulled, Wired magazine helpfully posted a guide for accessing the shows on the Web, pointing out that Jon Stewart's "The Daily Show" can be accessed on Hulu and that "South Park" episodes are on Fancast. The best parts of "The Colbert Report" are often viewed as email attachments or as snippets on mobile phones.

So, in a nutshell, the fact that consumers could get Viacom programming available through IVPDs gave Viacom more leverage against MVPD Time Warner because it increased the credibility of Viacom's threat to simply shut off programming to Time Warner if the cable giant didn't cough up more cash.  While this fact seems to have carried the day for Viacom, the availability of Viacom's content through IVPDs did have some secondary effects that also are worth noting:

During the negotiations, Time Warner Cable threatened to make it easier for its subscribers to connect laptop computers to their televisions so that Viacom shows could stream directly onto subscribers' televisions.

This is essentially a reversal of the tactic often employed by local broadcasters in their battles with cable operators:  give your customers a set of rabbit ears so they can still get your signal if you actually take your programming off the local cable network.  While this tactic doesn't seem to have helped Time Warner here, it does point to a long-term trend that could fundamentally change the programming marketplace:

The cable company also argued that it shouldn't have to pay more to distribute shows that Viacom made available free in other media.

I suspect that, as IVPDs further erode the viewership of cable and other MVPDs, the MVPDs will become more desperate for content--and therefore willing to pay more for it.  But it seems likely that both of the key revenue sources for MVPDs--subscriptions and advertising--will, at some point, begin to decline as Americans spend more time watching IVPD content and become less willing to pay for expensive MVPD plans.  As this happens, cable may have less revenue to share with programmers per subscriber, even as their need for that programming grows.

So how will this all end?  I doubt anyone really knows.  But I feel reasonably comfortable making two predictions.  

First, the overall health of the video programming content market will become increasingly dependent on the profitability of advertising--for MVPDs, IVPDs as well as programmers.  This will require technological innovation to produce smarter advertising.  The better advertising is targeted to a specific consumer's interests, the more revenue it will produce for all concerned.  But if the government short-circuits this process by hindering the evolution of targeted advertising in the name of protecting consumers' privacy (or simply to protect them from the supposed inherent unfairness of advertising--an old Marxist shibboleth), the total amount of funding available for content could plummet.  The dynamics described so well by Chris Anderson in "Free! Why $0.00 Is the Future of Business" could drive video programmers to make their content available online for "free" (i.e., at no charge to the user) even if that content ends up producing (via advertising, etc.) significantly less revenue than it currently does on MVPDs (primarily from subscription revenue).  Plenty of smart people have explored this question and have far more intelligent things to say about it than I do.  But since the long-term trend seems to be that consumers are increasingly unwilling to pay even small sums for content, I just don't see any alternative to increasing advertising revenues--other than public financing, which will necessarily bring with it government control and censorship.

Second, the other part of the solution to this problem will be business model innovation:  If individual consumers won't pay for online video content, and if future ad revenues for online video content  don't replace existing revenue streams, programmers are going to look for other sources of funding.  This dynamic seems to be on a collision course with net neutrality mandates.  The WSJ reported:

At one point, it looked as if Viacom might have escalated by trying to block Time Warner Cable broadband subscribers from accessing its Web sites to see its shows.

Whatever actually happened here, one can easily imagine a programmer like Viacom at some point in the future trying to get ISPs to start paying money per broadband subscriber for video content just as MVPDs currently pay per subscriber.  This is really the inverse of the fear generally expressed by net neutrality advocates that ISPs would try to charge programmers for the bandwidth used to transmit their content to an ISP's subscribers.  If it's true that programmers (the Viacoms of the world) and not distributors (Time Warner Cable the MVPD or Time Warner Cable the ISP) really have the market power, as this story suggests, then such arrangements might well be the economic salvation of content creators.  As with regulation of advertising, I only hope that government mandates against such innovation in the name of abstract "neutrality" principles don't end up dooming us to a future where, with free market solutions (better advertising, revenue sharing with ISPs) rendered ineffective by government, government itself seems to be the only option left.

posted by Berin Szoka @ 3:34 PM |