Historically, the cable industry has had two areas that has generated very good returns for shareholders:
- Distribution companies / cable channels. They monetize content.
- Infrastructure companies that own the physical coaxial cables.
Cable channels make money from two areas:
- Subscription fees from cable companies.
- Advertising dollars.
Both areas are heavily driven by scale. Larger cable channels can afford to pay more money for original programming, make the channel more attractive to consumers. With superior content, they can charge higher subscription fees.
On the advertising side, wider reach allows for higher CPM rates. Advertising spending tends to be cyclical because advertisers tend to cut their ad budgets during recessions.
Historically, cable channels lose a lot of money in the beginning as they try to achieve a critical mass. Some of them have gone bankrupt or disappeared. Some of the most successful cable channels came close to failure because times were tough in cable’s early days (e.g. Discovery Channel, which is now a multi-billion dollar company).
Successful cable channels enjoy wonderful software-like economics because video content costs almost nothing to reproduce. Cable channels are able to capture most of the value generated by content creators because cable channels are so difficult to put together and so difficult to compete against.
The power of the bundle
Cable channels have to figure out what works with viewers. In a Cable Center interview (transcript | Youtube) David Zaslav promotes the theory that “less is more”. While broadcast networks can offer an eclectic range of programming, cable channels are better off focusing a niche and focusing on defining their brand. Viewers can tune into Discovery Channel and expect certain types of shows. What the industry has found is that viewers stick to a handful of their favorite cable channels. They rarely go looking outside their favorite channels for new content. By sticking to niches and very specific audiences, cable channels help match viewers with content that fits their tastes.
The scheduling of shows can also make a difference. Some programmers will use “lead-ins” and put similar types of programming back-to-back. That way, viewers who finish watching their favorite program will be inclined to stick around if the next program fits their taste. Programmers also have to pay attention to the time of day and to program based on whether people are at work, at home, just arrived home from school, are sleeping, etc. etc.
Because there are 24 hours in a day and 7 days a week, programmers need to fill most of that airtime to maximize utilization. This is another barrier to entry.
Cable channels are incredibly difficult to displace
The #1 channel in a niche will often ask for exclusivity in its contracts. This means that the channel will lock up most of the best content in a particular niche. It is hard for competitors to gain viewership without superior content and without the subscriber base to finance original programming. It also takes time to change consumers’ viewing habits.
These difficulties essentially act as strong moats for successful cable channels. They also allow cable channels to extract an unusual amount of money out of content creators.
Cable companies have been able to earn high returns on capital because they have limited competition. Historically, they have competed against terrestrial broadcasting, satellite, and (later) video delivered over phone lines and fibre optics. For much of cable’s history, the competitive situation has largely been a duopoly between cable and broadcast. The lack of competition has allowed cable companies to enjoy high returns on capital and to exercise their pricing power.
Improvements in cable technology and in cable programming have been huge tailwinds for cable operators. The explosion in channels with high-quality programming gave cable a compelling value proposition versus free over-the-air programming. Nowadays, most people equate television with cable rather than broadcast.
Part of the reason why the cable industry has made so many billionaires is because many of the ‘cable cowboys’ used a lot of leverage. Banks were willing to provide cable companies with lots of leverage because cable seemed to have fairly stable cash flows. In some instances, cable companies could finance a takeover with 100% debt. Leverage wasn’t necessarily safe in all cases. For example, Charter went bankrupt due to too much debt and poor management.
Part 2 will look at where the cable industry is headed.