June 24th, 2013

Future of TV
Why channel bundling is detrimental to consumers
By Saad Fazil on June 23rd, 2013

Published by: sfrocks

Why do cable providers such as Comcast bundle channels? What would the future of TV look like? Does HBO need to bundle its programming with other channels? Read the book to find out and stay tuned to further updates.

Inspired by Ben's series on Changes Coming to TV , I am going to write a series of my own on the same topic. Each part will roughly parallel in focus to Ben's respective piece. In his part 1 , he makes a case why channel bundling is beneficial to consumers, and therefore difficult to disrupt using a traditional TV approach. I agree with the latter. I earlier wrote : While disrupting the TV industry with an all-powerful Apple TV (not just a set-top box, but a TV set) certainly sounds ambitions and more fitting to Apple's DNA, it would be much easier to allow 3rd party apps (and especially games) on the current line of Apple TV set-top boxes. However, I do not think that bundling channels is beneficial to consumers. It will be instructive to look at when and why bundling works for suppliers (suppliers can be cable providers such as Comcast and Verizon FiOS; networks such as HBO and ESPN; or their parent companies such as Time Warner and Walt Disney). In general, suppliers use bundling as a pricing strategy to maximize their profits. It works well for suppliers if there is heterogeneous demand amongst the consumers, that is, different users value each channel differently. I earlier wrote in iTunes turned the music market on its head. Could iTunes TV do the same for TV? : Comcasts basic digital TV option its digital starter subscription costs more than $60 without a 6 months offer. And though it does offer dozens of channels, how many do you watch on a regular basis? Except for premium channels such as HBO and Cinemax, for which most consumers have higher willingness to pay, viewers have very different programming preferences. Some like the Food Network, others like TNT or the History Channel. Why would anyone want to pay for a bundle made up of many channels they never plan to watch? Let's look at a hypothetical example.

June 24th, 2013

Published by: sfrocks

Let's assume that cable providers and channel networks split revenue evenly. Since, suppliers can't price discriminate, they only have three viable pricing options available to them. 1. Price each channel at $2. This allows every consumer to watch all channels, each at $2. Each consumer brings in $8 in revenue, resulting in $20 for networks ($5 for each), and $20 for the cable provider. 2. Price each channel at $10. This allows consumers 1 through 4 to watch only one channel, and prices out consumer 5 completely. Cable provider and channel networks both end up pocketing $20. 3. Bundle all channels, and price the bundle at $16. Consumer 5 is still priced out, but now consumers 1 through 4 can all enjoy all channels. This option results in maximum revenue for the suppliers: $32 for the cable provider and $32 for channel networks ($8 for each). While the numbers used above are very simplistic, the trend shown is reminiscent of how cable industry actually works. Therefore, it's no surprise that suppliers prefer to bundle channels. Now, let's throw in a premium channel in the mix.

From HBO's point of view, here are three viable pricing (packaging) options. 1. Sell HBO as part of the 5-channel bundle. Since each bundle sells at $22, consumer 5 is priced out. Therefore, HBO makes $12. 2. Sell HBO as a stand-alone but only to those consumers who have the basic 4-channel bundle. This option also results $12 in revenue for HBO. 3. Sell HBO independently. All consumers by HBO at $6, and thus HBO ends up making $15, highest of the available options. Using this example, HBO would clearly benefit from offering HBO as a la carte without a need for a basic bundle. For example, HBO could offer its programming via Apple TV/iTunes for a paid subscription, without requiring users to buy a cable subscription first. But here are a few reasons it does not do so. - Cable providers help HBO sell to a much larger user base than would be possible via iTunes today. In addition, HBO gets "free" marketing from its cable partners, and would lose out if it were to anger its partners. - HBO (and many other premium networks) is not an independent entity. Time Warner owns HBO and many other channels. Time Warner benefits greatly from selling its channels as a bundle to cable providers because it can then offer attractive advertising opportunities (by offering a single ad on multiple channels for example)

June 24th, 2013

Published by: sfrocks

- I wrote the third reason here : Comcast and other cable providers already have strong relationships with advertisers. It would be hard for cable networks like HBO to transfer those advertising relationships over to broadband TV, and that means theyd risk cannibalizing their revenues if too many of their viewers switched to iTunes. Unless iTunes can give these cable networks a sweeter deal (more share of the revenue or some other comparable advertising partnerships), it would be hard for them to make a good business case. Back to my original argument that bundling while beneficial for suppliers does not benefit consumers. Ben concluded his piece by making the following points; let's take a look at each one of them. Ben: Networks earn much more per viewer than would be sustainable under a la carte pricing. While more revenue is of course beneficial for networks, I do not think that a la carte pricing will not be sustainable. Beneficiaries will change as they always do with democratization of the internet, but consumers will be better off with a la carte pricing. There are indeed reasons when bundling is beneficial for consumers (more on this in another piece), but cable industry does not exhibit those characteristics. Ben: Networks are incentivised to create (or in ESPNs case, buy rights to) great programming; making your content mustwatch lets you raise your affiliate fees. This goes back to my point above: There is no strong evidence that a la carte pricing will hurt networks' ability to provide superior programming. If anything, shuffling in the value chain should only encourage new entrants thus raising the quality of programming. Ben: Viewers get access to multiple channels that are hyper-focused on specific niches. Sure, folks complain about paying for those niches, but only because they dont realize others are subsidizing their particular interests. While individual channels will likely rise in price, they will not increase substantially. More importantly, the total bill of consumers will still be less than what is today. Subsidies work well when a few folks subsidize the rest (as is the case with social gaming); but not so well when masses subsidize a few (as is the case with healthcare), unless there are many unexpected costs (which is indeed the case with healthcare and insurance industry in general). Ben: Cable companies know the cable TV business, and would prefer to put up with customer disgruntlement over rising prices than become dumb pipes. I couldn't agree more, and central point of my post is precisely that. Moreover, while I disagree with Ben's argument about why bundling is beneficial to consumers, I agree with his uber-conclusion that Any grand vision Apple, or any other tech company, has for television is likely to sustain the current model, not disrupt it directly. I will write more about this in my followup posts on this series. Other posts that you might like related to this topic: What I want from the new Xbox Is cutting the cord worth it and how you can do it too 3 reasons TVs about to get a facelift Should you buy Google TV or wait for the new Apple TV to launch? What to expect from Apple's event tomorrow? Does Apple's "vertical integration" philosophy hurt it in the home entertainment market?