Cable's Next Phase: Homogenization

By ERIC ROTHENBURG -- Multichannel News, 7/31/2000

The cable-television industry will have to parallel the banking and brokerage sectors to remain competitive in the 21st century.

During the 1990s, cable went through its first phase of vertical mergers and combinations. Now, the industry must undergo a "second phase" of homogenization and diversification in order to remain competitive.

When cable was first developing, there were many small operators. This was quite simi-lar to the small neighborhood banks that one would find in a local community.

A customer would get personal service and recognize the bank's employees. It was a friendly approach with regard to customer service.

Main Street would consist of the local bank. When cable television entered the area, the local office would be on the same Main Street.

Then, economies of scale started to take over. Small operators could not compete with the big MSOs, as they had fewer subscribers over which to allocate fixed costs, and because their variable costs took up a higher percentage of net revenues. And programming costs for a small operator could triple those paid by the large MSOs.

Economies of scale would take over. By minimizing costs, profit margins would be much higher.

This was when the first phase of cable-industry mergers occurred-basically a vertical-combination phase that resulted in intra-industry mergers.

This was very similar to what happened in the banking industry: the local neighborhood banks disappeared and huge, regional banks took over. Personal service was compromised. But this was the only way the banking and cable-television industries could remain competitive.

What followed in the banking industry is what must happen in the cable television industry, in order for it to remain competitive. The wall between commercial and investment banking all but disappeared with the repeal of the Glass-Steagall Act.

When you walk into a bank, brokerage services are offered under the same roof. In economics, we call this homogenization.

It became difficult to distinguish a commercial bank from an investment bank, as brokerage houses started to offer the same services as commercial banks. The whole financial-services industry was homogenized.

Within the last five years, cable's competitors have done the same thing. Cable is now in competition with direct-broadcast satellite.

Now, Blockbuster Inc. is working on deals through which it would offer DBS systems and video-on-demand. The telcos are trying to enter the cable-television industry. Many programmers are also cable-system operators.

Cable's direct competitors have actually homogenized themselves. This is similar to what occurred in the banking and brokerage industries. We now see horizontal mergers within these industries, as well as the vertical mergers that were so reminiscent of the 1990s.

In order for cable television to survive, it will have to undergo this same type of homogenization. Cable is particularly vulnerable due to the rapid technological changes.

What was a state-of-the-art upgrade in the 1990s is nothing compared to what is on the horizon.

Systems that were upgraded during the last decade are actually at a disadvantage, as they'll miss out on the upgrades that take place now. Managers reason that since a particular system was upgraded only 10 years ago, there is no need to upgrade it again. Therefore, the "neglected" systems will be the ones that obtain the newer, more current technology.

Technology and homogenization are quite complementary. In order for cable television to survive, it must realize that homogenization is important. Adding more channel capacity will not be enough.

In economics, there is a principle called the law of diminishing marginal utility. Adding more channels will not necessarily make subscribers happier. Here, the concept of "quantity over quality" does not apply. Most subscribers probably watch 10 channels on a regular basis. This is why VOD would be deemed more useful.

To sum it up, cable operators are now meeting new challenges in the 21st century. They will have to diversify and homogenize in order to remain competitive. In addition, they must to keep up with the ever-changing technology.

Vertical mergers alone will not suffice. Branching out into diversified fields will be the only answer. Time will tell if cable will adjust and not lag far behind their competition.

Eric Rothenburg is an assistant professor of accounting and economics at Kingsborough Community College of the City University of New York.