Analysts: Much Ado About So Little

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Federal Communications Commission chairman Kevin Martin came out swinging last week in favor of letting cable viewers pay just for the channels they want to watch. But the potential savings of so-called a la carte service might not amount to a hill of beans.

In testimony before a U.S. Senate committee on indecency, Martin used the forum to criticize a 2004 FCC report that found a la carte to be economically unfeasible. At one point, Martin focused on the report’s failure to mention that subtracting costs for additional digital set-top boxes (unneeded if a la carte were offered only to digital-cable subscribers) would result in a 1.97% reduction in cable bills.

40 CENTS A MONTH

Well, a 2% reduction in a customer’s cable bill works out to about 40 cents per month, Bear, Stearns & Co. Inc. media analyst Ray Katz calculated. For that 40 cents in savings, customers would be paying for about 17 channels (10 over-the-air channels plus seven cable channels), instead of the 70 to 80 channels currently in expanded-basic tiers.

“So, we’re going to do all this so the average American after one year has enough money left over for a Happy Meal,” Katz said, referring to a popular McDonald’s kids offering. “That’s what we’re talking about — 40 cents a month. It’s a Happy Meal, and it’s not even a large Coke.”

While most analysts — including Banc of America Securities’ Doug Shapiro, Katz and Merrill Lynch & Co.’s Jessica Reif Cohen — believe it is unlikely that an a la carte mandate will ever come to fruition, it was the first time in recent memory such a high-ranking government official came out in favor of the practice.

Those same analysts believe a la carte is just a tool to give the FCC chairman what he really wants — a family friendly tier on all cable systems.

Obviously, the issue of a la carte is rife with variables, and Martin, in his brief testimony, offered no hard data to back up his claims that a la carte would result in lower monthly bills.

“I had many concerns with this [2004 FCC] report, including the logic and some of the assumptions used,” Martin said, adding that he enlisted the FCC’s Media Bureau and its chief economist to take a more thorough look at the issue.

“The staff is now finalizing a report that concludes that the earlier report relied on problematic assumptions and presented incorrect and incomplete analysis,” Martin added. That report is expected to be released sometime this week.

THREE KEY POINTS

Martin honed in on three key points in the 2004 FCC report, which was based on findings from independent research firm Booz Allen Hamilton Inc.:

  • The contention that the amount of television watched by pay television audiences would drop 25%, if viewers paid for channels one at a time;
  • The failure to subtract the cost of broadcast stations when calculating the average cost per channel under a la carte;
  • The inclusion of costs of additional set-top boxes, when a la carte is offered to digital cable subscribers.

Here’s a closer look at those points.

Martin disagrees with the FCC report’s assumption that the move to a la carte would result in consumers watching 25% less television.

“It seems unrealistic that we would see this kind of decline in viewership simply because consumers could purchase only those channels they found most interesting,” Martin said.

But in the Booz Allen report, that 25% drop was a weighted average per cable network, based on current revenue per network segment, including emerging mass-audience networks, emerging niche networks, older-skewing and younger skewing networks, news networks and general-entertainment and sports networks.

Booz Allen split consumers into two groups: heavy viewers and occasional viewers. While heavy viewers of networks are expected to continue watching them in an a la carte environment, occasional viewers will likely drop those channels.

“Neither Booz Allen Hamilton nor Kevin Martin knows what the right number is,” Katz said regarding estimates for declines in viewership under a la carte. “But nobody can deny the direction, which is that viewership will go down. It may go down by 1%; it may go down by 25%. It won’t go up.”

BROADCASTERS: IN OR OUT?

Martin also criticized the FCC report for including the cost of broadcast channels in the average cost per channel, asserting that practice limited the number of channels that consumers could buy without their rates going up.

But Martin neglected to mention that cable subscribers are required to buy the broadcast tier no matter what level of service they sign up for. In A research report issued on Nov. 30, Katz valued the 10 over-the-air networks at about $10 per month.

According to Katz’s research, offering 10 broadcast stations and five popular cable networks — Disney Channel, ESPN, MTV: Music Television, Spike TV and TBS — would cost $20.75 to $45.02 per month, depending on customer take rates. According to Katz, the lower rate kicks in if 75% of cable customers choose a la carte and the higher rate if only 25% sign up to buy channels individually.

The Booz Allen report attached a $15 monthly charge for the broadcast networks — their estimate of the average price among cable operators for the broadcast-basic tier, which would include the four major over-the-air networks, UPN, The WB, PBS and educational and religious stations. That would leave consumers with about $28 per month to spend on cable channels — or about seven additional channels based on an average price per cable channel of $4 to $5 per month, Booz Allen determined.

Taking the broadcast channels out of the mix could reduce monthly cable bills by as much as 13%, the new FCC report is expected to say, according to a report in USA Today last week.

Katz said he didn’t include the cost of the broadcast stations in determining his average price per channel, but he did include it in the final cost of a la carte service, because it is a cost that consumers will have to bear.

“Booz Allen Hamilton allocated the cost to customers of the broadcast tier over the cost of the a la carte channels, because it is a cost to the consumer,” Katz said. “Personally, I wouldn’t have done it that way, but not to include it is more wrong.”

SET-TOP COST IMPACT

And while it is true that the Booz Allen Hamilton report said that backing out set-top box costs would results in a 1.97% reduction in consumer cable bills, that is part of a scenario in which cable networks receive no increase in affiliate fees from cable operators and are forced to substantially reduce programming costs to maintain their profit levels. Under that scenario, Booz Allen predicted that 25% to 30% of established cable networks would fail.

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