Margins Rise for Local Ad Sellers

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Local ad sales are the rising stars at most cable
operations. That's good news. Also good news is the fact that ad sales' benefit to the
bottom line is growing even faster than top-line increases.

Cash flow continues to outgrow revenue at most local
cable-advertising-sales operations, MSO-level ad execs reported. Operating-cash-flow
growth of 20 percent to 30 percent per year typically accompanies 15 percent to 25 percent
annual revenue gains, boosting already robust 50 percent to 60 percent net margins and
making corporate stars of ad-sales divisions and their leaders.

"Margins improve every year. Sales are growing 20
percent to 25 percent per year. Our expenses aren't growing 20 percent to 25 percent per
year," said Patrick Esser, who was recently promoted to vice president of operations
at Cox Communications Inc. from vice president of advertising.

"Every investment we have been making in this business
during the past 10 years has been bearing fruit for us, from putting research managers and
national sales managers into our operations, to installing digital ad-insertion gear and
expanding insertion from 15 channels to 30," Esser added. "These investments are
paying for themselves and generating cash flow."

At Cox, cash flow produced by advertising sales now
"represents just under 15 percent of the cash flow for the entire corporation,"
he said.

"It's a dynamic process when you look at the ad-sales
business from a P&L [profit-and-loss] point of view," Time Warner Cable corporate
vice president of advertising sales Larry Zipin said.

"You have a revenue stream that's growing at an
average of 25 percent," he added. "If you look at the model on a same-store
basis, you have a variable expense or cost-of-sale equation that is maybe 25 percent or 30
percent of net revenue. And then you have fixed, embedded costs which aren't really
growing much at all, except by some rate of inflation."

Those trend lines alone are enough to lift cash-flow
margins. But another dynamic is accelerating the process.

The ad-sales business "is now in a situation,
especially in Time Warner Cable's case, where it's not a same-store basis," Zipin
said. "We're going through a lot of market consolidations and improvements in
technology. To a great extent, the fixed expenses are actually going down, so margins have
improved even more dramatically."

When a market previously served by several ad-sales
operations is consolidated into a single unit, "the revenue opportunity and growth
remain the same, but you consistently eliminate redundant operating expenses," Zipin
said. "You eliminate operating costs that may be replaced by automation. The same
revenue stream may be produced today by perhaps as few as one-half as many back-office and
technical personnel."

"Our fixed costs are getting much more identifiable,
and digital ad-insertion gear allows you to really get a handle on your fixed costs,"
Esser said. "So when you go from 15 channels to 30, you don't have to double the size
of your technical staff."

Moving from analog to digital ad insertion has
"certainly been a major contributor in both driving top-line results and helping to
contain costs," MediaOne Group Inc. vice president of advertising sales Ed Dunbar
said. "We're concentrated in large markets, and our growth rates are such that the
capital payback for digital gear has typically been 12 months or less."

In stark contrast to MediaOne and most top MSOs, Falcon
Cable TV Corp. mostly operates small-market "classic" systems, many of which
still deploy analog ad-insertion equipment.

Falcon doesn't differ from its counterparts, though, when
it comes to net margins on ad sales: They're 50 percent to 60 percent and expected to
rise, due in part to cost savings and revenue enhancements from planned digital
conversions later this year.

According to Falcon vice president of advertising sales
Ovie Cowles, going digital will reduce or eliminate costs for repair and maintenance of
VCRs, slash videotape expenses and give existing staff more time to develop sources of
incremental revenue.

In the analog world, Falcon has sustained healthy cash-flow
growth by tightly managing expenses while riding the cable ad-revenue wave

"We ask our managers to always be looking for
cost-saving opportunities," Cowles said. "We tell them that in a competitive
environment, lots of companies are trying to get your business and offering you a discount
for it. Telephone service is one area. So is using an outside collection agency, or music
libraries for commercial production. We ask managers to make sure every year or two that
they're still with the right vendor, getting the best price."

Also contributing to higher ad-sales margins is a decline
in a key variable expense: bad debt. "For most of the 1980s, it wasn't unusual to put
in an accrual against bad debt of between 2 percent and 4 percent," Zipin said.
"The business is 10 times larger than it was 10 years ago, but now, the rate of bad
debt and the expense associated with credit and collection is a fraction of 1

Fueling the higher bad-debt levels of the 1980s and early
1990s were "the turnover nature and the churn rate generated by dealing primarily
with a lot of small local retail clients as our core customers," Zipin said.

"In our company's case, less than 30 percent of our
total ad-sales revenue now comes from that direct local-retailer category," he added.
"The 70 percent of revenue coming through agencies from the national-regional arena
is less likely to translate into bad debt."

What's more, regional and national spot ad dollars
generally flow to cable operators at a higher margin than local business. The total cost
of sale for national-regional business is typically a commission of 20 percent of net
revenue paid to a national rep firm or interconnect, "plus whatever in-house,
back-office expenses we incur," Zipin said.

Whereas local sales usually involve paying account
executives' salaries, benefits and commissions, "we don't have to pay salaries and
benefits to national reps," noted Allan Eisenberg, director of advertising sales and
local programming for Greater Media Inc.

Total compensation (commissions, salaries and benefits) for
all ad-sales personnel, including traffic-and-billing and technical staff, generally
amounts to 25 percent to 35 percent of total net revenue, MSO ad-sales execs said.

Total net revenue is revenue after agency and rep
commissions: It includes not only ad-insertion sales, but also revenue generated by
commercial production, photo-ad channels, infomercials, local-origination programming and
print ads in billstuffers and direct-mail pieces.

All other expenses attributable to ad sales typically
amount to 10 percent to 20 percent of net revenue, which means 45 percent to 65 percent of
net revenue flows directly to the bottom line.

Although cash-flow margins (or earnings before interest,
taxes, depreciation and amortization as a percentage of net revenue) vary by region and
size of operation, the difference between a 45 percent and a 65 percent margin is often
"simply a matter of which of the parent company's generic expenses are allocated
toward the operation's ad-sales P&L," Zipin said.

These expenses include "a lot of ancillary or support
services that we take for granted because we're part of a large company," such as
payroll services, human resources and benefits administration, Zipin explained.

In the case of Cox's ad sales, "we charge everything
against our operations -- the guy out front mowing the grass, the janitor cleaning the
building," Esser said. "So we know our real margins. Cox has acquired some cable
systems that don't charge any of these things against their ad-sales operations. When
people say, 'I'm at a 70 percent margin,' I say, 'Well, yeah, nothing gets charged against

Margins are also "fully loaded" at Media
Partners, the ad-sales division of Adelphia Communications Corp., according to Media
Partners vice president Jack Olson.

"We count everything right down to rubber bands,"
Olson said. "We capture our portion of floor space if we share space with operations.
We assess our general ledger for rent. We even include a 'management fee,' if you will, to
cover the hidden expenses of tapping into our legal, human-resources and engineering

But even fully loaded margins are north of 50 percent for
most cable ad-sales operations.

More important, margins still have room to climb, ad execs

"In the next couple of years, market consolidation and
the deployment of technology will have run their current course," Zipin said.
"I'm also talking about office technology -- PCs [personal computers] on every desk,
wide-area networking and as much automation as you can push into the sales process. That
will stabilize in the next couple of years."

Zipin continued, "Then, we'll once again have kind of
a same-store model when it comes to expenses. We'll have a revenue stream that's growing
25 percent or more, and the only increase in costs will again be just variable expenses --
the cost of sale. This suggests that we can perhaps drive toward that extra five
percentage points of margin. If you're at 60 percent, it becomes 65 percent."

Margins on emerging revenue streams, such as ad sales tied
to cable modems and the Internet, can be "as good as, if not better than, the
incremental margins we're generating now," Zipin added.

"In markets where Time Warner Cable has already
launched [cable-modem service] Road Runner or full-time news channels, the ad sales for
those products are handled by the incumbent ad-sales operation. So you have a new revenue
stream that simply becomes incremental to the existing cost structure. Creating an
ad-sales application on a Road Runner page isn't any greater an investment of capital than
when you wrote the page in the first place."

"The question is, are you going to be able to do it at
the same margin initially?" Cowles asked. "If you want to start selling
advertising on the Web, and you project that the first year is going to generate $1
million in revenue, is it going to cost you $1 million to get that $1 million?"

Cowles added, "If you can say that you're going to
make $1.5 million in revenue the second year and $2.5 million the third year, and that the
initial $1 million per year of expense will remain flat, it may well be worth taking the
breakeven hit the first year to start that business."

"There are times when you make major investments to
grow when your margin could go back for a period of time while that business gets off the
ground," Esser said.

"For example," Esser added, "Cox is building
a hotel network in Las Vegas. Different commercials will run in the hotel rooms than run
in the residential homes in that market. For maybe three months, as we put those people
and equipment in place, as we purchase research and marketing materials, it's going to
hurt our margin in one operation. But look out the following year, because everything on
top of that will be incremental."

Margins are expected to continue their ascent, but higher
isn't necessarily better.

"If you squeeze too much, you're probably not putting
enough resources into the business," Esser said. Concurring, Olson said, "If the
margin gets a little too strong, it raises a red flag. It tells a good manager to ask: Am
I starving any opportunities? Am I choking someplace where I should be maybe spending a
little more money? You don't want to spend money that you don't have to spend, but if you
put too much emphasis on margins, top-line revenue results can suffer."

Consequently, MSO upper management looks more closely at
cash-flow and revenue growth than at margin growth to measure ad-sales-department

For example, top executives would rather see a sales
operation with $4 million in annual net revenue and $2 million in cash flow (a 50 percent
margin) boost revenue by 25 percent to $5 million and cash flow by 30 percent to $2.6
million (a 52 percent margin), than see it increase sales by 15 percent to $4.6 million
and cash flow by 25 percent to $2.5 million.

That's because it yields $100,000 less cash flow -- $2.5
million versus $2.6 million -- despite producing a higher margin (54.3 percent).

"At Cox, we don't manage margins in the ad-sales
business," Esser said. "If you focus on growing cash flow faster than revenue,
your margins will take care of themselves. We have very limited discussions about

"The generation of real revenue and cash flow is the
goal. Both get measured and factored into our compensation and bonus programs," Zipin

Although the cash-flow picture looks bright overall, cable
ad sellers acknowledged that they face cost pressures on some line items such as computer
software, commercial production and audience research.

"If any costs go up, it will be in the area of
software for traffic-and-billing and inventory management," Zipin said. "We
already have a need for them to be wider in scope than they currently are. Therefore, the
license fees will be higher, and the ongoing support and maintenance fees will be

He added, "We're trying to fully automate the sales
process with tools such as proposal generators and multimedia-presentation software. As we
demand greater sophistication from software as a backbone for our business, its cost as a
line item will probably continue to rise a bit."

Olson agreed: "To really get state-of-the-art in the
way that we want to communicate with one another and to create a virtual presence in all
of our markets, we're probably going to see increased spending on networking

"Traffic and billing is really causing the industry
major headaches," Esser said. "We have a very antiquated way in which we do
traffic and billing, and the year 2000 is only [six] months away. Our business has become
more complex, and the traffic-and-billing systems available out there have struggled to
stay on top of it. That's our pressure point" for increased spending.

"Costs could go up in our commercial-production
department, to add and keep good, talented people producing those commercials,"
Eisenberg said.

Falcon is feeling greater pressure from advertisers to
provide local audience research. "We operate many smaller rural systems, so we don't
have Nielsen [Media Research] or [The] Arbitron [Co.] pounding on our doors in these
markets to say, 'Subscribe to our service,'" Cowles said.

"Therefore, we look to firms such as Griffin Reports
to do customized research," he added. "We need to give our salespeople better
tools to work with in their marketplaces. That means an expense we haven't historically
shouldered at Falcon."

But in what seems to be a recurring theme with local cable
ad sales, it's an expense that Cowles expects to attract incremental revenue, carrying at
least a 50 percent net margin.