Of the 20 most-watched programs ever on cable TV, 16 were episodes of Monday Night Football—a show that Walt Disney’s (DIS) ESPN sports network didn’t begin broadcasting on cable until 2006. ESPN is also the only cable channel ever to have more than 20 million households watching a regularly scheduled program at once—a feat it’s accomplished four times. That ratings strength is the reason most cable operators believe carrying the world’s No. 1 sports network is essential to keeping 99 million U.S. pay-TV subscribers shelling out monthly fees.
Now system operators are being forced to figure out how much subscribers are willing to pay for sports—and at what point they’ll throw in the towel. In early September, ESPN announced a deal to broadcast Monday Night Football for eight more years. It will pay $1.9 billion a year to the National Football League, a 73 percent increase, says a person familiar with the contract details who is not authorized to speak on the record. While ESPN says it won’t add a surcharge for the new deal, the network will almost certainly make companies such as Comcast (CMCSA), Time Warner Cable (TWC), and DirecTV (DTV) pay more for programming when contracts come up for renewal. “We’re concerned that the rising cost of cable programming, especially sports programming, is starting to price some consumers out of the market,” says Jerald L. Kent, chief executive officer of Suddenlink Communications, the seventh-largest U.S. cable carrier.
Already facing competition from cheaper Web rivals, cable and satellite operators are in a bind. If they pass on the costs to customers, they risk more defections. If they drop the hot network, they also stand to lose subscribers. Frets Matthew M. Polka, president of the American Cable Assn., which represents 900 small and midsize cable systems: “ESPN can force costs to customers indiscriminately because they know the cable and satellite operators feel like they have to offer sports to be competitive.”
There are signs price hikes are hurting pay-TV subscriptions. Last quarter the six largest publicly traded U.S. cable and satellite-TV providers lost about 580,000 customers, the biggest decline in history, according to company and Bloomberg data. ESPN Executive Vice-President Ed Durso says there’s little evidence a significant number of subscribers is dropping service. “The cable operator industry tends to understate the true value of their video product,” he says. “Compared to other forms of entertainment, the price value component of cable is extremely reasonable.”
Besides Disney, companies including Time Warner (TWX), News Corp. (NWS), and Viacom (VIA) are charging cable companies more for programming, particularly sports. NBCUniversal paid $4.38 billion for TV rights to the next four Olympics. Comcast, which owns 51 percent of NBCUniversal, has said it plans to charge higher distribution fees to make the deal profitable.
ESPN charges cable operators an average $4.69 a month for each subscriber that gets the channel, up from $4.34 last year, according to researcher SNL Kagan. Cable networks such as CNN or TBS charge less than a dollar, says Kagan’s Derek Baine. ESPN’s average annual price increase to pay-TV providers will likely exceed 10 percent after the new Monday Night Football deal, says Baine.
Paying more for ESPN is only part of the problem. Disney charges distribution fees and collects ad revenue from its other channels, including ESPN2, ESPN Classic, ABC Family, and Disney Channel. To get ESPN, pay-TV systems must take bundles of channels, including some less popular. ESPN and ESPN2 account for almost 20 percent of the wholesale cost of the average pay-TV subscription, says Sanford C. Bernstein (AB) analyst Craig Moffett.
“Cable operators are typically at the mercy of the large content providers, who tie carriage of smaller-niche channels to carriage of the ‘must-haves’ like ESPN,” explains Ryan Vineyard, an analyst at RBC Capital Markets. The fees programmers charged cable channels jumped to $24.9 billion in 2010, up 90 percent from 2004, according to Bloomberg data. Now prices are set to go even higher as content providers negotiate new deals that charge cable companies extra for the right to send movies and TV shows to their subscribers’ laptops and mobile devices via the Web.
For years, pay-TV subscribers have pushed for the option to pay less for only a few channels of their choice, instead of basic packages that now can include hundreds of channels. Yet the programmers’ channel-bundling rules have made it difficult for pay-TV providers to offer such à la carte options. “If I could offer high-cost channels like ESPN as stand-alone channels, à la carte, I’d do it,” says Suddenlink’s Kent.
Disney has no interest in selling ESPN as a stand-alone service. Fewer subscribers would watch, so ad revenue would fall and Disney would lose the $4.69 it now receives for each basic cable subscriber, says Durso. Besides, he notes, “For cable operators, the best subscriber they have is an ESPN customer, because ESPN customers buy more high-speed data and buy more HDTV than any other customer.”
Disney would likely have to charge about $30 just for ESPN to make up for lost advertising and affiliate revenue it gets from the network and the networks it bundles with ESPN, Moffett says. The end result would be consumers paying more money for just a few channels than they pay for hundreds today.
Polka of the cable association says it makes more sense to relegate ESPN to a “sports tier,” where sports fans can pay extra for it and other customers can opt out. Time Warner Cable is testing such a product in New York without ESPN for $39.95 for 12 months and $49.95 thereafter, vs. a standard cable package with ESPN for $68. Still, should the cheaper package catch fire and become the most or second most popular Time Warner Cable offering, a provision in ESPN’s contract would require the cable operator to include the costly sports network in that trimmed-down package—eliminating the reason it was introduced in the first place. “ESPN has demonstrated its value as part of basic cable for more than 30 years,” says Durso. “There isn’t any case that can be made for putting ESPN on a sports tier.”