A tweet over the weekend about a Milwaukee paper’s editorial on the proposed Comcast-TWC merger had me thinking it was probably time for another posting on that topic. The editorial repeated the typical (misplaced) concerns over “net neutrality” but then also went on to suggest an odd pair of proposed concessions Comcast should make relating to video:
Comcast and Time Warner should eliminate forced bundling and allow a la carte purchasing and smaller bundles; they could agree not to discriminate in Internet pricing and to sell access to the Net without a cable TV bundle; and they should divest all of their programming assets.
This had me thinking it was time to again explain, this time with some more detail, how cable bundles are actually controlled at the wholesale level, by programmers (cable networks/channels), rather than by cable (or satellite, or telco) operators. For the above excerpt clearly reflects a lack of understanding of the cable operators’ role in that process.
Upon re-reading the editorial the next day, however, I noticed that there was a link to the Forbes commentary by Warren Grimes from which the above proposals were drawn. And in reading that, I realized that while Professor Grimes is, in my view, off-base on some concerns, he does understand the basic issues in play at the wholesale level, when it comes to channel bundling. (Rather, it was the Milwaukee paper that misunderstood, in paraphrasing his suggestions in a fashion that didn’t make sense.) Grimes also clearly recognizes that the most important television-related concerns around this merger relate to programming, not distribution.
Still, the impact of the merger on the problems as they already exist at the wholesale level would be minor, and the solution Grimes proposes (blocking the merger) would be wholly inadequate in addressing those much larger, existing problems. Furthermore, it seems likely that many will have misunderstood Grimes’ commentary on the problem, just as the Milwaukee paper did. And with many politicians still clearly lacking any real understanding of the issues (see for example recent coverage of Al Franken’s statements), it still seems worthwhile to post an explanation of the problems that exist, as well as a discussion of changes policy makers ought to consider in order to meaningfully address such.
The Problem with the Cable (and Satellite, and Telco) Bundle
The heading above says a lot, in itself. That the same basic bundle problem exists across all distributors—with every cable provider (whether incumbent or overbuilder) and every satellite and telco provider—demonstrates that the problem is not at the distributor level. When it comes to video, each of these companies are fierce competitors. Virtually all markets have at least three competitors, and in many markets there are now four competitors—all competing for subscribers in a market that is at best stagnant, and more likely, actually declining in total subscribers. Accordingly, this is fierce competition where one operator’s gain is normally another operator’s loss.
This kind of competitive market is normally extremely good at addressing consumer wants. In a free market, one or more of the competitors will seek advantage by offering something different from the others, seeking to satisfy a consumer need or desire. And yet, the clear consumer desire for smaller bundles, of popular channels, at lower cost continues to go unserved. And even as high costs and a struggling economy have caused that desire to reach the level of a need, there still has been no meaningful change.
The reason this happens is simple: the distributors simply lack the power to substantially change the bundles.
Understanding why is the key to understanding what will and what won’t make the situation worse, and what would be necessary to make the situation better.
With all those hundreds of channels that get packaged together, there are actually relatively few major programmers that account for almost all of them. Here’s a list of the largest programmers, and some of their channels/brands (with either full or partial ownership):
Disney: ABC, ESPN, A&E, Biography Channel, History Channel, H2, Military Channel, Crime & Investigation, Lifetime, Disney channels, ABC Family, Fusion
CBS: CBS, The CW, Showtime, CBS Sports, The Movie Channel, Smithsonian Channel
NBCUniversal [owned by Comcast]: NBC, Telemundo, Bravo, The Weather Channel, CNBC, MSNBC, E!, Esquire, Golf, Oxygen, G4, Sprout, USA, NBCSN, Syfy, Universal, Comcast Sportsnet channels (regional sports networks)
Fox: Fox, FX, Fox News, Fox Business, Fox Sport channels (regional sports networks), Speed
Viacom: MTV, Comedy Central, Nickelodeon, CMT, Spike, TVLand, VH1, Epix
Time Warner: HBO, Cinemax, CNN, HLN, TBS, TNT, TCM, Cartoon Network, Adult Swim, truTV, Boomerang
Discovery: Discovery channels, American Heroes, Animal Planet, Science Channel, TLC, Oprah Winfrey Network, Velocity
Scripps: HGTV, DIY, Food, Cooking, Travel, Great American Country
AMC: AMC, IFC, Sundance, WE
If you noticed that most of these programmers have at least one or two channels that you consider essential, and then many others that you don’t, you can see the problem. Every programmer has at least one “must have” channel—a channel which, if it were permanently dropped from a cable/satellite/telco provider’s lineup, would cause a large number of consumers to consider the service unacceptable, and switch to another provider. This gives the programmers tremendous leverage. The distributors need those “must have” channels to compete, and the programmers know it. So the programmers are in an extremely strong position to extort what they want.
Now, extort is a strong word, but unfortunately it’s an accurate one. The script is, by now, well-established, and goes something like this:
Step 1: Set your carriage agreement to expire shortly before some major television event. For example, the Superbowl, the World Series, the Oscars, or perhaps the start of a new season of a very popular program. This ensures maximum pressure from politicians and the public, if there is a blackout.
Step 2: Make sure that only one of the several competitors is expiring at that time. For example, at one time, it’s a major cable operator. At other times it will be the various other satellite and telco operators (but always one at a time). This isolates the distributor, ensuring that customers have alternative providers to switch to, if there is a blackout.
Step 3: Extract your pound of flesh. The distributor is now caught between a rock and a hard place. Either they capitulate to the programmer’s demands, and suffer customer wrath down the road when rates rise (and for many years now, also a financial impact due to absorbing some of those increases, themselves), or they hold out, and suffer a blackout. The blackout will mean subscriber losses, as some customers switch to other providers, and a negative impact to the customer relationship with those who remain—but if the distributor can hold out long enough, may end with slightly better terms for the new carriage agreement.
It’s worth noting that these channel blackouts are almost always harder on distributors than programmers. The programmers lose a fraction of their advertising audience (since the blackout affects just one of many distributors), whereas the blackout typically affects the distributor’s entire customer base. Then also, when the blackout ends, the programmer immediately gets all of their advertising audience back, whereas the distributor doesn’t get back their former customers who switched to a competing provider.
Perhaps the biggest irony of this process is that, while the process is overwhelmingly controlled by programmers, consumers almost always blame their distributor for the loss of a favorite channel.
Retransmission Consent and the Explosion of Channels
Over the last two decades, as DBS satellite distribution came into its own with high-capacity digital systems, and cable systems vastly expanded their capacity by also adopting digital delivery, the programmers have used their leverage not just to increase prices on existing channels, but also to gain carriage for new channels.
Furthermore, programmers virtually always demand the carriage of those channels in low tiers, that are distributed to the vast majority of subscribers. The reason for this is simple: not only do they typically get paid a monthly fee for each subscriber, but they also sell advertising based on audience size. So they always want the largest subscriber base possible, and that requires getting bundled into a low tier.
In fact, the major broadcast television networks, ABC, CBS, NBC, and Fox—each of which owns many local broadcast stations (e.g., WABC, WNBC, etc.) in major markets—initially used retransmission consent negotiations to launch new cable networks, rather than to seek direct subscription fees for their broadcast channels. These stations were the original, and still the most powerful, “must have” channels.
For those who aren’t familiar with it, retransmission consent was introduced in the early 90s, when Congress changed the law, allowing local broadcast stations to require cable operators to negotiate a carriage agreement in order to carry their signals. Previously, cable operators carried local broadcast stations (and actually were required to carry them) under a compulsory license, with no negotiations required.
And if you look at the lists above, you’ll notice that the longest lists belong to the companies that own broadcast networks. (In fact, it’s also worth noting that CBS was part of Viacom, prior to 2006.) This is not by accident. It is a direct product of the leverage those networks were given by the introduction of retransmission consent.
In more recent years, having pushed channel expansion about as far as they could, the broadcast networks have turned to charging direct subscription fees for carriage of their channels.
The net result of all this was the explosion of channels that get bundled into the most widely distributed channel tiers, and the tremendous inflation of the cost for those channel bundles.
How to Fix the Problem
When Warren Grimes wrote:
…the merging parties should demonstrate their good faith by voluntarily eliminating forced bundling and allowing all distributors to offer consumers a la carte or smaller customized bundles.
…the two firms could eliminate substantial anticompetitive effects of this proposed union by agreeing to divest all of their programming assets.
he was getting at precisely the problem at the wholesale level, in the program carriage market, where programmers constrain the ability of distributors to offer more flexible packages to consumers. (The Milwaukee paper clearly misunderstood this, instead taking taking the former statement to be a suggestion for what Comcast and Time Warner Cable should do in their capacity as distributors, rather than what they should do in their capacity as programmers.)
The trouble with Grimes’ proposed fixes is that they either don’t do enough (if Comcast agreed to meaningful changes, it wouldn’t address the same issue with respect to all other major programmers), or do nothing at all (if Comcast and TWC actually divested their programming assets, that would do nothing at all to solve the problem).
What is truly needed to address this problem is meaningful reform of the program carriage market.
If policy-makers mean to be serious about doing something, they should consider the following potential reforms:
1) Repeal retransmission consent
Retransmission consent is, quite simply, a completely failed policy, and is the single greatest cause for what has happened to cable bundles and rates over the last two decades. What’s more, the very notion of retransmission consent goes against the basic social compact whereby broadcasters were given (for free) extremely valuable broadcast bandwidth, in exchange for agreeing to provide free (advertising-supported) programming to consumers.
Retransmission consent should be repealed.
If broadcasters want to charge subscription fees in addition to collecting advertising revenue, then they should be required to convert to cable networks, and give back their broadcast spectrum. (Those who still receive over-the-air broadcasts would be unhappy, if they did. But given that only a single digit percentage of households still rely solely on over-the-air reception, it’s time to stop requiring the rest of us to pay through the nose in order to subsidize that over-the-air service. What’s more, if broadcasters did convert to cable networks, getting television broadcast spectrum back would be a huge boon to government coffers, and to other industries that desperately need additional spectrum, for much more efficient uses.)
2) Prohibit channel tying
Programmers should never be able to use a must have channel to force carriage of additional channels. In a normal world, this would be treated as a per se antitrust violation. Each channel should be separately licensed (meaning that programmers cannot offer discounts on one channel for carrying another).
This would also create a more level playing field for independent programmers to negotiate carriage, in competition with the major programmers.
3) Prohibit or strictly limit penetration requirements and discounts
Programmers force distributors to bundle channels into widely distributed tiers by requiring minimum percentage penetrations of the subscriber base, by offering hugely discounted rates for high penetrations (or conversely, offering only ridiculously inflated rates for lower penetrations), or occasionally, by charging a flat rate, independent of how many subscribers actually receive the service.
These practices should all be either prohibited entirely, or strictly limited.
An effective regulatory limitation would be to allow low-cost channels to offer discounts for wide distribution, but to disallow high-cost channels from doing such. After all, bundling does actually offer benefits for consumers, and having a large subscriber base does enable channels to earn higher advertising revenues, offsetting the need for subscription fees. The impact, however, of forcing very expensive channels, such as sports networks costing several dollars per month, into base channel bundles is very different from the impact of having channels costing only cents per month included in such. So allowing the lowest cost channels to keep their subscription costs low by offering volume discounts is likely a reasonable policy.
What’s more, a well-crafted policy could actually help to drive subscription fees lower. For example, a policy that allowed only channels with subscription fees lower than average to offer penetration discounts would create ongoing pressure for channels seeking carriage in low tiers to reduce their prices, in order to qualify.
4) Prohibit discriminatory pricing
Larger distributors have more negotiating clout than smaller distributors, so they get better pricing. This creates a fundamental impetus toward consolidation among distributors.
But as a matter of public policy, why should, say, a small rural cable operator—and its customers—have to pay more than a large operator, like Comcast, to receive the same content? And is there any good that comes from having direct competitors pay vastly different rates, based on their size?
Unless there is some good policy reason to encourage the massive consolidation that this inevitably encourages—and I don’t believe many would argue there is—this kind of price discrimination should be prohibited. It does direct harm to consumers and competition.
Rather, programmers should be required to make their best rates available to all distributors, on a non-discriminatory basis. If a programmer wants to give Comcast a great deal to gain carriage, then they have to offer the same deal to all other distributors. Programmers would retain the right to set their own terms and prices, but not the right to discriminate in setting terms and prices.
Enacting policy-changes along these lines would address what have become systematically anti-competitive business practices by programmers, that have resulted in dramatic harm to consumer interests for two decades now. It is high time for policy-makers to act in a meaningful way to address those harms.