ESPN’s Problems Are of Its Own Making

Source: ESPN

If you are a cable customer, I'm going to apologize to you in advance. See, I'm a sports fanatic; basketball, football, baseball, I simply can't get enough. And just like the average American, I get excited during the Olympics season and the World Cup. As such, I put a high value on the availability of coverage of these events. As far as sports networks go, especially Disney's (DIS 0.18%) ESPN, I'm the perfect subscriber.

However, while I'm debating the newest multi-million dollar sports contract with my friends, there's a rather uncomfortable fact: our "addiction" (and those multi-million dollar salaries, for that matter) is being subsidized by others, including those who don't watch sports. As I'm reminded nearly daily by my fiancee, who'd quickly join the cord-cutting crowd if it wasn't for my proclivities, ESPN alone is almost as expensive as our Netflix subscription.

More recently, however, those who wouldn't know Tom Brady from "The Brady Bunch" are pushing back. A recent article from The Wall Street Journal, using Nielsen's data, found that ESPN lost 3.2 million subscribers in a little over a year as a combination of "cord cutters" and "cord slimmers" abandoned cable or chose packages without the expensive network. ESPN is responding by cutting costs, particularly by cutting on-air talent, but it may not be able to solve the big problem... and it's one of its own making.

Sports costs are too high
For ESPN, the cord-cutting and cord-slimming trends are coming at a rather inopportune time. The cost the network is paying for content is exploding.

For example, in 2014, ESPN's new contract with the NFL kicked in -- and while the new contract did add some new benefits, ESPN paid 73% more compared to the last contract: $1.9 billion per annum compared to $1.1 billion. This year, ESPN and Time Warner's Turner also re-upped their deal with the NBA, which will go into effect in the 2016-17 season and cost nearly 200% more than the previous contract.

Unlike a standard network/studio relationship, where the terms of a deal are generally negotiated on a show-by-show basis, sporting leagues benefit from their uniqueness. By contrast, a comedy show typically has multiple competitors with similar characters and plotlines, limiting the producer's leverage.

As such, sports broadcasting contracts tend to be longer (the NFL deal is for eight years and the NBA for nine) and more one-sided for the content provider. For example, in Disney's first-quarter earnings, the company explicitly referenced its increased NFL costs when addressing increased operational expenses.

That's been good for athletes and leagues, which have seen their salaries and team values skyrocket over the past decade. However, those who don't watch football or basketball but do have ESPN in their channel lineup are paying for these large contracts -- to the tune of $6.61 per month according to cable analytics firm SNL Kagan. That makes ESPN far more expensive than any other cable channel.

Athletes, owners, and leagues should take note here
It doesn't appear that the parties directly affected by this are paying much attention to this apparent secular trend. Just this week, Anthony Davis of the New Orleans Pelicans signed the most expensive contract in NBA history, at roughly $29 million per year. LeBron James has been signing one-year deals in order to make more money in 2016-17, when the aforementioned NBA deal will increase the salary cap.

With each new record-breaking contract, ESPN gives a splashy announcement, seemingly oblivious to the fact that it will have to contend with these higher costs eventually. Simply put, ESPN's highly effective marketing of athletes and leagues has become a Frankenstein's monster of sorts. It has driven up ESPN's costs, and now the company is having problems passing these along to consumers.

While I certainly don't blame athletes for making as much money as they can, how long these increased salaries can continue before they lead to dwindling numbers of cable subscribers is a critical question. If Disney is unable to continue to monetize this content, look for more tense negotiations with sporting leagues going forward.

Next time you hear about your favorite team signing a star athlete to a record-breaking contract, remember that you're probably paying a portion of that money. Disney's cost-cutting efforts do nothing to address the cost of this content, and that's a problem for the company and cable subscribers wary of future price increases. For those who don't watch ESPN but pay for the channel, I'd personally like to thank you for subsidizing my sports habit.