AT&T (NYSE:T) is the biggest pay-TV provider in the United States. Between DIRECTV, U-Verse, and its streaming service, DIRECTV Now, it has nearly 24.5 million subscribers.
The company launched DIRECTV Now in late 2016. Management insists the product is a way for the company to reach customers that otherwise wouldn't subscribe to one of its traditional pay-TV services; it's not cannibalizing its traditional pay-TV services.
But even if that's how it started, streaming alternatives like DIRECTV Now are starting to act as full replacements for traditional television subscriptions. Worse for AT&T, services from Hulu and Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) YouTube are proving more popular than services from traditional TV providers like DIRECTV or DISH Network (NASDAQ:DISH).
A complete replacement
More and more streaming TV subscribers are ditching their traditional subscriptions in favor of streaming. A recent UBS survey found that "[f]ewer respondents plan to 'double up' or keep both their traditional and streaming TV subscriptions, reversing an earlier dynamic where customers kept both as they tested new platforms."
The UBS survey also found the number of respondents willing to sign up for streaming TV increased 5 percentage points from six months earlier to 33%.
There are a few explanations for the consumer preference. Pricing and price transparency are key advantages of streaming versus traditional pay-TV. The flexibility to suspend service for a period of time is another. The comparative ease of streaming live TV on mobile and integration with existing streaming services like Hulu or YouTube may also convince consumers to switch.
That's bad news for AT&T and DISH. The average revenue per subscriber for traditional services is much higher than the new streaming services. AT&T's reported video revenue per subscriber is $121.76. But its DIRECTV Now ARPU is closer to $31 per month. Likewise, Sling TV subscribers have a much lower ARPU than DISH satellite subscribers. On top of that, the profit margin on the streaming business is much smaller than on the traditional TV business.
As consumers opt for the lower-priced, lower-margin services, both companies will see operating profits fall over time. Dish has managed to improve operating income in 2018 as a result of lower subscriber acquisition expenses, but most of its other operating metrics are increasing as a percentage of revenue.
Not only that, but both traditional TV providers are at a greater risk of losing customers altogether due to increased competition.
The pay-TV industry has long benefited from low amounts of competition. If you want traditional pay TV, you only have maybe three options. That's because traditional pay-TV operations require a lot of overhead -- laying cable or launching satellites, installing hardware on the customer's premises, etc. The start-up costs can prohibit competition.
With new streaming TV options, there are a lot more competitors in the market. With the advantages of scalable public cloud computing services like Google Cloud, the start-up costs are relatively low.
Companies that already have significant investments in streaming video like YouTube and Hulu are at a unique advantage in the space compared to traditional pay-TV providers like DIRECTV and DISH.
Not only do Hulu and YouTube have expertise in streaming video over the internet -- reducing outages and other technical problems -- they have a built-in audience of viewers already on their platforms. YouTube has 1.9 billion global users logging into its app every month. Hulu has 25 million paid subscribers for its streaming services.
Indeed, the UBS survey found the two most popular streaming alternatives were Hulu Live and YouTube TV followed by DIRECTV Now and Sling TV.
Meanwhile, AT&T's DIRECTV Now service is having a hard time hanging onto customers without promotional pricing. The company lost 267,000 subscribers last quarter as many of them came off of promotional pricing. After raising rates over the summer, net additions totaled just 49,000 in the third quarter compared to over 300,000 in each of the previous three quarters.
DISH Network's Sling TV has also seen its subscriber additions decline as competition increases. DISH added 26,000 net new Sling TV subscribers in the third quarter, down from a 236,000 subscriber increase in the third quarter of last year.
So not only are DIRECTV Now and Sling TV cannibalizing more profitable products, they're losing significant market share to the competition. That's a bad combination for investors in legacy television providers.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Alphabet (C shares). The Motley Fool owns shares of and recommends Alphabet (A shares) and Alphabet (C shares). The Motley Fool has a disclosure policy.