AT&T (NYSE:T) lost another 1.16 million video subscribers in the fourth quarter, bringing its 2019 total to 4.1 million. The company ended the year with 20.4 million subscribers between DirecTV, U-Verse, and AT&T TV Now.

The rapid decline in subscribers puts AT&T behind its biggest competitor in pay-TV, Comcast (NASDAQ:CMCSA), which closed out 2019 with 21.25 million video subscribers. Even when only counting Comcast's residential subscribers, it's about neck-and-neck with AT&T at 20.29 million.

AT&T's management expects its subscriber losses to have peaked last year, but that doesn't mean it's completely out of the woods. Meanwhile, Comcast expects its losses to increase in 2020 as it focuses more on profitability and its broadband business.

Ultimately, the relative size of AT&T's video subscriber base could negatively affect the margins of the business as it loses leverage over media companies in negotiating carriage rates. That could have a meaningful impact on AT&T's 2020 results as it looks to launch AT&T TV nationwide.

The AT&T TV set-top box and a TV displaying the home screen

Image source: AT&T.

AT&T TV is the future of the video business

AT&T TV will launch nationwide next month, and management is holding it up as the future of its video business alongside HBO Max. The product is a hybrid approach -- somewhere between its premium DirecTV product and its over-the-top AT&T TV Now product. 

The service delivers linear TV over the top to consumers, but they'll only be able to receive it via AT&T's proprietary set-top-box. That's in contrast to other live TV streaming services that allow consumers to use whatever connected-TV device they choose. However, in doing so, AT&T is able to exercise greater control over the user experience, which it thinks will enable it to attract consumers at the higher price point necessary to make such services profitable. Furthermore, it opens the opportunity for distribution revenue from other streaming services.

Sending customers an easy-to-install box that connects to their TV also means AT&T will see significantly lower customer acquisition costs. DirecTV, by comparison, requires a contractor to come to a customer's home, install a satellite dish on their roof, and wire cable to their television set. Management says it'll be able to pass those cost savings onto subscribers in the form of lower prices compared to its legacy DirecTV service.

Management also expects to see a higher take rate from its broadband subscribers for AT&T TV compared to DirecTV satellite. That could further reduce its average customer acquisition costs for the new video service.

All of those factors could lead to a video business with better margins. Operating margin for AT&T's Entertainment segment (which also includes its broadband business) fell 30 basis points to 6.6% in the fourth quarter despite AT&T eliminating many of its low-value video subscribers over the past year.

Content is its biggest expense

AT&T can cut overhead and operating expenses involved with acquiring new customers, but nothing changes the fact that its biggest expense for its video business is programming. And programming expenses per subscriber continue to climb.

Comcast saw its programming expenses increase 1.1% in 2019 despite a 3.2% decline in subscribers. That's the impact of contractual rate increases from media companies gaining increasing leverage after a series of mergers in the industry.

As AT&T's subscriber base continues to shrink faster than the rest of the industry, it diminishes its ability to negotiate better contracts with media companies than the competition. In an industry competing for a smaller and smaller customer base, being able to negotiate better carriage deals could have the biggest impact on a company's ability to offer customers the best value and stand out from the competition. Ultimately, that's what's going to drive operating profits.

When AT&T focused its AT&T TV Now on profitability, raising prices twice in 2019 to offset higher programming expenses, it lost over 40% of its subscribers. Management expects to tell a different story for AT&T TV despite offering a more expensive product to consumers and seeing diminishing negotiating power from its legacy subscriber base.

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