ESPN has always been on the cutting edge of television technology. In its new deal with the NBA, Disney (NYSE:DIS) also bought the rights to stream games over the Internet to anyone with a connection -- no cable subscription required. ESPN announced similar plans for its Major League Soccer rights back in May, and it looks to be gearing up for a full-fledged a la carte Internet cable channel that combines those MLS and NBA rights with any future rights it acquires.
Live sporting events are key to the television industry in 2014 after Netflix and other over-the-top services have promoted bingeing on shows instead of watching them live. That's why we've seen tremendous increases in NFL rights, and it's why the NBA's new contract costs 160% more than it did six years ago. Is a Netflix-style service the next thing in live sports and the downfall of the cable bundle?
The direct-to-consumer challenge
ESPN's over-the-top service will not compete with its cable channels. That means the service will be filled with games that didn't make the cut for airtime on the television networks. Starting in 2016, Disney will air 100 regular season games across ESPN and ABC. TNT will broadcast 64.
That leaves over 1,000 games that will be broadcast on regional sports networks, but out of market viewers won't be able to watch unless they subscribe to the NBA's League Pass, which streams every out of market game. That's likely the market ESPN will target, which is why it had to incentivize the NBA with an equity stake in the service.
The challenge for ESPN is to find the market of people that want to watch some out of market games, but not necessarily every game, and package that at a price that works for both ESPN and consumers. The League Pass costs $150 for the five-and-a-half-month season, or just over $27 per month. If ESPN can offer a package for $5 to $10 per month, it might be able to find an audience.
Why go direct-to-consumer anyway?
The move by ESPN to offer what's essentially a streaming channel is curious. ESPN gets over $6 a month from pay-TV operators for nearly every cable subscriber. It gets an additional $0.74 per subscriber for ESPN 2. As a result, ESPN collects over $8 billion in carriage fees for its suite of channels every year.
What's more, that number is rising rapidly. SNL Kagan expects ESPN's carriage fee to increase to $8.34 per subscriber in 2018, an 8.5% annual growth rate. It's much easier to raise the rates on pay-TV operators every year than it is to raise rates for consumers. Just ask Netflix.
So, why is ESPN bothering with a direct-to-consumer outlet instead of just forcing another cable network on operators for $0.50 per subscriber. The only answer that makes sense is that it's a hedge.
Many believe that the cable bundle's days are numbered, and ESPN doesn't want to be left out in the cold should the industry suddenly change. A streaming business will be its first foray into a direct-to-consumer business, so it can work out the kinks in its customer service and marketing approach while the stakes are still very small. It can build the necessary infrastructure to provide a smooth and pleasant customer experience with the rights to the NBA and MLS games, and expand from there if the opportunity exists or if it's forced to.
Is traditional cable dying?
ESPN has made a lot of noise lately by buying and licensing rights to stream content over the Internet. More than anything though, ESPN should want to keep traditional cable alive. At least until it can milk every last penny out of the bundle format. That means all the best content ESPN gets the rights to will air exclusively on its cable networks or parent company's ABC.
There may be a small market out there that might find ESPN's over-the-top service appealing enough to cut the cord and solely subscribe to the Internet channel, but the vast majority of sports fans will likely find that option unappealing. If I'm wrong, and this is the first crack in the bundle, then at least ESPN is setting itself up for success as the industry evolves.
Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Netflix and Walt Disney. The Motley Fool owns shares of Netflix and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.