While the biggest cable companies have every desire to wring the last drops of profit out of their failing model, some smaller providers are making big changes to their offerings. This has included, in some extreme cases, dropping television altogether to focus on Internet and phone and, in others, not offering some expensive channels.
It may be small movement, but it's the cable company version of cord cutting. If these smaller service providers can't offer their customers a reasonably priced package of channels, they'll either give up on television, or make choices. That's very bad news for companies that own multiple cable channels, including Walt Disney (NYSE:DIS). Time Warner (NYSE:TWX), Viacom (NASDAQ:VIA), and Comcast (NASDAQ:CMCSA)
In the same way that a growing number of pay TV customers are learning that they can replace cable with digital service like Netflix, Hulu, and Amazon's Prime Video, these small providers are finding they can hold onto their customers without making money-losing deals with content owners.
How big is this trend?
While the big cable companies get the vast majority of the press, about 10% to 11% of the 100 million U.S. cable subscribers are served by smaller companies that have a couple of million, or fewer, customers, The Wall Street Journal reported. That's 10 million people. While each company is small, the amount they pay to the big media companies is significant. The cable channel owners will, according to The Journal, collect a total of $35 billion in license fees in 2014, according to SNL Kagan.
The numbers may be small to start, but they get big pretty quickly. About 5% of current pay-TV households will "no longer be doing business the way they do today with video," National Cable Television Cooperative CEO Rich Fickle told the paper. (NCTC negotiates programming deals on behalf of about 915 small cable-TV providers.) That loss of 5% of households could cost the basic cable networks $2.4 billion a year by 2018, according to SNL Kagan.
Why is this happening?
Cable channel owners receive fees from the cable providers for each channel they carry. If a company owns a highly desirable channel, it has the ability to force pay-TV providers to make deals that involve paying for channels they don't want. Disney knows that cable company X needs The Disney Channel and ESPN in order to keep its subscribers happy. As part of the rights fee deal for those stations, the company can force through a package that also includes various lesser Mouse House-owned networks. Each of those might only cost $0.10 or $0.25 a month, but when you multiply that cost by a number of content owners, it adds up quickly.
Oklahoma-based BTC Broadband, which served fewer than 500 cable subscribers, got out of the TV business because it could not afford the rising cost of offering a basic cable package including ESPN, TNT, and MTV, The Journal reported. BTC President Scott Floyd explained to the paper that, if it simply passed on the rising costs to customers, by 2016, cable bills would double from $60 to $130.
More typical than a company getting out of the cable business altogether is the small provider using the one tool it has -- the ability to walk away from bad deals. Suddenlink, a small St. Louis-based pay-TV provider dropped the Viacom family of channels, which includes Nickelodeon, Comedy Central, MTV, and VH1. This happened because Viacom wanted "a nearly 50% increase in payments, even though viewership has decreased in the last several years for their main channels, some by almost 30%," Suddenlink told Deadline.
Suddenlink even maintains a website where it not only spells out its own problems with making carriage deals, but also lists the many other cable providers that have had to drop stations. On the site, the company tries to lay out its logic for consumers.
When the owners of TV stations and cable networks ask for more money, we negotiate with them in an effort to keep costs as low as possible. By holding firm in our negotiations, we've kept your annual price increases, on average, between 3% and 5%, which is well below the level that many channel owners demand during negotiations. Some channel owners are asking for 20%, 30%, 50%, or even higher increases in what they're paid – and often for the exact same set of channels.
Costs are going up, which has clearly forced some hard choices, and caused a number of providers to drop channels. or stop providing television packages altogether.
How will this be solved?
The channel owners are trying to squeeze the last few drops out of a cow that's nearly out of milk. Using leverage to get higher prices and to force cable providers to pay for channels they don't want to carry -- and most of their customers won't want to watch -- worked for a long time; but that era is coming to an end.
Content owners are rapidly losing leverage. With so many alternative sources for entertainment, each individual channel is becoming less valuable. Yes, there will be exceptions like ESPN, which has a number of exclusive sports deals; but most content offered by the vast majority of stations can be found digitally if you have enough patience. Right now, the small providers are a slow stream eroding the giant concrete wall that is the major media companies. At the same time, the cord cutters are chipping away, too, and eventually, a flood will come.
If Big Content wants to keep its model afloat a little longer, it has to realize that the market has changed. Pricing yourself out of the game won't bring in any revenue, and eventually, the small loss of subscribers will become larger. Then, the floodgates will open, and the wall will come crumbling down.
Daniel Kline has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Netflix, and Walt Disney. The Motley Fool owns shares of Amazon.com, 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.