Cord-cutting might not be a myth, but it's grossly overblown. While a few consumers may have ditched cable in favor of a few a la carte options like Netflix (NASDAQ:NFLX), many more have simply augmented their cable subscriptions with Netflix. It's more like a premium network than a replacement for cable.
The problem is that people have a finite amount of time to spend on entertainment, and as Netflix buys and creates more and more quality content, the amount of time spent on the service is increasing. Pay-TV operators shouldn't care, though. They're still getting paid a flat fee every month. The real impact is on those companies that depend on showing ads to viewers for a large portion of their revenue.
I'm talking about the broadcast networks.
Over the last year, the average time spent watching television in the U.S. declined about 13 minutes per day, according to Bernstein Research. At the same time, the average viewing time per Netflix subscriber increased by 12 minutes per day.
While that doesn't completely explain the drop in television ratings (there are more TV watchers than Netflix subscribers), it's clear viewers are shifting their TV time to Netflix. As Netflix continues to grow rapidly, the impact will only get worse.
To make matter worse, Netflix is most appealing to the audience once dominated by broadcasters -- people that don't subscribe to cable. At least with cable, Fox and CBS are part of the bundle, but with Netflix many consumers -- particularly young ones most valuable to advertisers -- are bypassing television altogether. Perhaps that's part of the reason why CBS began offering its own over-the-top service.
If viewers go away, advertisers don't pay
Losing viewers is a bigger issue for CBS than Fox. Last year, CBS generated 58% of its revenue from advertising. Fox generated 26% of revenue from advertising in fiscal 2014.
In the first half of 2014, CBS's advertising revenue fell to 52% of total revenue as ad revenue declined 11%. As a result, overall revenue declined more than 5%.
Fox saw a 5% decline in advertising revenue in its Television segment in its first quarter of fiscal 2015. Fox, unlike CBS, was able to overcome the decline in ad revenue as retransmission fee increases completely offset the decline in ad revenue. Overall, Fox's revenue increased nearly 12% year over year.
Given the impact of a decline in viewer ratings on advertising revenue, CBS is working to improve its ad rates with several measures.
First, it's negotiating advertisement deals using C-7 ratings (up to seven days after broadcast) instead of the typical C-3. CBS believes this gives advertisers a better representation of its actual audience. Second, CBS bought the rights to air eight games of Thursday Night Football, and it's asking a whopping $500,000 per 30-second ad spot. Finally, it's using dynamic ad insertion to capitalize on viewers watching its programs on demand.
Still, none of those efforts combat the real problem: Netflix's content is getting better.
And there's nothing broadcasters can do about it
The sad part about this situation is it's a problem CBS and Fox made themselves by licensing their old content to Netflix. Now, they're stuck in a Catch-22. If they stop licensing their content to Netflix, they lose that revenue and they lose the potential audience it draws to its shows. Continuing to license content to Netflix just makes Netflix more attractive for viewers.
It gets even worse, though. Now that Netflix is creating its own content and has a large war chest of content from other networks and media companies, it's gaining leverage over individual networks. The only way for the networks to fight back is to all agree not to license content to Netflix -- which could land all of the executives in court facing antitrust charges.
CBS will see the biggest impact as it struggles to grow retransmission fees fast enough to offset a drop in its huge advertising business. As such, the declines in overall revenue may just be getting started.
Adam Levy owns shares of Apple. The Motley Fool recommends Apple, Google (A shares), Google (C shares), and Netflix. The Motley Fool owns shares of Apple, Google (A shares), Google (C shares), and Netflix. 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.