There's a growing camp of people who believe the option to purchase access to individual television networks without paying for a whole bundle of channels is an inevitability. We've already seen Canada mandate a pick-and-pay model for pay-TV providers, requiring some channels to be offered a la carte. HBO has finally gone over-the-top, and no longer requires a cable subscription to access its content library. Most recently, we saw Verizon (NYSE:VZ) attract the ire of media companies with its Custom TV offer, which, on top of a $55-per-month base package, breaks up the bundle into optional packages based on interest sold for $10 per month apiece.
Verizon's moving Disney's (NYSE:DIS) ESPN into an add-on package prompted ESPN to take file suit against Verizon, alleging breach of contract. But Verizon is coming off as the good guy with consumers because it's fighting for their interests. But it's also fighting for its own interest as times are changing. In an a la carte TV world, the need for a company that packages and delivers television content to the home is greatly diminished. Sure, an Internet connection is still necessary for over-the-top delivery, but there are a growing number of options beyond traditional cable providers that can offer Internet access.
Let's take a look at how cable operators make money, and why they might be interested in offering customers more flexibility.
How your cable company makes money
Pay-TV operators have several streams of revenue. You pay your provider a monthly fee. That fee consists of charges for your video programming, of course, but it also includes fees for renting equipment like a set-top box or services like DVR. Cable providers also make money from your video-on-demand purchases. And they make money by selling local advertisements.
Last year, Comcast (NASDAQ:CMCSA) brought in $20.8 billion in revenue from video billings to its residential customers. It brought in an additional $2.4 billion from advertising. While a decline in video subscribers negatively affected Comcast's video customer revenue, an increase in average rates more than offset the decline.
Yet Comcast says the increases in customers receiving additional and higher levels of video service accounted for increases in revenue of 7% from 2012 to 2014. Meanwhile, Comcast's programming costs have increased 17% in the same period. As the number of over-the-top options increases, it puts pressure on how much cable operators are able to raise their prices. With the increasing cost of programming, that puts pressure on their margins and churn rates.
So, many cable operators now find themselves charging more and making less money from their video services. For now, however, growth in high-speed Internet and voice services are helping to offset the declining profitability of video.
What's to be gained from offering a la carte?
Many cable providers are seeing their subscribers leave for other options. As mentioned, Comcast saw a decline in its total video subscribers last year, as competition like Verizon's FiOS service encroached on its territory. Offering more flexible options to consumers could prevent customers from leaving for over-the-top options and make new subscribers out of cord-nevers.
Margins on an a la carte offer will inevitably be lower, however, as media companies will demand a higher price per subscriber and there's a limit to what consumers will pay. However, cable operators will still be able to generate profits from video on demand, equipment fees, and advertising.
They risk missing out on those profits if they allow someone else to come in and package an a la carte offering. Many people believe that's something Apple is working on with its rumored television service said to be rolling out later this year. More likely, however, is that Apple has put together a skinny-bundle of channels similar to Sling TV.
Cable operators have access to a cheap and efficient distribution channel with their cable networks as well as the breadth to cover customer service expenses, which will make them key partners in any transition to a la carte. Networks trying to go it alone, like CBS with its All Access service, will incur much higher costs per subscriber for distribution and customer service. Even Apple has to pay for content delivery over the Internet.
But most networks aren't going to go a la carte without a push. Most media companies rely on the bundle to increase their subscription revenues. Disney, for example, is able to force most cable subscribers to pay for some of the most expensive channels available in ESPN, ESPN 2, and The Disney Channel, even if they don't watch any of them.
Somebody, however, is going to come along and break the bundle. Cable operators, which media companies rely on for distribution, are about the only company with enough leverage to force change in the industry. Once their margins on video subscribers shrink enough, they'll be forced to act, and media companies may find themselves with no better options but to stay with the old cable guys.
Adam Levy owns shares of Apple. The Motley Fool recommends Apple, Verizon Communications, and Walt Disney. The Motley Fool owns shares of Apple 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.