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Cost Cuts Won't Solve ESPN's Biggest Problem

By Jamal Carnette, CFA - Sep 27, 2015 at 8:40AM

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ESPN is axing 200-300 jobs, but it still won't solve its biggest problem.

Source: ESPN

When it comes to cable bills, there's probably no better posterchild for increased costs than The Walt Disney Company's (DIS -0.21%) ESPN. As a direct beneficiary of America's increasing love of sport over the last decade or so, the network has been able to essentially raise prices at will. In a bout of irony, the company may have been too effective at raising the costs of their content.

More recently, as a result of content cost increases across the board, many subscribers are looking to cut or shave the cord. Regardless of whether the user is looking to go without cable entirely or merely to trade down to smaller packages, ESPN's high-cost host of networks are mostly included. Earlier this year, cable-analytics firm Nielsen (h/t The Wall Street Journal) found Disney lost 7.2% of its subscriber base in the last four years, and a massive 3.2 million, or 3.3%, in a little over a year as many subscribers are looking to save money.

As a result, the company has had to adjust to lower subscriber numbers. And if the newest report from The Big Lead is correct, ESPN is looking to lay off 200-300 employees in the upcoming months to cut costs. In the end, however, the company is still not addressing the elephant in the room.

ESPN is playing small ball with costs
Following on the heels of parting with big names as far as online talent -- controversial commentators Keith Olbermann, Colin Cowherd, and Bill Simmons were recently released -- ESPN appears to be focusing on cuts in order to trim $100 million from the 2016 budget and $250 million from the 2017 budget, The Big Lead reported. While that seems like an aggressive number, and perhaps it is from an operational standpoint, ESPN is playing small ball with costs because, quite frankly, it has to.

For a comparison, last year ESPN's new contract with the NFL kicked in, ESPN now pays the league $1.9 billion per year for the content, as opposed to $1.1 billion in the prior contract, a 73% increase. While these contracts are negotiated in seven-year increments, it still amounts to an 8% annualized increase. For the upcoming year, the contract with the NBA brings ESPN's content costs from $485 million to $1.47 billion, a near $1 billion price increase on a yearly basis. In the end, $100 million-$250 million is small ball (pun shamelessly intended) in the scope of the content cost increases.

There's four ways to pay for these added costs
As a business, there are four main ways to handle increased costs: ESPN can grow subscribers, monetize the content more effectively, cut costs to offset the content price increases, or become a less profitable entity. The first option is decidedly off the table, mainly as a result of the company's already aggressive monetization through increased carriage fees that total $6.61 per user -- making it, by far, the most expensive cable channel.

The second option is simply not increasing carriage fees, even though cable television monetizes viewers in two distinct ways: carriage fees and advertising. Unfortunately, traditional television advertising is experiencing a growth slowdown as more marketers shift ad spend to digital and mobile channels, and it seems ESPN has gotten more serious about its digital presence by recently updating their website for the first time in half a decade. But, in the end, any growth in the digital realm for ESPN will be unlikely to offset the large amount of the content cost increase. 

In order to avoid the final option, as investors really don't like investments to become less profitable, the company has also decided to cut non-content related operational costs and 200-300 jobs to make up for increased league fees that will go to players and owners. So while NBA players and fans will be tuning in to ESPN to find out the newest eye-popping contract, you can bet the announcement will be somewhat bittersweet for the team of production assistants, writers, editors, and even on-air talent that lost a talented co-worker as a result thereof.

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