When the undisputed king of sports is forced to make layoffs and can't resign highly visible television, radio, and print personalities, you know there must be something wrong.
In the case of Disney's (NYSE:DIS) most valuable asset -- ESPN -- the trouble reached a peak in October, when the company announced that 300 people would be losing their jobs at the network. Not only does this seem trivial for a cable network segment that's reported $5.1 billion in operating income over the first nine months of this fiscal year alone, it's telling that ESPN is cutting staff as it pays billions of dollars to major sports leagues.
How did ESPN get here? Who is to blame? The answer may lie in the increasing arms race in sports.
Cable networks aren't what they used to be
It may not be broadly known that cable networks -- ESPN in particular -- really drives Disney's results. In the first nine months of this fiscal year, 54% of operating income came from media networks, and 86% of that income came from cable networks. That's dominated by ESPN.
ESPN makes money from two sources: subscriber fees and advertising. There's the first problem ESPN is facing. It's well known that cable subscribers are falling as people cut the cord (including myself), and as they do, advertising revenue falls. ESPN has offset this loss in subscribers by increasing what it charges cable providers for ESPN, reportedly upping the cost to $6 per subscriber.
Here's where the problems start to come in though. According to Ourand and Nielsen, the network has lost 8.5 million subscribers over the past four and a half years. That's $612 million in lost revenue potential.
On top of that, ESPN being in fewer homes means less in ad dollars. Neither of these facts has resulted in declining revenue or earnings given the price increase, but in time, ESPN's revenue will likely begin to fall.
Costs are spiraling out of control
This brings us to the conundrum ESPN faces with major sports leagues. When ESPN got started, it was the home of off-center sports like yachting, bowling, and skateboarding, but with more subscribers came the demand to offer more prime live sports. The NBA, MLB, NHL, and even Monday Night Football soon came under ESPN's control.
Ironically, these deals came about as Twenty-First Century Fox (NASDAQ:FOX) and Comcast's (NASDAQ:CMCSA) NBCUniversal are building out their own sports cable networks in an effort to draft off of ESPN's profits. To do that, they need talent and content. You guessed it, that creates an arms race for major sports content.
Spending money on sports right is great when subscribers and fees are increasing, which ESPN has seen since its inception, but ESPN signed some big deals with major sports just as its subscriber fees are falling apart. Last year, $1.9 billion in increased rights payments hit ESPN, and in 2016, it will see an $825 million increase to the NBA, which will mean an annual bill of $1.4 billion from the NBA alone.
So, subscribers are trending lower, revenue will soon start trending lower as a result, and costs are rising to the tune of nearly $3 billion over the course of a few years. There's trouble brewing at ESPN.
Layoffs are the easy answer
If you want to know why ESPN didn't renew the contracts of Bill Simmons, Keith Olbermann, and Colin Cowherd, or why 300 people lost their jobs in Bristol, you don't need to look any further than the cost of offering major sports leagues. ESPN made a bet that people could do without personalities and behind the scenes workers before they could do without football on Saturdays and Mondays, or the NBA.
Layoffs are an easy answer when you can see shrinking profits on the horizon, and that's what ESPN and Disney have resorted to. But I don't think that solves any of ESPN's profits long term.
Given the competitive landscape, it's easy to see why ESPN bet so big on sports. But it could simply be perpetuating the sports network arms race in an unsustainable direction. That's the way it looks today.
Sports leagues need new solutions
This isn't just a problem for ESPN, Fox, and NBCUniversal/Comcast; it's a problem for the major sports leagues, too. When the current lucrative contracts come up for renegotiation, it's a safe bet that none of the big players will be willing to dole out the billions they have over the last few years. They can't afford to with people cutting the cable cord.
This creates a problem for sports leagues that want to maximize revenue while being in as many homes as possible. More revenue today and fewer fans tomorrow is a bad trade-off long term.
Sports leagues need to find the next step forward, and there's no easy solution. They've indicated a semi-willingness to try subscription models like NBA League Pass or MLB TV. But those are primarily used for out-of-market games that weren't available on cable anyway. They've maximized both national and local TV revenue and, as a result, given up viewing flexibility for fans.
As a cord-cutter, I'd love to watch local games from time to time, and I'd even be willing to pay for them. I'd pay the NBA $200 for a streaming subscription to watch all of my local Timberwolves games (hold your jokes) from streaming and mobile devices, but no such subscription is available. So, a year and a half after I cut cable from my life, I watch fewer sporting events than I ever have before. And my family becomes less and less likely to spend money on game tickets, jerseys, or streaming subscriptions in the future. Eventually, a short-term problem becomes a generational problem for sports leagues.
ESPN's layoffs may seem small in the giant sports world, but they could be a canary in the coal mine. Sports leagues and sports networks don't want to lose the next generation of fans by pricing them out of the market or not offering content in the way they'll use it. But that's exactly what's happening, and layoffs at the biggest name in sports networks shows that challenging times are ahead.
Travis Hoium has no position in any stocks mentioned. The Motley Fool owns shares of and recommends 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.