The cable bundle is misunderstood. While analysts and pundits focus on when the cable bundle will finally succumb to Netflix, HBO, and Hulu, the reality is the future of television will be built on the video bundle's back. Due to attractive economics, video bundles are one of the best values in the media space and will remain the dominant way we receive premium video content. We are quickly approaching the point where Apple can capitalize on market dislocation to destroy the modern-day big cable bundle with a leaner bundle that is built to thrive in a mobile world.
Video Bundle Economics
The cable bundle has been one of the best consumer deals in the modern era. By subsidizing content's true cost, the bundle makes it possible for consumers to receive a vast amount of video content for an artificially low monthly price. The bundle works marvelously well as long as everyone pays into the system, and this has been the case for the last 20 years. Nielsen estimated there were 116 million homes with televisions in the U.S., of which approximately 100 million had some form of pay TV for the 2014-2015 TV season. ESPN is one of the most widely distributed cable networks, reaching 95 million homes. ESPN has a farther reach than Facebook, a testament to how much power the cable bundle holds.
While the video bundle will remain relevant for many years, the content associated with the bundle will change. New companies have relied on the old bundle parameter, namely, selling a wide range of content to as many people as possible to carve out a piece of the subscription video streaming market. Companies like Netflix, HBO, and Hulu sell video bundles. Instead of charging viewers by individual shows and series, these companies charge for access to a wide selection of content appealing to a range of consumers.
Most cable networks are in existence today because of the large cable bundle. Without the bundle, these networks would not be able to fund their current slate of programming. The mistake many people make when analyzing the bundle is to ignore the value of access. Having a window to nearly 100 million households is in many ways more lucrative than the pennies or nickels that the average channel receives from each household each month. This is a cable distributor's key selling point, and we often see fighting between content owners and distributors over access.
The Trickiness in Going Direct to Consumer
When contemplating the future of television, many have thought the strongest cable networks can one day bypass the large cable bundle and sell their programming direct to consumer. For simplicity's sake, I position ESPN and AMC as the poster children of this theory. In the current system, ESPN receives approximately $6 per month from every household subscribing to cable. AMC receives quite a bit less, approximately $0.50, although it is still well above the average $0.15 received. If ESPN and AMC were to leave the bundle and embrace the direct to consumer model, they would need not only to make up lost subscriber fee revenue, but also contemplate losing access to 100 million households. AMC relies on that access to sell new series, like "Fear the Walking Dead," to viewers. "Fear the Walking Dead" just became the highest-rated series premiere in cable TV history thanks to AMC's reach. ESPN also benefits from grouping sports programming into one channel, appealing to a much wider fan base, including those who may only watch a game or two each month.
There is no question that the best networks will have loyal fans ready to pay top dollar for a direct to consumer option. However, that won't be enough since these networks are simply not built to support such a model. It will be very difficult for ESPN and AMC to stop subscribers from signing up for their content only to watch their favorite series or sports season and then cancel their membership afterwards. With the cable bundle, such month-to-month volatility does not exist.
I am very skeptical that a cable network will be able to go 100 percent direct to consumer. The economics are just not in their favor. Instead, a hybrid approach may work although in many instances, the best case scenario would be to just get to a point that matches the current large cable bundle. There is much incentive on the part of cable networks to make the bundle work.
Time for Action
The mobile revolution has weakened the large cable bundle's fundamental underpinning. Mobile hasn't changed just the way we communicate, but also the way we create and consume content. Having new types of video content in our pocket has led us to no longer sit in a particular room at a particular time to watch a particular show. As smartphones continue to grow in screen size, all other pieces of smart glass in our lives, including our television sets, will lose value and importance.
The old definition of TV doesn't do justice to the much wider array of available content that we now have at our fingertips. As smartphone adoption grew, the idea that anyone could be a content creator became reality. While YouTube may still lead in terms of mindshare when thinking of user-generated content, we also have plenty of interesting content found on video-sharing networks like Vine, Snapchat, and Periscope, not to mention premium content from the likes of Netflix, HBO Now, Hulu, and Amazon.
One example of an entirely new form of content that people are increasingly turning to is vlogs, which is short for video blogs. The following Google Trends chart highlights vlogging's expanding popularity. The vlogging industry, notorious with young people chronicling their daily activities, is still in its infancy. Vlogging combines elements of reality TV with scripted television as many vloggers record real-life situations although the heavy use of editing and some pre-planning suggest there are also elements of a regular sitcom.
Exhibit 1: Google Trends for Vlogging
All of this new and entertaining content made available due to mobile and new video bundles suggest that the large cable bundle is a house of cards held together by cable distributors. We have evidence that the large cable bundle is fraying a bit at the edges although collapse is not imminent. Disney CEO Bob Iger started a panic on Wall Street a few weeks ago when he disclosed on Disney's earnings conference call that ESPN had continued to see modest subscriber losses. Anyone following ESPN's recent cost cutting initiatives, including a move away from expensive on-air talent, would have seen this news coming. Assuming Iger's comments about ESPN subscriber loss trends remain unchanged for the rest of the year, ESPN will likely report a 2-3 million decline in subscribers in 2015, which may actually represent a slight improvement in the rate of decline compared to last year.
Exhibit 2: Change in ESPN Subscribers
Although ESPN is experiencing recent weakness, there is no evidence to suggest an exodus from the bundle is taking place.
I suspect cable subscriber trends are being impacted by cable distributors. As anyone trying to cancel his or her cable can attest to, it is not the easiest process, and very often consumers receive discounts or other promotions from their cable company to keep the bundle instead of completely canceling cable. The problem for many cable content owners is that if things remain status quo, we will enter a vicious cycle where weaker cable viewer ratings will result in less ad revenue, leading to inferior programming, which will only drive weaker ratings over time. Instead of there being a quick implosion, the cable bundle would deteriorate over time. The cable industry needs that one factor that will not only cause the house of cards to fall, but also address fundamental issues plaguing the large cable bundle.
The modern-day cable bundle is now vulnerable. Apple's strategy to destroy the large cable bundle would entail taking the best parts of the current bundle and creating an improved bundle. Essentially, Apple would be using a slimmer cable bundle to kill the large cable bundle. This may not seem too innovative. However, it is one way of addressing the biggest issue people have with their large cable bundle: finding and watching content at a time of their choosing.
As has been previously reported by the WSJ and Re/code, Apple's slimmed down cable bundle would include 20-30 channels and be delivered over the internet to iOS devices. These channels could be considered as home to the best content found within the current large cable bundle. Similar to the modern cable paradigm, the combination of monthly subscriber fees and advertising revenue would represent the primary funding sources for networks included in the bundle. Add in live programming like sports, which come with a hefty price tag, and local news, which depend heavily on advertising revenue, and a new kind of bundle begins to take shape.
Why would networks work with Apple? Having a customer base of nearly 90 million iPhone users and rising in the U.S. is very appealing to content owners. In an era where content bundles obtain their economics by having the widest access, 90 million users represent great opportunity. Similar to how Apple Music will be available on Android, it would be in Apple's best interest to make this new video streaming bundle available to Android as well.
With a rethought cable bundle, Apple would be appealing to the 95 million households that still subscribe to cable, not those who stopped paying for cable. To destroy the large cable bundle, Apple will need to have current cable subscribers be willing to go through the hoops of canceling their current cable with their distributor. The house of cards would then collapse.
On paper, Sling TV, an over-the-top video service owned by Dish Network, sounds similar to the bundle Apple would be looking to put together: a collection of 22 channels, including ESPN, for $20 per month. The problem is Sling TV is designed for those who aren't subscribed to cable, the exact opposite target market for an Apple streaming video service. Sling TV has limitations that cable payers would simply not be able to put up with such as only being accessible on a single device at a time and not including broadcast networks or stations. There are also valid questions over the quality of Sling TV's streaming with many reports of inferior viewing experience during popular shows.
Video Bundles on a Smartphone are the New TV
Mobile will determine not just television's future, but also video's future. Any company or producer that thinks otherwise will likely be left behind to fight over legacy remnants of a bygone era. Instead of some truly revolutionary video streaming service that leaves all prior ideas about cable and TV in the dust, we are headed towards a future that has distinct similarities to the past, namely a handful of companies subsidizing a vast amount of content by offering video bundles to tens of millions of people. The large cable bundle's demise will occur when the 95 million U.S. households that still pay for cable each month are presented with an attractive alternative that takes the best parts of the bundle, adds better discovery and curation, and finally embraces mobile.
Receive my exclusive analysis and perspective about Apple in a daily email containing 2-3 stories (10-12 stories a week). For more information and to sign up, visit the membership page.