Asymmetrical Information - Megan McArdle

11.28.12

Why Are Cable Companies Forcing People to Turn to Piracy?

Hint: they're not. Also, they're probably better at running their business than their many, many freelance marketing consultants among the digerati.

"A system set up in the 80s to stop different media cannibalising each other is forcing honest viewers into piracy". That's the rubric on Frederic Filloux's column arguing that Showtime's practice of not making the show available on iTunes until after it finishes its television run has stupidly, and for no apparent reason, herded hitherto paying customers into the unscrupulous arms of pirate sites.

A couple of months ago, I purchased the first season of the TV series Homeland from the iTunes Store. I paid $32 for 12 episodes that all landed seamlessly in my iPad. I gulped them in a few days and was left in a state of withdrawal. Then, on 30 September, when season 2 started over, I would have had no alternative but to download free but illegal torrent files. Hundreds of thousands of people anxious to find out the whereabouts of the Marine turncoat pursued by the bi-polar CIA operative were in the same quandary (go to the dedicated Guardian blog for more on the series).

In the process, the three losers are:

• The Fox 21 production company. It carries the risk of putting the show together (which costs about $36m per season, $3m per episode)

• Apple which takes its usual cut. (The net loss for both will actually be $64 since the show has been signed up for a third season by the paid-for Showtime channel and I wonder if I'll have the patience to wait months for its availability on iTunes.)

• And me, as I would have to go through the painstaking task of finding the right torrent file, hoping that it is not bogus, corrupted, or worse, infected by a virus.

Here, we highlight the stupidity of the release windows system, a relic of the VHS era. To make a long story short, the idea goes back to the 80s when the industry devised a system to prevent different media – at the time, cinemas, TV networks, cable TV and VHS – from cannibalising each other. In the case of a motion picture, the release windows mechanism called for a four months' delay before its release on DVD, additional months for the release on pay-TV, video-on-demand, and a couple of years before showing up on mainstream broadcast networks (where the film is heavily edited, laced with commercial, dubbed, etc).

This argument is both ludicrous, and wrong. Ludicrous, because if piracy is actually wrong, it doesn't get less wrong simply because you can't have the product exactly when and where you want it at a price you wish to pay.  You are not entitled to shoplift Birkin bags on the grounds that they are ludicrously overpriced, and you cannot say you had no alternative but to break into an the local ice cream parlor at 2 am because you are really craving some Rocky Road and the insensitive bastards refused to stay open 24/7 so that you could have your favorite sweet treat whenever you want. You are not forced into piracy because you can't get a television show at the exact moment when you want to see it; you are choosing piracy.

If that's not wrong, then hey, no need to write long articles about how they've really backed you into a corner. If you think it is wrong, then act like a grownup and wait until you can buy it legally. And really, if you wouldn't write an op-ed urging storeowners to stay open 24/7 lest they drive their customers to a little light B&E, then please don't write essentially the same thing about cable networks.

The column is wrong because it gets the relationship between Showtime, and Showtime's television shows, backwards. Showtime does not exist to make shows you want to buy on iTunes; it makes shows you want to watch in order to get you to buy a subcription to Showtime. Sociologist Gabriel Rossman explained this last spring for the benefit of people who were claiming that HBO's refusal to make HBOGo available as a standalone product was forcing--forcing!--them to pirate HBO shows, and a dumb business decision to boot, because look at all that revenue they're leaving on the table!

And here we get to the real issue. It's not that HBO would like to cut out the middleman and sell to us directly, rather requiring you to buy basic cable is the whole point. Cable is a total cash cow and a more flexible business model means lower revenues. The reason is that the incumbent business model of cable combines the features of bundling (basic cable) and a two-part tariff (premium cable channels) for a perfect storm of price discrimination. For much the same reason as Disneyland could only lose money if it sold a la carte tickets to Splash Mountain for $20 without requiring $80 park admission (which includes access to Main Street, Jungle Cruise, etc), cable companies would lose money if you could buy HBO Go for $20 without first buying basic cable (which includes access to ESPN, Mtv, etc).  Basically, economic theory (and some reasonable assumptions about the structure of demand) suggests that an a la carte video market could not make as much money as a bundled video market.

So, that's why the cable companies don't want you to buy a la carte HBO Go, but why is that HBO's problem? Let's contrast it with the NFL. The NFL offers standalone access because the credible threat of a streaming business model gives them more leverage to negotiate with the MSOs. In contrast, HBO doesn't want leverage because most of its sister companies are part of the basic cable ecosystem. (They used to have an actual MSO as a sister company but they spun off Time Warner Cable in 2009). Time Warner makes a lot of money from HBO subscriptions, but it makes even more money from carriage fees on CNN, Cartoon Network, and most of the cable networks starting with the letter "T." Unlike HBO (which would do well under an a la carte model) most of these other channels rely more on channel-surfing audiences than cult followings and so couldn't sell subscriptions on their own and would have to settle for something like a Hulu Plus or Netflix business model, probably with less money per subscriber and far fewer subscribers than they currently get through basic cable. Basically, cord-cutting would help HBO but devastate the rest of the company. For what is a media conglomerate profited if it gain a few hundred thousand a la carte HBO Go subscriptions, and lose its carriage fees and ad revenue? What can a media conglomerate give in exchange for its Turner and WBTVG divisions?

Showtime is owned by CBS, which also owns other cable properties--nothing like as many as HBO's parent, to be sure, but presumably enough to care about keeping cable providers happy.  Moreover, making its premier show available on iTunes at the same time as could easily cost it more US revenue than they made on folks like Frederic Filloux. Total affiliate fee revenue was $32 billion in the United States last year, with CBS/Showtime taking $273 million of that.   Using Filloux's math, Showtime would have to sell their top shows to an extra 8.5 million people annually to make up that lost revenue.  

Of course, they wouldn't actually lose all their customers.  But for every customer who cancels Showtime once you make it easy to get his favorite show from iTunes, you have to generate an extra three or five or ten paying customers on iTunes, because of course, most subscribers buy their subscriptions year round.  

Or maybe a lot more.  If you anger your cable providers by making it easier for US cord cutters, they may stop carrying your network, or jack up the price of your subscription, or otherwise cause you to lose affiliate fees.

That is not to say that their business model is eternal; they may eventually sell this stuff by the episode.  But if they did, as Rossman points out, they will probably ultimately do so for less money than they made as a cable network--not more.  And it is going to take longer than you think, because media-elitish types tend to radically overestimate how many people are cutting the cable cord and watching everything on line--the percentage is high in my professional demographic, but low almost everywhere else.  

But something seems to make peoples' brains drop right out of their heads when it comes to streaming media, causing them to issue pompous lectures to folks in other businesses about how their revenue model ought to work.  The idea seems to be that if you like to watch television, you probably have a pretty good idea of how to make and market it to consumers, particularly if you have some actual experience in a completely unrelated digital content market.

That's not to say that there might not be a better revenue model out there for cable networks with hit shows like Homeland and Game of Thrones. But for heavens sake, it takes a little bit more than third grade arithmetic to demonstrate their folly.