As cord-cutting accelerates, the Worldwide Leader in Sports is cutting tens of millions of staff salary from its books. It’s a harbinger of potential downstream impacts that we simply can’t ignore. Don’t be left holding the severed cord.
Editor’s Note: As reported by Sports Illustrated and other outlets this week, ESPN will be executing another round of layoffs over the next four months. If you’ll recall back in 2015, approximately 300 ESPN employees were shown the door. Mostly behind-the-scenes contributors. You probably didn’t even notice. The unfortunately newly-unemployed and their families surely noticed.
The 2017 layoffs will be much deeper and more visible. Per SI, “Multiple sources said ESPN has been tasked with paring tens of millions of staff salary from its payroll, including staffers many viewers and readers will recognize.”
It sounds like consumers will be noticing this time.
This is not happening because ESPN, a proxy for the sports business industry, is healthy. No business ever says, “You know what, our margins are too high. Our business is too awesome. We should lay off people and crush morale around here.”
So why is this happening? Consider that as of December 2016, 88 million U.S. households subscribe to ESPN. Not bad, right? Except that ESPN had over 100 million subscribers in 2011. Combine that with rights fees concurrently catapulting to the moon (ESPN now pays over $3.3 billion annually to broadcast just the NFL and NBA), and the problem becomes obvious. Increasing Costs + Declining Revenues = Hard-Working People Losing Their Jobs. Don’t think this can’t trickle downstream.
The bull case for ESPN is that they’ll figure it out. No one does content better than parent company Disney. I’m sure they will figure it out, and it will be awesome. Disney's recent stake purchased in MLBAM spinoff BAMTech demonstrates they are hot on the scent, as is the leadership in league offices.
OTT isn’t rocket science. The content is the same. It’s simply a different distribution channel. But even if ESPN viewership steadies with an OTT offering coupled with the coming of age of 5G mobile networks, that still doesn’t account for lost subscribers who infrequently or never watched the network while still paying for the right not to do so. Only cable bundles provide that free money, and OTT by its very nature sticks a fork in cable bundles. It is my belief that the ESPN restructuring marks the beginning of an industry-wide correction. As an industry, we might have to actually emphasize selling tickets again. Gasp.
In the 2015 fall issue of SEAT Magazine, the ALSD published the following editorial that addresses cord-cutting and the very real impacts of ESPN subscriber losses. In light of the recent reports, it warrants a return visit today. Let's face the challenge together, adapt together, and get better together. That only happens when we understand and accept that the current is against us, and we are all rowing in the same boat together. Happy reading.
According to Forbes, the world’s 50 most valuable sports teams are worth an average of $1.75 billion in 2015, which is a whopping 31% increase from just last year. In North America, the Dallas Cowboys and New York Yankees are both currently valued at $3.2 billion, ranking second globally behind Real Madrid, the world’s most valuable team at $3.26 billion. Exact valuations can vary slightly from source to source and can depend on when the information is published, but for the sake of this discussion, let’s just agree that valuations are high. And what’s feeding these eye-catching valuations is without question their lucrative cords that are plugged into multi-billion-dollar media rights contracts.
Television is the golden goose for all sports leagues. In the NFL, its current TV deals, including both network and DirecTV contracts, are worth $6.5 billion annually to the league. Divide that figure by 32 teams, and each team receives approximately $200 million from television before it sells one ticket, one suite, one sponsorship, one tee shirt, or one hot dog.
The NBA will soon begin its new deal with ESPN and TNT, worth $2.5 billion per year, which fueled a free agent frenzy this summer and will continue to do so in the coming years, as the money pool fills higher. Meanwhile, franchise valuations are reaching new highs with each new sale. The Atlanta Hawks, for example, sold for $850 million earlier this year, which was double the Forbes valuation from just one year earlier.
In the midst of this unprecedented prosperity and bullish view on sports business, it’s important to understand a potential landmine, which is the fact that the lucrative cord of cash flow fueling the prosperity is being shaved, or cut altogether.
Cutting the Cord
A little over 100 million U.S. households still pay for traditional bundled cable TV services. But there is no doubt that a shift from the bundle package to over-the-top services is in motion that is altering the business model for the television industry. And as the shift escalates, the sports industry will experience downstream impact.
ESPN is paid $6.04 per month per subscriber by cable providers (whether or not that subscriber watched one second of ESPN). Keeping the math simple, $6 multiplied by the 100 million households with a bundled cable package equates to $600 million of revenue per month for ESPN. So even if a modest 15% of subscribers end up cutting the cord, ESPN will lose $100 million of revenue per month.
Cable television continues to observe subscription losses at a record pace. According to media research firm SNL Kagan, the largest-ever quarterly drop, 625,000 subscribers, occurred this year, and acceleration for the trend doesn’t seem like it will reverse direction.
ESPN, the Worldwide Leader in Sports, isn’t immune from these declines. According to Nielsen, the most watched cable TV station in America has seen subscriptions drop from 100 million to 94 million, with half of the decline occurring just in the past year according to Business Insider. In the wake of these declines, and increases in rights fees, ESPN was forced to lay off 300 employees, nearly 4% of its payroll, in October.
Even if the bundle continues at some level (and many television executives are desperately trying to convince investors that it will), enough consumers are fleeing cable subscriptions to affect profit margins. So while I’m not suggesting television is about to crater, a critical mass is developing that is bringing inevitable change to the existing model, creating significant revenue gaps.
Take ESPN again as an example. Most cable TV providers offer ESPN on their most basic cable packages nowadays. The channel is paid $6.04 per month per subscriber by these cable providers (regardless of whether or not the subscriber watched one second of ESPN). Keeping the math simple, $6 multiplied by 100 million cable-subscribing households equates to $600 million of revenue per month for ESPN. So even if a modest 15% of subscribers end up cutting the cord, ESPN will lose $100 million of revenue per month unless the current model changes. The profitability of the entire ecosystem, including advertising, can be traced back to subscriptions, and subscriptions are shaving, if not cancelling altogether.
Word on the Street
Traditional media companies have seen their stock prices sell off into bear market territory. At the time this editorial draft is being written, many leading traditional content producers and suppliers have seen their stock prices drop substantially in 2015. Year-to-date, Time Warner is down 17%, CBS 25%, and Viacom 38%. While the traditional media sector struggles, over-the-top is booming. Netflix, the S&P’s best performing stock of 2015, is up a staggering 125%.
Disney, who owns ESPN, is up 10% YTD, but it is well off its highs after investors were spooked by a recent earnings report and comments by CEO Bob Iger about the possibility that ESPN could one day be sold direct to consumers as an à la carte service, similar to what HBO has started to do with its stand-alone, over-the-top offering. If that happens according to the Wall Street Journal, ESPN would need to charge $30 per month for its own over-the-top offering to generate the same revenue that the current cable bundle does. Will enough people be willing to pay $30 a month? By comparison, current over-the-top services, such as Netflix, Hulu, and Amazon Prime, cost around $10 a month.
Any revenue gap could, in theory, be closed if à la carte services are priced at levels that make up for the shaved or lost bundle. But I just don’t see how that happens. Personally, I do not pay even an additional $9 per month for NFL Redzone, and I love the NFL. So if the league can no longer gain revenue from people who are not watching NFL games even though they are paying for them (through bundled services), and it experiences churn from some avid, but cost-conscious, NFL fans, then it’s not difficult to see the potential problems on the horizon.
Regional Sports Channels
In the case of ESPN, the network is still able to milk profit, despite reductions in subscription revenue because viewership is still high relative to everything else on TV. And whether through a bundle or à la carte, I predict ESPN will figure out a profitable model. But what about all of the regional sports stations that have emerged in recent years? Are they going to be just fine?
Its seems like a fait accompli that 500-channel TV packages are headed the way of the dodo bird and cord cutting will only accelerate moving forward. And if that happens, there are significant downstream impacts on the valuations of sports franchises.
In the country’s largest markets, New York and Los Angeles, local TV money is largely credited with increasing the value of MLB’s Yankees and Dodgers. The Dodgers have a 25-year, $8.35 billion contract with Time Warner Cable, while the Yankees continue to reap the benefits of their YES Network.
Many MLB and NHL teams across their respective leagues now have similar equity interests in local sports networks or similar lucrative local TV rights contracts. And many of these channels are almost entirely dependent on cable subscription fees to keep their lights on. One sports executive familiar with the local TV deal of a small market team told me that 85% of the local sports network’s revenues come from subscriptions.
When XYZ Network isn’t broadcasting a hometown game, they’re showing a replay of a high school JV basketball game or fishing lessons with Uncle Ed. There are a couple of reasons for this strategy. The first is the fact that low-budget, basic programming is dirt cheap to produce. Now couple that with the fact that many of these networks don’t care whether anyone’s watching or not during these times because their revenue models aren’t based on advertising. And as illustrated earlier, these channels are paid subscription fees by the cable providers whether anyone is watching or not.
Again, let’s use overly-simple math just to illustrate the point. Let’s say 90% of the citizenry of a typical small market has a cable package that includes that market’s local sports network, but only 15% of those consumers are actually watching the games on that network. Does that mean if given the opportunity to unbundle or go completely over-the-top, 75% will shave the local sports network? That scenario has drastic implications on a model that is primarily funded by subscriptions.
Adapting to the New World
The future of television consumption in general is not with cable, which we’ve established is the anchor revenue source for the sports industry as we know it today. The future is with digital media and Internet streaming. In the next ten years, it’s possible that there will be no cable TV bundle, and all content will be purchased à la carte and consumed through streaming services.
Think about it. How many TV channels do you pay for each month? How many of those channels do you actually watch? Its seems like a fait accompli that 500-channel TV packages are headed the way of the dodo bird.
With valuations increasing at unconscious rates, due in large part to proportional TV rights escalations, at the same time that cutting the cord is fashionable and technologically feasible, is it that unreasonable to say that market conditions are a bit frothy right now?
The sports industry does have a couple of silver bullets in its chamber. Firstly, live sporting events are DVR-proof, something few programs can offer. And an enormous slice of consumers obsesses over these events. So we are not facing a popularity barrier, nor is the barrier a limitation in technology. Most networks offer access to their content through streaming sticks and set-top boxes, including Apple TV, Roku, Google Chromecast, or Amazon Fire, as well as on mobile devices through applications. So the custom experiences that consumers are now expecting are available on the market.
The barrier for the sports industry is how to capture the same content-related revenue without the traditional cable bundle. To illustrate, consider that for the week of October 19th – 25th, Sunday Night Football claimed the number-one ranking for TV viewers with 20.61 million. The 20% of Americans watching the NFL on Sundays isn’t the issue. That’s an astounding number. It’s the 80% of households who do not watch, yet are still profited off of, that is the issue to keep in mind. I know I keep reiterating the same point, but that’s because it’s so important to realize.
At the highest levels, conversations for change are happening. For example, the NFL is experimenting with live streaming, including during its International Series in London. On October 25th, the Buffalo Bills versus the Jacksonville Jaguars was delivered digitally on Yahoo for free to anyone in the world on any device for the first time ever. This beta test was a big win for the NFL, as 15.2 million unique viewers streamed the game according to Yahoo. That’s more than the 13.5 million viewers that Monday Night Football draws on average. Accounting for one-third of the streaming audience was the international segment, demonstrating the huge global opportunity for the NFL and its partners. The digital platform provides a hugely profitable channel for non-premium games that if only regionally distributed, will only reach roughly one million viewers.
It Affects All of Us
In my opinion, cord cutting is the single-most important issue for our industry over the next decade. And in everyone’s favorite demographic, Millennials, many will never cut a cord because they’ll never even have a cord to begin with. With valuations increasing at unconscious rates, due in large part to proportional TV rights escalations, at the same time that cutting the cord is fashionable and technologically feasible, is it that unreasonable to say that market conditions are a bit frothy right now? And if there is a market correction, good luck telling the player’s associations that they need to take pay cuts during the next round of collective bargaining negotiations.
This issue trickles down to all of us in sports, not just commissioners, owners, or players. While not all of us are in positions to affect the outcome, we should all understand the crux of this note – that it’s an undeniable fact that record team valuations are hand in glove with current TV rights deals. And if only a modest percentage of people cut the cord, those deals will drop significantly, followed by valuations. And if valuations go down, so does the net worth of our owners as well as the salaries of our players.
The model is changing. We can be a participant in the wave and see where it takes us, or we can be left behind to drown in its wake. The sports and media industries can either continue to try to get ahead of the shift with over-the-top, live streaming services or risk being left holding the severed cord.
How is your organization addressing the threat of a changing media landscape?
Write to Jared at firstname.lastname@example.org.