Good morning,
Tomorrow I am appearing at MoffettNathanson’s Technology, Media, and Telecom Conference; as I noted last week I will be taking the day off as far as Updates are concerned. The audio of my appearance will be available as the Stratechery Interview on Thursday (perhaps I should say that the interview subject will be me!).
On last Thursday’s Sharp Tech Andrew and I had an extensive discussion about tech business models in the context of Google, Facebook, and Apple. I got a ton of feedback from listeners who really enjoyed this episode, so check it out if you’re not a regular subscriber. You can listen at the link above, or by adding Sharp Tech to your podcast player using the links at the bottom of this email.
On to the Update; I hope you’ll indulge me going a bit long, but hey, you have a break tomorrow!
Cord-Cutting and YouTube TV
Speaking of MoffettNathanson, the company just released their latest Cord-Cutting Monitor, and it’s brutal; from Variety:
As streaming video continues its ascendancy, cable, satellite and internet TV providers in the U.S. turned in their worst subscriber losses to date in the first quarter of 2023 — collectively shedding 2.3 million customers in the period, according to analyst estimates…
With the Q1 decline, total pay-TV penetration of occupied U.S. households (including for internet services like YouTube TV and Hulu) dropped to 58.5% — its lowest point since 1992, two years before DirecTV launched as a new rival to cable TV, according to Moffett’s calculations. As of the end of Q1, U.S. pay-TV services had 75.5 million customers, down nearly 7% on an annual basis. Cable TV operators’ rate of decline in Q1 reached -9.9% year over year, while satellite providers DirecTV and Dish Network fell -13.4%. In addition, so-called “virtual MVPDs” (multichannel video programming distributors) lost 264,000 customers in Q1, among the worst quarters to date for the segment…
Comcast, the largest pay-TV provider in the country, dropped 614,000 video customers in Q1 — the most of any single company — to stand at 15.53 million at the end of the period…Google’s YouTube TV was the only provider tracked by MoffettNathanson that picked up subs in Q1, adding an estimated 300,000 subscribers in the period (to reach about 6.3 million) and netting 1.4 million subscribers over the past year. Hulu, meanwhile, has barely grown over the past three years (and lost about 100,000 live TV subs in Q1), Moffett noted, while FuboTV lost 160,000 subscribers in North America in the first quarter to mark its worst quarterly loss on record.
I’m starting with this item mostly to provide context for the next one, but it is interesting to see how big YouTube TV has gotten; the virtual MVPD has around 40% of the customers as Comcast, and unlike Comcast, which is mostly losing customers, those are customers who have affirmatively chosen to be there in just the past few years.
Of course Google being Google, we don’t have any real visibility into the YouTube TV business, beyond an acknowledgement that it’s doing well; one thing I would love to understand is what churn looks like. Virtual MVPD’s have the advantage of being very easy to sign up for, but of course they are very easy to cancel as well.
That ease of sign-up is an important ingredient when it comes to filling the hole in the funnel, particularly in terms of sports; I wrote in terms of the Phoenix Suns and their plans to go over-the-air (a deal that was struck down by a federal judge given Diamond Sports bankruptcy-derived automatic stay in terms of partners unilaterally changing their rights agreements):
This is why I have been concerned about the long-term outlook for the league: it’s hard enough to get attention in the modern era, but it’s even harder if your product isn’t even available to half of your addressable market. That was the reality, though, of being on an RSN: social media gave the NBA top of the funnel awareness, but there wasn’t an obvious next step for potential new fans who weren’t yet willing to pay for pay TV.
However, if this deal goes through, that next step will exist in Phoenix: potential fans can check out games over the air or through a Suns/Mercury app; if they like what they see they will soon be disappointed that they can’t see the best games, which are reserved for the national TV networks. That, though, is a good thing: now the Suns/Mercury are giving fans a reason to get cable again (or something like YouTube TV), increasing the value of the NBA to those networks along the way. And, of course, there is the most obvious way to monetize content on the Internet: deliver a real-world experience that can’t be replicated online — in this case attending a game in person.
I should have been clearer: if this plan — when and if the Suns are able to execute on it — works, the biggest beneficiary will almost certainly be YouTube TV. More broadly, when and if the bundle does stabilize into the sports bundle, that bundle may very well be simply called YouTube TV.
Disney Earnings
From Bloomberg:
Walt Disney Co. shares fell the most in six months after the company posted a drop in subscribers to its namesake streaming service and predicted a wider loss in that business this quarter. The loss from streaming will increase by $100 million this period because of shifting marketing costs, Chief Financial Officer Christine McCarthy said Wednesday on a conference call with analysts. The stock dropped 8.6% to $92.44 in New York Thursday morning.
Disney’s direct-to-consumer segment, which includes the flagship Disney+ streaming service, suffered a loss of $659 million in the just-ended fiscal second quarter, the company said. That was significantly lower than the $850.3 million that analysts projected and less than half what it was just two quarters ago. But a wider loss this period, which McCarthy characterized as a “little blip,” rows back some of the progress Disney has made toward achieving profitability in its streaming businesses. The company is simultaneously seeing a sharp decline in its traditional TV business, which includes ABC and ESPN.
To improve the financial performance of its streaming business, the company introduced a new ad-supported tier for Disney+ in December and raised the price of the ad-free version by 38% to $11 a month. While boosting revenue, the move appeared to cost the company customers: Paid subscriptions to Disney+ fell to 157.8 million. Analysts had expected 163.1 million. It’s the second straight quarter that Disney+ has lost subscribers.
Chief Executive Officer Bob Iger said on the call with analysts that the Burbank, California-based company plans to increase the price of the ad-free Disney+ service again this year. Disney also will be removing films and TV shows from its services to reduce costs, leading to a charge of up to $1.8 billion. Iger plans to combine Hulu and Disney+ content on a single app later this year. The move suggests the company will ultimately buy Comcast Corp.’s one-third stake in Hulu. The two companies have an agreement for Disney to purchase that stake starting next year in deal that values Hulu at a minimum of $27.5 billion. Hulu subscriptions were flat in the second quarter. Comcast and Disney have held “cordial” talks, Iger said.
There’s a lot going on here, so let me take it piece-by-piece:
Linear Losses: I noted last quarter that we had likely reached the end of the road in terms of affiliate fee increases out-pacing losses due to cord-cutting, and that certainly was the case: affiliate revenue finally tipped into negative growth territory, decreasing 2% year-over-year thanks to a 6 point decline from fewer subscribers offset by only 3 points of growth from rate increases.
Of course the fact that rates continue to increase while the product has gotten dramatically worse (thanks to all of the non-sports content being put on streaming services) gets at the core problem here (if anything it speaks to how sticky the bundle has been). Craig Moffett wrote in the aforementioned Cord-Cutting Monitor:
In the past we’ve described two vicious cycles. The sports cycle drove prices higher, precipitating more and more churn, which only drove prices higher still to compensate. The impoverishment cycle stripped traditional video of viewership, driving media companies to move their best content elsewhere, and therefore driving viewership lower still. We used to talk about these two cycles as though they were simultaneous as well as equal in their import. But perhaps it would have been better to describe them as sequential. The sports cycle drove prices higher first, and that got the impoverishment cycle started. It is the impoverishment cycle, at least now, that is the more important of the two.
I think this observation about these two cycles being sequential is correct, but I do wonder about the causal drivers; I wrote earlier this year about the Netflix effect:
What changed over the last five years is that nearly the entire TV ecosystem decided to compete with Netflix, instead of accommodate it. Competing with Netflix, though, meant attracting customers to sign up for a new service, instead of simply harvesting revenue from people who hooked up cable whenever they moved house, without a second thought. The former is a lot more difficult than the latter, which meant the media companies had to leverage their best stuff to attract customers: their most interesting new shows, and sometimes even their sports rights.
After linking to an interview with Matthew Ball who noted media companies actively made pay-TV worse by moving content to streaming services I concluded:
I asked Ball that question in the light of recent remarks by most media company executives this past quarter about renewing their focus on pay-TV, but as Ball noted, it is probably too late. In the long run it is Netflix, thanks to its subscriber base and relatively healthy capital structure, that will have the capability to pay for content media companies will have to sell to pay the bills, suggesting a potential future where Netflix is the primary distributor for everything but sports. And if this is true, the company will have won without televising sports, or even stepping foot on a soccer pitch, thanks to the media networks scoring an own goal by sacrificing pay-TV.
So which is it: did media companies screw up by chasing Netflix, or did sports rights start an inevitable and irreversible cycle? In fact, I think these two are inextricably linked. I’m most familiar with the NBA, and it’s interesting to look at the league’s right deals over the last 25 years:
- In 2002 the NBA signed deals with ESPN and TNT for a combined $766 million/year, a big increase over NBC’s offer of $330 million/year. The former could justify the higher price because they were on cable, and thus made money from both advertising and affiliate revenue; this was the start of the cable rate increases Moffett highlights.
- In 2007 the NBA extended both deals for a combined $930 million/year, despite the fact that ratings had fallen from where they were on NBC. That’s how lucrative those affiliate fees were.
- In 2014 the NBA extended both deals again for a combined $2.7 billion/year.
This last extension is the most interesting and where I think the Netflix angle is most pertinent: ESPN and TNT were willing to pay that price not simply because they had had previous success leveraging sports rights to drive affiliate fee increases, but also because that was the moment in time when media company executives were becoming the most paranoid — and jealous — of Netflix. I suspect they saw sports rights as the best way to have their cake and eat it too: preserve the cable bundle, even as they started planning their own Netflix competitors.
As Moffett notes, though, buying bundle insurance from the sports leagues was like buying fire insurance from an arsonist: part of the idea of a bundle is that the bundler has negotiating leverage over the bundle contributors, but in this case the networks gave so much to the sports leagues that they dramatically accelerated the vicious cycles Moffett describes.
The end result is that everyone is in the process of losing: the sports leagues are still taking their pound of flesh, but face long-term questions particularly in terms of customer acquisition, while the networks have gutted the parts of their business that actually made money to pour their best content into streaming services that don’t, destroying any leverage they had with sports leagues in the process.
Streaming Rationalization: Iger was very critical of Disney’s prior attempts to acquire worldwide subscribers, particularly in markets that had minimal revenue potential. From the earnings call:
We launched Disney+ in many, many markets around the world, including many very low ARPU markets. And not only did we launch in those markets, but we spent a lot of money on marketing in those markets, and we spent money on local content. So, as we rationalize this business and we head in the direction of profitability, clearly, we’re looking at opportunities to reduce expenses in those markets where the revenue potential just isn’t there.
Iger added in response to another question:
The goal was, as you know, global subs, and we wanted to flood the so-called digital shelves with as much content as possible. To achieve, obviously, as much sub growth as possible. And now, as we grow the business in terms of the global footprint, we realize that we made a lot of content that is not necessarily driving sub growth, and we’re getting much more surgical about what it is we make. So, as we look to reduce content spend, we’re looking to reduce it in a way that should not have any impact at all on subs. We believe that there’s an opportunity for us to focus more on real sub drivers.
And one interesting example and I should also throw marketing in, too, where when you make a lot of content, everything needs to be marketed. You’re spending a lot of money marketing things that are not going to have an impact on the bottom line, except negatively, due to the marketing costs. One thing we also know is that our films, those that are released theatrically, big tentpole movies in particular, are great sub drivers. But we were spreading our marketing costs so thin that we were not allocating enough money to even market them when they came on the service, as witnessed by the ones that are coming up, including Avatar, Little Mermaid, Guardians of the Galaxy, Indiana Jones, Elemental, etcetera, where we actually believe we have an opportunity to lean into those more, put the right marketing dollars against it, allocate more from basically away from programming that was not driving any subs at all.
This is a pretty compelling example of the adage that you better be careful what you measure, because that is what you will optimize for. In this case Disney was so focused on subscriber numbers that not only did they completely forget about profitability, but at least in Iger’s estimation, they didn’t even maximize their subscriber potential because they were marketing the wrong things in the wrong markets.
At the same time, this is a reason for optimism about Disney; yes the stock market reacted negatively to Disney’s decline in subscribers, but not only were nearly all of those a function of Disney losing cricket rights in India, but it also seems likely that Disney needs to be aggressive about losing “wrong” subscribers who weren’t aligned with actually running a money-making streaming service.
Centralized Marketing: Speaking of marketing, from Iger’s prepared remarks:
As we’ve been looking at the structure of the company these past several months, what’s become clear is that there is an enormous opportunity to harness our full potential by increasing alignment and coordination in marketing across our businesses. That’s why I named Asad Ayaz our first ever Chief Brand Officer in addition to his role as President of Marketing for our studios. For years, our businesses have been incredibly successful in marketing our content, experiences, and products. And now with greater integration of our touch points with consumers, especially streaming, we’re able to be more efficient and more successful in reaching the right audiences with the right offerings from across our businesses.
Iger’s first order of business on returning to Disney was unwinding Bob Chapek’s centralization of content decisions, but it appears he is going in the opposite direction when it comes to marketing that content. This, frankly, makes all kinds of sense; as I noted when Chapek was ousted I thought that Chapek’s centralization made sense, but I was always thinking about that centralization in terms of go-to-market concerns, not in terms of what content was created or not. That’s exactly how Iger appears to be structuring things.
Disney’s Hulu Decision: There is a strong case to be made that Disney should simply focus on its own IP, which is not only a compelling product in its own right, but also feeds into Disney’s in-person experiences, which continue to crush it. The problem is that Disney not only has its own general entertainment studios, but it also acquired 21st Century Fox, and as part of that latter deal ended up with 2/3rds of Hulu and a contractual obligation to buy Comcast’s share by 2024. In other words, becoming a Disney-only company isn’t really an option.
One way to approach this would be to set up its general entertainment studios and Hulu as a standalone division, just as Iger did with ESPN. This would lay the groundwork for a spin-off at some point, which seems like the long-term trajectory for the sports network. Instead Iger is going in the opposite direction, and integrating Hulu into the Disney+ app.
Keep in mind that this integration is already the case outside of the U.S., so Disney has data about how well this will work. It’s also important to note that the economics of general entertainment are generally similar to Disney+, in that the content is created once and then can be monetized endlessly; sports rights, on the other hand, are effectively rented from the leagues, and their value basically disappears the moment they are aired.
Moreover, there is still value in bundling! Having general entertainment from Hulu and its studios together with Disney IP makes the streaming service more attractive to more people more of the time. Given that the company is basically stuck with Hulu, I think it makes sense to try and leverage all possible synergies in this regard.
Advertising: The real growth story for all of this is, like Netflix, advertising. Disney is clearly pleased with the success of the Disney+ ad-supported model, both in terms of driving revenue directly and also in terms of enabling more price increases for the ad-free version of Disney+. Iger said on the call:
On the first question regarding price increases, first, we were pleasantly surprised that the loss of subs due to what was a substantial increase in pricing for the non-ad supported Disney+ product was de minimis. It was some loss, but it was relatively small. That leads us to believe that we, in fact, have pricing elasticity.
With that in mind, I think one of the things that we not only have discovered, but that we believe we have to do, is that we’ve got to widen the delta between the ad-free service and the non-ad supported service. Because we clearly would like to drive more subs to the ad-supported service, which we did in the quarter, by the way, the obvious reason, because of the ARPU potential of the ad service Disney+.
And in fact, as we look to this up front and after careful and considerable discussion with our sales team, led by Rita Farrow, we see that there’s going to be a substantial growth in digital advertising in this up front, I mean, quite substantial. Suggesting, for the obvious reason, because digital advertising is so attractive to advertisers, that there’s an opportunity for us to really lean into ad-supported. And again, raising our prices on the ad-free, keeping the prices on the ad-supported relatively modest, maybe perhaps no increases, increasing the delta, driving more subs in a higher ARPU direction.
In short, Disney is focused on The Unified Content Business Model. The cable bundle may be dead, but the bundling of content and advertising will live forever.
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