Today, ESPN announced layoffs of 300 people or 4% of its workforce. See here and here. Disney CEO Bob Iger also ordered $100 million in cuts at ESPN. While the network has changed over the years, has its left-leaning slant applied to sports news become a liability? ESPN and other properties are experiencing income drops due to people cutting the cord on cable and using their mobile devices. But this Breitbart article from September 2015 lays out an interesting perspective on how cable channels make money. Let’s expand on this further by going through the economics of a video distribution company such as your local cable company or satellite provider.
The video distribution provider usually receives a license and operates as a monopoly within a given area. The big providers in Southern California are Time Warner Cable and Cox Cable. I won’t get into the conditions of the license such as public access and the “must carry” rule. Each company has several major expenses – labor, physical plant, and content.
Labor costs are significant for every company, and video distribution is no different. These are the people who perform customer service functions and maintain the lines to each residence or location. (Please note that actual in-house installations are performed by contractors most of the time.) Management and back-office functions are included in this cost.
The next big expense is the distribution system and the physical plant. This system includes the local receive facilities where the cable system receives the over-the-air signal for distribution, trunk lines, amplifiers, distribution facilities, and the cable to each individual house. Like the incumbent phone company, physical plant infrastructure is very expensive to build and maintain. In the case of a satellite provider, the teleports, local receive infrastructure, and the satellites are counted in this cost. In either case, the physical plant cost is amortized over many years and maintenance is always being done.
Content costs are the other large expense. We have seen many times disputes between media groups and distribution providers over carriage fees paid indirectly by the cable subscribers to the content providers. These disputes get resolved over time but the higher costs are passed on to subscribers. Every distribution provider has to pay these fees to carry groups of channels.
Using the Breitbart article as an example, ESPN receives $6.61 per month from each cable and satellite subscriber. This comes out to $79.32 per year per subscriber. ESPN makes 7.3 billion dollars per year from around 91 million subscribers. Other content providers charge carriage fees. This CNN Money article states that per subscriber per month, Fox News receives $1, CNN receives $0.61, and MSNBC receives $0.30. CNN and MSNBC do not receive a substantial portion of their income from advertising. Instead, CNN and MSNBC receive the lion’s share of their income from carriage fees. Using the ESPN numbers as a comparison, Fox News receives $1.1 billion in carriage fees per year, CNN receives $667 million, and lowly MSNBC receives $329 million. Once the carriage fees are taken into account, we now see how two news networks that anyone barely watches make money. There is no way to escape paying these carriage fees for channels you don’t watch.
Unless you cut the cord.
Last year, 3.2 million cable subscribers cut the cord according to the Breitbart article.
Using the same estimated numbers for carriage fees, last year ESPN lost $253 million, Fox News lost $38 million, CNN lost $23.4 million, and MSNBC lost $11.5 million. Comparing these numbers with the numbers above show each channel taking a significant hit in carriage fee losses. Fox News can make up the $38 million lost in cable fees from advertising increases. CNN and MSNBC cannot do the same because of low viewership.
Unlike the cable news channels, ESPN has additional problems. As a sports provider, ESPN pays to carry sports content. ESPN signed a 20-year agreement in 2014 with the SEC to carry sports from the Southeast Conference. ESPN also signed a similar agreement in 2011 with the University of Texas to carry primarily Longhorn sports. ESPN has significant long-term liabilities that become worse for the parent network over time. If the cord-cutting trend continues, ESPN may not have the money to bid on contracts such as NFL Monday Night Football.
As streaming becomes more prevalent and people cut out traditional distribution services, it will be very hard to justify the stock valuations of the channels’ parent companies. If we have a recession in 2016, I expect increasing numbers of cable and satellite subscribers to terminate service and move on to streaming. But if an avalanche of subscribers terminate service, how long can channels like MSNBC, E!, Comedy Central, and Discovery hold out? Could whole groups of channels disappear from the lineup? It all comes down to the actual operational cost for each individual channel. Below a certain point, every cable channel becomes unprofitable.
Now that the proverbial tide is going out on cable and satellite, who’s swimming naked now?