Untested assumptions

Yesterday I wrote a post about how "untested assumptions block learning". In it, I included a handful of examples of untested assumptions, including "This is the business model that works".

Every business model favors some set of market participants. High fixed costs, for example, favor a select group of winners that can use scale to provide outsized returns. In those markets, the marginal cost of selling one more unit or adding one more customer is much less than the average cost allocated across every product sold.

Innovation, including a change in technological infrastructure, typically shifts the business model and its competitive dynamic. Before cable and fiber-optic networks became the primary delivery vehicle for video content in the United States, broadcast television held a relative monopoly, so much so that the government restricted cross-media ownership and required a minimum share of public-service programming.

At the time, broadcast networks earned the lion's share of their revenues from advertising. Cable changed a lot of that, siphoning audiences to a wide range of new channels. Broadcasters responded by negotiating with cable providers to earn retransmission fees, and cable providers began paying broadcasters a monthly income based on the number of customers served.

Broadcast networks weren't that happy with the changes, and skirmishes about retransmission fees still flare up from time to time. But the market moved to cable, and broadcaster networks pursued the audience.

In their early days, cable networks offered programming "tiers": prepackaged sets of channels for a range of interests. In general, they all included at least some sports coverage, typically ESPN as well as a regional sports affiliate. Not everyone wanted to watch sports, but everyone paid for access.

Now, technology allows video consumers to choose their programming, even to the level of a single, on-demand offering. Services like Netflix and Aereo open the door to consumers asking, "Why do I have to pay for I don't want?" It's a question that has an audience in the U.S. Senate, where Arizona senator John McCain wants to introduce legislation that would "unbundle" cable programming.

The bundled model works pretty well for consumers who watch a lot of sports, mostly because everyone who doesn't watch those channels still pays a monthly fee. Collected by the cable provider and forwarded to various video networks, the money effectively subsidizes the most avid sports programming enthusiast.

At The Atlantic, Derek Thompson recently concluded that letting people decide what they would want to watch would cost people more than the current model. His analysis omits one important word: "some". Some people would pay more.

These would be the people who value and want to watch premium content. Everyone else would pay less.

Using ESPN as an example, Thompson notes that the network may earn as much as $7.2 billion annually in subscription fees. Fair enough; maybe it does. But his bias toward "the business model that works" becomes evident in his assessment:

Starting to make up that $7.2 billion among a smaller cohort of pay-TV households would require each household to pay much more for today's ESPN. "We believe that only 20 million super-fan homes would pay $30/month for ESPN's group of channels," the authors write, which is "equivalent to 100 million households paying $6/month today."

The operating assumption here is simple: ESPN "should" earn $7.2 billion in revenue, because that's what's going on right now. That's the kind of thinking that blinds us to other possibilities.

In one way, it is funny and telling: the cable business today is making its version of the same arguments the broadcast business made 30 years ago. That's predictable, and maybe for a time that will work. But that time does come to an end.

About Brian O'Leary

Founder and principal of Magellan Media Consulting, Brian O’Leary helps enterprises with media and publishing components capitalize on the power of content. A veteran of more than 30 years in the publishing industry and a prolific content producer himself, Brian leverages the breadth and depth of his experience to deliver innovative content solutions.

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