Look out below: cord cutting consensus moves lower

The following article contains my own opinions and analysis and is not official Deloitte research.

It looks to me like there is a new consensus emerging on the near future of US pay TV: from a peak of 101 million homes subscribing in 2011, and 90 million as of today, the next step down is being predicted to be 55-60 million homes. That level could be reached as soon as 2022, or it could take longer, but the shocking thing is who is making those predictions.

The first source isn’t all that shocking, actually: Kagan Research has been around for 40 years. Back in 2011 they were cautious on cord-cutting – although lots of people in surveys were considering it, the actual number who were cancelling was around 0.1% per year. But the trend started accelerating, and by 2018 they were predicting a more dire future for the pay TV industry. In their most recent forecast, they predict a fall to 59 million US pay TV subscriptions by 2022.

The second source made me sit up though. The CEO of AT&T, which was the largest pay TV operator in the US as of 2019, was asked about cord cutting in the Q3 conference call. He said “I don't know what the cord cutting rate is going to be over the next couple of quarters…” but that he thought subscriber losses for the industry would continue and at the “…55 million, 60 million household range, we're probably going to see a little bit of a plateauing as a result of [sports consuming households.]”

I find both the Kagan and AT&T predictions interesting, because they are almost exactly what I predicted in some private conversations with media clients in 2016. Let me explain why I thought so four years ago.

What is Pay TV? Historically, pay TV was a bundle of broadcast channels for a monthly fee, with shows at fixed broadcast times and most channels had commercials. At first, that was only possible over coaxial cable, hence the moniker “cable TV.” But over time it was also distributed over phone company wires, fiber optic cable or satellite dish: it was always a bundle of broadcast channels with commercials and monthly bills, only the distribution technology differed. The US term for that is an MVPD or multichannel video programming distributor. (Yes, terrible name.) In the last decade, we have also seen services such as Sling, YouTube TV and Hulu Live that offered a bundle of broadcast channels with commercials for a monthly charge, but delivered over the internet, aka over the top or OTT. These services have the catchy name of virtual multichannel video programming distributors, or vMVPDs.

At the end of the day, they are all basically the same thing, but with different delivery technologies, and to keep things simple, I will just call all of these “pay TV”, as distinct from other non-pay TV video services such as regular YouTube, Netflix, Amazon Prime or Disney+.

Introducing quintiles, or why averages lie: The average American watched almost exactly five hours of live and time shifted broadcast TV per day in Q3 of 2011 according to Nielsen. But that average was deceiving: 20% of Americans watched over 10 hours and 12 minutes of TV per day, while another 20% watched just under 35 minutes daily. The heaviest viewing 20% watched 17.5x as much as the lightest viewing 20%. When you analyze a population this way, each of the five equally sized groups is called a “quintile”.

In the chart above from Q3 2011, each quintile had just over 48 million people in it, and the middle quintile watched over three hours of TV per day, not the five hours average for the whole population. The average (arithmetic mean) is skewed by those folks who turn the TV on when they wake up and turn it off when they go to bed, which is why I say that when it comes to TV (and other forms of media consumption) “averages lie.”

When I saw this table back in 2011, something really jumped out at me: that fifth quintile was spending about $90 per month on pay TV…but watching a lot less than an hour of TV per day. That seemed like a lot of money for not much entertainment, but I wondered what would happen if they watched even less, which was already a trend?

It seemed logical to me that about a fifth of 2011 pay TV viewers were at significant risk of cancelling: daily viewing minutes and therefore ROI were just too low.

All through 2012 I talked to clients globally about my quintile analysis, and it made sense to them too -- it wouldn’t happen all at once, but 20% of current subs were at serious risk of loss over time.[1] They asked me if the at risk group might be even bigger, and I said that the fourth quintile looked pretty decent from an ROI perspective, as they watched nearly two hours per day of traditional live and time shifted TV. If pay TV cost $3 per day, that was about $1.50 per hour, which felt like a sustainable rate.

What I did not say (and I wish I had) was “…but we need to be cautious. If viewing by the fourth quintile starts dropping the same way the fifth quintile has, they will become at risk too.”

Fast forward five years to Q3 of 2016, and the Nielsen table above. Any fears I had about the fifth quintile came true in spades – daily viewing from that group was down to 12 minutes daily, down 65% or 23 minutes per day from the same quarter in 2011, see below.[2] Very few people will pay $100 per month (pay TV prices had gone up) for just over an hour of TV per week (not per day…per week!) The implication was obvious: cord cutting of pay TV was not only going to continue, it was going to accelerate, which is indeed what happened.

For context, total TV viewing had declined between 2011 and 2016, from about five hours per day to about 4.5 hours per day, or a 10% drop. For the first quintile of heaviest viewers, daily viewing fell from 612 to 608 minutes, or less than 1%...basically unchanged.

But another critical number for me was the fourth quintile. Daily minutes had fallen by 50 minutes in only five years and was down 43%. It was still above what I considered to be the magic number of one hour daily, but not by much, and if the decline continued and it fell under that figure, I would need to double the at risk number.

In 2016 and 2017, I started telling my clients that not only was it likely that pay TV subs in the US would drop from 100 million to 80 million, but a further drop to 60 million now seemed possible.

Fast forward another four years to 2020. What is going on with the fourth and first quintiles? I don’t know: Q3 2016 was the last time Nielsen published publicly the quintile TV viewing numbers. I am sure those numbers are available to those who subscribe for Nielsen research, but I don’t have that kind of budget. :)

But we do know what happened to overall TV viewing minutes: between Q1 2018 and Q1 2020, live and time shifted TV viewing fell by 30 minutes daily to 4 hours and 16 minutes, and was down 48 minutes from Q1 2016. Assuming that viewing for the lighter viewing quintiles dropped in line with previous trends, I would guess that the fifth quintile is now well under ten minutes daily, and the fourth quintile is under 40 minutes daily…or where the fifth quintile was nine years ago.

If you want to know where Kagan, AT&T and I are getting that 60 million number? I think it is based on assuming that the fourth and fifth quintiles will cut the cord over time.

In the long run, we’re all dead – John Maynard Keynes. Yes, but what about the short run? I tend to side with AT&T CEO rather than Kagan on the timing of when we hit that 60 million number: 2022 seems too early.

The US pay TV market (reminder: this is the traditional cable/telco/satellite distributors plus the vMVPDs) had about 93 million subs at the end of 2019, which was down 3.6 million from 2018. It looks like COVID-19 has accelerated the trend, as the US industry is on pace to lose about five million subs this year, and will end 2020 at around 88 million. In order to end 2022 at 59 million subs, cord cutting would need to average 15 million in each of 2021 and 2022, which seems overly aggressive to me.

If the annual declines average ‘only’ 5-7 million annually, the 60 million threshold looks more likely to be reached in 2025 or 2026.

Why not a more rapid collapse? A pessimistic view would see annual losses accelerating each year: five million in 2020, 10 million in 2021, 15 million in 2022 and we would then drop below 60 million at some point during 2023. That is absolutely possible, but I don’t think that’s going to happen. Here’s why:

1)  Although daily minutes of viewing are dropping each year, they aren’t dropping at that kind of exponential pace: roughly ten minutes less per year. And I believe that it is viewing minute declines that drive cord cutting more than any other factor.

2)  Almost all pay TV companies also offer broadband. Everything I see suggests they are going to keep being aggressive in bundling pay TV with internet, which will reduce cord cutting.

3)  They are also bundling pay TV with TV sets: Comcast is looking at doing this with Walmart, for example.

4)  The pay TV companies are also likely to push the vMVPD options: they are already over ten million subs, and likely to keep growing.

In general, the pay TV industry has the ability to react. They can offer cheaper packages to encourage cord shaving instead of cord cutting. They can work at all kinds of bundles. None of it will be enough to start growing subs, or even to keep them flat, but there is a really big difference between losing 30 million subscribers in three years versus six years. The various responses from the pay TV companies are like a parachute: they won’t change how far the sub number falls, but they do change the rate of descent.

Other caveats:

1.  As I said at top, these are my own opinions and analysis, and not official Deloitte research.

2.  Just because the pay TV industry goes from 90 million subs to 60 million subs (a 33% decrease) doesn’t mean that every pay TV company would lose exactly a third of their subs. Some distributors might lose more, some might lose less.

3.  Just because a company loses a third of pay TV subs doesn’t necessarily mean their revenues or profits or share price will fall by 33%.

a.   Many pay TV providers are also broadband internet providers, and those revenues are often growing faster (at least so far) than pay TV revenues have been falling.

b.   The profit margins on broadband tend to be higher than pay TV: a lot of pay TV revenues are “pass through”. The subscriber pays $10 per month for a sports package, and the sports channel gets almost all of that and the pay TV company very little.

c.   Perhaps the current share price of pay TV companies already has an expectation “baked in” that subs will fall by 50% in two years. If it takes longer or subs fall less than that, share prices could actually rise. (The stock market can be weird that way.)

4.  On the other hand, there is a recent article which predicts that the current streaming wars will have an overall negative effect on the traditional TV industry. It says that moving to streaming is going to be inevitable…but it tends to have higher costs and lower revenues than the old model, and therefore lower profitability. Long article, but worth a read.

5.  The number of pay TV subs looks likely to have gone from 101 million to 90 million between 2011 and 2020. But the percentage of US households who have pay TV will fall from about 89% to about 70%, see chart at bottom. The number of US households keeps rising: even if subs were flat, the penetration rate of pay TV would fall.

6.  All of my numbers in the main body of this article are for the US market only. They are likely going to be highly relevant to some other markets (English Canada, Singapore, perhaps some others) but perhaps not relevant to other markets globally. Seriously, watch out…there are some global markets where they are not seeing these pay TV trends at all.

7.  TV sports is a big wildcard. Go back to the top of this article, and the AT&T CEO  is specifically anticipating a plateau in subs around 55-60 million due to sports fans keeping their pay TV subscriptions. Sports is the anchor tenant in the TV mall. There are a lot of diehard sports fans, they watch a lot of TV, and they are often demographically desirable. If any of that changes in the next five years, a plateau at 55-60 million subs likely won’t happen, and declines may continue at the same steep pace.

8.  That said, if the US pay TV industry is 60 million subs, and in just under half of American homes…that’s still a pretty big and important market. Depending on exact monthly cost, likely around $60 billion annually, or as big as revenues for US radio, books, newspapers, live music, and movie box office (in a normal year) combined.

[1] Things were more complicated than that, of course. The quintile data above is about people, while the pay TV business is about households. If a household only has one person in it, and that person watches very little TV, cord cutting is highly likely over time. But if there are two people, and one watches very little but the other watches a lot (perhaps sports on weekends?) then cancelling the household subscription is much less likely.

[2] It is very important to compare against the same calendar quarter, since TV viewing minutes are highly seasonal: people watch less in summer and more in winter.