The Truth and Distraction of U.S. Cord Cutting

Last week represented the start of Q3 2015 reporting for US Pay TV providers. And with it, the inevitable “cord cutter” headlines and hysteria. But the question media companies should focus on is not how many “customers” do they have, but what role do they play in a viewer’s life. For most media companies, this role is not only in decline, it’s less routine, less interactive and less meaningful every day. It’s this change that enables disruption. For too many, as I recently discussed with both Eric Jackson and Sharon Waxman, this realization will come too late. – Jason Hirschhorn. CEO, REDEF 

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By Liam Boluk

After decades of growth, the Pay TV ecosystem experienced its first quarterly net subscriber decline in the third quarter of 2010. In the years since, the concept of “cord cutters” – in addition to that of “cord shavers” and “cord nevers” – has dominated industry conversation and characterized its fears. Despite this, the cord cutter narrative remains profoundly misunderstood, largely as a result of media coverage that simultaneously over and under-exaggerates the behavior. Even still, the figure itself is a symptom, not a disease – and like any symptom, it presents earlier and more strongly with some patients (customers), than with others. To focus one’s business, programming and distribution strategies on it is to ignore the underlying condition. First, we need to properly understand it – and thanks to new research from MoffettNathanson, we finally can.

During the past five and a half years, the cable ecosystem has been hit with heavy losses. Nearly 8.9M net subscribers have been lost (versus 3.3M in net gains from Q3 2004 to Q4 2009) – a fact obsessed upon by journalists and bloggers alike. But at the same time – and with significantly less media coverage – Satellite (DirecTV and Dish) and Telco (i.e. AT&T U-verse and Verizon FiOS) MVPDs have surged to the point of offsetting (or reclaiming) nearly 95% of these net losses.

Today, the Pay TV ecosystem includes only 550K fewer households than it did at the end of 2009, or 99.41M total households compared to 99.96M (a mere 0.6% decline). Of course, the pace of cable losses is quickening while DBS and Telco gains are slowing, but even a fourfold increase in losses incurred over the past year (or 3.0M per year) through the end of the decade would leave Pay TV with more than 85M subscribers by 2020. Far from catastrophic.

However, focusing exclusively on net adds structurally understates the extent of US cord cutting. Over the past five and half years, the United States has added 4.8M new households – the majority of which have adopted Pay TV service. These new activations obfuscate “true” Pay TV subscriber losses. If two existing Pay TV homes cut the cord, for example, but a new one is created and adds service, only one net loss is recorded. As a result, it’s critical to look at how Pay TV penetration has declined nationally, not just the net reduction in subscriptions.

In Q4 2009, Pay TV penetration was at a then-record high of 88.9% (it actually peaked six months later at 89.4%). Had this remained steady, we should have seen the Pay TV ecosystem grow by 4.3M (or 4.3%) over the subsequent 22 quarters due to growth in the number of occupied households. The fact that it shrunk by 550K (or 0.6%) tells us that the “true” number of cord cutters is closer to 4.8M (representing a 5.4% decline). To this end, a more accurate MVPD net additions chart would be the following:

In this revision, negative quarters are both more frequent and more painful than they were in the traditional net adds chart. More importantly, this has resulted in a massive expansion in the number of households outside of the Pay TV ecosystem, which now sits at 18M – a 45% increase since the end of 2009.

It’s important to put this increase in context. Until Q2 2010, this group had never grown in size. Instead, its numbers had steadily decreased since the invention of Pay TV – even though the US population grew nearly 2.25x overall. At the current pace of year-over-year penetration declines, the number of non-Pay TV households would be nearly 30M by 2020. A doubling of this rate (some acceleration seems likely, if just due to new households) would result in 40M – making it just under half the size of the Pay TV ecosystem itself. And crucially, the vast majority of this growth will have come from those previously willing to spend $50-80 on Pay TV a month, rather than those who were never willing to in the first place (i.e. pre-2009 non-Pay TV households). This explains much of the reason why – in 2015 – networks like HBO are willing to “cut the cord”. The addressable base has finally become significant.

That said, focusing on cord cutting or even cord shaving largely misses the point.

It’s easy to be OK with single-digital subscriber losses or deprioritizing the non-Pay TV opportunity. The US Pay TV ecosystem is large and its value (a remarkable $170B in 2015 revenue alone) is unlikely to disappear anytime soon, regardless of the rate of subscriber or advertiser flight. But the real problem is relevance.

Across all audience segments under 50, television engagement is declining rapidly. The amount of time Americans aged 18 to 24 spend watching traditional TV (inclusive of live, VOD and DVR) is down 37% since 2010 – or 46 fewer hours per month. For 12-17s, TV time is down 31% (or 36 hours). 25-34s are down 28% (or 42 hours). Granted, Nielsen’s figures don’t capture TV Everywhere, but Adobe (the primary TV Everywhere authenticator) reports that only 13M of 250M+ Pay TV watching Americans used TV Everywhere in 2014 (and Q4 actually showed a 2.5% drop in users). Furthermore, had every one of 2014’s 2.1B authenticated streams lasted a full hour[1], it would have increased 2014 TV viewing time by a mere 0.41%.

This time is not simply evaporating. Instead, it’s moving to services such as Netflix (each of the company’s 43M US accounts watches more than 2 hours a day), Twitch (15M American viewers watching 30 minutes a day), YouTube (163M watching 35 minutes a day) and scores of other low cost (if not free) digital-first brands and services.

No television network can weather the loss of their younger audiences. No matter how steady the decline of Pay TV subscriptions appears (or is), the next generation of network would-be television viewers is choosing to get their entertainment from newer, OTT-centric providers. Netflix, Amazon and Hulu do help traditional networks maintain content relevancy, but they do little to build a network’s brand, forge a direct-to-consumer relationship or prepare them for an independent digital future.

Skinny bundles, adjusted affiliate fees, re-rationalized programming strategies, lower costs, declining Pay TV penetration. These can all be managed practically. But without a way of re-engaging youth audiences, all networks are on long-term life support. To thrive, they need to invest in new digital properties, create new distribution models and partnerships and invest in radically different content forms.

“How did you go bankrupt?”, Bill Gorton asked in Hemingway’s Sun Also Rises. The answer: “Two ways. Gradually and then suddenly.”

Liam Boluk is a venture capitalist focusing on the digital video space and heads up Originals at REDEF. He can found at @LiamBoluk or emailed at [email protected].

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The full catalogue of REDEF Originals can be found here. Pieces include:

• Less Money, Mo' Music & Lots of Problems: A Look at the Music Biz
• 7 Deadly Sins: Where Hollywood is Wrong about the Future of TV
• How YouTube MCNs are Conquering Hollywood
• The Digital Future of TV Networks & The Original Series Crunch
• Why the Next Sports Empire will be Built on eSports
• The State  & Future of Netflix v. HBO in 2015 

NOTES:

[1] This is essentially impossible, as it assumes 100% completion rates (versus an online video average of 11%), all streams be hour-longs episodes (v. half-hours) and linear ad loads are just as high online as they are on linear (which isn’t the case).

[Graphic 1] Though it’s tempting to annualize H1 2015, net adds are very seasonal, with Q2 typically the worst performer

[Graphic 2] Max/min informed by the assumption that none of the households formed in a given quarter that did not take Pay TV go on to adopt Pay TV service in a later quarter