Cutting Through the Myth of Cord-Cutting

by

This commentary was originally written in December 2015 for an MBA course at the Schulich School of Business. The version below has been slightly edited.


Introduction

Media consumption is changing. The television business is in transition. Canadian Broadcast Distribution Undertakings (BDUs) are facing new challenges brought on by that transition. This report focuses on the major challenges facing Canadian BDUs and how Canadian BDUs can protect their market positions. The report begins by looking at the current state of the broadcasting industry in Canada and profiling its main players, including BDUs and OTT services. It goes on to identify the main challenges facing Canadian BDUs and examines the underlying data behind two widely held assumptions; that people are watching less television and that a significant number of television subscribers are cutting the cord. The report concludes with three recommendations Canadian BDUs can implement to address the challenges and protect their market positions.

Industry Background & Overview

Communication Industry

The Canadian communications industry was worth $63.2bn in 2014, a 2.1% increase from 2013. This represents approximately 3.8% of Canadian GDP. The industry is made up of two broad segments: broadcasting and telecommunications. The telecommunication segment accounted for 73% of all communication revenues, with broadcasting accounting for the remaining 27%.

Regulation

The Canadian broadcasting and telecommunications industry is supervised and regulated by the Canadian Radio-television and Telecommunications Commission (CRTC), an administrative tribunal administered through the Ministry of Canadian Heritage. The CRTC’s primary responsibilities include licensing, promoting compliance with regulations, making ownership decisions, approving tariffs, encouraging competition, and providing information.

Concentration

The communication industry in Canada is highly concentrated. In fact, at both the broadcasting and distribution levels, Canada has, by a wide margin, the most vertically integrated media industry among its G8 peers. The largest entities in the Canadian marketplace are both vertically and horizontally integrated, offering various combinations of landline, wireless, Internet, and broadcasting distribution services. Combined, the five largest communications sector entities (Bell, Quebecor, Rogers, TELUS, and Shaw) accounted for 84% of communication industry revenues, a percentage that has remained constant over the last 3 years.

Broadcasting Industry

Within the $17.3bn broadcasting segment, the biggest component is BDU (broadcast distribution undertaking), a catchall term for cable, satellite, and IPTV distributors of bundles of television services. BDU revenues in 2014 were $9.1bn, accounting for 52.6% of broadcasting segment revenues. TV and radio make up the remainder of the broadcasting segment. TV and radio revenues in 2014 were $6.6bn and $1.6bn respectively. In the broadcasting segment, the five largest vertically-integrated companies (Bell, Rogers, Shaw, Cogeco, and Quebecor) accounted for over 87% of total broadcasting revenues.

Canadian BDU Market Landscape

The five largest BDUs by subscriber revenue (Bell, Shaw, Rogers, Quebecor/Videotron, and Cogeco) dominate the market and account for 87% of all programming distribution revenues. Canadian BDUs offer services through three technologies; cable, Direct to Home satellite (DTH) and Multipoint Distribution Systems (MDS), and Internet Protocol Television (IPTV). In 2014, approximately 61% of BDU subscribers used cable, 22% used DTH and MDS, and 15% used IPTV. IPTV is growing quickly in Canada, with a CAGR of 43.6% between 2010 and 2014.

BCE Inc. (Bell)

Bell (trading as BCE on the TSX) is Canada’s largest communication company. The firm posted net earnings of $2.7bn on revenues of $21bn in fiscal 2014. Bell offers satellite and IPTV, broadband Internet, and landline and wireless telephony. In Q3 2015, Bell became Canada’s largest TV provider, with 2.7m subscribers between satellite (1.6m) and IPTV (1.1m).

Bell is a major player in content and broadcasting through its Bell Media division. Bell Media owns 30 local television stations, led by CTV, the country’s most watched television network; 34 speciality channels, including TSN (Canada’s most watched specialty channel), Discovery, The Comedy Network, and CP24; and 4 Pay TV services including HBO Canada.

Furthermore, Bell owns an 18% stake in the Montreal Canadiens and a 37.5% stake in Maple Leaf Sports & Entertainment (MLSE), the parent company of the Toronto Maple Leafs, Toronto Raptors, and several other smaller sports franchises.

Shaw Communications Inc. (Shaw)

Shaw (trading as SRJ.B on the TSX) is a diversified and vertically integrated communications company. In fiscal 2014, the company posted net income of $880m on revenues of $5.2bn. It offers cable TV, DTH satellite, broadband Internet, digital telephone, and other services. As of August 31, 2015, the company had almost 2.6m subscribers between cable (1.7m) and satellite (0.8m).

In addition to distribution, Shaw is heaving involved in content and broadcasting. The company’s Shaw Media subsidiary owns Global Television, one of Canada’s largest conventional television networks, and 19 specialty networks, including HGTV Canada, Food Network Canada, National Geographic Channel, and HISTORY.

While Shaw is a publicly listed company, 79.3% of the firm’s voting rights are controlled by its Founder and Executive Chairman, JR Shaw, and his family, through various corporate vehicles. The Shaw family also controls 84.79% of the voting right of Corus Entertainment Inc. Corus (trading as CJR.B on the TSX) is involved in television, radio, and content creation. It owns three conventional television stations and 22 specialty and pay TV services targeted to kids, families, and women.

Rogers Communications Inc. (Rogers)

Rogers (trading as RCI.A & RCI.B on the TSX) is a diversified communications and media company. The company’s 2014 revenues were $12.9bn, with net income of $1.3bn. Rogers offers cable TV, Internet, and wireless telephony services. As of September 30, 2015, it had 1.9m cable television subscribers.

Rogers is also an active player in content and broadcasting through its Rogers Media subsidiary. Rogers Media owns 24 television stations, including conventional stations under the CITY banner, and speciality channels such as Sportsnet, The Biography Channel, FX, and The Shopping Channel.

Rogers is also the owner of the Toronto Blue Jays and has a 37.5% stake in MLSE, the parent company of the Toronto Maple Leafs, Toronto Raptors, and several other smaller sports franchises.

Videotron

Videotron is a subsidiary of Quebecor Media, which itself is a subsidiary of Quebecor (trading as QBR.A & QBR.B on the TSX), a Montreal-based integrated communications company. In 2014, Quebecor posted revenues of $3.7bn and a net loss of $30m. Videotron offers cable TV, Internet, and landline and wireless telephony services. As of June 30, 2015, Videotron had 1.7m cable television subscribers.

Quebecor Media also operates the TVA Group, the largest broadcaster of French-language entertainment in North America. TVA Group owns 4 conventional stations, has a minority stake in a further 2 conventional stations, and operates 8 French-language specialty channels, including TVA Sports, LCN, and addikTV.

Cogeco Inc. (Cogeco)

Cogeco (trading as CGO on the TSX) is a holding corporation that operates in the communications and media sectors. In fiscal 2015, the company posted a net income of $265m on revenues of $2.2bn. Cogeco offers cable TV, Internet, and digital telephony services in Quebec and Ontario. As of August 31, 2015, it has 765,000 cable television subscribers.

Canadian SVOD/OTT Market Landscape

The Canadian SVOD/OTT market is dominated by Netflix, with new entrants CraveTV and Shomi providing the only real competition. Popular American OTT services, such as Hulu, Amazon Prime, HBO Now, and others are not officially available in Canada.

Netflix

Netflix (trading as NFLX on the NASDAQ) is world’s pre-eminent SVOD service. In 2014, the company earned a net income of $267m USD on revenues of $5.5bn USD. Netflix entered the Canadian market in 2010, its first international expansion. The company has not disclosed the number of subscribers it has in Canada, but estimates range from 3.1m to 3.95m, or between 23% and 29% of Canadian households. Other estimates report that Netflix has penetrated 35% of the 11.5m Canadian households that have an Internet connection, or just over 4m households. Netflix monthly subscriptions range from $7.99 (Standard Video) to $11.99 (Ultra HD Video).

CraveTV

CraveTV is a Canadian SVOD service wholly owned by Bell. Launched in December 2014, the service has initially been only available to subscribers of Bell and affiliated TV service providers. As of August 2015, CraveTV had 730,000 customers. Starting in January 2016, the service will be available to the general public, expanding its reach from 3.5m to 11m households. A CraveTV subscription currently costs $4/month for television subscribers. That rate will increase to $6/month on February 1, 2016. Pricing for non-television subscribers has not yet been announced.

Shomi

Shomi is a Canadian SVOD service jointly owned by Rogers and Shaw and launched in November 2014. At launch, the service was only available to Rogers and Shaw subscribers but it has since been made widely available to the general public. Subscriber numbers are not available. A Shomi subscription costs $8.99/month.

Key Challenges for Canadian BDUs

Canadian BDUs are facing a shifting business environment. The way people are consuming content is changing and this change presents the BDUs with a number of inter-related challenges. There is a widespread belief among the general population that television is in a period of rapid decline, and that this decline will result in major upheaval among Canadian BDUs (and other established players in the broadcast industry). A scan of recent headlines on the topic seems to give support to that belief:

“Millennials ditching their TV sets at a record rate”

“TV subscriber losses increased last year and will keep growing, report says”

“Cord-Cutting In Canada 7 Times Faster Than Last Year, But Telcos May Have A Bigger Problem”

“Canadians abandoning pay TV for OTT services (Study)”

These are just a few of the many articles published in the last year proclaiming the impending death of TV as we know it. The arguments approach the issue from various angles, the most-popular being: decreasing television viewership, cord-cutting, and the growth of emergent market players such as Netflix. But the underlying narrative espoused in these articles is similar, since people are watching less and less television, an ever increasing number of them will cancel their television subscriptions, and we will eventually end up with a world where BDUs cease to exist. The question is, does the underlying data support these dire predictions?

Are People Watching Less Television?

One thing that can be said unequivocally is that overall video consumption is growing. Among US adults 18+, time spent watching video rose from 04:56 (hours:minutes) in 2011 to 05:53 in 2014, and is expected to reach 06:21 by 2017, representing a CAGR of 4.2%.

Another unarguable fact is that traditional television still represents by far the largest percentage of video consumption. In 2015, a typical American will watch 177 hours of video per month, of which 72% (127.5 hours) will be traditional TV and 14% (25 hours) will be subscription services, a category which includes the digital offerings of many traditional television players such as HBO Now, CBS Interactive, and Hulu (majority owned by Comcast/NBC, News Corporation/FOX, and Walt Disney/ABC).

Although traditional television viewing decreased at 2.8% per year between 2012 and 2015, subscription viewing increased 22% annually during the same period. Since part of the subscription growth is attributed to the digital offerings of traditional TV players, the magnitude of the decrease in viewership of traditional television players is smaller than it initially appears. Part of the phenomenon is viewers simply accessing the same content, from the same providers, via digital subscription channels.

In Canada, the trend is similar. For Canadians 18+, total video content viewing hours per week rose from 28.6 in 2014 to 28.8 in 2015, with the decline in traditional television viewing more than offset by the increase in digital channels.

One demographic that is often trotted out as the case exemplar of cord-cutting is millennials. The generation of roughly 18-34 year olds who are said to be the future of media consumption and the death knoll of television. However, millennials still watch over 20 hours per week of traditional television and consume more video overall than any other demographic group. While their viewing habits and preferred media are different that previous generations, millennials still rely on television for the majority of their video consumption.

Based on the data, it is clear that, overall, people are watching more video content than ever before and are expected to continue increasing video consumption. It is also clear that traditional television’s share is falling. However, traditional television companies (including Canadian BDUs) are successfully capturing some of the viewers that are switching to digital channels, and are not being completely marginalized as some have suggested.

Are Significant Numbers of People Actually Cutting the Cord?

In August 2014, Canadian BDUs reported 114,500 fewer subscribers than the previous year. Out of a total subscriber base of over 11.6m, this represented a decline of less than 1%. The corresponding household subscription rate dropped by 83.7% to 82%. Within those numbers was a much larger trend away from cable and satellite and towards IPTV. From 2010 to 2014, the number of IPTV subscribers more than quadrupled, from 419,000 to almost 1.8m. A far greater number of people are switching to more modern technologies within the BDU environment than leaving that environment entirely.

While official 2015 figures have not yet been released by the CRTC, various estimates put the number of lost subscriptions for 2015 in the 100,000 to 150,000 range, again representing only approximately 1% of the total subscriber base. The tidal wave of cord cutting that some have proclaimed is simply not happening.

Looking at customer surveys shows that not only is the big wave of cord-cutting not happening, but that it is very unlikely to happen in the immediate future. In 2014, 7% of Canadian subscribers said they were “very likely” to cut the cord in the next 12 months. Based on the actual decrease in subscribers in 2014, only 1 out of every 7 of that small base population actually did cut the cord. In January 2015, an IDC survey showed that only 4% planned to stop their service in the next 12 months, with a further 11% saying the planned to reduce the service package. A third survey done in 2015 again showed only 7% of respondents planning to cut their paid TV service. The data shows that cord-cutting remains a marginal phenomenon, not a large-scale disruption of the television status-quo.

Never the less, even a 1% annual reduction in subscribers will start to be felt sooner or later and Canadian BDUs will want to address the underlying reasons customers are leaving. Two of the aforementioned surveys also queried customers as to the reasons for reducing (cord-trimming) or stopping (cord-cutting) their subscriptions. In one survey, 45% of cord-trimmers and cord-cutters cited the need to save money, a further 25% cited they were not using the service enough. In the other survey, 65% of potential cord-cutters and 54% of potential cord trimmers cited cost as the primary reason.

Based on the responses from actual customers, this is an issue of value. A large percentage of customers that are considering cord-trimming and cord-cutting are doing so because they are not seeing the value at the current price point. For Canadian BDUs, this is an issue that can be addressed through tweaks to product offerings.

The Way Forward for Canadian BDUs

Looking back at the data, it’s clear that there is a definite shift in the way that people are consuming media. Video content consumption is on the rise. People are gravitating towards new channels and delivery platforms, from IPTV, to OTT services, to many others outside the scope of this report. New technologies continue to be launched and new players are entering the market. Canadian BDUs are definitely facing challenges that they will need to find solutions for. Some people are leaving the BDUs’ ecosystem behind by cutting the cord. Others are reducing their subscriptions or never subscribing in the first place. However, the magnitude and severity of the BDU exodus is far from the dire predictions made by many commentators.

The collapse of traditional television and Canadian BDUs is not imminent. Never the less, the challenges facing Canadian BDUs are real and Canadian BDUs should take the following three concrete measures to protect their market positions.

Embrace Let’s Talk TV

In its landmark Let’s Talk TV decisions, the CRTC mandated that, as of March 2016, all Canadian BDUs will be required to offer customers a so-called “skinny basic” entry-level service package for no more than $25 per month. Furthermore, by December 2016, all Canadian BDUs will be required to offer customers individual channels on a pick-and-pay basis and in small reasonably priced packages.

Canadian BDUs should embrace these decisions and aggressively promote the new options because these are measures the BDUs would have been wise to implement regardless of the CRTC directive. The majority of people who are considering cutting the cord cite cost as the main reason. The skinny basic package is aimed directly at people with this concern. A $25/month option will lower the cost enough for some part of the segment contemplating cutting that they will choose the skinny basic option over the cord-cutting route. The skinny basic option will also address the value proposition for some of those who say they are considering cancelling their service because they don’t use it enough. For example, a customer who is currently paying $65/month (the average revenue/subscriber for BDUs) may not be watching enough content to feel like they get their $65 worth. However, they may watch enough to feel like they get $25 worth of content and retain a lower priced subscription.

Furthermore, the introduction of skinny basic and pick and pay has the potential to actually bring people back into the fold. In a recent survey of people who do not currently have a BDU subscription, 32% of adults 18+ and 29% of millennials said they would be likely to subscribe given the new options. This directly counters the narrative that millennials, cord-cutters, and cord-nevers are permanently removing themselves from the BDU ecosystem. Given a product packaged and marketed appropriately, many of these people are willing to subscribe.

In order to win over these customers, Canadian BDUs will need to ensure that skinny basic and pick and pay options are promoted, easy to understand, and intuitive to navigate. Technological execution will be very important; think of a pick and pay interface that resembles an app store, modern e-commerce website, or OTT interface, not a 1-800 number with a 10 minute wait.

Content is King

People may be watching videos on new platforms and channels, but it is content that remains king. Canadian BDUs are already vertically integrated and control a substantial portion of the production/broadcasting value chain. They need to continue to focus on investing in and controlling content that users find valuable and that users cannot access on other platforms.

Canadian sports is one example. Bell and Rogers have already taken ownership stakes in the biggest sporting franchises in the country. These investments ensure that this content will be available only via their platforms. But there is room for further investment in the on-field product. Canadian BDUs should take notice of what happens when a sports team begins performing exceptionally well. Ratings for Blue Jays games nearly tripled in the tail end of the 2015 season following the team’s major trades and post-season run. A successful on-field product doesn’t just mean higher ratings and increased ticket sales, it means the games become conversation topics at homes and offices. It makes people want to watch, and they have to subscribe to a BDU service to do so. Canadian BDUs, particularly Bell and Rogers, would be wise to invest in fielding competitive sporting teams.

Additionally, the BDUs should prioritize signing long-term exclusive Canadian rights to content from traditional and emerging players in the US market. Securing the exclusive rights to content from the US Networks, HBO, Amazon, and others, ensures that these players will not bring Hulu, HBO Now, and Amazon Prime to the Canadian market and compete directly with Canadian BDUs. Furthermore, having this content makes Canadian BDUs’ traditional and OTT offerings that much more attractive against current competitors, such as Netflix, and significantly raises the barrier to entry for any new OTT entrants considering entering the Canadian market.

OTT Unity

Canada’s three largest BDUs have entered the OTT space with the launch of CraveTV (Bell) and Shomi (Rogers & Shaw). When these services were launched, they were only available to current subscribers of the respective BDUs. However, that has changed and both services will be open to the general public by the start of 2016. While this means that both services can now attract a wider array of clients, it also means they will be competing directly with each other and with the market leader Netflix.

The BDUs should come together and merge CraveTV and Shomi to create a single Canadian OTT competitor to Netflix. The concept of the BDUs working together to achieve mutually beneficial gains is not far-fetched. MLSE is jointly owned by Bell and Rogers. The precedent for joint-ownership of mutually beneficial assets already exists.

A combined Canadian OTT service makes sense for a number of reasons. It would have access to the content libraries of both services, greatly enhancing its competitive position versus Netflix. A larger single service would also have an improved negotiating position when trying to secure future Canadian content rights from the US players. It’s clear that content rights holders do not want to see a single dominant player emerge and would likely support a combined Canadian OTT entity that would be in a position to seriously compete with Netflix.

Participating BDUs could add the united OTT service to their bundles to improve its value proposition. Since the large BDUs dominate the communications market, having an OTT service bundled in with television, Internet, or wireless subscriptions would substantially increase the service’s user base. It would also have the effect of making Netflix the de-facto 2nd OTT service for most subscribers, limiting Netflix’s ability to grow its subscriber base or increase rates charged to current subscribers. A CraveTV-Shomi merger makes sense and would put Canadian BDUs in a significantly better position to compete with Netflix in the long-run.

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