Vandaele Capital

The Cord Cutters

Will we finally say goodbye to cable subscriptions and embrace online television in 2016?

Not so long ago, internet services were restrained to the back catalogs of older shows on Amazon and Netflix or simply day-after replays on Hulu Plus. But things have changed drastically and now these companies are not only creating their own original series but are also winning awards and fostering large audiences. Service providers like Sling and PlayStation Vue have sprung up to offer traditional cable channels like AMC and ESPN live without signing long-term irritating contracts with Comcast or Time Warner Cable, even HBO Go offers on demand service. So the big question remains; do you dare to “cut the cord” and still get to enjoy all your favorite shows? If the answer is yes, then what will be the cost? We’ve all heard the rumors, some of us even felt the temptation, but is cutting the cord and watching TV over internet the right move?

My guess is it’s not. Cord-cutters are rare species, and the reasons are pretty obvious. To start, even if you drop pay TV, you still need an Internet connection; generally provided by the very same companies; folks like Comcast and Verizon and their subscription packages are hedged to ensure that if your TV bill goes down, your internet bill goes up to maintain the balance. At the same time, cord-cutters often lose out on a huge swath of content that is available only through pay TV, including high-demand sports. “True” TV freedom and real cost savings require a much more thorough reorganization of the market.

Sole reason behind this whole fiasco is that people are still paying for TV. The thin trickle of households who dropped pay TV in recent years is barely enough to make a dent in the consolidated industry, in other words the numbers are simply ignorable. Slightly less than 100 million households use some sort of pay TV according to Nielsen surveys, which either comes from cable, satellite or alternatives like Verizon Fios, AT&T and U-Verse. These are lower when compared to the statistics from a few years back, when 105 million households had pay TV, but it is hard to classify it as a revolution and there are no clear indications of an accelerating trend. A separate survey by Leichtman Research Group found that around 83% of households had pay TV subscriptions in 2015. That indicates 4% decrease from 2010 where 87% population was using pay TV, but surprisingly higher than 81% in 2005.

Bottom line here is, pay TV continues to remain a staple in the American diet. So who is opting for Netflix and other similar services? In past few years explosive demand for internet streaming services like Netflix, Hulu, and Amazon Prime has confused many people. Netflix undoubtedly has emerged as an impactful player, and its subscription numbers depict its fast-growing popularity. In 2011, when the company started keeping track of streaming subscriptions as opposed to the old “send-me-a-DVD” service, they counted around 20 million paid users. Today the numbers are almost double. The catch though is that a large chunk of Netflix families also have pay TV at homes. It is not an either-or competition; in fact some research found that approximately 83% of households with an internet-connected TV also have a pay TV package. Comparing these numbers with “broadband-only” households, ones which have high-speed internet but no pay TV, estimates from Nielsen suggest they make up between 4-8% of total American households.

Why are people not cutting their cords? Given the expanding universe of high-quality programming available through internet and easy accessibility, it seems surprising and to some extent shocking that people are sticking with pay TV, but at the end of the day it’s all about costs and benefits. The biggest issue perhaps is that cutting cord does not save money, even if you drop pay TV, you still need internet for other daily chores, and guess who provides high-speed Internet? The very same companies which offer pay TV subscriptions. This gives them incredible market power, allowing them to adjust prices in a specific way that limits the benefits of cord-cutting. Simply glance at the packages available in Southern Florida, Comcast sells a bundle that includes 140+ channels, high-speed Internet, and telephone service for $89.99 per month for two years. Similar deals are available around the country. Getting just internet — at the same 75Mbps speed — costs $79.95. Opting for slower internet brings the cost down to $40 or $45 per month, but with uncertain consequences for your ability to stream video on multiple devices. Similar is the case of Verizon, the savings are considerably small. A bundle costs as little as $70, while purchasing internet alone — at identical speed — is $60. These calculations do not account for the fact that if you choose the internet-only approach, you’re more likely to want additional, sometimes costly streaming subscriptions — like HBO Now or Hulu Plus.

You cannot save $100 each month by simply dropping your cable account, unless you drop your internet connection with it. You need to ask yourself first: “Should I spend an extra $10 to $40 dollar per month — the cost of a single family meal — to get a range of pay TV channels, including lots of popular sports channels, which I cannot get otherwise.”

Then i asked myself: Does password-sharing change economics? Password-borrowers do get real benefits, accessing subscription perks on someone else’s dime. But they still need to pay for Internet — which is often a far bigger expense. Thus overall it doesn’t looks like that password-sharing changes unfavorable economics of cord-cutting. Meanwhile, Netflix and HBO have openly embraced this practice, which tells us that it must be fairly limited — posing little threat to companies. In fact, streaming companies tend to benefit from this practice, for instance your 20-something daughter insists on using your Netflix information in her new apartment, which makes it harder for you to cancel your account, even if you no longer need it. Netflix on the flip side is happy about this new development as it is on the winning side yet again. The contrary however is not good for them, a world where people drop their accounts for lack of interest and their children never purchase a subscription as they are unable to afford it. At some point, password-sharing may become so rampant that it necessitates a crackdown, but for now, it is considered a tolerable nuisance.

Will cord-cutting ever take off? Actually for cord-cutting to really take off, the economics of the industry need to change, which means less regulation, greater competition, or simply both. Those looking for reliable, high-speed internet usually are stuck with a couple of choices: perhaps a lone cable company and a satellite or telephone competitor. With these few choices, there is little pressure on companies to compete aggressively on price. Stricter regulation could force down costs by dictating rates — possibly also pushing companies to establish clear and separate prices for internet, TV, and phone. The trick in this case would be to find the appropriate price structure, something which keeps companies sufficiently profitable that they can continue to invest in new lines and technology, but not more than that.

Another option is competition, but again one needs to be careful about implementation. Companies like Time Warner and Verizon don’t just provide TV and broadband services, they also own and run physical lines, managing complex networks necessary to deliver those services. For new competitors like Google Fiber building their own equivalent networks from scratch would be costly and redundant. Yet they’d have a huge competitive advantage of simply piggybacking on existing infrastructure; without any obligation of maintenance or expansion. These problems are not insoluble, other countries have tackled these problems but competition comes at a cost. In current scenario costs are likely to remain high and with big players controlling both pay TV and internet access, unless a industry disruptor comes along, cord-cutting still seems a farfetched fairytale.

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