How to unbundle?

Recently HBO announced plans to start offering its service directly to customers – without requiring them to use cable providers, such as Time Warner, AT&T, or Comcast. While HBO’s step has been a topic of discussion for months (if not years), the company has a myriad of ways to enter this new market. The article discusses which ways will make the most sense, and how they affect the industry in general. The effect of HBO’s decision on other players is expected to be enormous: CBS is starting its own Internet subscription service, while FX and Showtime – no doubt – will also respond sooner or later.

When thinking about how to sell a brand new service, HBO has to keep the commercial interests of its most powerful allies, the cable companies, in mind. They are currently contributing the lion’s share of HBO’s revenues. Unquestionably, they won’t be happy to deal with a new player invading their currently fertile ground. On the other hand, Netflix and Amazon Prime are becoming more and more HBO-alike, by not only delivering content but by also producing it from scratch. In return, HBO has to step onto new ground. HBO’s options for that are as follows:

1) Make all content available online without any restrictions. That is what all fans are praying for and that, which, probably, is not going to happen. Considering the already existing contracts with cable operators or contracts that have to be signed. Also, if implemented, this package will cannibalize the existing subscription base more than any other way of online delivery. However, if properly advertised, this option will attract the largest number of never corders, primarily a younger generation born in late 80s and 90s that has never paid for traditional TV. Giving them a convenient all-in-one method to consume TV shows, the media conglomerate can safely charge way more than $15 per month (this is the amount HBO receives from cable operators today). All of this requires higher upfront SG&A expenses – but those should not be a problem in light of almost 2 billion dollars of operating profit.

2) Make all content available with a time lag, let’s say, 1 to 2 days. Die-hard fans of “The Game of Thrones” cannot afford to miss the latest episode, while other users will happily turn to such a delayed service. I assume that in this case, negotiations with cable companies should not be as tough as in the first alternative above.

3) Make only specific shows available. This alternative doesn’t make sense to me: the pricing of this package might be complicated; as well as the ways in which customers will be able to choose what shows to see. A trial period could probably work, but this opens loopholes for possible fraud using changing IP addresses. When the New York Times erected its paywall, there were numerous ways to get access to as many articles as one wanted.

4) Divide the content or even start producing ‘HBO digital only’ shows, and tailoring them to the tastes of the younger generation. HBO’s content creation group has enough competencies and experience to film series that might be watched on mobile devices or in smaller chunks. Shorter episodes (think of a 20+ minute long ‘Californication’) might be a good starting point. If we want to look even deeper, consider the 7.6% projected increase in the population of Hispanics teens over the next five years. While they are expected to be fully integrated into our multiracial society, their heritage will still have a considerable impact on tastes and preferences. Also, HBO could pioneer interactive TV (when viewers can vote on the outcome a show). The problem there will lie in cannibalization and scheduling: HBO won’t be able to utilize prime time slots on both channels. The same problem used to face sports leagues, until they made this a priority over and above the interests of teams and players. In HBO’s case, nobody wants to make any sacrifices.

Another question is if HBO will replicate Netflix’s monthly subscriptions or opt for longer plans of, let’s say, 12 months. Analysts and financial departments will root for the latter to ensure the stability of future cash flows, while newly converted customers would like to try such a new offering without a burden of annual contracts.

HBO chose the right moment to introduce the service: after the Q3 Earnings call, Netflix’s shares went down in light of slow subscription growth, while Amazon is just preparing for the next step by purchasing Twitch.TV, a web site where you can watch others playing computer games online. As always, the major goal of the online behemoth is to bring as many consumers as possible to Amazon Prime. Various Twitch.TV perks might become free for Prime subscribers. In this case, Amazon won’t be so concerned about not having a big blockbuster under its belt.

The content quality of series produced by Netflix and Amazon cannot be compared with those of HBO in terms of viewers’ appreciation: Netflix has only one definite blockbuster, ‘House of Cards,’ while Amazon hasn’t yet discovered a recipe. If content is still king in eyes of the younger generation, then HBO is well positioned to charge higher fees.

Moreover, it should not be forgotten that Time Warner still owns and cares about its most praised asset. Historically the conglomerate gave enough decision power to HBO, but nowadays it is taking some amount of autonomy back requiring hefty returns and calibrated decisions in the process. That said, HBO might postpone giving digital access to the markets where Time Warner Cable has the biggest piece of the pie in order not to harm itself. Some rumors say that initially HBO won’t be selling content directly but just allow cable providers create bundles such as one of ‘the lowest tier of channels + HBO’ – without making Americans pay for another dozen of shows they don’t care about. That also seems to be the most logical way to comply with the 1992 Cable Act and the buy-through prohibition.

Customers should feel relief about having more flexibility, while their total monthly dues might not decrease significantly. Instead of paying $80 to $100 to a cable provider, the consumer will divide that sum among Netflix, HBO and other soon-to-come channels. But it will be a conscious choice, and, after all, the concept of free will is one of the most important in the western society.

 
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