Pay-TV’s Big Sur

There was a fair amount of knicker-twisting over the past few days after reports surfaced that Charter Communications was raising its broadcast surcharge fees to customers by about 30% to $16.45 per month in August, possibly the highest rate charged by a pay TV company in the country. Aside from the usual shock and outrage expressed by consumer groups over the increase, they were missing the point. In the next five years, that 30% increase is going to seem quaint. Because these surcharges -- almost exclusively pinned to the retransmission consent fees that pay TV distributors pay to broadcasters for the right to carry their stations -- are only going to get bigger.

According to Kagan, a unit of S&P Global Market Intelligence, broadcast retrans fees are set to increase from $11.887 billion in 2019 to $13.332 billion by 2025, a 12.2% increase. At the same time Kagan expects the traditional pay TV universe to shrink considerably from about 80 million currently to 48.5 million by 2025.

Using Kagan’s 2019 numbers, the math works out to average retrans fees being about $12.40 per subscriber per month ($11.9 billion divided by 80 million). By 2025, when subscribers to traditional MVPDs are expected to fall to 48.5 million households, the retrans hurt rises to $22.91 per month, an 85% increase.

Not all retrans fees are the same. The Kagan estimates are an average, as some distributors pay more for retrans and others pay less. Sometimes the fees are based on geography and reach -- as in, a New York TV station will attract a higher fee than a rural one. Sometimes it's based on clout -- a smaller operator will pay a higher fee for a station than a larger distributor, no matter what the geography. 

And not all retrans fees are paid by traditional MVPDs -- some virtual MVPDs pay them, too -- but even factoring in that shift doesn’t change the numbers that dramatically. Kagan estimated that there were about 10 million vMVPD subscribers in 2019, rising to 16.1 million by 2025. If every one of those services paid retrans fees, subscribers would have paid $11.02 per month in 2019, growing to $17.20 by 2025, a 56% increase. first reported news of the Charter surcharge increase, adding that the fees are a way for the cable operator to pass on increases even to price-locked promotional customers. 

Others pointed out that Charter's broadcast fee was just $9.95 per customer per month in early 2019 before a series of rate hikes. 

While that seems like just another example of good old cable greed, it’s actually just the opposite. Cable operators to a person have stressed for years that broadcast surcharges cover their costs for providing the broadcaster’s signal. That each company has a different surcharge is more a reflection of the number of broadcasters in their markets and how they are able to negotiate better retrans deals, based on their total number of subscribers.

Charter has acknowledged the increase, adding in a statement that “programmers annually raise programming fees to deliver the same content, leading to higher costs across the entire industry. The increase we are passing through to viewers is a direct result of these rising programming costs. Similarly, we will pass through any rebates we receive from the loss of live sports during COVID-19.”

The increase vaults Charter to the top of the heap regarding broadcast surcharges -- it’s closest competitor is Comcast, which charges $14.95 per month for its broadcast TV fee. But Charter does not have an RSN surcharge -- the other three major cable operators do -- so overall it is at the bottom of the surcharge list.

Broadcast TV surcharges started to surface about seven years ago, about the time that retrans fees started to get out of hand. According to reports, AT&T was the first to implement a broadcast surcharge for its U-verse IPTV service, a now-nearly-comical $2 per month per customer, to offset some of its retrans costs.  Later, operators across the board began to implement similar charges -- some called them Broadcast TV Fees  -- all to offset rising retrans. Regional sports surcharges began about a year earlier -- DirecTV was first with a $3 RSN charge (only in markets that had RSNs) in 2012, with others following suit. Now those fees can top $10 per month.

The irony is, surcharges used to be a competitive weapon used by cable operators against phone companies. Time Warner Cable (now part of Charter) famously launched an ad campaign more than a decade ago using a stuffy English butler (dubbed “Sir Charge") who pointed out all the hidden fees that peppered competitor Verizon's home phone bills. Now, about 13 years later, landline phone service is an afterthought and surcharges are a part of every cable company’s reality.

There is an argument that the surcharges are necessary, if only to point out to customers that high fees are a way of life in the pay TV business. Not so much in the virtual MVPD space -- Sling TV for example, doesn't have local broadcast channels, so it doesn't have a broadcast surcharge.

Other vMVPDs like YouTube TV have broadcast channels but don't have a surcharge per se. YouTube TV raised the price of its service by 30% ($15 per month) to $65 for more than 85 channels a few weeks ago and has taken a beating for it. Since YouTube TV announced the increase on the same day they announced a deal to carry more ViacomCBS channels, those additional networks took a lot of the heat for the increase.

In a research note after the deal was announced, Evercore ISI media analyst Vijay Jayant estimated that the initial eight ViacomCBS channels (MTV, BET, CMT, Comedy Central, Nickelodeon, Paramount Network, TV Land and VH1) would cost YouTube TV between $3 and $3.50 per month per subscriber. An additional six channels (BET Her, MTV2, Nick Jr., Nicktoons, TeenNick and MTV Classic) were to be added at a later date, and chances are that they probably carry an even lower cumulative fee. I’ll bet that broadcast fees consumed a lot of that extra weight.

A lot of analysts have wondered aloud how long YouTube TV would be able to hold out with a $50 price point. Now they know. 

In a research note Tuesday, MoffettNathanson media analyst Michael Nathanson wrote that “due to the consolidation of the media sector and ever-increasing retrans fees, the vMVPD model is unable to deliver consumers the one thing we know they want: less networks at sub $40 per month prices.”

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Nathanson added that services like YouTube TV still represent a bargain compared to other pay TV formats. He estimated even with the rate hike YouTube TV was still a $75 per month savings over traditional MVPDs because they don’t have hidden fees and pricey equipment rentals.

But it is getting harder and harder for services like YouTube TV to compete. Nathanson referred to sports, news and entertainment streamer fubo TV, which reported total operating losses of about $172 million in 2019, or around $200 per subscriber on a gross margin basis. Over the past year fuboTV, which has a substantially smaller base than YouTube TV, has had to raise prices by $20 per month.

In his note, Nathanson wrote that there is real demand for sub $40 per month pay TV, but the desire of programmers to recreate big TV bundles with ever escalating rates worked in concert to form a “massively unprofitable business.”

That has shown itself in the first ever quarterly decline in total vMVPD subscribers, which occurred in Q1. Nathanson said to expect more of the same in subsequent periods. 

“As prices rise, say goodbye to those empty calories of vMVPD subscriber growth,” he continued.