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Value of the Game

When ESPN paid the National Basketball Association $2.4 billion for TV rights to the league's regular-season and playoff games from this season through 2008, it marked the first time in television history that one network held national rights to all four major professional sports leagues.

The fact that a cable network set that precedent underlines the highly influential position that such services yield within the sports world. But sports networks also exude the same powerful influence within the overall cable industry.

Sports programs consistently produce the highest ratings while serving as the champion driver of local ad-sales revenues for operators year after year. Some observers maintain that sports coverage has helped build the cable industry into the preeminent home-entertainment choice for most consumers.

But cable operators have paid a very hefty price for the appeal of sports programming. Sports networks draw the highest license fees of any basic networks, and those prices continue to climb at a pace that's unmanageably fast for most MSOs.

Few executives downplay the importance of sports to cable's overall appeal, or the value of games to the consumer. Yet in today's difficult environment, many argue that high-priced sports networks aren't worth the cost to operators.

Scoring for the industry

Any cable-industry veteran will confirm that live sports events — along with uncut and uninterrupted theatrical films — were a linchpin for much of the growth that the developing sector enjoyed in the late 1970s and early 1980s.

Once home to such obscure pastimes as bull riding and table tennis, cable sports networks have now superseded the broadcast networks as the preeminent source of marquee TV-sports programming. For example:

  • ESPN's NBA deal — complementing its contracts with the National Football League, Major League Baseball and the National Hockey League — makes it the first U.S. cable or broadcast networks to hold rights to regular-season games from all four major pro-sports circuits;
  • Regional sports networks hold local television rights to 67 of the 80 U.S.-based teams in the NHL, NBA and MLB;
  • Cable networks hold rights to a portion of all the major professional golf and tennis tournaments;
  • And, after having started with the 2000 Games, MSNBC and CNBC will televise a portion of the Winter and Summer Olympics through 2008.

Cable dominates the TV rights to all but two sports, the NFL and the National Association for Stock Car Auto Racing (NASCAR), said Fox Sports Networks chairman and CEO David Hill.

But the medium has even made inroads with both of those organizations. ESPN holds the rights to primetime Sunday-night NFL Sunday Night Football
games; FX and Turner Network Television air a sizable slate of NASCAR events; and Speed Channel offers a heavy dose of NASCAR-centric "shoulder" programming.

Even pay-per-view distributor In Demand LLC offers an enhanced NASCAR package.

Cable networks' ability to tap twin revenue streams — ad revenues and operator license fees — has all but put broadcasters out of the bidding for exclusive rights to the major sports.

"I don't think you can overestimate the value of sports to cable," said ESPN president George Bodenheimer. "Sports drives cable's foundation business, which is an expanded basic-cable subscription. That's the bread and butter of the business, because it's the most important product they have to attract and retain customers."

Sports equals ratings

Certainly, a lot of viewers are watching sports events. Despite operators' contention that only 20 to 30 percent of actual subscribers are interested in such programming, very few other genres can compete with sports in terms of overall ratings.

Over the last five years, sports — dominated by ESPN's NFL telecasts — represented nine of the top 10 and all but 14 of the top 50 highest-rated shows on cable, according to a Turner Broadcasting System Inc. analysis of Nielsen Media Research data.

"Sports are tribal, so inevitably the highest-rated programming on cable is always sports," Hill said. "With a cable world that is largely populated by repeats, sports by its very nature is the best original programming that you can get."

And after several years of declining viewership, cable sports ratings are actually on the rise this year. ESPN's third-quarter ratings were up 31 percent to a 1.7, according to Nielsen.

Cumulatively, Fox Sports Net's family of regional sports services posted a 3.54 metered home market household rating for coverage of local MLB teams — a 4 percent increase over the 2001.

This season's ratings rise comes on the cleats of the 2001 season, which generated a record 11 percent rate of year-to-year growth from the 2000 campaign.

And ESPN's monthly cumulative viewer numbers are upwards of 65 percent to 70 percent, according to Bodenheimer — giving further evidence of a large segment of the viewing population's intransigent interest in sports.

"There's an unpredictability about live sports events that makes it a consistent ratings product," he said. "Sure there are ups and downs, but by and large people schedule their lives around televised sporting events.

"Sports is ingrained in our society. It remains a pillar in the culture of United States."

Operators agree that sports are a societal phenomenon that touches the lives of many cable subscribers.

"Sports [and sports programming] are part of the fabric of people's lives," said Charter Communications Inc. vice president of programming and PPV Patty McCaskill. "You can look at attendance in professional and non-professional sports events all the way down to local high school games and kids' events. In order for us to adequately serve our customers, sports has to be part of our offering."

Sports may be the industry's most-watched programming genre, but it's also the most expensive in terms of license fees.

ESPN and the Fox Sports Net regional services are the only networks that command around a $1 or more per subscriber from operators. In some areas — where ESPN is in the midst of a long-term contract that allows for 20 percent per year increases — the "Total Sports Network's" license fee is now around $1.80 per month, according to sources close to the situation. And some regional sports services cost more than $2 per subscriber.

Those rates compare unfavorably to other networks that may generate higher primetime household or total-day ratings. Female-oriented Lifetime Television — which has won the quarterly household-ratings race in primetime for the last 7 quarters — costs operators nearly 10 times less than a regional sports service. And kidvid titan Nickelodeon, the total-day ratings champion for 28 consecutive quarters, costs only 33 cents per subscriber.

Arguably, other niche networks — including Cartoon Network, Food Network, Cable News Network and Fox News Channel — are very attractive cable brands. Yet combined, the license fees for those services barely top what operators pay for just ESPN and one regional sports network in major markets.

Throw in entertainment networks such as TNT — which offers very high-profile and expensive sports fare, such as NBA games, NASCAR, the British Open golf tournament and the Wimbledon tennis tournament — and sports makes up a significant percentage of an operator's overall programming outlay.

For a small operator, four sports-oriented channels — ESPN, ESPN2, TNT and a regional sports network — represent as much as 30 percent to 35 percent of the total programming bill, said National Cable Television Cooperative senior vice president of programming Frank Hughes.

While much has been made of the pure economics of ESPN's 20 percent yearly increases, operators said the high benchmark has had a trickle-up effect. The deal has emboldened other networks to create similar rate escalators — albeit not as steep as ESPN's.

"The big guys who are focused on sports have set the trends and everyone is following their lead," said one operator who wished to remain anonymous.

"Their mindset is, 'ESPN got away with it, why can't we?' But their pitch to us is, 'Well we're not asking for 20 percent like those other guys are. We're only asking for 5 percent or 10 percent a year.' "

The rapid rise in programming costs — triggered by rising sports outlays — has forced operators to walk a tightrope. They must try to manage near double-digit increases in their programming expenditures, while trying to keep consumer rate increases within the 4 percent to 5 percent range.

"Yesterday, the impact on programming costs in terms of margin erosion was tenths of a point," said Cox Communications Inc. vice president of programming Bob Wilson. "Now, its one or two percentage points per year. Programming costs are becoming an increasingly bigger part of our budget, and the rate levels that sports programming have reached makes those increases that much more impactful."

Blame game

Sports-network executives admit that their product is more expensive than typical entertainment fare, saying it costs more and more to acquire sports rights.

Despite the sluggish economy, the price of rights to marquee sports leagues and events continue to escalate. In the last decade, yearly rights for each of the major sports leagues have increased substantially.

The NBA, for example, will receive on average $765 million a year from ESPN/ABC Sports and TNT this season, more than an elevenfold jump from the $68 million it received from TBS Superstation and TNT in 1990. (In 1990, NBC Sports paid $150 million for a broadcast-only NBA package that included some games that will be televised by TNT or ESPN.)

Further, rights fees for NASCAR events and major golf and tennis tournaments have increased dramatically. Network executives bemoan the increase in sports fees, but say it's a natural function of a free market.

"Our prices are not either fair nor unfair, but rather determined like any price by the supply and demand of the marketplace," Fox Sports Net president Tracy Dolgin said. "That's why [operators] pay — not because we're nice people, not because they like Fox, but because the product is worth what it's worth."

Added Bodenheimer: "With any popular product, whether its sports, the movie business or the scripted drama business, you have big companies competing with each other. When you have competition, it tends to increase prices. It's a complicated structure with a lot of moving parts."

But Bodenheimer avers that ESPN, in particular, offsets those costs by providing operators with more value in other areas — particularly local advertising sales. ESPN will generate more than $8.25 per cable subscriber in local ad revenue this year, the network noted, and will drive an additional $3.10 in local ad sales revenue to other networks through packaging of its signature programs.

"Sports is your lead inventory in what should be a thriving local ad-sales business, and it defrays the notion of the wholesale expense of ESPN," Bodenheimer said. "So the end result is [operators] pay more for a cup of coffee than they do for a month's worth of service from ESPN. That's the best deal in the business."

Although Charter's McCaskill concedes sports networks' positive effect on ad sales, she doesn't believe it completely balances out the networks' high license fees.

"I think sometimes the sports networks tend to overestimate what they're bringing in," McCaskill said.

More bluntly, Time Warner Cable executive vice president Fred Dressler called ESPN's ad-sales argument "a joke."

But despite all of their posturing, operators have continued to ante up for sports programming. "To the extent that everyone has been successful up to this point, we've all been complicit in it," said Dressler. "But that doesn't mean it has to go on like that forever."

Operators claim they get the worst of the deal because, unlike the other members of the sports-rights fee chain, they can't pass increased costs on to the consumer.

"We are the last link in the food chain, and because of market forces, we don't have nearly as much discretion as other links in the food chain have to decide whether they want to have the product or not," Wilson said.

But the dynamics must also change if the cable industry is to remain financially solvent, operators said. Cable companies face depressed stock prices and losses in their profit margins, due to capital investments in digital upgrades and other technological advancements. Thus, operators said they can no longer absorb high license-fee increases.

"When your total programming costs go up 12 percent to 15 percent a year, and while the industry asks you to minimize retail increases at 5 percent or less, how long can you continue to survive when you programming costs are 40 to 50 percent of operating costs?" the NCTC's Hughes said. "If half of your costs are rising faster than your retail rates, how long do you have a business?"

In many cases, operators claim, the additional sports-rights costs stem from bidding wars between programmers. For instance, TNT recently outbid ESPN for the rights to golf's British Open, paying three times what the all-sports network had laid out. And because ESPN isn't offering a rebate for the lost tourney, MSOs feel they're paying for the same event twice.

"These increases allow the networks to go out and overpay for sports product that we're already paying for on another channel," said one operator who wished to remain anonymous. "We're not getting a discount from the network that lost the rights, but we're essentially paying twice for the same programming, and that's not right. But we're silly enough to pay for it."

Untouchable genre?

As license fees increase, talk of moving high-profile sports networks off of basic cable inevitably grows louder.

Operators have always threatened to remove sports networks from their lineups, but aside from a few isolated and short-term examples on the regional level, for the most part they've failed to pull the plug.

Fears of reprisal from a very vocal segment of the subscriber base — and the potential loss of sports fans to such competitors as direct-broadcast satellite providers — have prevented such action in the past.

But the economic challenges that many MSOs now face may force them to make tough decisions in the near future, operators said. Removing once-untouchable sports networks from basic must now be contemplated as a serious option.

"I think [sports networks are] very hard to touch, but I also think they are getting to a point where they are not untouchable," Cox's Wilson said. "I think people are looking real hard at that value relationship."

But Fox Sports's Hill said he believes sports are such a strong draw, that operators who decide to drop such networks do so "at their own peril."

While recognizing the value of sports, McCaskill said its value must be balanced with the need to maintain reasonable customer rates.

"There may come a time where we have to make those hard decisions," McCaskill said. "I hope that reason prevails and we don't have to get there, but if we do have to make those hard decisions, we will."

YES vs. Cablevision

Many operators said their fears about surviving without a major sports network were somewhat quelled by the ongoing dispute between Cablevision Systems Corp. and the start-up Yankees Entertainment & Sports Network.

The channel is partially owned by the New York Yankees, and this past season was the exclusive TV outlet for 130 of the MLB team's games — contests that had been televised by Cablevision-owned Madison Square Garden Network.

Unwilling to pay a $2 per subscriber fee, the Bethpage, N.Y.-based MSO refused to carry YES Network. And despite the popularity of the Yankees — and a major marketing push by DBS provider and YES affiliate DirecTV Inc. — the MSO was able to avert a significant blow to its subscriber base.

Cablevision lost an estimated 17,000 subscribers due to the YES dispute — a far cry from the masses expected to flee to DirecTV.

And for its part, YES has suffered significantly in terms of ad sales. It's provided significant make-goods for advertisers who expected to reach Cablevision's 3 million subscribers, all of which are in metropolitan New York City.

"If we learned anything from the Cablevision-YES situation, it's cable operators ought to be a little less concerned about the consequences of taking a firm position," said Dressler of TWC, one of the first MSOs to reach a carriage deal with YES.

Added Cox's Wilson: "We've all looked with interest at the YES situation with the expectation that it would tell us a lot about where we are now. It's helped us get much more comfortable with making some tough decisions."

But Fox's Dolgin warned operators not to read too much into the YES situation.

"Don't make the mistake of saying the YES situation has any representation in the rest of the world," he said. "If a cable operator honestly believes that YES has not had any effect on Cablevision's business, they would be sorely mistaken. It's definitely harming both of them to not have a solution."

Tier time

Another option for operators is to place sports product on a digital or pay tier. Time Warner and Cox are already experimenting with offering low-priced sports tiers as part of their digital cable packages.

For now, the tiers include upstart networks such as The Tennis Channel, the Fox Sports Digital Networks and Fox Sports World. But operators also project established services like Outdoor Life Network, The Outdoor Channel and The Golf Channel could be shifted to tiers. Ultimately, operators say the goal is to place all sports programming on the tier.

"My goal would be to take the regional sports networks and the ESPN networks and either offer them à la carte or on the tier," Dressler said. "As the regional sports deals come up, we're having those discussions."

Cox, which five years ago established sports tiers to alleviate major basic-cable fee increases related to the launch of new sports services, has a similar goal.

About 60 percent to 80 percent of Cox digital households are opting for the MSO's sports tier, which retails at around $6.95 to $7.95, said Wilson.

"As prices for some of these established sports networks climb, ideally that's where we would like to consider putting them to create customer choice," he said. "We want to create options like they do for the automobile industry. If someone doesn't want to pay full price for a car, then they can scale back some options to get the price down."

Indeed, consumers want control, which bodes well for the future of sports tiers, said McCaskill. Charter charges around $3.99 for its digital sports tiers, which in certain systems offer such networks as ESPN Classic and ESPNews.

But Bodenheimer said such scenarios are unlikely because removing an ESPN from the basic package would severely diminish the value of the operator's basic-cable offering — and hurt the network's overall ad-sales efforts by limiting its available viewing universe.

"I don't see a day where the most popular product in the U.S. is totally segmented up on a tier," he said.

Tennis Channel president David Meister, whose fledgling service will launch on TWC's sports tier sometime next year under a 15-year affiliation deal, believes the digital sports tiers are a "short-term marketing step."

Meister said the sale of such tiers will ultimately get lost in the MSO's overall sales push, which will include pitches for high-speed Internet access, premium subscription video-on-demand packages and basic digital tiers.

"After five or 10 minutes into an operator's sales pitch to a consumer, a [CSR] finally gets into digital tiers," Meister said. "If you consider that there's 30 to 40 percent that don't take these tiers, it's a matter of whether it's worth the bother for operators."

Nobody can — or will — predict how the contest between operators and sports networks will play out. Some observers believe that with the advent of broadband and interactive technologies, VOD and the Internet, the sports-television landscape shift completely over the course of this decade.

For the time being, operators and distributors say they'll continue to try to find some middle ground in dealing with the complicated issue of sports-rights costs.

"The negotiations have always been difficult," Bodenheimer said. "What we're doing is working to use the power of the ESPN brand to benefit the cable operators. I'm not concerned about any upcoming negotiations … I think we're delivering."

Said McCaskill: "As our partners they have to recognize that we have an obligation to our shareholders. I'm hopeful that as time goes by, we'll have productive conversations and find ways to be able to help everyone within the partnership find a good business model."