INSIGHTanalysis: Will On-Demand Save Cable?

In the US, the major cable companies have ploughed more than $70 billion into digital upgrades, but few consumers have been persuaded that the DTV platform is worthwhile, the group says. So much so, in fact, that churn rates – the proportion of customers leaving or downgrading from DTV – are twice as high as they are for standard analogue cable services.

Most departing customers are either buying into Tivo-style personal video recorders (PVRs) which allow them to watch programmes as and when they want, as well as skip past the advertisements, or they are switching to satellite packages, which now frequently come with a PVR unit built into their set-top boxes.

Customers are not particularly enamoured with paying more money for a digital service, when all it offers over the analogue platform is a slightly sharper picture (and with occasional digital encoding glitches not experienced with analogue) and an on-screen programme guide. In what McKinsey describes as a sure sign of dissatisfaction, customers for digital cable are more likely to abandon it or to downgrade their subscriptions than customers for analogue cable, high-speed internet services, or satellite television.

Whilst McKinsey’s analysis is based on the US situation, a similar pattern has emerged in the UK. Churn rates for cable companies Telewest and NTL currently stand at 16% and 13% respectively; for Telewest, 16% is a record low. The churn levels for BSkyB’s satellite services are presently at 9.4%, and have remained below 10% for some time.

In the US digital cable churn rates are 4.0%-5.0%, whilst analogue cable stands at 2.5-3.0% and direct broadcast satellite at just 1.3-1.5%, according to McKinsey.

Video on-demand to finally come good? Much talk has been made of video on-demand services, from the way they will revolutionise viewing habits and TV schedules, to how they will provide a much-needed injection of revenues for cable operators. These developments have been discussed in a previous INSIGHTanalysis: Video On-Demand Remains On Hold, which concluded that the VOD sector had effectively stalled, pending further investment in content and marketing from operators.

One of the key problems for cable companies is that to offer a genuine VOD service (where content is available spontaneously when demanded, rather then scheduled a regular intervals) is a very expensive operation. It not only requires a hefty network that can transmit all this information to different homes on demand, but operators must also strike deals with content providers like the TV networks and film studios in order to entice customers to the service in the first instance.

So far, most cable groups – both here and in the US – have been either unable or unwilling to generate this further investment, after having spent so heavily on building their networks and infrastructure.

Yet trials are showing that customers like the VOD experience, according to McKinsey’s report. It says that viewers with VOD watched television more and deserted their cable companies less. They were even willing to pay between $10 and $14 a month for access to this VOD content.

However, matters are complicated somewhat by the fact that television networks and studios are worried that VOD systems and PVRs are poised to undermine their advertising revenues, as viewers are increasingly able to avoid commercials altogether (see INSIGHTanalysis: PVR Users Regularly Avoid Ads). As McKinsey puts it:

“Networks and studios – on which cable systems depend for on-demand content – live in mortal fear that any new digital scheme, with for on-demand or Tivo-type services, will jeopardise not only their advertising revenues but also any brand recognition they have with consumers.”

However, McKinsey believes that these objections could be overcome if cable operators offer to share a portion of the revenues gained through subscription-based video on-demand (SVOD) services. In this way networks could be compensated, at least to some degree, for lost advertising revenues.

For the cable groups, SVOD could lead to annual industry profits of $1.5 billion, as new customers subscribe to the services and fewer users cancel or downgrade. McKinsey analysts predict that SVOD could shift the ‘lifetime value’ of a digital customer to the cable companies from a net loss of $20 to a profit of $50.

This revenue gain must be shared with TV networks and film studios if they are to overcome their fear of providing content to such ‘ad-dodging’ platforms as VOD and PVR.

McKinsey says that on-demand services are now at a pivotal point, having only just emerged from the early disappointment of a slow roll-out and poor content. If networks and operators work together, generating quality SVOD content and sharing the resulting revenues, on-demand could become a saviour for successful and savvy networks, mitigating against PVRs’ deleterious effect on advertising revenues.

If cable companies fail to capitalise on the trial successes of SVOD, an altogether different scenario may unfold, according to McKinsey. “In this scenario, the cable companies roll out DVRs [PVRs], which could make ad revenues fall steadily, thereby hurting all networks. These lower revenues would degrade the quality of network programming, and this development would in turn make customers unwilling to pay for digital cable, thus hurting the cable companies,” the group warns.