ESPN Sues Verizon Over Cable Offerings
ESPN sued Verizon seeking a declaratory judgment that Verizon's recent cable offerings -- which create a sports tier of programming separate from the basic cable tier -- violate the contractual agreement between the two companies to always feature ESPN on the basic cable package tier. When you seek a declaratory judgment you are essentially asking a judge to say that the contract says what you say it does. So why is ESPN suing Verizon asking for a judge to say that Verizon's new cable offerings are impermissible under the existing contracts between the two companies?
Because Verizon's recent cable offerings undermine the basis of ESPN's entire business plan. (Fox and NBC also may eventually sue Verizon as well. And, just for the record, I work for Fox's cable channel FS1).
I'll explain that in greater detail below, but in the meantime let's talk about Verizon's new product offering. Verizon Fios has just shy of six million cable subscribers -- making it the fourth largest cable company and sixth largest cable or satellite company in the country. Verizon recently announced a new cheaper alternative to a basic cable package. That offering allows consumers to subscribe to a basic cable package for around $55. Unlike Dish Network's recent Sling TV offering which includes ESPN in its basic tier, the new Verizon Fios package doesn't include ESPN in its basic tier pricing of 35 channels. Instead ESPN -- along with ESPN2, ESPNU, FS1 and NBC Sports Network -- are included in a sports tier package. There are also six additional tier packages for kids, pop culture, entertainment, lifestyle, news and information and sports plus, an additional sports tier package that includes ESPNews. Consumers can pick two of these channel tiers for around $55. If they want an additional tier they must pay $9.99 a month. The key point here is that it's possible to subscribe to Verizon's new cable package without receiving ESPN as part of the basic tier of cable channels.
Why does that matter?
Because only around 20% of cable subscribers are "sports fans." But the other 80% are paying for ESPN and other cable sports channels anyway. That's because under existing cable packages we all pay for channels we don't watch. Indeed, the average cable subscriber may have access to hundreds of channels, but most of us only watch around 17 channels. ESPN's business plan -- as well as just about every cable channel's business plan -- is predicated on receiving money from people who never watch their station.
What Verizon's new package has done is threaten the life blood of ESPN's cable hegemony. Right now ESPN gets money from just about every cable and satellite subscriber in the country, all 97 million of them. That's why ESPN is suing, because this is a direct assault on their business plan.
The huge question we don't know the answer to is this -- does Verizon have the contractual right to create these cable package offerings and exclude ESPN from the basic tier? Given that Verizon is a $200 billion company -- Disney, ESPN's parent is a $188 billion company -- Verizon's lawyers must have signed off on the legality of this maneuver. That suggests there is probably some uncertainty about exactly what these companies have agreed to in their existing contracts. Or at least enough uncertainty for Verizon to make the decision that the potential business benefits of this new offering outweigh their potential business consequences.
Both companies issued statements today on the lawsuit. ESPN said, "ESPN is at the forefront of embracing innovative ways to deliver high-quality content and value to consumers on multiple platforms, but that must be done in compliance with our agreements. We simply ask that Verizon abide by the terms of our contracts."
Verizon fired back: "Consumers have spoken loud and clear that they want choice, and the industry should be focused on giving consumers what they want. We are well within our rights under our agreements to offer customers these choices. "
Some of you may be reading this saying, okay, why should I care about a lawsuit between two hundred billion dollar companies? How does this impact me? Well, the easy answer is this -- this is the first battle over a version of a la carte cable. While Verizon isn't allowing consumers to pick individual channels, they're offering a version of it that allows non-sports fans to avoid paying for sports content.
And in a moment I'm going to try to explain to you guys why this is a potentially blockbuster battle between two media titans that could reconfigure the cable landscape.
But first let me dial you back and walk through the existing cable structure. The most important detail for you to know is this: Every channel in your cable package costs something. While consumers are well aware that HBO, for instance, is a premium channel that costs a specific amount a month, the reality is every single channel has a varying cost. While your cable bill isn't broken out by individual channel, you are paying something for every channel you receive. They all cost something.
According to SNL Kagan these are the ten most expensive channels on cable television and what they cost a month. (I've bolded all the networks reliant on sports to help justify their subscriber fees.)
1. ESPN $6.61
2. TNT $1.65
3. Disney Channel $1.34
4. NFL Network $1.31
5. Fox News $1.12
6. USA Network $1.00
7. FS1 $0.99
8. TBS $0.85
9. ESPN2 $0.83
10. Nickelodeon $0.73
ESPN is in 97 million homes. So at that rate, ESPN would be worth right at $7.7 billion a year in subscriber revenue. That's just from subscriber fees, mind you, it doesn't include advertising.
TNT is worth $1.92 billion a year, much of it predicated on live sports as well.
The NFL Network, which is only in 72 million households, brings in $1.131 billion a year.
FS1 is worth over a billion dollars a year, TBS is worth around the same thing and ESPN2 would be worth just shy of a billion dollars.
This means that your most lucrative sports cable channels are as follows:
1. ESPN: 97 million households $7.7 billion
2. NFL Network: 72 million households $1.131 billion
3. FS1: 88 million households $ 1 billion
4. ESPN2: 97 million households $966 million
5. SEC Network: 75 million households $611 million
6. NBC Sports Network: 80 million households $259.2 million
7. Pac 12 Network: 26 million households $249.6 million
8. Big Ten Network: 52 million households $237.1 million
9. ESPN News: 75 million households $207 million
10. NBATV: 60 million households $194.4 million
11. ESPNU: 75 million households $189 million
12. CBS Sports Network: 53 million households $159 million
13. ESPN Classic: 31 million households $78.1 million
Now, it's important to note that while sports channels are some of your most expensive on cable, they aren't the highest rated. Only twenty percent of cable subscribers watch sports at all. It's why, for instance, "The Walking Dead" ratings crush just about all sports ratings on cable. Sports is a huge and profitable niche, but hard core sports fans are just that, a programming niche.
So how do ESPN and Fox and NBC justify these costs? By putting unique sports programming on their cable channels. Ever wonder why ESPN is so quick to put the college football playoff on cable instead of ABC or why Fox puts the NLCS and the U.S. Open on FS1 instead of just Fox? Or why TNT and TBS want the NCAA tournament on cable too? Because that drives revenue and helps justify these subscriber fees. Sports fans aren't the majority of the country, but they are the most passionate viewers in the country. ESPN can charge so much for its programming because sports fans demand that the channel be carried.
Witness the recent debut of the SEC Network last year, which was the most successful cable launch in the history of the medium. SEC fans would have rioted without the network, voila, the cable and satellite companies all buckled before fans missed a single game. Yes, the cable money is massive, but it's predicated on all consumers, sports fans or not, subsidizing the cost of sports programming.
So you can see why ESPN -- and Fox and NBC -- are so nervous about what Verizon is attempting to pull off here. Verizon has stuck its toe in the a la carte ocean. In a purely a la carte world consumers would be able to select whichever stations they want to subscribe to as opposed to buying cable bundles. Why does that matter? Well, as discussed above, only around 20% of consumers would buy ESPN. That means 80% -- more if you count advertising -- of ESPN's business model would be under siege. (Advertising ads substantial revenue to the cable networks as well, but advertising rates are predicated on the number of households reached. So in an a la carte world, advertising rates would plummet as well since the number of viewers of programming would decline also).
Either ESPN would have to drastically shrink in size or you and I -- the sports fans of the world -- would all have to pay substantially more for fewer cable channels. (This, by the way, is why I believe in bundles and don't support a la carte. The idea of a la carte cable is much more appealing than the reality of a la carte cable. Especially if you're a sports fan. Under the current bundled model we all subsidize channels we don't watch while receiving the best entertainment in the history of the universe for less than, on average, $100 a month. It's not just sports that benefits from the bundle. Shows like AMC's "Mad Men" or FX's "The Americans" only draw a few million viewers. Yet nearly a hundred million pay for AMC and FX. If only those subscribers who love AMC had to pay for it, would "Mad Men" exist? I have my doubts. The bundle relies on everyone paying for something they don't watch. The result? Every station has more money to spend on top notch programming).
If just sports fans had to cover the cost of sports TV ESPN would cost in the neighborhood of $33 a month. Maybe higher. That's nearly $400 a year just for ESPN. Keep in mind that you'd also have to pay for ESPN2 and FS1 and NBCSN and TBS and TNT and whatever additional regional sports networks you wanted. Pretty soon, in order to see all your favorite teams and games, you'd be paying more than you pay for everything now. That's why I believe the bundle makes more sense for sports fans than a la carte cable.
But it's not just sports on TV that would be an issue in an a la carte world. Guess where the money for player contracts come from? Mostly television. Every sports league is built on the bundle too. If the bundle collapsed then either the sports media companies would all lose billions on these contracts -- potentially driving some to near bankruptcy -- or they'd have to restructure for much lower rights fees. If the rights fees came down, the owners would have less money to spend and player contracts, which are ultimately reliant on the bundles as well, would plummet as well.
So if you're wondering why this ESPN and Verizon lawsuit is a big deal, there's your answer. Verizon is attempting to undermine the very structure of all sports deals in the cable era. Attacking the subsidy for sports television that non-sports fans all pay.
It's the first real bullet being fired in the coming a la carte war. This isn't just about what Verizon is doing, it's about what others might do if Verizon has the contractual right to do this.
So here's the biggest question of all: What do those contracts between Verizon and ESPN actually say? And more importantly, what would a judge say they say after he or she reviews them? That's not just a million dollar question, it's potentially a hundred billion dollar question.
Stay tuned.
This battle's just beginning.