Weekly Update

HBO, CBS and net neutrality

When CBS got into a retransmission dispute with Time Warner Cable last year, resulting in the network going dark on TWC systems in New York, Los Angeles and a handful of other major markets, the cable operator lost 306,000 subscribers in a month before finally knuckling under to CBS’ demands for higher distribution fees. The episode provided a vivid example of the leverage that content and content owners have over distribution and distributors in the traditional pay-TV industry.

When it comes to over-the-top video, however, the shoe would seem to be on the other foot. According to Reed Hastings, Netflix had no choice but to submit to the “extortion” exacted by Comcast, Verizon and other top ISPs in order to ensure its video streams were getting through to subscribers smoothly, by paying to interconnect directly with the ISPs’ networks.

Fear of ISPs’ power over online content providers, in fact, has animated much of the debate over the FCC’s proposed net neutrality rules, leading to calls to reclassify broadband service as a common carrier utility (a flame Netflix itself as done as much as anyone to fan).

Underlying those demands is an unspoken and largely unexamined assumption that the current power dynamic between ISPs and content providers is both inevitable and immutable. Thus, when HBO and CBS announced this week they were launching standalone, over-the-top streaming services outside the traditional pay-TV bundle, it was widely assumed they could both eventually face the same headaches that Netflix has faced getting their traffic down the last mile.

I doubt CBS and HBO see it that way, however. Rather, I think we’re about to start discovering just how mutable the current dynamic may be.

CBS CEO Les Moonves has made no secret of his desire to squeeze more money from distributors for carrying CBS content. And he’s not too particular about who is doing the distributing, or how. Nor does he regard any potential source of distribution fees as off the table, as CBS made clear during the Time Warner Cable dispute when it blocked online access to its content from TWC broadband subscribers. As as CBS executive VP of planning, policy and government relations Martin Franks pointed out to the New York City Council as it was looking into the dispute, cable operators, including Time Warner Cable, earn “handsome profit margins” from the broadband side of their business and could “easily choose to absorb these [higher] programming costs.”

CBS, of course, won that dispute.

HBO is even more eager than CBS to squeeze more money from distributors because, unlike ad-supported networks, distribution fees are its only revenue stream (apart from DVD sales of its original series). Moreover, HBO is in the wholesale business. It sells through distribution, leaving most sales, marketing and customer support functions and costs to the distributors. It’s entire organization and operation is structured around that wholesale model. Going direct-to-consumer, at any significant scale, would be a fundamentally different business for HBO, with different economics and requiring a different skill set.

It seems far more likely, as I alluded to in my previous post on HBO, that both CBS and HBO see direct-to-consumer OTT streaming ultimately as a source of leverage to drive up distribution revenue more than as an end in itself. And they see the “handsome profit margins” that ISPs are earning by providing streaming access to their content without paying for carriage as a large and largely untapped source of new distribution revenue.

How the networks try to structure deals to get at that revenue may vary. These are very early days yet. In the case of cable ISPs, payment for broadband carriage may get laundered through pay-TV carriage and retransmission consent deals, for instance, an arrangement that might suit both sides: retransmission consent is the networks’ greatest point of leverage with distributors, while the operators will not want to advertise to shareholders that their fat-margin broadband business is turning into the low-margin pay-TV business. In other cases, HBO may come bundled with broadband service, disguising the cost to the consumer. But disguising the payments won’t change what’s really going on.

As consumers increasingly demand online access to content, content owners — slowly, inexorably — will gain leverage over broadband distributors, including ISPs, just as they have in nearly every other media distribution market (ebooks are currently a notable exception). When that happens, questions regarding paying to connect, or paying for prioritization could produce very different answers than they do today.

Net neutrality is a complex issue. There may be many good arguments for treating broadband service as a utility and regulating providers that way. But insisting that ISPs will perpetually be able to extort payments from the likes of Netflix, HBO and CBS if not restrained is not one of them.