Hollywood’s Next Reckoning: Studios Get Real About Runaway Spending on Streaming
There was no honeymoon period for Warner Bros. Discovery last year after the two companies tied the knot in April.
CEO David Zaslav, his top lieutenants and the teams at HBO, Warner Bros., Turner and Discovery went straight into hard months of restructurings, layoffs and management changes. That was expected after a massive $43 billion transaction.
What Team Zaslav didn’t see coming was the sudden slowdown in subscriber growth for streaming services and the extreme pressure that unwelcome trend would put on the new enterprise. Eleven days after WB Discovery was born, Netflix delivered a shock to the industry with its earnings disclosure that the pace-setter for streaming growth was starting to lose subscribers.
What came next for WB Discovery was not pretty. A slew of TV shows were canceled and movies were scrapped, even at the eleventh hour of post-production (RIP “Batgirl”). In the feverish search for cost savings, the HBO Max streaming service began pruning its vast content library of little-watched shows in order to save money on residual and royalty obligations.
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But that was 2022. As the new year dawns, WBD is moving forward with a much-refined strategy for growth. And in many ways, that blueprint looks more like the TV business of old, before the streaming boom upended the market. JB Perrette, CEO and president of Warner Bros. Discovery Global Streaming and Interactive, predicts that TV’s major players will move in the same direction, as Hollywood struggles mightily to improve the economics of streaming.
“In 2022, we were the canary in the coal mine,” Perrette says. “We got ahead of it first. What you’re going to see in the next couple of months is everybody following that playbook.”
Part of the blueprint for the biggest players in the entertainment sector might include a return to an earlier strategy to guarantee income: bundling channels that entice consumers to make longer commitments. Also in the mix: using sports rights to preserve the linear cash cow, and partnering with telcos, TV-set makers and even retail outlets to help drive digital subscriptions.
As WB Discovery, Disney, Comcast, Paramount Global and other entertainment conglomerates look to turn the tide of red ink after years of heavy investment in streaming, a harsh reality has come into sharp relief. Hollywood is spending more than it ever has on content to build up new platforms that are unlikely to ever deliver the kind of fat profit margins that old-fashioned cable TV channels (think USA Network, ESPN, TNT, CNN, Disney Channel, MTV, Discovery Channel) did when cable was in its prime from the late 1990s to the late 2010s.
One reason is that linear cable was built around regionally based cable operators that sold consumers packages of TV channels at various price points. The bundling of channels provided a cushion for content owners because it was an all-or-nothing proposition. Consumers had no ability to pick and choose individual channels. That meant channels received contractually guaranteed monthly revenue, not from subscribers directly but from affiliated cable operators.
Another factor that made the cable programming business so good to Hollywood for the past few decades is that Disney, the former Time Warner and Viacom were able to jack up the wholesale price of their most-watched channels every four to five years in their contract renegotiations with cable operators.
When Netflix came on strong a decade ago and popularized the direct-to-consumer streaming model, Hollywood’s major studios saw a big chance to cut out the cable middleman and build their own channel platforms. As it turns out, attracting subscribers one by one is a much heavier lift than leveraging the value of must-have channels against cable operators.
“Someone once described the old cable bundle as being part of the socialist world,” says Michael Nathanson, senior analyst for SVB MoffettNathanson. “Going forward, it’s very much a capitalist world.”
Seasoned showbiz watchers are predicting 2023 will be a hard year of restructuring, layoffs, budget slashing and strategic second-guessing for the biz. There will be cuts; there will be shutdowns of underperforming assets.
Preview the year in media in VIP+ special report “2023 Outlook”
“Consumers are spending more money than ever on home entertainment services. That’s been a success. The question is, why have profits collapsed?” says Benjamin Swinburne, media analyst for Morgan Stanley.
The math on the costs of streaming versus earnings potential isn’t adding up, which is why every major media and entertainment conglomerate ended the year with double-digit declines in their stock prices.
“This is a very painful transition, from one model to the other and from one technology to the other. It’s going to be a multiyear shakeout of the major players,” says Swinburne. “The reality is that everyone outside of Netflix is pretty early in the streaming game. They’ve gone into it guns blazing to build businesses. Pivoting from heavy investment mode to maximizing profits is not easy for any company, especially those with legacy infrastructure costs.”
Many predict new forms of content bundling will emerge out of necessity for consumers and content owners alike. Verizon is among the well-positioned players looking to capitalize on the shakeout through its fledging +play service. That service, which launched in beta form last year, offers Verizon customers one-stop shopping for an array of streamers. Verizon issues +play users a single bill, and it handles all promotional communications with subscribers on behalf of the streamer. Verizon wants to partner with content owners to become a portal for easy billing and navigation for their streaming apps, but it does not want to go so far as to become a middleman distributor of channels.
“A lot of consumer behavior is trending the way we’re going. We’re à la carte — Pick your own bundle and get the connectivity that you want,” says Erin McPherson, chief content officer for Verizon Consumer Group. “We’re going to rebundle in a more consumer-friendly manner than the traditional bundle.”
While there is new scrutiny of the production and marketing costs associated with feeding high-end streaming platforms like Netflix, Disney+, HBO Max, Hulu, Paramount+ and Peacock, there has been a surge of activity in advertising-supported streaming. That side of the streaming sector has grown so fast and so wide that it has replicated almost everything that was once found in the double- and triple-digit channels on the cable guide. There are themed channels for every genre and niche interest imaginable, from sports to anime to silent movies (see Variety Intelligence Platform's "Life in the FAST Lane 3" special report, pages 13-17, for a breakdown). On the Pluto TV platform, owned by Paramount Global, for example, there are around 100 free, 24/7 livestreaming channels devoted to individual shows like “Beverly Hills, 90210,” “Baywatch,” “Star Trek,” “CSI” and many more.
Known by the acronym soup of AVOD (advertising video on demand) and FAST (free advertising-supported television), some channels stream a nonstop linear feed of content and some offer a mix of live and on-demand options. The number of such channels available in the U.S. exploded in 2022 to more than 3,000.
Go deep on FAST in VIP+ special report “Life in the FAST Lane”
“It’s a pretty compelling substitute for basic cable programming,” says analyst John Harrison, EY Americas leader for Media and Entertainment. “They are curated channels with a huge amount of content that used to be syndicated and on basic cable. Now it shows up on a much more targeted basis and at a price point that works for most people: free.”
Paramount Global has been the most aggressive among the majors in diving into the FAST sector with its Pluto TV unit, even as it also plays in the subscription sector with Paramount+. Paramount bought the fast-growing Pluto TV in early 2019, just in time to ride the ad-supported wave. In tough economic times, Paramount likes its hand, according to Jeff Shultz, Paramount Global’s chief strategy officer and chief business development officer for streaming. “We do think that people will begin to take a look at the total amount they are spending on subscription services, and Pluto TV will always be a fallback,” Shultz says. “You don’t have to go from paid video to nothing at all.”
Industry veterans say the streaming business was destined to eventually encompass a broader mix of subscription and ad-supported channels, because the dollars from Madison Avenue are essential to the profitability of content over the long haul. The new regime at WBD is actively considering launching some free streaming channels outside the HBO Max paywall. Those channels would feature older content from the HBO, Turner and Warner Bros. libraries.
“The history of the content business has been ‘Produce once and sell it as many times as you can in different windows,’” says Perrette. “What’s happened the last 15 years or so in the streaming business is that the belief became ‘Produce once and monetize once.’ Somehow, in the streaming context, that got translated to ‘Forget windowing, forget exploiting content on multiple platforms.’ The streaming business got into the content-warehousing business. For the economics of content, warehousing is not a good strategy.”
Smart TV manufacturers including Sony, Samsung and LG are helping to make sure that viewers have ready access to free streaming channels. Apps for Netflix and others are built right into the set’s home operating screen, turning it into a portal for all kinds of video and audio content. LG and Samsung, in particular, are trying to capitalize on the strength of their proprietary platforms by creating their own ad-supported streaming channels that are highlighted on the home screen. The vast majority of viewership of Pluto TV’s ad-supported streaming channels comes through smart TVs, Shultz says.
"Smart TVs are set to be the delivery mechanism of the future for households via their cohesive interfaces," says Gavin Bridge, who has written extensively about the FAST phenomenon as the senior media analyst at Variety Intelligence Platform. "The fact that the majority of FAST viewing is coming via Smart TVs and not handheld devices or computers also shows how consumers consider FAST in their content mix: it is living room entertainment and thus part of the entertainment consideration set alongside other sources like TV and subscription streaming."
Last month, LG unveiled a pact with culinary TV star David Chang’s Majordomo Media to create a Majordomo TV channel featuring original and vintage content. Roku, another disruptive digital distributor, is similarly creating its own channels. “The TV is the hub of the home. It’s more than what the TV was 20 years or even 10 years ago,” says Matthew Durgin, LG’s senior director of North America Partnerships. “We built both a TV set and an operating system. And we put partnerships into those things that put real consumer value into owning an LG set.”
That means opportunity for LG to grow in multiple directions as a provider of content, data and information. It’s a new kind of platform that makes it easy for consumers to tailor channel lineups to their tastes.
Durgin sees huge potential for free streaming channels distributed via independent voices such as Chang’s to launch channels with far lower startup costs. “It’s a great time to be an entrepreneur with content,” he says. “You can develop a very robust strategy delivering content directly to consumers. In the past, you needed millions of dollars to develop an application with engineers. Now, with the rebirth of TV with linear services directly in the device, we can bring content directly to consumers without having to build content applications.”
The 2023 outlook for Big Media is grim, in part because the pay TV arena reached a milestone in the third quarter of 2022. The total volume of affiliate fees — the money distributors pay content providers to carry their programming — earned in the quarter by the largest publicly held companies, including Disney, Warner Bros. Discovery, Comcast and Paramount Global, declined year over year for the first time in more than a generation. By Wall Street’s measure, the collective dip was only about 2%. It may even rebound slightly in future quarters, but it was nonetheless a psychological threshold that set off a new level of alarm behind studio gates.
“The industry has seen huge growth in streaming costs, but there hasn’t been anything similar in the reduction of linear spending. It’s been almost entirely additive. That’s why the industry finds itself where it is right now,” Swinburne says. “Investors are looking for a sense of urgency around costs in linear that hasn’t been there in the past.”
The biggest holdouts that have stayed firmly rooted in linear cable are, not surprisingly, two of the most profitable TV channels in the history of the medium: Disney’s sports juggernaut ESPN and WB Discovery’s CNN. Nathanson goes so far as to predict that the fate of the linear cable bundle hinges on what Disney CEO Bob Iger decides to do with ESPN over the next two to three years.
If the flagship ESPN channels, endowed with pricey sports rights deals, become available as a stand-alone streaming app, linear cable’s video customer loss rate will accelerate faster than the current rate of decline, which is about 6% to 7% a year.
At present, the number of U.S. households paying for a traditional pay TV bundle of channels — including the new breed of digital distributors like Hulu Live — stands at about 61%, or about 74 million households. That’s the lowest point since 1993, the year before the launch of DirecTV brought to the marketplace a formidable national competitor to regionally based cable operators, according to Nathanson’s research.
“The linear model won’t die of old age, it will instead die of neglect,” Nathanson wrote in a research report in December. “The key issue, after all, is not demand, but supply. If linchpin content — read marquee sports programming — is exclusively available on linear platforms, then the linear model will be preserved, at least for a time, and at least for a segment. If that same programming is ‘leaked’ onto stand-alone DTC platforms, then the linear bundle will die. It’s as simple as that.”
The conventional wisdom among media biz observers is that the decline in total traditional cable video subscribers in the U.S. will plateau at 40 million to 50 million. Earnings from linear cable won’t fall off a cliff in a single quarter, but the melting-ice-cube effect can’t be ignored.
“For years there have been channels populated with a light amount of content but were reliable generators of affiliate fees. Now viewership is so low they’re moving toward a loss-making proposition,” EY’s Harrison says. “Companies are moving them to ad-supported streaming or downright shutting them down.”
Industry insiders see a move back to bundled content as a means of combating Enemy No. 1 for subscription services: churn. Part of the appeal of streaming for consumers is the ease of dropping and adding subscriptions. There are no clunky set-top boxes or wired connections or satellite dishes to install or return. It’s so easy that some consumers are savvy about using free trial periods and promotions to turn services on and off like a light switch when there’s a new season of a favorite show. And that is a nightmare for studio CEOs and programming executives who are much more accustomed to the security of being part of a bundle.
“It’s easier to churn when you can always find something to watch for free,” Nathanson says.
Industry insiders say there are growing rumblings about efforts to turn the pay TV business structure on its ear with a cafeteria-style model that would allow subscribers to pay a baseline monthly or annual subscription fee for predetermined levels of access to a range of competing services. But bringing the biggest names in TV together for such an effort would be challenging, given the competing interests of the largest media conglomerates.
Verizon made progress this month with its +play service, adding Lionsgate’s Starz to its menu of apps. “The fact that Verizon does not have an interest in creating content and owning rights to content — that has been helpful,” McPherson says. “We’re truly neutral. It’s made it more possible for us to aggregate and put competing programming apps on the same platform. Because we really are aligned. If we’re helping content owners acquire subscribers and retain them, it’s likely they’re helping us with our goals.”
Hollywood is getting creative around opportunities to partner with entities that have big retail sales footprints. Paramount Global just set a deal with Walmart+ — the chain’s e-commerce membership service — to include a Paramount+ subscription as part of the $98 annual fee for Walmart Plus membership. “Now Walmart+ becomes an entertainment proposition for them,” Shultz notes.
As industry economics tighten, Swinburne, Nathanson and other top media industry analysts see a pullback coming in the volume of series and movies produced for streaming platforms. The sharp increase in streaming losses on Bob Chapek’s watch, fueled by content and marketing costs for Disney+, Hulu and ESPN+, was one of the issues that led to his ouster and Iger’s return as Disney CEO in November.
Perrette predicts “a bit of a purge on volume” across the industry, among other “rationalizations” of the streaming marketplace.
“There was too much content being produced and not enough of it was good,” he says. “I think everyone is resetting their expectations. For streaming content, it’s not just about driving subscriber growth, but finding how you can make money with this content at various points in time.”
