Cable's New Digital Services Could Be Victims of Recession

Can an economic downturn derail cable’s plan to cash in by selling new digital services?

That’s a billion-dollar question for operators racing to introduce broadband products such as high-speed data, video-on-demand and telephony. They’ve been running tests to determine consumer demand and price sensitivity.

But a rocky economy could dash operators’ best-laid plans and create new problems if they can’t generate the revenue they’ve been promising Wall Street.

"Anyone who says they know what’s going to happen is kidding themselves," says one MSO executive. "This is a brave, new world for us. Analog services have performed brilliantly during economic downturns in the past. But clearly, the argument could be made that the new services we are offering customers have more of a discretionary element to them."

Operators insist some digital offerings will be more affected if consumers begin pinching pennies and that some strategies can keep customers online even if a recession comes to pass.

Cox Communications, the only MSO not just to test but sell bundled new services to its customers, is bullish on its prospects during a bearish economy. Cox VP-marketing Joe Rooney points to the low churn rate the MSO has experienced in advanced services subscribers.

"Bundles are sticky, meaning they are recession-proof," Rooney says. "We are golden from a retention point of view."

As a follow-up to its 1997 introduction of high-speed Internet, telephony and digital television to residential customers, late last year Cox studied the retention of its bundled and non-bundled subscribers. It found that the longer the customer subscribes to a bundle (defined by Cox as subscribing to two of the company’s three offerings), the lower the churn rate.

After three months, Cox found 95% of its analog-video customers were still customers compared with 99% of bundled customers.

After six months, both rates slipped — 83.7% and 91.4%, respectively, but more bundled customers stayed with the company.

Cox also sees another reason its telephony business would be solid: It offers a 30% discount over its local competitors.

That may not be enough to get people to switch, no matter how squeezed consumers are financially. Ladenburg Thalman analyst Robert Routh says most customers will stay with their existing phone providers simply because it’s easy. They know what they’re getting, and it’s a proven product. The only way operators are going to be really successful at luring new local phone customers, he says, is if it’s bundled with other services.

Operators are offering varying speeds of high-speed data services at different monthly rates, which could offset massive downgrades. Massillon Cable has been doing that from the beginning with great success. Cox plans to begin trials later this year, experimenting with different speeds and price points.

There is disagreement about whether digital video will be as recession-proof as analog video has been in the past. Dropping some extra channels may be seen as a simple way for a subscriber to cut his monthly bill.

"I don’t think customers will give up their digital services, but even if they do, we can’t afford not to offer it," says Bob Gessner, VP at Massillon Cable in Massillon, Ohio. "We could weather a long storm with little digital penetration, but it probably wouldn’t be very fun."

Gessner says multiplex pay services and other premiums could be hurt more than digital.

"What a recession will do is put more pressure on the premium side of the business to do better content," says AT&T Broadband’s SVP-marketing Doug Seserman. "Digital is all about value relative to satellite. People may actually gravitate to or stay with digital rather than go out and buy a dish they don’t need. But overall, if I had to rank the resiliency of the services, I’d say phone was the most recession-resistant, followed by analog video, high-speed data and digital/premium. You could flip-flop those last two depending on where you are."

Some pundits point out that digital tiers may be one of the more attractive services for consumers looking to put their discretionary dollars to work. For instance, consumers can spend $4 on a video-on-demand movie from their local cable company, or they can spend up to $9.50 per person going to the movie theater.

If VOD is going to be a bang-up business in a recession, the DBS firms may do very well. Both DirecTV and EchoStar Communications offer a deep slate of VOD and pay-per-view product — something few operators today can duplicate. Both DBS firms have offered customers "giveaway" deals on dishes, receivers and installations, making the DBS route easier and more economically attractive.

DBS growth isn’t likely to stall, but the acceleration the sector has enjoyed for the last four years is likely to diminish this year, predicts Jimmy Schaeffler, CEO of The Carmel Group.

"Clearly, growth will depend on a number of factors: the company, the offering and the region of the United States," Schaeffler says. "But, in general, I think you’ll see a downturn in growth for the cable, DBS and DSL sectors."

Since 1997, DBS services have added customers at exponential rates, culminating with an additional 3.5 million new subscribers last year for a total 14.6 million customers. Schaeffler insists that growth will remain steady in 2001.

"It’s not like growth will stop altogether," he says. "But you probably won’t say, ‘Wow, DBS added 4 million customers in 2001.’"

Perhaps more problematic for DBS providers is the downgrade scenario, Schaeffler says. Rather than take a package of services that costs $50 or $60 a month, some consumers may opt for a more modest monthly outlay of around $30 or $40.

That’s a concern shared by cable operators, particularly as the industry’s highest paying customer group has already been eroded by DBS.

Many customers kept their $10 to $15 a month service to continue having access to broadcast channels. Many also opted to downgrade their pricier services. Since the best margins lie with those services, operators have been heavily marketing new ancillary services such as digital and HSD.

So far, the strategy has worked.

"We’ve become dependent on high-speed Internet access," says Ladenburg’s Routh. "In fact, we’re so dependent on it, that I would say it’s not viewed so much as an entertainment service, but more like a utility. In a slowed economy, people will still be incented to be productive, and high-speed data does that for them."

Worldgate Communications CEO Hal Krisbergh agrees, "If you’re staying home and using the TV and Internet as entertainment ... people will want to spend more on those kinds of services, and high-speed data is included in that category."

As George W. Bush enters the White House, indicators for a market downturn in 2001 are everywhere. Even as the nation’s economy becomes increasingly rocky, MSOs continue to publicly forecast strong growth numbers for services such as digital video, high-speed data, telephony and interactive services.

A downturn would cut into rosy predictions about cash flow, which is crucial to an industry that has spent more than $41 billion in plant upgrades since 1996.

Remember the ’90s?

Clearly, the recession of 1991-92 played little havoc with basic growth. Some of the industry’s most glorious growth numbers came during that general downturn in the economy. The customer growth even outstripped the increase in new construction and expansion of plant, according to data from Paul Kagan Associates.

It wasn’t until competition from the DBS providers that growth for the cable operators started to slow significantly.

"We believe the cable companies are well positioned to weather a downturn in the economy," says UBS Securities analyst Tom Eagan. "Growth of new services may or may not slow down, but the stock prices of those firms have, in the past, [and] should, in the future, perform well."

Privately, some operators are beginning to express concern that a recession could hurt new service sales.

How much? It’s too soon to tell.

"The ‘nice to have’ upgrades will probably be more sensitive," says Scott Cleland, CEO of Washington, D.C.-based research firm Precursor Group. "A recession could lessen the demand for these services, but it probably won’t result in a lot of cost cutting — at least yet. The economy is going to have to get a lot worse than it is today to begin worrying about that. In six months, [when] unemployment jumps a point or two, people should be concerned about the health of the economy."

Most operators and experts say interactive products could be one of the most affected. The viability of interactive television services has been hotly debated — regardless of outside economic pressures, such as a recession.

"If they were more widely deployed, ITV would probably be the most vulnerable to the economy," says Routh. "[A recession] probably won’t kill the services altogether, but it will likely delay the availability of them."

MSOs such as Time Warner Cable, which is rolling out Wink Interactive in the New York market, are getting their feet wet with interactive. The one operator banking most heavily on enhanced services is Charter Communications.

At a recent Salomon Smith Barney conference, Charter CEO Jerry Kent told analysts that Wink’s interactive services are now available to 225,000 of its customers, 56% of whom use the service an average 5.1 times a month. Those early interactive deployments have generated more than $1 million in incremental cash flow.

Other MSOs aren’t convinced ITV is the best option. At the same conference, Cox CEO Jim Robbins and CFO Jimmy Hayes told analysts and investors the MSO doesn’t plan to begin rolling out interactive services until at least the end of this year.

Worldgate’s Krisbergh says even slowed growth will positively affect operators’ bottom lines.

"When you’re starting from zero, it doesn’t take much growth to be significant," he says. "These services don’t require a lot of upfront costs, so any additional revenue [operators] get from the infrastructure they’ve already got in place is good news."

Packaged goods

That’s why cable operators have to keep their bundles simple, Seserman says. Bundling services can provide the glue operators need to sell services and keep customers in any economic climate.

"Packaging is the most underrated marketing strategy in the business," he says. "And it’s the most healthy way to sell services. Studies show that 60% of the population is interested in bundling, and half of those people are really interested in bundling. It’s all a matter of value. You’re either giving them volume discounts for taking more services, or you’re giving them more at the same price. That works in any kind of economy."

Operators need to offer new services because they continue to deploy expensive digital boxes, and anything they can do to offset those costs helps them, Krisbergh says.

"There’s little cost involved in adding services, and if people take them, great," he says. "Even if the number of people who take them [in a slowed economy[ isn’t as many as in a robust period. But I’m not convinced that we’re even headed into a recession."

Recession or not, most MSOs and analysts claim cable/broadband companies are safe from serious financial straits. The stock prices of most MSOs have increased year-to-date, as have share prices at key vendors such as Motorola, Scientific-Atlanta and Worldgate.

When it comes to another Bush in the White House, this time around MSOs are confident.

Having weathered a stormy economy under the father, the industry is making sure that it’s in good shape for whatever type of weather is looming under the son.