The New Economics of Network TV: What's wrong with this picture?

[Network Programming Assigned Reading]

Gunther, Marc

Citation:Fortune,  v137n1,  Jan 12, 1998
 pp.106-114; European 56-61,  7pages,  NUMBER:02-05401 0015-8259  Features:Graphs  Copyright:Copyright Time, Inc. 1998                 

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Plenty. The broadcast networks are having their worst season ever. Their ratings are down. Their costs are out of control. The advertisers are restless. This can't go on-or can it?

Michael Jordan, the CEO of CBS, had lots to celebrate the week after Thanksgiving. His network had just won the November sweep, toppling NBC to become America's most-watched broadcaster. Flanked by Bill Cosby and Dan Rather, he'd rung the opening bell on the New York Stock Exchange to set off trading in shares of the new CBS Corp., formerly known as Westinghouse. Best of all, the stock had climbed above $30-an eyepopping 66% gain since last spring.

But the man in charge of CBS was low-key, even somber -no high-fives from this Michael Jordan-when FORTUNE visited to talk about the business of broadcast television. Sure, CBS had won the sweep, but only by paying extravagantly for programming and attracting an audience of older viewers, who are scorned by advertisers.

Not surprisingly, the network is losing money- $50 million to $90 million this year, depending on whose numbers you trust. The surprise is that Jordan doesn't see a dramatic turnaround coming anytime soon-or maybe ever. "The pure network television business is basically a low-margin to breakeven business," Jordan said. "Radio," he added, "is the best media business that we're in."

Hold on, you say. That's lowly CBS, burdened as ever by its aging audience and weak stations. Fair enough-so let's stroll two blocks down Sixth Avenue to 30 Rockefeller Center, home of NBC, the proud peacock that has dominated TV viewing in recent years. The story's different there, right?

Well, yes and no. The bottom line's dramatically different: NBC will earn close to $450 million in operating profits from its network this year.

Since NBC put on ER and Friends in the fall of 1994, "every year has been a record year for us," says CEO Bob Wright.

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Captioned as: Ratings are down

Ad revenues keep climbing

But Wright's worried about the future. NBC's prime-time lineup is losing viewers; just recently, its weekly Nielsens hit an all-time low. At the same time, the network is getting squeezed by its program suppliers-the NBA, the NFL, Warner Bros.' ER, all demanding more money. If they get what they're asking-and if Jerry Seinfeld calls it quits this spring, as he may-NBC's profits could be all but wiped out. Says the understated Wright: "Sure, we're concerned."

Right about now, you may be thinking that you've stumbled onto a rerun. The broadcast networks, after all, have been losing viewers for a decade, putting a squeeze on profits. Overspending for big-time sports or hit shows isn't new either. Just say the words "Calgary Olympics" at ABC, and veteran executives wince.

This time, though, it's different. The situation for the networks has never been worse. Their cable competitors are stronger. Their viewing levels are lower: Ratings for ABC, CBS, and NBC are all down this season, the first time that's ever happened. They are paying more for programming, unable to resist the demands of sports leagues, prime-time stars, and Hollywood studios. Indeed, they might have gone out of business by now if not for the willingness of their advertisers to pay more and more for less and less, like the kid who plunks down a quarter for a downsized candy bar that once cost a dime. Even so, after six consecutive years of a boom economy and robust demand for advertising time, no network other than NBC will make more than a modest profit this year. "Only NBC is truly healthy," says Jessica Reif Cohen, who tracks the business for Merrill Lynch. That's a big change too-in the past there's been enough profit in the business to feed two or three networks' bottom lines and cover up lots of mistakes.

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Captioned as: Must-Buy TV:

Luckily, network executives are a lot smarter than most of the shows they put on. Most of them won't quite admit it, but they know the networks are no longer reliable profit makers. So they are rethinking their businesses, often before your very eyes. They now look at the networks as the lifeblood of the global, vertically integrated entertainment giants that own them: not as loss leaders exactly, but as ways to deliver programming to their moneymaking TV stations, introduce shows they own that later can be sold at enormous profit, and promote their more lucrative operations. Think of ABC as Disney's megaphone, to be used by Michael Eisner & Co. to tell the masses about Disney movies, theme parks, and toys, and to launch Disney-made shows that are resold around the world. Think of Rupert Murdoch's Fox as the engine that drives the value of Fox's TV stations, cable networks, and owned shows like The X-Files and The Simpsons. Says Chase Carey, the chairman and CEO of Fox Television: "The network is the locomotive for our television business, the place you create the Fox brand." So what if Fox wrote off $360 million in losses after buying rights to the NFL? They'll make it back by selling Bart Simpson.

That is the new economics of network television, and it's the reason the business isn't about to go bust anytime soon. It shapes the thinking at all the established networks as well as at the two emerging ones, Paramount's UPN and Time Warner's WB, which are losing even more money than the big guys. It explains why Barry Diller and Lowell "Bud" Paxson plan to launch networks No. 7 and No. 8. It doesn't, however, change one ineluctable fact about broadcast networks-to survive long-term, they need to remain mass media, towering over their rivals. Even if they have to spend billions to stay there.

The High Costs of Hits

Talk to networks executives about the rising costs of prgramming, and they start to sound like dieters trying to resist that second helping of pie. ABC Inc. CEO Bob Iger: "You have to be able to say no on occasion." CBS programmer Leslie Moonves: "We have to be selective." Both men are slim, as it happens, but their programming budgets are not.

At first blush, this doesn't make sense. With audeinces shrinking would try to curb their appetite for costly shows, right? Ideally, yes. But they're hungrier than ever, revenous for the taste of a hit.

There's a perverse logic here-one that Hollywood understands perfectly. Says Chris Barrett, the owner of Metropolitan Talent, an agency whose clients include Kirstie Alley and Jane Seymour: "The networks are increasingly reliant on a few linchpin shows. If you're NBC, do you want to face the world without ER? If you're ABC, do you want to go forward without Home Improvement?"

Plainly, they do not, and so they are paying $5 million per episode for Seinfeld, $4 million per episode for Frasier and Home Improvement, shows that cost $500,000 or $600,000 per episode when they first went on the air. Soon the stakes will rise again. Warner Bros. is seeking an astonishing $10 million per episode of ER-$500 million for 50 episodes over two years, more than quintupling today's price. (Talk about the increasing cost of health care.) NBC's Bob Wright will probably pay it, knowing that ER delivers millions of viewers to the late local news on NBC's 11 owned stations, to The Tonight Show, even to Today the next morning. "One show like that can drive an entire network," says Paine Webber entertainment analyst Christopher Dixon. Okay, but how do you explain Fox's paying a reported $80 million for the rights to Steven Spielberg's Lost World, a single movie? You can't, and Fox execs won't even confirm the deal.

Costly as they are, ER and Seinfeld could look like bargains once the networks add up the bills for the rights to pro basketball and the NFL over the next four years. NBC recently agreed to pay $1.75 billion for an expanded package of NBA games, nearly double the cost of the current contract. This for a league where veteran superstars Michael Jordan and Charles Barkley will soon give way to the likes of Allen Iverson and Latrell Sprewell. The value of the NFL package, which is now shared by Fox, ABC, NBC, TNT, and ESPN, could climb from $4.4 billion to more than $7 billion if CBS, the odd network out last time around, aggressively tries to get back in. (Negotiations were heating up at press time.) Incidentally, NBA and NFL ratings are down, albeit by not quite as much as the rest of the network lineups.

Let's concede, even so, that spending for sporting events and hit shows makes sense, since losing the NFL or an ER to a rival can reshape the competitive landscape. What the networks can't afford to do is to overpay for failure, and they've done lots of that lately. ABC's Iger invested a fortune in production deals with DreamWorks SKG and Brillstein-Grey that have yet to pay off. CBS's Moonves spent millions to take the aging sitcom Family Matters away from ABC; the show is losing its time slot. Stars like Ted Danson, Arsenio Hall, Jenny McCarthy, and Tony Danza demanded and got expensive guaranteed contracts to perform in new shows, all of which fizzled. Even twentysomething producers and writers are cashing in with multimillion-dollar development deals and on- air guarantees. "When you've got six buyers," a studio executive says, "you can create panic."

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Captioned as: Why Buy TV?

Star salaries are the biggest conundrum. Most TV hits-Friends, Touched by an Angel, Home Improvement-make their own stars, but there's enormous incentive to write a big check when a Bill Cosby or a Michael J. Fox becomes available. Star-driven shows can be sold, sight unseen, to advertisers; they can emerge from the clutter to get sampled by viewers; and perhaps most important, they can be defended if they don't work. ("Who would have bet against Arsenio?") But most do not work, and they are terribly expensive to mount.

And here's a scary thought: Some network programmers actually like spreading around all that cash. Andy Hill, a former CBS executive, explains: "When you spend a ton of money, you've built swimming pools. You've got agents thinking you're terrific. You've got actors, writers, and directors thinking you're a great supporter. The only people who are upset are the people in New York who are wondering how they lost so much money. And they're not the ones who are going to give you your next job. There doesn't seem to be a penalty for losing money, if you do it spectacularly." Yikes.

It's not just programming budgets that are rising. Each network pays an estimated $200 million a year in compensation to its affiliated stations, a cost item that spiked upward after Fox snatched a group of affiliates from CBS in 1994. That set off furious bidding wars for distribution in bigcity markets, driving up station values at the expense of the networks. Paying affiliates to carry shows that make them rich is "one of the absurdities of this business," grumbles an insider at NBC.

The networks aren't oblivious to any of these cost issues. NBC is reviewing affiliate compensation. This year ABC is paying more up- front for new shows and in exchange getting the studios to grant five-year, instead of four-year, license agreements. That postpones costly renegotiations for hits. "We are trying to avoid having a gun put to our heads," Iger says. ABC also has trimmed $15 million of overhead through layoffs and attrition, and Iger's not through yet. "This network needs to do more now," he says, hinting that troubled ABC News could face cutbacks.

More repeats are airing on all the networks. In an unorthodox move, ABC shows the sitcom Sabrina the Teenage Witch twice on Friday nights. Look, too, for more reality programs, which are cheaper to make than sitcoms or dramas: Among them: Candid Camera and Kids Say the Darndest Things on CBS, TV's blooper specials on NBC, and America's Funniest Home Videos on ABC, not to be confused with the The World's Funniest... on Fox. NBC's Wright can't get enough of the newsmagazine Dateline, which airs four nights a week. "Its ratings are going up, and its costs are not," he says. Now there's a switch.

The danger is that the networks could overload their lineups with repeats and low- cost shows, not unlike cable. Viewers want fresh ideas and new faces-not another blooper show from Dick Clark.

Why Less Is More

STEVE HEYER IS hell-bent on breaking what he calls advertisers' "irrational addiction" to broadcast TV. The bluntspoken head of sales for Ted Turner's cable networks even muses about hiring a psychologist to help him change Madison Avenue's mindset.

Heyer could be dismissed as just another cable pitchman except for a couple of things. First, he's the former president of Young & Rubicam, an industry heavyweight. Second, he's commissioned the largest customized study ever done by Nielsen, which demonstrates that popular cable networks are now viewed widely enough to deliver the reach of broadcast TV. Finally, his argument that advertisers can get their messages out more effectively on cable is starting to take hold among media buyers, many of whom have been slow to follow audiences to cable. "We are growing, and the broadcasters are shrinking faster than the dollars are shifting," Heyer declares. Basic cable gets roughly 42% of all TV viewing but just 25% of ad spending. "It's my mission in life to close that gap," he says.

Up to a point the disparity makes sense. Top- rated network shows can command a premium because they are by far the most efficient way to reach lots of people at once. To open a Hollywood movie or launch a new automobile, advertisers have little choice but to buy network television. "In a more fragmented universe, network reach is more valuable," says CBS's Jordan. A new study says prices for 30-second spots on the very top shows will climb from today's average of about $500,000 to $1 million in five years.

More important, demand for network advertising has grown briskly since 1991. New buyers-technology companies like Intel, financial services giants like Fidelity, telecom firms like Sprint-have been clamoring to reach mass audiences. By auctioning up to 80% of their prime-time inventory during a frenzied week of "upfront" buying in May, the networks have been able to drive up the cost of what remains a scarce commodity. "We call it the less-is-more syndrome," says NBC's Wright. "It isn't necessarily value pricing." No, it's not: NBC was able to raise prices by 14% last spring after losing 5% of its prime- time target audience, and the other networks followed suit.

But the value is concentrated in the highest- rated broadcast shows, not at the low end of the Nielsen ladder. There, the networks still manage to charge CPMs (the cost per thousand viewers) that are as much as 100% higher than cable. This makes cable a better value, pure and simple. "A lot of people have recognized the viewing shift and begun moving dollars to cable," says Irwin Gotlieb, the president and CEO of Televest, the most powerful ad buyer on Madison Avenue.

Of course, if you're a media buyer it's still easier to spend your ad budget during a couple of lunches with broadcast salespeople than it is to spread your commercials across a dozen cable channels. Old habits die hard, but that's not much of a rallying cry for a business.

The Netorks' New Math

BY NOW YOU MAY BE wondering: If the broadcast business is so tough, why did Disney buy Capital Cities/ABC for $19 billion and Westinghouse spend $5.4 billion for CBS just a couple of years ago? The CBS deal, as it happens, hasn't paid off-the network, TV, and radio stations acquired by Westinghouse will generate an estimated $225 million in operating cash flow this year. Those are anemic returns. But Jordan could never have remade industrial Westinghouse into a media company without the centerpiece of a broadcast network.

The Disney-ABC deal looks better because Disney also acquired lucrative cable assets, notably ESPN, the world's most profitable network. But analysts like Prudential Securities' Melissa Cook, who has a "hold" rating on Disney stock, say the ABC network's prolonged ratings slide has become a drag on earnings. Still, Cook adds, "you can't look at the network business in a vacuum."

Synergy, that overworked buzzword, is the key to today's network economics. The oldest form of synergy is simply networks' delivering programming to the stations they own, which as a rule remain very profitable. ABC's ten stations, the best managed among the network groups, enjoy 50% margins and this year will produce about $550 million in operating profit, largely because localnews and syndicated shows like Oprah and Wheel of Fortune have held their own against cable competition. "Our local-news ratings in New York are as strong as they were ten years ago," says Steve Burke, who oversees the ABC group. The NBC and Fox stations throw off nearly as much cash-New York's WNBC-TV, by itself, will earn $250 million this year- while CBS's lag far behind. That's why Mel Karmazin, the former CEO of Infinity Radio and CBS's largest stockholder, took over the TVstation group last spring and vowed to improve revenues, margins, and profits. Not coincidentally, that's when CBS shares began to climb.

What's good for the stations isn't always good for the network, though. This fall, CBS put on urban-themed dramas like Dellaventura and Michael Hayes to help boost ratings at the stations it owns in major markets like New York and Chicago. "The joke is that we don't want to see any more grass or trees on our air," says CBS's Jordan. The shows have helped those stations, but they haven't done nearly as well elsewhere in the country.

The other big payday for the networks comes when they own and syndicate a hit show, something they couldn't do before they were deregulated in the mid-1990s. Here, Fox has led the way with The X-Files and The Simpsons, each of which has generated $500 million or more in revenues. CBS hasn't done badly either, selling reruns of Touched by an Angel, Promised Land, and Dave's World to Florida-based broadcaster Bud Paxson and his new PaxNet for an estimated $175 million. Surprisingly, ratings leader NBC has lagged behind-the network doesn't own any of its big hits, unless you count Dateline, and therefore hasn't profited much from syndication, to Wright's dismay. "There's no question that we have not connected all the dots," he says. By owning more of their shows, the networks also avoid being held up by the studios for ever-increasing license fees.

But program ownership only raises the stakes of the prime-time business. For one thing, the networks have to absorb production deficits on their owned shows; on those they license, the studios pay the deficits. "Sometimes vertical integration means you just get to lose twice," says Kerry McCluggage, chairman of the Paramount Television Group. The bigger risk is that a network will miss out on a hit by favoring its own shows. NBC, for example, has incurred big opportunity costs by turning over the cushy time slot between Friends and Seinfeld on Thursdays to a couple of mediocre NBC- owned properties, The Single Guy and Union Square. NBC and Disney have blocked out certain nights of the week for their own shows. "It can hurt your network business if you're not open to diverse suppliers," says McCluggage.

Fox and Disney are best constituted to exploit their network platforms. Murdoch has taken the old Fox brand, injected new life into it with the bold and youthful programming at the Fox broadcast network, and extended it into cable news, sports, and family networks. Disney has the assets to produce shows for ABC, cycle them through cable services like the Disney Channel and the just-announced Toon Disney animation channel, and then distribute them on Disney channels around the world. Moreover, every big Disney Co. event-the Flubber movie, the launch of cruise ships, the new Animal Kingdom gate at Disney Worldgets promoted on ABC, in prime-time specials or the Disney Sunday movie.

This all sounds great until you notice that the Disney Sunday movie did an 11 share a few weeks ago. That's no megaphone; it's a whisper. Synergy works only so long as the networks stay big. How Low Can They Go?

It's another beautiful day in Hollywood, time for a nine o'clock breakfast with an industry insider in the dinning room of a Beverly Hills hotel. Juice, coffee, muffins, and an omelet for $38.50. No quotes on the record naturally. "This is a dying business," the executive says, "and very few of the people involved want to admit that the patient is sick."

That's an overstatement, but understadable in light of the prime-time- rat

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Captioned as: Ouch, Doc! That hurts: The rising costs of programming are squeezing all the networks, especially NBC. The network already is paying dearly for Seinfeld, Frasier, and the NBA. Now Warner Bros. is seeking a heart-stopping $10 million per episode for ER

That's an overstandable in light of the prime- time ratement, but understandable in light of the prime-time ratings trends for the networks. They're grim. Since 1992-not that long agoNBC and Fox have held their own, but ABC and CBS have lost 25% and 23% of their viewers, respectively. If that's "erosion," the beach is approaching Montana.

"Sales departments are too powerful," says the executive, arguing that the narrowing of the networks is happening almost by design. "They've always wanted 18-to-49 programming. Now they're insisting on it. So everybody's going after the same writers, the same concepts, the same audience. They're programming themselves out of business."

Another overstatement, but not by much. With NBC, ABC, and Fox all targeting urban, upscale 18- to 49-year-old viewers, the networks are cannibalizing each other. Older audiences have been ceded to cable and CBS, which is how the Tiffany Network won the November sweep. But CBS has flopped on Madison Avenue because nearly half its viewers are over 55.

Young viewers, too, are deserting the Big Four. That's a bigger worry because they are tomorrow's prime-time targets. Teen viewing levels of ABC, CBS, NBC, and Fox have dropped by nearly 30% in the past four years, with only the WB showing growth among teens. Nearly 80% of kids' viewing now goes to cable, most to Nickelodeon and the Cartoon Network.

This fall has been an especially unhappy time for the networks because of their own strategic mistakes. They started the season a week later than usual, introduced 33 new shows, moved another 20 to new time slots, disrupted their momentum with post-season baseball, and prayed viewers would figure it all out. They didn't-and six weeks into the season the average new show had been sampled by just 12% of the adult audience, down from 16% a year earlier.

The Big Four also moved away from traditional counterprogramming-where they offer a contrasting alternative to a popular show on a competing network-to what's been called "confrontational programming." Flush with success, NBC was the worst offender, taking aim at Fox's. The Simpsons and ABC's Drew Carey with young-skewing comedies. The moves backfired, and with a surfeit of second-rate sitcoms on the air, viewers again turned elsewhere.

The result? Basic cable viewing is up 11% this season. This is a long-term trend that in all likelihood can't be reversed, even if the broadcasters do everything right. New cable networks arise, capturing slivers of viewers; older ones upgrade their programming and promotion. Broadcasters like to point out that some cable networks, notably TBS and ESPN, are themselves eroding, but most are growing. And we haven't even begun to ponder the impact of the Internet. "Fragmentation will probably accelerate over the next few years," says Jack Myers, president of Myers Consulting Group, a media research firm.

Fortunately for the broadcasters, they've expanded their own cable holdings in the 1990s. Just this fall, CBS-the last holdout- completed its purchase of the Nashville Network and Country Music Television, after launching Eye on People. That may be too little, too late. Better diversified is ABC, with ESPN, Disney, and stakes in Lifetime and A&E, all of which rake in subscriber fees as well as ad revenues. "The profits from our cable businesses today far exceed the profits of ABC," says Iger. If Mike Jordan's a radio head, Iger's a cable guy.

To see just how far the balance has shifted to cable, consider Geraldo Rivera. (No, you don't have to like him-just consider him.) When Rivera, the biggest prime-time player on NBC-owned CNBC, recently threatened to defect to Murdoch's Fox News Network, Bob Wright decided that he could not afford to let him go. To keep Geraldo, Wright offered him exposure on NBC's Today and four hourlong NBC News specials, despite the objections of anchor Tom Brokaw and some news executives.

There's an example, albeit an odd one, of using the network as a value creator. Wright used NBC's airtime as a bargaining chip to keep the star of his moneymaking cable network happy.

A decade from now, he could look prescient.

Follow his logic by following the money Revenues flowing to cable will be reinvested in original programming and promotion that will help the most successful cable networks attract more viewers. That will bring in more dollars, more programming, more promotion. Wright's CNBC will never be the biggest ratings winner, but there's no reason that broad-appeal cable networks like Barry Diller's USA or Turner's TNT or even Lifetime can't, with the right programming and a bit of luck, achieve parity with the weakest of the broadcast networks. Says Televest's Irwin Gotlieb, a highly respected analyst: "I fully expect to see a day when a cable network passes one of the broadcast networks in the ratings."

That doesn't mean that the broadcast networks and would-be networks will disappear, although one or two probably will, particularly if the economy slumps. It does mean that changes, perhaps wrenching ones, are ahead in the ways the networks develop programs and sell advertising. And it surely means that a business that was once close to idiot-proof will get even tougher than it is today.