FCC Releases Eighteenth Video Competition Report

Please contact Michael Bennet at mbennet@bennetlaw.com or Howard Shapiro at hshapiro@bennetlaw.com for more information.

The Federal Communications Commission (FCC or Commission) has issued its Eighteenth Annual Report to Congress on the Status of Competition in the Market for the Delivery of Video Programming.[1]   The Eighteenth Report focuses on developments in the video marketplace in 2015. 

Bottom Line: The most significant trends since the last report relate to the expansion of digital and high definition programming, the increase in television viewing on mobile devices and the progress of the online video industry. Cable MVPDs have continued to experience actual decreases in the number of subscribers, losing market share to their large telephone MVPD competitors during this period. OVD services continue to grow and evolve. 

EIGHTEENTH REPORT

The Eighteenth Report follows the same analytical framework that the Commission first implemented in 2012. However, continuing a trend that began with the Sixteenth Report, this year’s Report focuses on year end rather than mid-year data.  As in prior years, video programming distributors are categorized into three groups: multichannel video programming distributors (MVPDs), such as Direct Broadcast Satellite (DBS) and cable television; broadcast television; and online video distributors (OVDs), such as Netflix and Hulu. The Report describes the providers of delivered video programming in each group, summarizes their business models and competitive strategies, and presents selected operating and financial statistics.  In this Report, the Commission has also examined the development and accessibility of customer premises equipment (CPE) used to receive video programming services.  The following highlights the Commission’s findings with respect to each of the designated categories of video providers. 

MVPDs

• MVPDs as a group lost about 1.1 million video subscribers in 2015, continuing a trend that began in 2013. Specifically, cable MVPDs lost 599,000 subscribers, accounting for 53.1 percent of all MVPD subscribers at the end of 2015 (down from 53.4 percent at the end of 2014) and DBS MVPDs lost 477,000 subscribers, accounting for 33.2 percent of all MVPD subscribers at the end of 2015 (down slightly from 33.3 percent at the end of 2014). Telephone company MVPDs gained 14,000 subscribers in 2015, accounting for 13.4 percent of all MVPD subscribers (up from 12.9 percent at the end of 2014).
• At the end of 2015, ten MVPDs each had over one million subscribers. These include seven cable MVPDs (Comcast, Time Warner Cable, Charter, Cox, Cablevision, Bright House, and Suddenlink), DISH Network (a DBS MVPD), Verizon (a telephone company MVPD), and AT&T (a combined telephone company MVPD and DBS MVPD). Another fourteen cable MVPDs and three telephone company MVPDs (CenturyLink, Consolidated Communications, Cincinnati Bell) each had over 100,000 video subscribers.
• Google Fiber continued to expand its video footprint in 2015. As of late 2015, Google Fiber passed about 427,000 homes, and 96,000 business locations. At the end of 2015, Google Fiber offered 1 gigabit Internet service and 220 plus channel video service to neighborhoods in Austin, Texas; Kansas City, Kansas; Kansas City, Missouri; and Provo, Utah. In building its network, Google has pursued alternative strategies in some communities, including leasing fiber from municipal utilities and existing industry providers.
• Although most consumers have access to three competing MVPDs (two DBS MVPDs and a cable MVPD), some consumers also have access to a competing telephone company MVPD, for a total of four MVPDs. In 2013 the Commission estimated that 35 percent of homes had access to at least four MVPDs and this number increased to 38.1 percent in 2014. However due to the acquisition of DIRECTV by AT&T in July 2015, the percent of homes having access to four competing MVPDs dropped from 38.1 percent in 2014 to 17.9 percent of homes at the end of 2015.
• In 2014, there were 94 national programming networks (44 were HD networks) affiliated with the top six cable MVPDs and six national networks that were affiliated with DIRECTV (three in HD). More recent data show that vertical integration has increased for MVPDs. Data for November 2016 show 159 national networks affiliated with the top six cable MVPDs (59 in HD) and specifically that Comcast has ownership interests in 52 national networks (26 in HD), Charter Communications has ownership interests in 30 national networks (17 in HD), and Cox has ownership interests in six national networks (three in HD). In addition, the six national networks that were affiliated with DIRECTV are now affiliated as well with AT&T, Inc. (three in HD).
• The total number of cable systems has been declining. As of June 8, 2016, there were 4,413 cable systems in the country. This is a drop from the 4,562 cable systems reported in the 17^th Report and the 4,833 cable systems reported in the 16th Report. A reduction in the number of cable systems often has no impact on the number of households receiving cable service where, for example, one cable system is consolidated with another system. Sometimes, however, cable systems are shut down, which may result in some households losing service from the MVPD. The Commission does not collect information on why cable systems shut down or the characteristics of such systems. It is possible that some such systems have integrated with other systems while others actually terminated service.
• Cable MVPDs continue to upgrade their systems by transitioning from analog to all-digital systems. By the end of 2014, this all-digital transition had reached approximately 69 percent of the collective footprints of the top eight cable MVPDs. By year end 2015, most major cable MVPDs had completed, or nearly completed, their all-digital transition.
• MVPDs continue to build out Wi-Fi Networks that enable subscribers to use Internet services on secure networks outside their homes. These hotspots enable subscribers to access “TV Everywhere” content and OVD content on mobile devices outside their home without additional charge.  A consortium, called Cable Wi-Fi, comprised of Bright House, Cox, Cablevision, Time Warner Cable, and Comcast, allows a subscriber of any of these cable MVPDs to access the hotspots of the other consortium members. The consortium provided more than 400,000 hotspots at the end of 2015.
• MVPDs continue to deploy “TV Everywhere” services in response to competition from OVDs. TV Everywhere allows subscribers of certain MVPD services to access MVPD video programming on stationary and mobile Internet-connected devices including: televisions, computers, tablets, and smartphones. Adoption of TV Everywhere services continued to see gains in 2015, with 17.5 percent of MVPD subscribers using those services – up from 12.8 percent in 2014. In addition to offering TV Everywhere services, some MVPDs have entered into cooperative arrangements with OVDs (e.g., Netflix, Hulu, YouTube, and Vudu) and included access to third-party OVD services through the set-top receiver.
• MVPDs continue to increase video revenue, in part, by raising the prices charged for video services. SNL Kagan estimates that video revenue for cable, DBS, and telephone company MVPDs increased from $112.7 billion in 2014 to $115.6 billion in 2015. Nonetheless, data show that the additional video revenue generated has failed to keep up with increased MVPD costs, especially programming costs. The result has been falling video margins (i.e., revenue minus cost divided by revenue).   At the end of 2015, video margins were just over 10 percent, down from 15 percent in 2014, and 20 percent in 2013. Rapidly rising programming costs, which increased 8.1 percent in 2015, 6.8 percent in 2014, and 7.4 percent in 2013, are cited as the primary cause of declining video margins. A relatively new strategy for addressing increased programming costs involves listing “broadcast fees” and “regional sports fees” separately on customers’ monthly billing statements. The strategy raises monthly bills while typically leaving the advertised prices for video packages unchanged. Another strategy for addressing increased programming costs involves deemphasizing video services and focusing on Internet services.
• In response to competition from OVDs, stagnant household incomes, and higher programming costs, MVPDs have continued to offer “skinny” video packages, which include a limited selection of channels with add-on options revolving around specific subscriber interests such as sports, children’s entertainment, or movies. 

TELEVISION BROADCASTERS 

• The number of licensed full power commercial and non-commercial television broadcast stations decreased slightly since the last report.  As of year-end 2015, there were 1,387 commercial stations down from 1,390 commercial stations licensed as of year-end 2014. During this period, the total number of full-power noncommercial television stations held steady at 395.
• As of year-end 2015, 102.1 million U.S. television households, or 92 percent of such households, had sets capable of displaying and/or receiving digital signals, including HD television signals. This figure is up from 98.3 million U.S. television households, or 85 percent of such households, in 2014. Broadcasters have provided HD programming in response to the increasing number of HD televisions. As of the end of 2015, 1,496 (87.9 percent) of full-power stations were broadcasting in HD, down slightly from 1,517 stations at the end of 2014.
• In addition to HD content, broadcasters are bringing more programming to consumers, particularly in smaller, rural markets, by expanding the availability of the four major networks and newer networks through digital multicast signals. Many commercial stations use multicast streams to offer consumers additional programming choices. For instance, multicast streams often carry newer networks such as Me-TV (with 151 digital multicast affiliates), This-TV (with 81 digital multicast affiliates), and Grit (with 114 digital multicasting affiliates).
• Television stations use their online and mobile platforms to address consumers’ increasing desire to view video programming in more places and times and on more devices. Broadcasters use their websites as extensions of their local brands, and offer advertisers online promotions coordinated with on-air advertisements. Television stations are also taking a “three-screen approach” – distributing news programming online and via mobile devices, as well as over-the-air.
• The top station groups in 2015 in terms of revenue include FOX, Sinclair Broadcast Group, Inc., TEGNA Inc., CBS, Comcast Corporation, Tribune Media Company, Media General, Univision, Walt Disney, and Hearst.
• The number of television households relying exclusively on over-the-air broadcast service (as opposed to accessing broadcast stations via an MVPD) increased since the last report. Nielsen Reports that this figure increased from 11.4 million television households in 2014 to 12.4 million households in 2014, representing an increase from 10 percent to 11 percent of all television households. Figures from NAB indicate that 26.7 million television households, or 23 percent of all television households, rely exclusively on over-the-air television service on at least one television in the home, up from 21% the previous year.
• Television broadcast stations earn about 69 percent of their revenue through the sale of advertising time during their programs, a slight decline since the last report. Retransmission consent revenues make up 23 percent of station revenue, while online revenue accounts for seven percent. Network compensation revenues are minimal, accounting for less than one percent of station revenues.
• Broadcast television station revenues reached a high of $26.3 billion in 2000 and have declined thereafter. Industry gross revenues were approximately $27.0 billion in 2014, but were reported to dip slightly to $26.9 billion in 2015.
• Retransmission consent fees continue to account for an ever-increasing share of broadcast station revenue, trailing only advertising revenue. Since the last report, retransmission consent fees have increased in dollar terms and as a share of industry revenues. In 2015, retransmission consent fees represented about 23.0 percent of total television revenue, or $6.4 billion in 2015 up from 18.0 percent, or $4.8 billion in 2014. 
• In addition to selling advertising time during their programming, stations often sell advertising on their websites. Online revenues from advertising increased slightly from $1.7 billion or six percent of total broadcast station industry gross revenues in 2014 to $1.8 billion or seven percent of the total broadcast television station industry revenues in 2015.

OVDs

• SNL Kagan estimates that 59.4 million households used online video in 2015 and projects that while the majority of U.S. households will continue to subscribe to MVPDs, the increased availability of content via OVDs combined with the increased availability of broadband service and Internet-enabled devices will likely lead to fewer MVPD subscribers and more OVD usage over the long term.
• SNL Kagan projects that by the end of 2016, 65 million households will subscribe to at least one OVD service and collectively they will purchase 109.0 million subscriptions to OVD services. Netflix had 46 million subscribers at the end of the second quarter of 2016, up from 41.1 million subscribers in second quarter of 2015. Hulu had 11.3 million subscribers at the end of second quarter 2016, up from 9.3 million in second quarter of 2015. Amazon Prime reported 63 million subscribers, all of whom receive free access to Amazon Video, in the second quarter of 2016. Many households subscribe to more than one OVD.
• OVD business models range from “all-you-can-eat” video streaming options and subscriptions to more traditional single-item “a la carte” video rentals. Some MVPDs now offer OVD services that do not require a subscription to MVPD services. For example, Dish Network offers Sling TV, AT&T offers DIRECTV NOW, and Verizon offers go90. These OVD services provide access to a wide variety of content, including linear programming channels, VOD programming, and original programming.
• The OVD marketplace continues to expand and change. Entrants often use new technologies and experiment with a variety of business models. OVDs are constantly entering and exiting the market and changing the services and programming they offer, in response to viewer demand as well as external factors, such as the ability to access content and reach consumers. Accordingly, it is difficult to measure market shares and to determine the extent of horizontal concentration in the OVD marketplace. Furthermore, due to the lack of standardized metrics for measuring viewership, measuring online video viewership raises unique challenges that the industry is continuing to address.
• The OVD industry is evolving, and no single business strategy has emerged as the dominant model. Depending on the OVD, consumers access programming in several ways, including: (1) for free, usually with advertising; (2) through a subscription service, with or without advertising; (3) through an on-demand rental service, similar to MVPDs’ video on demand (VOD) services; and (4) via “electronic sell through” (EST) content downloading. Several OVDs offer multiple options.
• Netflix reports that it earned a profit of over $1.37 billion from its domestic streaming segment during 2015, an increase of $434 million from the $936 million in profits it earned in 2014.  Due to the diverse nature of OVD business models and strategies, however, Netflix’s success may not be representative of the OVD industry as a whole.
• Access to high-speed data pipelines capable of delivering a high quality video signal is critical for OVD entrants. OVDs require sufficient Internet capacity to transmit their programming, and consumers need sufficient broadband service to access OVD content. For example, Netflix recommends that subscribers have a speed of at least 3.0 Mbps to watch programs in standard definition quality; 5.0 Mbps to watch content in HD quality; and 25 Mbps to watch programs in Ultra HD quality. Households viewing multiple video streams on multiple devices at the same time require higher speeds.
• Increasingly, OVDs are using content delivery networks (CDNs) to enhance the speed and quality of video content delivered to consumers. Specifically, CDNs reduce latency in the transmission of data by storing cached versions of the data in geographic locations closer to the consumer. Major OVDs that provide CDN services to third parties include Amazon (through its Amazon CloudFront service), Microsoft (through its Azure service), and Verizon (since it acquired EdgeCast). Google and Netflix each operate their own proprietary CDNs – Google Cloud CDN and Netflix Open Connect – which they use for their own content. Similarly, Apple operates its own CDN in the United States and Europe. New and smaller OVDs often rely on third party CDNs, such as Akamai, Limelight, and CDNetworks to deliver their content.
• Content owners’ traditional windowing strategies play a key role in determining which OVDs are able to access content and the timetable on which they are able to gain access. Recently, some major studios have changed the timing of when they release content electronically and are making digital copies of titles available through EST earlier than the DVD version. In addition, networks and studios factor in the possibility that MVPDs may be less willing to carry them at all, or pay them high rates, if the TV Everywhere rights aren’t included in their carriage agreement.
• Another potential barrier to content acquisition can be cost, particularly for subscription services. Analysts expect that in 2016, Netflix will have spent $6 billion on content acquisition, an increase of $830 million over the $5.17 billion it spent in 2015. Of the $6 billion Netflix was expected to spend on content in 2016, it is expected that approximately $1.32 billion will have been spent on developing original programming, with the remainder invested in content acquisition and licensing costs.

CUSTOMER PREMISES EQUIPMENT (CPE)

• The 17^th Report discussed the emergence of Ultra High-Definition (Ultra HD) televisions in the marketplace. Ultra HD screens encompass higher resolutions (more pixels) for a more realistic picture and color quality than HDTV. Currently, Ultra HD comes in resolutions of 4K (2160p) with 8.3 megapixels, or four times as many as full HD (1080p), and now 8K (4320p) with 33.2 megapixels, or 16 times as many as full HD. In addition to the higher resolutions associated with Ultra HD, television manufacturers have recently introduced televisions that can process HDR signals. HDR allows televisions to display brightness and darkness more precisely, which produces a more vivid picture. The industry has not settled on a single standard for HDR. This battle over format, along with the bandwidth required to deliver Ultra HD and HDR content to subscribers, are potential obstacles to adoption of Ultra HD and HDR displays and content.
• Leased CPE is used by approximately 99 percent of MVPD customers and generates approximately $20 billion dollars of revenue per year to MVPDs. Leased CPE is a significant cost for consumers and source of revenue for operators.
• CPE used to access applications typically fall into one of two categories: (1) smart TVs that can access streaming services and streaming devices that turn any display into a “smart TV,” and (2) mobile devices. OVD services tend to be available on both categories of devices. MVPDs typically make applications available on mobile devices only, but some MVPDs have recently introduced apps and others claim to be on the verge of introducing apps that consumers can use to watch MVPD video programming on TV sets without leasing a set-top box.

CONCLUSION

The most significant trends since the last report relate to the expansion of digital and high definition programming, the increase in television viewing on mobile devices and the progress of the online video industry. Cable MVPDs have continued to experience actual decreases in the number of subscribers, losing market share to their large telephone MVPD competitors during this period.  OVD services continue to grow and evolve.

[1] In the Matter of Annual Assessment of the Status of Competition in the Market for the Delivery of Video Programming, MB Docket No. 16-247, Eighteenth Report, DA 17-71 (rel. January 17, 2017) (Eighteenth Report or Report).

For additional information, please contact Howard Shapiro.