Captive Audience: The Telecom Industry and Monopoly Power in the New Gilded Age (19 page)

Among the many grails sought by the companies and developers behind next-generation communications, one of the holiest is online video services. Of course, not all online video is the same. Only long-form, professional online video—a series of half-hour- or hour-long shows with continuing narratives and high production values—would substitute for the proprietary bundles of cable networks offered by Comcast. (Roberts was a bit disingenuous in talking about Google's videos, which at the time amounted to a vast collection of ten-minute YouTube snippets.) But this alternative would turn Comcast's cable infrastructure into little more than pipes for someone else's moneymaking activities.

As previously separate services have converged, becoming indistinguishable bits passing over wires, the market for the long-form, professionally produced video preferred by Americans has already moved “online.” That is, the television that the vast majority of Americans watch is made up of electronic packets that are sent using the Internet Protocol, and those packets travel through the same digital pipe that the cable companies use to distribute a relatively narrow (when compared to the available capacity of the cable pipe as a whole) trickle of Internet access. Just 10 percent or fewer Americans use rabbit ears to watch television broadcast over the air.
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But conventional television distribution as a practical matter remains a centralized, tightly controlled marketplace in which programmers and pipe owners jointly participate. True “online” services can be launched without the permission of the Internet access distributor (think Facebook in a Harvard dorm room); by contrast, access to the bundles of cable networks that Comcast sells is available only by paying the freight to Comcast in its role as distributor.

Because conventional television—a $70 billion a year advertising vehicle—offers such a lucrative marketplace,
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the possibility of substituting online video for cable networks poses risks to both programmers and cable distributors. Cable distributors and media conglomerates have cooperative arrangements in place that channel more than $30 billion in fees paid annually by the distributors to programmers, their largest source of revenue.
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The distributors, in turn, charge individual subscription rates that keep going up: a typical cable subscriber pays more than $128 a month for video, high-speed Internet access, and phone services,
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and the average subscription price has increased about 30 percent in the past five years, while household incomes have declined.
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The programmers and distributors have powerful market positions that allow them to keep these flows going, and the advantage of regulatory schemes that support the status quo. As long as the distribution pipes dominate their physical locations and there is no reasonable substitute for cable networks available over the open Internet, every part of this controlled distribution chain produces enormous profits. “I think everybody is going to do well in this mix,” John Malone told industry analysts in a public conference call in May 2011.
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Online video, which threatens to cut out the middlemen, would disrupt this flow.

Why then did Brian Roberts say in March 2011 that he wanted to encourage online video?

A large part of the answer is that the cable industry's growth area does not come from television but high-speed Internet access, and Americans are increasingly getting their high-speed data services from their local cable monopolist. Online video, whatever it does to traditional television, will keep them signing up for data services. By mid-2011, Comcast had persuaded 17 million of its 22 million television subscribers to purchase high-speed Internet access as well as television—“incredible high penetration rates,” according to Malone in the analysts’ conference call. Roberts was optimistic about his company's ability to sign up additional millions of data customers over time.
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Comcast would continue to do well even if it lost a few video customers.

The rest of the answer lies in Comcast's power, as the country's largest provider of both data and video services, to pressure potentially competitive online video providers. Netflix, an online long-form video service that became enormously popular with consumers by providing a cheap monthly subscription to streaming movies and archives of TV shows, is a prime example of an “over the top” provider of video (one that makes videos available over the Internet access portion of Comcast's pipe). The absence of any effective regulatory regime or oversight over the cable giant makes it unlikely that Netflix will ever be able to challenge Comcast. Comcast has a number of options that will make it extremely difficult for independently provided, directly competitive professional online video to challenge its dominance.

Roberts crystallized one aspect of his company's power in early 2011: “What used to be called ‘reruns’ on television is now called Netflix. We're not seeing it cut into our core business, but we are glad as a producer of content to see the value of that content rising.”
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His words could be seen as a reminder to Netflix that its costs were bound to go up because the dominant programmers and Comcast shared an interest in undermining competition from independent online video platforms, and because Comcast controlled the pipes.

In other words, the NBC Universal merger made online video a two-sided issue for Comcast. Comcast would be able to use its control over NBC
Universal content, its relationships with programmers dependent on money from Comcast, and its technical control over gateways to its subscribers to protect itself from any rise in the popularity of competitive independent long-form online video. At the same time, interest in online video services provided on Comcast's terms and with its permission would drive Americans’ appetite for high data speeds. Comcast would be there to sell them those services and its version of TV Everywhere—over the same pipe—reaping ever-higher revenue from each user.
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The trick would be to slow the loss of customers who were only interested in video while simultaneously selling high-priced high-speed Internet access to as many people as possible.

By mid-2011, the major cable providers had a monopoly in wired high-speed Internet access (at speeds necessary to download video satisfactorily) in areas not served by Verizon's FiOS service, and the telcos (AT&T and Verizon) had stopped expanding their fiber networks. At the end of 2011, Verizon and Comcast tacitly agreed not to compete in the provision of wired Internet access service: in a complex deal involving a transfer of spectrum worth $3.6 billion from Comcast and Time Warner to Verizon, the former competitors announced that they would jointly market each other's services. As the analyst Craig Moffett of Bernstein Research put it, the deal was “a partnership between formerly mortal enemies.”
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Tired of spending money on wired Internet access service, Verizon had essentially conceded to cable's unrivaled superiority in that arena.

The only thing that could have limited the cable industry's power, in Malone's view, was regulation. He had told the
Wall Street Journal
while the Comcast-NBCU deal was being reviewed that he was not interested in U.S. cable deals. “It is entirely feasible that government may choose to open these networks up. They could come in, for instance, and tell cable operators they can't bundle broadband with video, with telephone, that they've got to sell them all a la carte and they can't do any deep discounting, no exclusionary deals and so on. And [as they review the Comcast-NBCU deal] they can set the pattern that they would later enforce on the industry at large through rulemaking.”
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But that didn't happen. The reaction of the regulators to the expansion of Comcast's power by way of the NBC Universal merger to slow the advent of competitive online video was mild. The government did not open up the cable networks, require that
they separate content from conduit, insist that they provide high-speed access at reasonable prices to all Americans in exchange for their access to public rights-of-way, or meddle with the content industry's relationship with the cable distributors. Things continued to be good for Comcast.

In the highly concentrated American media business, all deals are watched closely by all the other players. Because so few actors have real power, each move that might jostle some other player is carefully examined. This is why a 2008 deal that Netflix made with Starz, a premium-cable channel, was so surprising: Netflix agreed to pay $25 million a year for the right to stream Starz content, which includes Sony and Disney movies, online. Starz sensed that online streaming would be big but had been unable to make its own online venture, under the leaden name Vongo, work. Netflix, however, already had access to millions of Americans. Twenty-five million dollars seemed like a lot of money to Netflix at the time, but the other programmers felt that the deal was a steal for Netflix and a huge mistake by Starz.
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In hindsight, Starz does not seem to have known what it was selling and what effect the sale might have on the programmers and cable companies. The deal made it possible for Netflix to offer cheap online subscriptions that brought consumers easy access to high-value content—twenty-five hundred movies and television shows, many of recent vintage.
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Netflix marched on, signing a nearly one-billion-dollar licensing deal in August 2010 with the premium channel Epix that allowed it to stream current-release and back-catalogue movies from Paramount, Lionsgate, and MGM for five years. Netflix also lined up a huge range of back-catalogue television shows for online streaming from a variety of sources.
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It announced plans to start acquiring first-run original content, beginning with a 2012 political drama called
House of Cards
, starring Kevin Spacey.
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At the same time, its subscription numbers were surging.

Netflix, an online upstart that had not built the network it was using, had by mid-2011 built an online business that had more subscribers than Comcast, which had spent untold billions on infrastructure. According to some observers, Netflix downloads accounted for almost 30 percent of peak traffic across data lines running to residences in North America in 2011.
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This was not the digital future that Comcast had in mind.

Netflix has long been viewed as a company that can carry out its strategies well and change direction on a dime. As high-speed data connections were rolled out in the late 2000s, it quickly pivoted from exclusive reliance on DVD by mail, which entailed $600 million in postage costs, to streaming video directly to subscribers;
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it continued to ship DVDs, but streaming became a bigger part of its operations and grew faster. And Netflix's approach to advertising was innovative as well; its software recommended movies and shows to subscribers based on what they had already watched.
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Consumers loved it.

The studios and programmers that licensed content were clearly pleased with the idea of an online distribution partner who could make consumers happy. And happy they were: new users embraced the idea of streaming-only subscriptions without the trouble of DVD returns.
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Netflix went farther, embedding its software in hundreds of electronic devices—Windows and Mac PCs, Sony PS3, Microsoft Xbox, Nintento Wii, AppleTV, iPad—which gave it even greater access to American consumers.
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For game players who were in love with their devices, having Netflix available on gaming consoles was a thrill. Even after the company deeply annoyed subscribers by changing its pricing policy so that choosing both online streaming and DVD shipping would mean a 60 percent price hike for many of its customers, Netflix retained most of its loyal followers.
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Jeffrey Bewkes, CEO of Time Warner, was not happy about Netflix. A gifted, frank man who had prospered through years of turmoil inside Time Warner, Bewkes was responsible for leading HBO into the twenty-first century and spinning off Time Warner's cable-distribution assets into a separate company. In response to Netflix's 2008 deal with Starz, he made some remarks, published in the pages of the
New York Times
, that could be taken as a message to the company. In a December 2010 article (published before Netflix's numbers overtook those of Comcast) headlined “Time Warner Views Netflix as a Fading Star,” Bewkes noted that Starz programming would probably be many times more expensive when Netflix sought to renew its deal in 2012. “Mr. Bewkes suggested a new deal [with Starz] may not be reached,” reporter Tim Arango wrote, “because Netflix's subscription streaming service, which costs about $8 a month, isn't high enough for the company to pay top dollar for movies.”
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The highly concentrated
content industry might well understand by this that it would not be a good idea to give favorable terms—or perhaps any terms—to Netflix.

If consumers were satisfied with what they got from Netflix, why would they pay for Time Warner's flagship HBO content as part of a large bundle of well-branded channels sold by a cable company? Bewkes's words could be seen as a call to the rest of the industry to raise Netflix's costs. “It's a little bit like, is the Albanian army going to take over the world?” he said to Arango. “I don't think so.”
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His remarks to the
Times
appeared to be a signal: no one else had better make a low-price content deal with Netflix who wanted to continue to participate in the high-dollar cable-distribution structure—including Starz, when it renegotiated with Netflix.

In September 2011, Bewkes's confident prediction came true when Starz cut its ties with Netflix, leaving behind an offer of more than $300 million, ten times the amount of the original 2008 deal. The
Los Angeles Times
reported that Starz had wanted Netflix subscribers to pay more than Netflix's standard $8 per month for Starz content, essentially making Netflix into an online replica of a cable distributor. Starz was unwilling to disrupt its relationships with traditional distributors, who did not want subscribers to “cut the cord” and switch to online-only content. But Netflix had refused to set up tiered pricing.
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The
Los Angeles Times
later reported that Greg Maffei, CEO of Liberty Media, Starz's parent company, had made it clear in December 2011 at an investors’ conference that Starz had left the $300 million from Netflix on the table because it had not wanted to alienate its cable-distribution customers: “You just can't have a non-premium type price and offering of a premium service that doesn't create enormous channel conflict,” Maffei said. “Our product is marketed through cable companies, satellite companies, telcos,” he said. “You have to provide an offering that works for them. To put it into perspective, we have $1.3 billion in revenue from those guys. What can we get on the digital side?”
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