Content Costs Challenging Streaming's Business Model, Says Nathanson

The “negative cycle” in content spending depresses return on invested capital, he said. Streaming is a good business model “if you can scale it,” but “that requires a ton of spending in advance and the hope that you’re not too late to the game,” he said, and “the hope that you can raise pricing” and learn to “live with churn.”

Comparing the streaming business to traditional pay TV, Nathanson said networks were insulated from “the feedback loop of rising pricing” where MVPDs charged consumers for linear networks, which continually raised prices, and then passed those increases on to consumers. In the DTC streaming model, services have to go directly to consumers where pricing “has real-life implications on churn.” It’s hard to raise pricing in the streaming market, said Nathanson, noting Netflix has implemented price increases over time. “Price increases are a real challenge.”

Churn is a challenge in the streaming world vs. pay TV, said the analyst. DTC platforms have seen average monthly churn at rates up to 10% of subscribers vs. the linear-TV rate that can be as low as 2%-3%, he said. Churn makes it difficult to grow a business; in pay TV, it's “low enough that you have a stable revenue stream.”

Sports seasonality affects average revenue per user (ARPU) for streaming services when subscribers to services including fuboTV and YouTube TV ditch the service after a sports season or event ends, said Nathanson. The promotional activity in streaming also puts pressure on ARPU, he said, citing recent Amazon offers for discounted pricing on services from Discovery+, AMC+ and Paramount+.

In the positive column for streaming TV's business model is the benefit of targeted advertising vs. demographic targeting used in linear TV, said Nathanson. Networks can drive higher ARPU by going DTC, and they can grow their international addressable markets in streaming, which they couldn’t do in linear TV, he noted.

Advertising-based VOD is a “much better opportunity” than subscription VOD, said Nathanson, who’s very “bullish” on what he sees as an underappreciated market with “explosive” growth potential. He forecast the AVOD market will grow from $4 billion in 2020 to nearly $20 billion in 2025, on continued declines in linear ratings, additional cord cutting and better content coming to AVOD platforms. NBCUniversal, ViacomCBS and Fox are bundling their linear and AVOD offerings, he noted.

Nathanson called AVOD a hybrid offering, giving Hulu as an example. Two-thirds of Hulu subscribers opt for the ad-based version, he said, with an ARPU similar to that of the premium Hulu+Live TV offering. Hulu, Discovery+ and Peacock are using advertising “to offset, perhaps, an inability to drive higher subscription prices,” he said. Discovery+ is monetizing its audience at triple the cost per thousand of Discovery linear channels, said the analyst. Discovery+ is “selling addressable TV with one-to-one targetability” and better data, he said.

Last year, digital accounted for more than half of all U.S. ad spending with “not much left” in print, radio or outdoor, said Nathanson. TV advertising will continue to decline, with online and digital accounting for 73% of all U.S. ad spending going forward, up from 52% last year, he said: “A big portion of that growth is coming from AVOD, which is being sold in tandem by some companies with linear TV.”

Nathanson pegs current annual pay-TV subscriber losses at a combined 7.5% for cable, telco and satellite TV. Initially, there was a one-to-one conversion to virtual MVPD services as consumers shifted to the cheaper options. But as vMVPD prices have continued to rise -- now at $65-$70 per month, reflecting higher content costs -- they’re “very close to the linear bundle,” he said. “We thought in the beginning these virtual bundles would be lifesavers to the industry -- that there would be an erosion of cord cutting -- but that’s not been the case,” he said, saying 3.5 million-4 million homes annually “are leaving the system.”

Nathanson predicts “very slow growth” of consumer spending on video, from 0.8% of disposable income to 0.7% by 2024, due to promotions and discounts and a “surplus” of service options. “It’s a great time to be a consumer,” he said.

The smart TV market has reached an “inflection point” where technology advances in processing power, memory, connectivity and displays have converged with higher speed internet to enable a device that serves “multiple purposes and has the bandwidth” to do multiple things, said Susan Agliata, director-business development at Samsung, on a panel on smart TV ecosystems. Samsung sees the smart TV as much as a home hub as an entertainment device. Consumers today are looking for more than just a TV, she said: “They’re looking for something closer to a computer, which is what they actually are.”

LG, which bought a controlling stake in data analytics firm Alphonso earlier this year, is integrating its webOS platform with gaming, TV commerce (t-commerce) and interactivity, said Matt Durgin, senior director-North America smart TV partnerships at LG, saying the timing meshes with growing innovation from content partners.

Owning the operating system and hardware gives LG the ability to “choose where you want to innovate,” said Durgin. “You end up having the capability of moving very quickly toward a new feature like high-quality streaming, HDR or 4K, and then you can go create a partnership with somebody who can stream in that quality, so the barriers get removed.” The company doesn’t have to wait for a market to develop before introducing devices; it can test “micro-innovation with “a limited number of partners,” he said.

Smart TVs developed quickly over the past seven years because they became “the best way to watch content,” said Durgin. Binge-watching, a “tremendous innovation,” was enabled by streaming partners being able to introduce content in new ways. “We take it for granted now, but that’s a tremendous innovation that happened because of smart TV, and it continued the cycle of driving users.”

Smart TV advances are "happening in ways that look linear,” said Durgin. By integrating over-the-air and streaming content in a single electronic program guide, he said, “you end up looking like you’re copying an MVPD playbook, but you’re not.” He called such EPGs “tried and true methods to bring content to consumers however they want to watch it.”

As consumers have identified more TV options in the market, they’re spending more time in the smart TV environment -- 70% more in the past year on Vizio’s SmartCast platform -- and becoming more discerning, said Katherine Pond, Vizio vice president-business development. On TV’s future beyond its traditional role in entertainment, Pond said Vizio is “always looking at how we can move beyond TV.” The company looks for ways to use the TV to deliver experiences, not just content, she said. One possibility could be to interact with the baby monitor from the other room on the family room TV, she said.

Nick Colsey, Sony vice president-business development, noted the Japanese TV maker showed the first smart TV platform at CES 2007. The company had free apps and added automatic content recognition in 2012 to provide targeted ad data. What’s changed is scale and bandwidth, he said. Sony adopted the Android TV platform in 2015. Sony expects to see TV experiences this year around interactive sports, said Colsey, referencing sports betting. “Whether it’s from us or somebody else, I think you’re going to see that coming into the smart TV ecosystem.”