field study disruption of television

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Executive Summary While television executives broadly agree that new technologies will bring sweeping changes to the entertainment landscape, it is much more difficult to find consensus on what those changes mean for individual companies. The timing, nature and scope of innovation are highly uncertain, and it is difficult to quantify the inertia of entrenched interests. However, we believe the careful application of management theories can make the future of television much clearer.

In this paper, we examine the past, present, and future of television from a variety of perspectives. We begin with an overview of television’s role in our lives, emphasizing the social, emotional, and functional purposes television can serve. We then examine the historical evolution of the industry through Clay Christensen’s related theories of disruptive innovation, commoditization and modularity/integration. Following an overview of the television value chain, we issue four bold predictions for the future:

1. Highly integrated consumer device manufacturers will win the living room war

2. Telecommunications companies will disrupt cable and satellite providers as distribution becomes commoditized

3. Emerging social discovery and recommendation models will enable curators to add value in new ways

4. Rising programming costs will force incumbent content creators and distributors up-market, creating new opportunities for disruptive new entrants

Finally, we offer advice for business leaders throughout the television industry and conclude with a vision of the future from the consumer’s perspective.

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Introduction We live in a world of constant disruption and technological change. Over the past several decades, we have witnessed resource-rich incumbents fall to smaller, innovative new entrants in a variety of media-related industries. Amazon became our local bookstore. We replaced our local newspaper with Yahoo! News. We began tuning into Pandora instead of traditional radio stations. However, throughout all these transformations there was one industry left relatively unchanged: television.

From the time the first TV set was produced in the mid 1940s, television has proven to be one of the most revolutionary and disruptive technologies in history. Less than ten years after launch, television sets were found in over 80% of all U.S. households and became a “must have” for the living room1. But for most Americans, “TV” was more than just a large box that displayed moving images. It was the center of the home. Families gathered around the “tube” during the evening to enjoy I Love Lucy and The Ed Sullivan Show. Homemakers tuned into their favorite daytime soap operas to be swept away into a world of drama, romance and suspense. For the first time, people from coast to coast watched live historic moments like presidential debates and NFL Championship Games. Television changed the American lifestyle forever.

Fast forward to today. While there are more choices, sharper images and (arguably) better programming, the television viewing experience has remained relatively unchanged. Consumers still primarily sit in front of large boxes in their living room and enjoy their favorite content. Household penetration now hovers above 90%, where it has been since the early 1990s, and over 35 million households now own four or more TV sets2. Americans spend over 35 hours per week watching television programming and media consumption is at an all-time high3. We even continue to watch many of the same broadcast television networks that existed in the beginning of the television era. Given such momentum, could the television industry be the exception to the rule and avoid the seemingly inevitable disruption typically brought about in the internet age? Can major corporations such as Disney, News Corporation, Viacom and Comcast stave off newer entrants such as Netflix and Google going forward?

Many equity analysts and industry incumbents seem to believe that disruption will not occur in the television industry, at least in the short term. Since 2009, many television players have seen consistent stock price growth. For example, CBS Corporation’s stock price grew tenfold between March 2009 and March 2012, from a low of $3.40 to a high of $344. And while many of these high-performers have made significant efforts to compete through internet-based channels (e.g., Comcast’s Xfinity TV Online and NBC.com), the war is not over. In fact, it is just beginning. Television incumbents must better understand the important Jobs-To-Be-Done of the television consumer, identify compelling new value propositions and viable business models, and allocate resources in a way that best positions them to succeed. Perhaps most importantly, these companies must continue to test and learn quickly in order to avoid the dangers of complacency that doomed so many of the traditional media players in the music, newspaper, and radio broadcasting industries.

1 Kyle Harig, “Technology Adoption,” Find What Works (blog), September 2010, http://findwhatworks.files.wordpress.com/2010/09/technology-adoption.jpg, accessed March 2012. 2 “Nielsen State of the Media: Consumer Usage Report 2011,” Nielsen Holdings, accessed March 2012. 3 Ibid. 4 Data excerpted from Yahoo! Finance.

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This paper is intended to help both incumbents and new entrants navigate the complex and uncertain future of television by analyzing consumers and industry structure through Clay Christensen’s theories.

Why We Watch Television: Analysis of Consumer “Jobs-To-Be-Done” In order to analyze the television industry, we must first examine consumers’ Jobs-To-Be-Done, or the fundamental problems they are trying to solve when they opt to watch television. From this perspective, customers don’t buy products or services; they “hire” them to fulfill specific jobs. For example, people don’t buy television sets to watch TV, they buy television sets to cure boredom or bring the family together. For every job, there is a functional, emotional and social dimension. Only after gaining a solid understanding of how consumers evaluate potential solutions along these dimensions can companies develop compelling value propositions and business models that consumers want to “hire.” Furthermore, by looking at the market through the lens of the Jobs-To-Be-Done theory, companies can identify substitutes that threaten the business, both from within and outside the TV industry.

So why has the television set continued to function as the center of the home for over 60 years while other innovative products have come and gone? Historically, few competing solutions have been able to better fulfill important Jobs for which consumers hire television. Fundamental Jobs-To-Be-Done rarely change; only the available solutions do. For example, while we have progressed from fuzzy black and white cathode ray tube TV sets receiving “over-the-air” signals via an antenna to high definition TV sets connected to HD DVRs that record and save our favorite shows, families still need to be entertained at night, fans still need to root for the favorite sports team and people still need to stay informed about what’s happening in the world.

Just as smart-phones and applications provide us with the ability to find unique solutions for an incredibly diverse set of tasks, TV sets and television programming provide us with the flexibility to fulfill diverse, yet important Jobs by simply changing the channel. Given the advantages of a visual medium, television has thus far been able to compete successfully against substitutes such as newspapers, radios and magazines in regards to important Jobs. As seen in Exhibit 1, cable and broadcast television grew its share of total media consumption in the U.S. from 47.2% in 2004 to a staggering 65.5% in 2010 (10.1% CAGR), primarily at the expense of broadcast and satellite radio. While internet and mobile consumption has grown 5.2% per year since 2004, it still only accounts for 6.4% of total consumption.

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EXHIBIT 1: AVERAGE TIME SPENT PER YEAR BY MEDIA CHANNEL (% OF TOTAL)

SOURCE: “Average Time Spent With Consumer Media/User/Year,” Communications Industry Statistics, Veronis Suhler Stevenson, August 3rd 2009, accessed March 2010 To determine why consumers are increasingly selecting television over the alternatives, we must first identify and understand the fundamental jobs that television is “hired” to fulfill. To provide a starting point for both incumbents and new entrants, our team conducted interviews with a diverse set of consumers to find out why they watch TV. Exhibit 2 summarizes our findings across the various functional, emotional and social dimensions of consumers’ Jobs-To-Be-Done.

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EXHIBIT 2 – JOBS-TO-BE-DONE, SOLUTIONS AND SUBSTITUTES IN THE TELEVISION INDUSTRY Dimension Meta-Job Jobs-To-Be-Done TV-Related Solutions Traditional Substitutes Emerging Substitutes

Help me live vicariously TV Dramas Books Internet based TV/Movies Make me feel alive Game shows Movies in the Theater Video gamesBreak me out of my day-to-day routine

Reality TV Sports YouTube clips

Cheer me up TV Comedies Stand up/comedy shows Internet clips/memesHelp me lighten the mood Funny Video Shows Newspaper comic strips Social networking

Late Shows/Talk Shows Jokes among friends Comedic BlogsRemind me of what's important in life

TV Dramas Stories from friends Inspirational News Stories

Inspire me to change or act Competition Shows Movies in the Theater Social NetworksTalk Shows Newpaper articles

Watch my team play Local Sports Networks Live Games Digital solutions (MLB.tv)Watch big sports games Franchise RSN’s Newspaper Columns Fantasy SportsFollow my favorite sport ESPN Radio Broadcasts Legal streamingWatch the highlights League Sports Networks Illegal StreamingWatch the fight Sports Packages

Pay Per ViewShow me something interesting

Video on Demand Games Internet surfing (YouTube)

Fill evening hours between work and bed

Primetime TV Books Video Games

Give me time to complete other tasks

Kid-focused networks (e.g., Nickelodeon)

Toys & Games Internet Surfing

Keep kids out of trouble Playing Outside Video GamesRelieve my stress Music video channels Books Digital musicHelp me fall asleep "Trashy" TV shows MagazinesDon't make me think Music

Vices/HabitsShow me what's new/cool Documentaries Newspapers The Huffington PostTell me how I am affected Local News News Shows on RadioHelp me understand changes News NetworksEducate me on something I am interested in

Informational Networks (e.g., History Channel)

Books Wikipedia

Educate my kids School/CollegeProvide me with popular topics to talk about

News Networks "Watercooler" gossip YouTube clips

Help me find others with similar interests

Cable/Broadcast Shows Newspapers Social Networks

Sit down as a family to watch Movie Night At Home Movies at the Theater Video Games

Watch and discuss with my husband/wife

Viewing Favorite Shows Going to Restaurants Texting

Assert my status Expensive home theater systems

Restaurant/Bar Network Video Games

Make me popular Super Bowl parties Recreational Activities Online Fantasy Leagues

Cure my boredom

Occupy my kids

Help me unwind and relax

Keep me informed of what's happening in the worldHelp me to learn something new

Help me connect with others

Bring excitement into my life

Make me laugh

Make me cry

Help me feel loyal

Bring my family together

Help me build friendships

Emotional

Functional

Social

SOURCE: Interviews by author. Cambridge, MA, March 2012.

After reviewing the diverse set of jobs listed above, one thing becomes clear: the most effective TV solutions revolve around specific types of content. Not the television network, not the television set and not the cable or satellite provider. It is the specific shows, genres, sports teams and characters that fulfill Jobs-To-Be-Done. As a result, companies and technologies that lie between the viewer and the content serve just one important purpose: helping consumers find the right content in the right circumstance as easily as possible and at the lowest cost. For example, Hulu.com now ranks fourth among internet video websites in average time spent per month because it has the unique ability to aggregate high production

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value content and allow users to quickly search for, discover and watch their favorite shows across electronic devices5. It is no wonder that many in the industry claim that “content is king.”

Furthermore, by viewing the market from this jobs-based perspective, companies can better defend themselves against disruptive new entrants by creating proprietary new solutions or “bundled” solutions through partnerships. In a complex ecosystem with powerful players all fighting for a piece of the pie, our research indicated that most consumers still rely heavily on “bundled” solutions to fulfill their most important jobs given the lack of a compelling end-to-end solution. For example, a father hoping to bond with his family after dinner may choose to watch a Netflix film on his PlayStation 3, which is hooked up to his Samsung HDTV and connected over Wi-Fi with his Comcast High Speed Internet service. Given complex interdependencies throughout the value chain, the industry has adopted open standards such as HDMI to allow consumers to “bundle” various solutions together. For example, a consumer may have a game console, Blu-ray player, audio/video receiver and cable box all hooked up to their television. While these “bundled” solutions currently address critical jobs of consumers, will the difficulty of getting “everything to work together” open the door to new, better solutions?

The stranglehold of traditional television over a diverse set of jobs is not as strong as it may seem. Increasing internet speeds, the proliferation of media-capable devices, and the advancement of cellular mobile communications have given consumers new substitutes to accomplish these jobs. Looking at the solution preference by age group, the trends are troubling. While television is still the most popular leisure activity among all ages, substitutes such as video games and internet surfing are beginning to compete successfully against television in fulfilling important Jobs-To-Be-Done (see Exhibit 3).

EXHIBIT 3 – SHARE OF LEISURE TIME BY AGE, 2009

SOURCE: “American Time Use Survey 2009,” Bureau of Labor Statistics, http://www.bls.gov/tus/, accessed April 2012. In particular, younger consumers who have grown up in the age of iPhones, Facebook, and PlayStation 3s are increasingly choosing emerging solutions over traditional TV. For example, youth are now turning to

5 “Nielsen State of the Media: Consumer Usage Report 2011,” Nielsen Holdings, accessed March 2012.

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video games such as Grand Theft Auto IV, which many consider to be an interactive film with well-acted, riveting plots and unending action, instead of CSI: Miami to fulfill the important job of “Bring excitement into my life.” In order to successfully compete against these emerging substitutes, the television industry must view them as a legitimate threat and act accordingly.

However, before we can address the patterns of disruption affecting the industry and devise innovative solutions to defend against it, it is important for companies to learn from the past. After all, this is not the first time the industry has had to deal with disruptive forces.

A Brief History of Television Following the release of the first affordable television set in the 1940s, there were, unsurprisingly, relatively few options for consumers. Only a few local stations existed. Content was scarce and production quality was low. While the revolutionary new medium had the potential to fulfill the important job-to-be-done of “Bring my Family Together” during the hours of 7 and 11pm better than alternatives (e.g., radio, board-games, and books), performance was simply not yet good enough to satisfy consumers. It was not until the parent companies of the “Big Three” networks – CBS, NBC and ABC – began employing highly vertically integrated architectures that the quantity, quality, and reliability of the technology began to improve, but why? When a solution to an important job is not yet “good enough,” the advantage typically goes to competitors that employ interdependent architectures.

Interdependent architectures optimize performance, in terms of functionality and reliability. By definition, these architectures are proprietary because each company will develop its own interdependent design to optimize performance in a different way. These highly integrated architectures provide product engineers with the freedom to develop unique “end-to-end” solutions that do not need to compromise based on constraints in other areas of the value chain. This is why integration acts as a critical competitive advantage when products are not yet “good enough” (Exhibit 4). However, when a product becomes more than “good enough” in the eyes of consumers, “overshooting” has occurred. Consumers are no longer willing to pay a premium for improved performance and the basis of competition shifts towards cost, convenience and customization. In this scenario, modular architectures in which there are no unpredictable interdependences across various stages of the value chain, allow companies to compete by decreasing their costs and increasing speed to market by outsourcing standardized components. These non-integrated competitors eventually disrupt the integrated leader.

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EXHIBIT 4 – PRODUCT ARCHITECTURES AND INTEGRATION

Source: “The Innovator’s Solution,” Clayton Christensen and Michael Raynor, 2003

In television, when performance was not yet “good enough” for the majority of American consumers in the mid 1940s, networks and their parent companies were able to succeed by using interdependent architectures. They invested heavily to build or acquire local broadcast stations, connect them through coaxial cable infrastructures and roll them up into a nationwide “network” in order to achieve sufficient economies of scale. Once scale was achieved, networks were able to invest more in the production of reliable, high quality programming, which helped them compete against rival networks for advertisers that valued the medium’s extensive reach and audio-visual experience. To ensure their programming worked reliably with television sets in the home, companies such as RCA manufactured their own sets and even sold them through their own retail stores. This integrated strategy worked very well. While television sets quickly became standardized, the highly integrated “Big Three” networks (CBS, ABC, NBC) benefitted immensely as TV set prices fell and became affordable to the masses. As a result, television adoption grew from less than 1% in 1947 to nearly 80% of U.S. households by 1957 and the “Big Three” networks were able to enjoy nearly 40 years of limited competition6.

While television viewership exploded in popularity during the 1940s and 1950s, consumers in remote or inaccessible areas who could not receive broadcast TV station signals (e.g., valley towns where signals could not reach) fervently sought workaround solutions7. This pent up demand led to the creation of the first subscription cable providers, which charged upfront and monthly fees to connect the community’s local station antenna (“CATV”) to the consumer’s home through a cable. However, for over twenty years, these providers could only deliver programming from local broadcast stations due to FCC regulations. But in the early 1970s, the rules of the game changed overnight. The FCC deregulated the industry, and

6 Kyle Harig, “Technology Adoption,” Find What Works (blog), September 2010, http://findwhatworks.files.wordpress.com/2010/09/technology-adoption.jpg, accessed March 2012. 7 Ibid.

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cable operators were able to carry any stations they wanted, changing the basis of competition in the industry from signal and picture reliability to variety of programming8. Few incumbents realized at the time that this set in motion the eventual disruption of broadcast television.

Deregulation provided new entrants with the ability to target important Jobs-To-Be-Done in a way that broadcast stations could not. For example, new entrants could now fulfill the “Make Me Laugh” job better than broadcast networks by launching comedy networks such as Comedy Central. Given that it would be very difficult, risky and costly to develop and launch new networks, cable providers employed a modular approach by using standardized components (programming formats, compatible TVs, etc.) to compete effectively with broadcast stations along the new performance measure. By charging fees to consumers for access to third party cable networks (the birth of pay TV), providers were able to quickly build out channel lineups by sharing a portion of the subscription fees with the cable network. For cable networks, the ability to develop and transmit television programming to specific geographies and demographics attracted higher advertising revenue to complement the subscriber fees from cable providers. With relatively attractive profit margins, the cable network industry was flooded with new entrants such as WTCG (Turner Communications Group) all trying to take a piece of the fast growing pie9.

This modular approach enabled cable television to create customized solutions that fulfilled important jobs-to-be-done such as “Help me feel loyal to my favorite team” better than broadcast television. While new entrants into the provider market such as DirecTV (direct broadcast satellite technology) and Verizon FIOS (fiber optic cable) have offered similar services and increased pricing pressures over the past two decades, cable TV penetration continued to grow exponentially from less than 15% in 1975 to nearly 70% by 200010. While broadcast network programs on ABC, NBC, FOX, and CBS still tend to dominate the ratings on a show-by-show basis11, cable networks’ “primetime” share of viewers between 18 and 49 years old surpassed that of broadcast networks for the first time in 200212. Today, cable networks are still growing rapidly and generating attractive profit margins.

EXHIBIT 5 – TRANSITION FROM VERTICAL INTEGRATION TO MODULAR ARCHITECTURE

8 C.H. Sterling, “Deregulation,” Museum of Broadcast Communications, http://www.museum.tv/eotvsection.php?entrycode=deregulation, accessed March 2012. 9 “Milestones in TBS History,” Behind the Scenes, http://static.tbs.com/about_us/PR/mile.htm, accessed April 2012 10 Kyle Harig, “Technology Adoption,” Find What Works (blog), September 2010, http://findwhatworks.files.wordpress.com/2010/09/technology-adoption.jpg, accessed March 2012. 11 “Nielsen Top 10 Ratings,” March 5th 2012, http://www.nielsen.com/us/en/insights/top10s/television.html, accessed April 2012 12 Turner Research, “Share of Prime Time HH Viewing,” May 27th 2010, accessed April 2012.

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However, declining costs and technological innovations in the telecommunications space over the last two decades are planting the seeds for a classic disruption scenario. With rising penetration rates of high speed internet and internet-enabled devices, consumers are beginning to turn to internet-based solutions for important jobs-to-be-done that were previously best fulfilled by traditional television (see Exhibit 5 for evolution of the TV industry). New entrants such as Netflix, Hulu and Apple are all capitalizing on this consumer trend. Additionally, many consumers are now looking to substitutes such as internet surfing and video game playing to fulfill important jobs. Will internet-driven solutions and substitutes transform the industry again, just as cable networks were able to slowly overtake broadcast networks? Should companies respond to changes with integrated or modularized strategies? Where will the profits be in the value chain? In order to answer these questions, we must first understand the television value chain as it exists today.

The Television Value Chain The television value chain is complex and ever-evolving. Conglomerates such as News Corp, Time Warner, Comcast and Disney are both vertically and horizontally integrated across the ecosystem. Others focus solely on particular areas of the value chain, such as Fremantle Media, the production studio behind American Idol. However, for reasons of simplicity, we have segmented the television value chain into four distinct areas: “consumers”, “distributors”, “curators” and “creators,” as shown in Exhibit 6.

EXHIBIT 6 - OVERVIEW OF THE TELEVISION INDUSTRY ECOSYSTEM

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Consumers

The “consumers” segment of the television value chain, as we define it, encompasses all products or services through which consumers watch television programming. This includes not only television set manufacturers, but increasingly laptop, tablet and smartphone device manufacturers, internet connected video game console manufacturers and manufacturers behind “over-the-top” devices such as AppleTV and Roku. Driven by the significant growth in smartphones and tablets of late, the U.S. consumer electronics industry has grown to $190.5B in 2011 from $170B in 200913. However, television viewing is still primarily experienced through television sets with companies such as Vizio and Samsung dominating the flat panel market (see Exhibit 7 for Q4 2010 market share).

EXHIBIT 7 – TOP 8 FLAT PANEL TELEVISION BRANDS IN THE UNITED STATES, Q4 2010

Source: “Top 8 Flat Panel Television Brands,” IHS iSuppli, February 2011, accessed April 2012

13 Teryn Papp, "Connecting the Dots Between Consumers, Content and Consumer Electronics in the HomeCEA: 2012 Ownership Report", Consumer Electronics Association, December 2011, www.ce.org, accessed April 2012.

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Revenue in this segment is primarily generated from device sales through brick and mortar retailers as well as directly to consumers. However, as broadband penetration rates have risen and profit margins on television sets have decreased, many device manufacturers are now pursuing internet-driven revenue streams such as movie rentals, video on demand and digital video game sales (e.g., Xbox Live and Samsung SmartTV) to diversify and grow. In addition, with the significant growth of internet-connected tablets, smartphones and PCs, consumers now have more options than ever for viewing their favorite television programming (Exhibit 8).

As for cost structures, the device manufacturing industry is heavily driven by economies of scale and input costs (e.g., LCD screens) which means global manufacturers such as Samsung and LG enjoy significant cost advantages. However, going forward, cost advantages may shift to companies with diversified revenue streams that allow them to subsidize device costs for consumers.

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EXHIBIT 8 – CONSUMER ELECTRONICS DEVICE PENETRATION AND INTERNET CONNECTION

SOURCE: Teryn Papp, "Connecting the Dots Between Consumers, Content and Consumer Electronics in the Home, CEA: 2012 Ownership Report", Consumer Electronics Association, December 2011, www.ce.org, accessed April 2012. Distributors

Distributors include all companies that purchase the rights to television content or programming with the objective of passing it onto consumers through a variety of owned or leased distribution channels. The major players in this industry include cable, satellite and “telco” providers that purchase television programming from networks, rights holders (e.g., NFL) and production studios, typically on a per subscriber basis. Many of these providers also function as Internet Service Providers (ISP) and in that capacity function as distributors. We also consider internet-based platforms such as Netflix to be distributors of content. Similarly, Apple’s iTunes is a distributor in that it acts as an intermediary between sellers (networks/production studios) and buyers (consumers).

The primary revenue stream of the various distributors are monthly fees charged to subscribers for access to television programming packages including basic programming, premium programming (e.g. HBO), video on demand and DVR/equipment rentals. In regards to cost structures, satellite providers currently hold a cost advantage over cable providers due to the relatively lower equipment and labor costs of maintaining infrastructure. For example, DirecTV needs only to launch a new satellite every few years and provide customer service while cable providers must maintain their entire terrestrial cable infrastructure in addition to other costs. Cable providers have spent between $10B and $15B per year in capital expenditures to maintain their network over the past 5 years compared to roughly $1B per year for satellite providers14.

14 “IBISWorld Industry Report: Cable Providers in the U.S.,” IBISWorld (September 2011), http://www.ibisworld.com/, accessed March 2012.

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EXHIBIT 9 – COMPARISON OF REVENUE AND COSTS AMONG TOP DISTRIBUTION CHANNELS

SOURCE: Compiled from “IBISWorld Industry Report: Cable Providers in the U.S.,” “IBISWorld Industry Report: Satellite Providers in the U.S.” and “IBISWorld Industry Report: Internet Service Providers, IBISWorld (September 2011), http://www.ibisworld.com/, accessed March 2012.

Curators

We use the term “curation” to describe the process by which the universe of available content is selected, packaged and presented to consumers. Curators in the traditional television industry include broadcast networks and cable networks as well as online players such as Netflix and Hulu. Broadcast networks supply content primarily via over-the-air transmission, while cable networks sell content to operators who own (or lease) the cable infrastructure that reaches homes and businesses across the country. “Must-carry” regulations also require cable operators to carry local broadcast content under certain conditions.

Broadcast networks earn 85.5% of their revenues from advertising.15 As consumers have begun using digital video recorders to skip commercials, and cable networks have faced new competition for ad dollars, advertising rates have dropped. Many broadcast networks have responded to this development by creating a new revenue stream: charging cable providers retransmission fees for carrying broadcast content. Industry revenues totaled $36.1B in 2011, with profits of $4.8B (13.3% margin). Major cost drivers include the purchase of broadcast rights on programming (33.7%), wages (21.4%), and equipment purchases (11.0%). Profit margins can vary considerably from one year to the next, since many costs are fixed whereas ad revenues vary substantially with swings in the macroeconomic business cycle. The largest companies by market share are Walt Disney Company (17.6%) and News Corporation (13.5%)16. The four largest broadcast networks are ABC, NBS, CBS, and FOX.

Cable networks earn revenues from three primary sources: national and regional advertising (33.6%), licensing the right to broadcast or redistribute content (26.8%), and other industry services (27.3%).17 Industry revenues totaled $16.7B in 2011, with profits of $1.6B (9.6% margin). The two main cost drivers are production equipment purchases (38.2% of revenue) and wages (35.6%). The largest companies by 15 “Broadcast Networks In The US – Industry Report,” IBISWorld, November 2011 16 “Broadcast Networks In The US – Industry Report,” IBISWorld, November 2011 17 “Cable Networks In The US – Industry Report,” IBISWorld, November 2011

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market share are Walt Disney Company (15.3%), Viacom (13.4%), Time Warner Inc (11.0%), Comcast (10.9%), and News Corporation (9.0%). The largest cable networks by subscriber base include TBS Superstation, ESPN, Discovery Channel, USA Network, C-SPAN, CNN, TNT, Nickelodeon and Nick at Nite, A&E Network, TNN and Fox Family Channel.

In recent years, new curation models have emerged as online video consumption has grown. Netflix, YouTube, and Hulu are three popular platforms that employ proprietary algorithms to determine the taste preferences of individual users and present them with content they are likely to enjoy. Many of these emerging curation models reach consumers directly, blurring the line between “curation” and “distribution,” which are more distinct segments in the traditional television value chain. Emerging models also have a very different cost structure than broadcast and cable networks. In 2011, Netflix revenues totaled $3.2B, with profits of $226M (7.1% margin).18 Major costs included content acquisition, licensing, and delivery (55.9% of revenues), marketing (12.6%), and technology investments (8.1%).19 Creators

Content creation refers to the process by which studios and independent producers develop and film content that is sold or licensed to broadcast and cable networks and, more recently, digital distribution partners. Traditionally, television content has been created by independent studios using deficit financing. Content creators license the initial broadcast rights to a network, and then seek to cover the rest of their costs through syndication, international licensing and DVD sales. A broadcast network television show now costs on average ~$3M/episode with networks paying ~$1.5M to license the content.20 As such, the long tail of revenue from content can be incredibly important to content creators.

Recently, more curators and distributers, such as HBO and AMC, have moved into content production rather than buying content from third-party studios. Strategically, absorbing content creation’s financial and reputational risks allows for streamlined operations (cost advantage), marketplace differentiation and higher profit potential, as the curators have access to the long-tail revenue. Netflix, for example, is developing its own original programming, most notably the dramas Lilyhammer and House of Cards slated for release later in 2012. It already has the distribution channel, so can plug in the new original content there.

At the lowest end of the market lies user generated content delivered largely over the internet. Here, barriers to entry are lower than ever. Any consumer can now produce HD quality video by simply walking into a local Best Buy and buying relatively inexpensive high-quality production equipment. In 2009, for instance, Colin, a zombie feature with a $70 budget and actors hired from Facebook premiered at Cannes.21 This trend of low-budget content creation is spreading quickly as the internet enables even the smallest content creators to distribute directly to consumers.

18 Netflix 10-K filed 2/12/2012 19 Ibid. 20 Bill Carter. “Weighty Dramas Flourish on Cable,” New York Times, April 5, 2010, http://www.nytimes.com/2010/04/05/business/media/05cable.html?_r=1&partner=rss&emc=rss, accessed April 2012. 21Tom Foster. “Hollywood eyes $70 zombie movie wowing Cannes,” CNN, May 21, 2009, http://articles.cnn.com/2009-05-21/entertainment/Colin_1_zombie-low-budget-left-films?_s=PM:SHOWBIZ, accessed April 2012.

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Now that the television value chain is better understood, we will explore how changes in television consumption patterns, advancements in technology and new business models will reshape the industry going forward.

Key Trends and Industry Predictions After analyzing major industry trends, our team predicts four distinct outcomes that will likely transform the industry over the next five to ten years:

1. Highly integrated consumer device manufacturers will win the living room war




These predictions are summarized in Exhibit 10 below:

EXHIBIT 10 – COMPARISON OF REVENUE AND COSTS AMONG TOP DISTRIBUTION CHANNELS

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1. Highly integrated consumer electronics manufacturers will win the living room war

Consumers lie at the center of the entertainment industry, especially television, where they influence multiple revenue streams. Television networks such as CBS rely on CPMs (cost per mille, or price paid for each thousand views in advertising) and viewership to set advertising rates. Multiple service operators (MSOs) such as Comcast and Time Warner Cable charge consumers monthly fees for cable subscriptions. Technology companies rely on television consumption to sell devices such as Samsung HDTVs and Playstation 3s. However, consumer behavior is changing rapidly largely due to the rise of internet-connected devices and faster internet speeds. As a result, companies are attempting to adapt to changes in consumer preferences, which is transforming the entire television ecosystem.

Television consumption in the United States has historically been driven by penetration of television sets and improvements in distribution and programming. Since the late 1970s, broadcast television reached and has since maintained high-90% penetration rates, while cable and satellite desperately played catch up, peaking at 80% in the early 2000s (Exhibit 11).

EXHIBIT 11: HOUSEHOLD PENETRATION OF CONSUMER MEDIA AND DEVICES (%)

SOURCE: Veronis Suhler Stevenson, Communications Industry Forecast At the same time, household internet penetration rates rose drastically, giving consumers the option to engage with television content away from their TV sets. Today there are 115.8M smartphone users and 54.8M tablet users in the U.S, figures that are expected to grow to 157.7M and 89.5M respectively in 2014.22 The proliferation of these devices has been aided by the simultaneous advancement in cellular mobile communications networks’ fourth generation (4G) networks that reach unprecedented speeds. As a result, consumers are able to view high quality streaming video on their mobile devices, in the home, on the train and everywhere else they go. The availability of these new options is driving rapid consumer adoption, as we see smartphone and tablet video consumption skyrocketing.

Television was traditionally hired to fill the role of weeknight prime-time entertainment with roughly 45% of early-1950s viewing occurring between the hours of 7:30pm and 11pm.23 While viewers have steadily increased their overall television consumption over the past 60 years, many consumers have slowly shifted away from prime-time viewing. In fact, only 23% of television programming today is viewed during prime-time hours.24 This phenomenon can be explained by two distinct factors. First, consumers today have an increasing number of substitutes competing to get hired for important jobs-to-be-done during primetime hours. For example, internet surfing, social networking and video games are all compared when determining the ideal solution for the “Cure My Boredom” job. Second, “time shifted

22 Source: Mobile Data Dashboard, eMarketer, accessed April 2012. 23 Media Dynamics Inc. “TV Dimensions, 2011” Pg. 67. 24 Ibid

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viewing” technologies have emerged that provide consumers with the ability to watch their favorite television content outside of prime-time hours. For example, relatively new products such as MSO or satellite provided digital video recorders (DVRs) and online platforms (e.g., Hulu and Netflix) now enable consumers to keep up with their favorite television content regardless of the time.

While overall media consumption has largely remained flat since 2004, there are major shifts in consumer behavior occurring in the media sector that will significantly affect industry players going forward. For example, broadcast television consumption has dropped 2.2% p.a. between 2004 and 2009 and is expected to continue to decline by 3.5% p.a. through 2014. Though cable television continues to grow, this growth is starting to slow (4.6% and 3.1% p.a. over the same time periods). So what is starting to steal share from television? It is the internet (7.7%, 1.9% p.a. growth, respectively) and mobile phones (26.9%, 8.8% growth, respectively).25 With quickly evolving consumer devices and compelling new substitutes beginning to steal share of overall media consumption from traditional television viewing, we are seeing a decline in ratings and a shift in advertising spend.26

Companies are trying to capitalize on the advancement of internet technology, increased connection speeds and the proliferation of media-capable devices. As consumer behavior continues to shift to internet based media, many industry players are fighting to own the living room of the future. Internet-based curators and consumer electronics manufacturers are recognizing that the ease, convenience and quality of traditional television in the living room is a critical component of meeting many of the jobs highlighted earlier in this paper. As such, they have identified the importance of seamlessly integrating their internet based platforms into the living room in order to challenge traditional TV on these metrics. This has led to unique partnerships between internet based curators and consumer electronics manufacturers, such as the partnership between Netflix and Sony to stream content through the PlayStation 3.

After conducting interviews with television consumers, we found that in order for these models to succeed the offering must be intuitive, easy to use, and seamlessly integrated into the living room in addition to providing entertaining and relevant content. These are important elements of the decision consumers make when hiring television programming. As consumers continue to view media content on their portable electronic devices, a solution which allows them to find, select and view content across all of their devices will also be necessary.

However, today’s bundled solutions are failing to deliver on ease-of-use and seamless integration. Consumers, particularly in older demographics, struggle to understand how all these devices work together. The barrier of purchasing additional electronics is also slowing adoption of these bundled solutions. TV manufacturers are recognizing this trend, and have begun incorporating internet connectivity into their television sets. Today, 38% of U.S. households have at least one TV connected to the internet27. The majority of these connections (28%) are through video game systems, and only 4% are connected directly through the TV set.28 While only 29% of TVs shipped in the U.S. are currently

25 Veronis Suhler Stevenson, “Communications Industry Forecast, 2010-2014,” Pg. 4. 26 Cotton Delo, “Citi Analyst: Online-Ad Market Reaping Benefit of TV Ad Dollars’ Shift,” AdAge Digital, April 17 2012, http://adage.com/article/special-report-digital-conference/citi-analyst-online-ad-market-tv-dollars/234181/, accessed April 2012. 27 Nielsen, “State of the Media: Consumer Usage Report 2011,” Pg. 8. 28 Robert Briel. “U.S. Connected TVs reach 38%,” Broadband TV News, April 10, 2012, http://www.broadbandtvnews.com/2012/04/10/us-connected-tvs-reach-38/, accessed April 2012.

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internet-ready, this number will rise dramatically given that internet-enabled TV set shipments are projected to rise to 80% within three years.29

Today’s internet-based television experiences in the living room are not yet good enough when compared to traditional television along critical performance dimensions such as ease of use and seamless integration. As internet-based curators continue to acquire better content it will be critical for the consumer electronics players to solve this performance gap. For example, Exhibit 12 shows that there are clearly unfulfilled functional jobs of consumers, who desire a better experience for streaming video content.

EXHIBIT 12: CONSUMER ATTITUDES ON DIGITAL VIDEO CONTENT

SOURCE: Consumer Electronics Association, “Connecting the Dots Between Consumers, Content, and Consumer Electronics in the Home,” Pg. 16

“Bundled” solutions are almost never the right approach when performance is not yet good enough. Interdependent architectures optimize performance as product engineers have the freedom to develop unique “end-to-end” solutions that do not need to adapt to constraints in other areas of the value chain.30 Accordingly, we expect that the manufacturer who can develop a tightly integrated solution that brings the best internet-based television experience into the living room will win the battle.

Apple, renowned for integrated solutions that seamlessly fit into consumers’ lives, is expected to be a major player going forward. Its AppleTV device, which was designed as a plug-in to televisions, did not live up to expectations because of the aforementioned barriers. However, Apple is rumored to be developing its own connected television, an “iTV” or “iPanel,” to overcome these adoption barriers. Peter Misek, an analyst with Jefferies, is confident that this will be released in Q4 2012, just in time for Christmas.31 Apple’s ability to vertically integrate across the curation, distribution and consumer areas of

29 Wayne Friedman. “Net-Connected TV Fuels 3dTV Popularity,” MediaDaily News, Jan 19, 2012, http://www.mediapost.com/publications/article/166164/net-connected-tv-fuels-3dtv-popularity.html, accessed April 2012. 30 Clayton M Christensen and Michael E. Raynor, The Innovators Solution: Creating and Sustaining Successful Growth (Boston: Harvard Business Review Press, 2003), p. 129. 31 Ben Reid. “Apple’s Rumored Connected TV Set Will Reportedly Be Called ‘iPanel’, Will Be Available This Year?” Redmond Pie: Covering Microsoft, Google, Apple, and the web! April 6, 2012, http://www.redmondpie.com/apple’s-rumored-connected-tv-set-will-reportedly-be-called-ipanel-will-be-available-this-year/, accessed April 2012.

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the value chain may position them well to boost the competitiveness of internet-based TV on the important hiring criteria of consumers.

Whether it is Apple, or any of the other consumer electronics manufacturers who eventually solves the ease of use problem, the impact on the entire television industry will be significant. Digital media consumption will continue to grow, and consumers will increasingly cut the cord from their traditional TV subscriptions. Furthermore, the growth of internet-based distribution and curation will provide content owners with more leverage over broadcast and cable networks. Solving this problem could shift the entire landscape of the television industry over the next decade while also changing the television viewing experience.


The advancement of mobile technology and the proliferation of internet connected televisions and portable electronics devices is creating an interesting battle in television distribution.

Telecommunications companies have been expanding their service offerings beyond traditional consumer and business telecommunication products, showing consistent interest in television distribution. Verizon and AT&T have both invested in fiber-optic networks (FIOS and UVerse respectively) in attempts to enter the space. More recently, as wireless carriers complete their rollout of 4G long term evolution (LTE) networks, their wireless broadband speeds are surpassing the broadband speeds offered by cable providers32. Consumers are using these networks to download and stream video on their phones and tablets, yet they predominantly still use cable and satellite distributors to watch video on their television sets and cable or DSL broadband to connect their computers. With a rapidly growing number of device manufacturers building TV sets with wireless internet connection capabilities, there is a disruptive opportunity for the major telecommunications companies to uproot Multiple Systems Operators such as Comcast with “triple play” packages of their own (4G/5G cellular phone, television, and high speed internet).

Mobile networks enjoy substantial cost advantages over cable/satellite providers who must invest significantly to keep their high fixed-asset cable systems up to date. Customer acquisition is also cheaper with this model as a telco carrier needs only to install a tower to cover a service area, whereas cable and satellite providers must pay high-cost technicians to travel to homes for installation. As network costs decline with scaling and network capacity increases going forward, these 4G, and soon to be 5G, networks will begin competing directly with services from traditional cable and satellite providers. As a telling example, Verizon recently launched a new “fixed wireless” service in March of 2012 called HomeFusion that offers “households in areas with limited broadband options a reliable alternative for data connectivity in their homes.33” Verizon’s new service installs an antenna-like device, referred to as a “cantenna,” which acts as a cellular tower in the customer’s home, amplifying the signal from the metro

32 Mark Kurlyandchik. “Verizon CEO: LTE Will Compete with Cable,” Daily Tech, December 8, 2010, http://www.dailytech.com/Verizon+CEO+LTE+Will+Compete+with+Cable/article20343.htm, accessed April 2012. 33 “HomeFusion Broadband From Verizon Powers In-Home Internet Connectivity With 4G LTE,” Verizon Press Release, March 6 2012. http://newscenter.verizon.com/press-releases/verizon/2012/homefusion-broadband-from.html, accessed February 2012.

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LTE tower.34 This work-around arrangement is eerily reminiscent of the work-around solutions of the early 1970’s which led to the birth of cable broadcast stations.

In homes with broadband internet, Verizon and AT&T also offer a femtocell, or microcell technology that boosts signals within the home. This technology allows you to use broadband internet to create a mini cellular signal in your home. As both of these technologies continue to improve, telecommunications companies will have many options to distribute media to any device in a consumer’s home.

In addition to directly competing, telcos are beginning to partner with cable companies to sell wireless subscriptions as part of a “Quad-Play” bundle, which helps drive higher penetration of 4G enabled devices while at the same time keeping cable companies out of the wireless space35.

Verizon ($150B enterprise value) and AT&T ($238B enterprise value) are massive companies with IP-based television services (FIOS TV and Uverse) and likely have strong incentives to capture market share within the higher-profit television market. Verizon recently stopped its “me-too” strategy of deploying fiber optic cable to the home (FIOS) and instead is focusing on fixed LTE broadband solutions36.

By launching subsidized femtocell devices, which allow customers to connect all of their home devices, the major telcos could potentially disrupt traditional MSOs going forward. As mobile communication technology continues to develop, the future of television distribution looks certain to change.

Network bandwidth and spectrum scarcity will be two short-term limiting factors in this disruption. Today, the rapid growth of video traffic, video communications, and bandwidth intensive applications is already threatening to over-tax the networks. This is being curtailed by price-rationing content consumption through higher data usage costs passed through to the consumer.37 Today’s 4G LTE networks provide ample data transmission rates, at 1 GB/second fixed and 100 MB/second mobile, to stream high definition video at today’s compression rates to any device. Given even conservative Moore’s law assumptions, it would be tough to argue that compression rates or transmission rates would be a long-term limiting factor to this disruption. That being said, overall media consumption in the U.S., when traditional TV viewing is included, would demand far more spectrum than is currently available, or in the pipeline.

The 4G LTE spectrum allocation is only 700 MHz38. In 2012, the net surplus was only 87 MHz. This is projected to become a deficit of 275 MHz by 201439. The impact of this deficit, if it is not addressed, will

34 Lee Ratliff. “Verizon Unveils Fixed LTE Broadband Service,” iHS iSuppli Market Research, March 27, 2012, http://www.isuppli.com/Home-and-Consumer-Electronics/MarketWatch/Pages/Verizon-Unveils-Fixed-LTE-Broadband-Service.aspx, accessed April 2012. 35 Victor H. “Verizon partners with Comcast, now offering cable TV ‘quad-play’ bundles,” Phone Arena, Jan 17 2012. http://www.phonearena.com/news/Verizon-partners-with-Comcast-now-offering-cable-TV-quad-play-bundles_id25967, accessed March 2012 36 Karl Bode. “Verizon’s Fixed LTE Efforts Could Live On Option Not Necessarily Killed By New TV Deal,” Broadband DSL Reports, December 12, 2011, http://www.dslreports.com/shownews/Verizons-Fixed-LTE-Efforts-Could-Live-On-117390, accessed April 2012. 37 Greg Ireland, Suzanne Hopkins, Carrie MacGillivray. “Thoughts on Mobile Following CTIA Wireless 2011” IDC, March 31, 2011, 38 Stacey Higginbotham, “For Better Mobile Broadband, the U.S. Needs More Spectrum,” GigaOm, August 17, 2009, http://gigaom.com/2009/08/17/for-better-mobile-broadband-the-u-s-needs-more-spectrum/, accessed April 2012

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be felt by consumers in the form of lower quality service, increased dropped calls, and increased data usage costs. This will place unprecedented pressure on the FCC and the U.S. spectrum allocation fiat, forcing them to marketize broader swaths of the spectrum. We are already seeing the effects. Congress reached a tentative deal in February approving voluntary auctions that would let TV broadcasters spectrum licenses be repurposed for wireless broadband use.40 This is creating the ironic situation wherein incumbent traditional TV distributors are selling spectrum allocations to competitors who threaten to disrupt their distribution business. Comcast recently divested its entire wireless spectrum portfolio to Verizon for $3.6 billion.41 As in most low-end disruptions, we foresee this trend continuing as incumbent distributors will feel little pain and see little-threat as telecommunications companies steal share of the low-margin customers.

In analyzing the spectrum capacity issue, our determination is that the spectrum crunch, although real, is over-hyped. The government will feel pressure to ensure spectrum allocations meet the needs of the American public as those needs evolve, and as such will find solutions on a just-in-time basis. We’ve seen this pressure forcing the governments hand over the last two years. In March, 2010, the FCC released a National Broadband Plan, calling for the allocation of 500 MHz of additional spectrum for the wireless industry. In June, 2010, President Barrack Obama issued a memo in support of this plan.42 The Radio Spectrum Inventory Act and its companion bill, calling for identification of additional spectrum to be relocated for commercial wireless use, passed the House in April 2010.43

Our position is that this government pressure will combine with necessary improvements in spectrum efficiency to address the spectrum issue as-needed. Although spectrum allocations could be used as a lobbying blockade by threatened incumbents, their actions in selling spectrum allocations are likely to continue in the pursuit of short-term profit.

Rather than lobbying for restricted spectrum allocations, incumbents are protecting themselves against disruption by integrating across the value chain. For example, Comcast recently extended into curation by acquiring NBC Universal in 201144 while News Corporation extended into distribution by acquiring DirecTV back in 2003.45 These integrations are providing the incumbents with increased leverage throughout the value chain and options to hedge their risks in case of disruption.

If telecommunications companies do ultimately disrupt traditional MSOs, they are not necessarily in the clear, as the elements are in place for commoditization of distribution. We see curation and consumer electronics as game-changing opportunities in the future of internet based television. Since both of these elements are “not good enough” at meeting the hiring criteria of consumers, they will likely become the 39 FCC, as sourced by David Goldman. “The Spectrum Crunch: Sorry America, your wireless airwaves are full,” CNNMoney, February 21, 2012, http://money.cnn.com/2012/02/21/technology/spectrum_crunch/index.htm, accessed April 2012. 40 ibid 41 David Goldman, “Verizon’s $3.6 billion spectrum buy reshapes wireless field” CNNMoney, December 2, 2011, http://money.cnn.com/2011/12/02/technology/verizon_spectrum/index.htm, accessed March 2012. 42 CTIA The Wireless Association, “Position on Spectrum, Tower Sitting & Antennas,” http://www.ctia.org/advocacy/policy_topics/topic.cfm/tid/65, accessed April 2012. 43 Ibid 44 Tim Arango. “G.E. makes it official: NBC will go to Comcast,” New York Times, Dec 3rd, 2009, http://www.nytimes.com/2009/12/04/business/media/04nbc.html, accessed April 2012. 45Associated Press. “FCC OK’s News Corp. purchase of DirecTV,” MSNBC.com, December 19, 2003,http://www.msnbc.msn.com/id/3763546/ns/business-us_business/t/fcc-oks-news-corp-purchase-directv/#.T4zLRs1GhHA, accessed April 2012.

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performance defining elements of the value chain in the future. Consumers will care which device they are using to watch television and which curation mechanism is helping them select content. As internet speeds continue to grow, and picture and audio quality are more than adequate, consumers will likely be indifferent to the distributor. This will give a significant amount of leverage to the consumer electronics manufacturers and curators of the future in regards to distribution negotiations. This comparative leverage will combine with a scale-race amongst competing telcos to create significant downward pricing pressure. We foresee distribution becoming a “dumb pipe” in the television value chain, with little profit extracted for the telecommunications companies in the long term.


One common element among many of the jobs-to-be done revolves around the decision of what to watch. This decision is sometimes active, when the consumer seeks out content to watch. They may have heard of a show from friends, or seen an advertisement that they found intriguing. Other times, this is passive. A consumer will turn on a major TV network or cable channel and consume content, allowing the network to act as his/her curator. In both circumstances, the consumers we interviewed noted that the ability to quickly find programming that fulfilled that particular job (entertain them, amuse them, inform them), was critical to their hiring decision. The mechanism that has been used to accomplish this task has evolved over the history of TV.

Prior to the deregulation of the early 70’s, curation was handled by the integrated “big three” broadcast networks, who chose content which would relate to a broad-swath of the American population. Hits like I Love Lucy, and The Andy Griffith Show, which brought in terrific ratings for CBS, ran for six and eight seasons respectively. In this way, consumers’ preferences affected which shows were aired, but the process was passive for the consumer. Deregulation led to the emergence of cable channels, which had more specialized selections of content catered to specific demographics. The Discovery Channel, Home and Garden TV, and MTV are some examples of these more targeted channels. These specialized channels were attractive to advertisers, who favor targeted populations, and as such, cable channels received attractive CPMs.

These trends have led to the continued propagation of specialized cable channels. By 2008, the average U.S. TV cable subscriber had access to 130.1 channels.46 These specialized and niche offerings provide an incredible array of content options for consumers.

Consumers have also historically discovered content in social ways. Their friends tell them about an interesting show they’ve been watching and they decide to watch it based on trust in their friends’ opinions or out of desire to have something to talk about around the water cooler. This behavior is not easily replicable through the traditional one-way delivery mechanism, but people are now filling this job-to-be done by cobbling together internet based solutions. For example, James Franco leveraged this behavior at the 2011 Oscars by tweeting during the show. The event had 10,000 tweets per minute and 1.8 million tweets overall.47 Internet-based curation provides an ability to integrate these social curation and

46 Joe Mandese. “TV Universe Expands, Share of Channels Tuned Does Not,” MediaDaily News, July 21, 2009, http://www.mediapost.com/publications/article/110159/tv-universe-expands-share-of-channels-tuned-does.html, accessed April 2012. 47 David Wesson. “The future of TV is social & the revolution is coming!” David Wesson’s Digital Culture Social Media Marketing, Innovation and Digital Dialogue (Blog), June 12, 2011,

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water-cooler behavior mechanisms online. This is unlocking opportunities to personalize and socialize the TV experience like never before.

A myriad of online curation players are trying to leverage this capability to meet the “what to watch” element of jobs-to-be-done in superior ways. Netflix built much of its initial success on a constantly evolving algorithm that recommended shows based on the patterns and ratings of both the user and users like them. In other countries, Netflix has taken this a step further by leveraging social networks to allow users to share what they are watching with their friends, much like Spotify has done with music. In December 2011, Netflix successfully lobbied a bill to allow this sharing in the United States.48 “Netflix views its recommendation algorithm as a strategic priority; in 2011 they spent $260m on technology and development, which was 8.1% of total revenue49.

Facebook is actively pursuing social TV as well, by building in features like TV communities & TV check-ins, and they recently announced plans to build an electronic program guide (EPG) with both a recommendation engine and social integration.50 A plethora of social TV applications are entering the fray as well. Apps like GetGlue allow viewers to “check-in” to the TV show they are watching and share it with friends. Today seventy five major networks and ten movie studios promote their content to GetGlue’s two million viewers51

Next New Networks, which was acquired by YouTube in 2011 for ~$50M52, is attempting to build out a “cable network” infrastructure online. To do so, Next New Networks is leveraging the wisdom of the crowd with YouTube-based shows to curate channels that target specific consumer interests, which is an attempt to modernize the cable model online. Since launching in 2007, the company has gotten more than one billion unique views and surpassed six million subscribers.

The ability to leverage the wisdom of the crowd, social graph, and sophisticated recommendation algorithms may allow internet-based curators to fulfill the “what should I watch” hiring criteria better than could ever be imagined with the existing television model. Because consumers are currently cobbling together solutions for socializing their TV experience online, there is an opportunity to integrate these experiences into a curation platform.

The player who can most perfectly fulfill these elements of the job-to-be-done will win, as curation becomes a critical performance defining subsystem of the future television value-chain. This winning curation platform will be well positioned to negotiate favorable terms with content producers as they draw

http://davidwesson.typepad.com/david_wessons_digital_cul/2011/06/-the-future-of-tv-is-social-the-revolution-is-coming-.html, accessed April 2012. 48 Devin Henry. “Franken committee to examine calls to ‘modernize’ video privacy law,” MinnPost, January 31, 2012, http://www.minnpost.com/dc-dispatches/2012/01/franken-committee-examine-calls-modernize-video-privacy-law, accessed March 2012. 49 Netflix, 2011 Annual Report, pg. 26 & 30, http://ir.netflix.com/secfiling.cfm?filingID=1193125-12-53009&CIK=1065280, accessed April 2012. 50 David Wesson. “The future of TV is social & the revolution is coming!” David Wesson’s Digital Culture Social Media Marketing, Innovation and Digital Dialogue (Blog), June 12, 2011, http://davidwesson.typepad.com/david_wessons_digital_cul/2011/06/-the-future-of-tv-is-social-the-revolution-is-coming-.html, accessed April 2012. 51 Source: TechCrunch, “CrunchBase Company Profile for GetGlue,” http://www.CrunchBase.com/product/glue-2, accessed April 2012 52 Jim O’Neill. “YouTube Acquires Next New Networks,” Fierce Online Video, March 7, 2011, http://www.fierceonlinevideo.com/story/YouTube-acquires-next-new-networks/2011-03-07, accessed April 2012.

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an increasing number of viewers, while also enjoying leverage over distributors and consumer electronics manufacturers.

What makes curation even more important to the future of TV is the impending commoditization of content, which is discussed next. As the breadth of available content continues to grow, consumers are demanding that someone do the pre-work for them and help them sort through the noise.


In a well-developed industry, like television, incumbents are incentivized to move up-market in search of higher profits. High-end customers may be more demanding, but they are willing to pay more and are viewed as important to increasing the business’ profitability. However, some customers do not need the most cutting edge product offering available, and as such, are not willing to pay an increased price for these offerings. This creates an opportunity for low-end disruption, where new players can enter the market and take share by capturing over-served customers that are perceived as low value to the incumbents. After acquiring these low end customers, these new entrants begin to search for higher profits and inevitably move up-market, eventually competing against incumbents in higher ends of the market with superior business models.

There are three conditions that must be met for low-end disruption to take place, all of which are currently seen in television content creation and distribution.

First, the market must have a “rate of improvement that customers can utilize or absorb.”53 In the case of television, the relevant performance dimensions are the quality and variety of available programming. Customers are willing to pay for improvements on this dimension, but only to a point.

The second factor captures a distinct difference in a market between a customer’s ability to absorb increased performance and the performance trajectory in markets. As incumbents keep trying to make better products, they inevitably overshoot the customer absorption trajectory because of their focus on increasing profitability in the market. In the television industry, very few customers need the biggest and most expensive cable package with hundreds of channels and seemingly unlimited content. However, the cable providers have moved that direction as they seek to improve the most critical metric, Average Revenue Per User (ARPU).

Finally, there is an important distinction to note between sustaining and disruptive innovation. 54 Sustaining innovations are those that, as alluded to, focus on incremental improvements to an existing product. In television, this can be seen when content creators produce shows with slightly higher budgets and cable providers slightly improve cable bundles offered to subscribers. Historically, established companies typically win in the sustaining innovation space because they have a clear starting point for the product and simply have to innovate from there.

Disruptive innovations redefine the trajectory of the market by creating products and services that are not as good as incumbent options and offer a comparative benefit– such as being less expensive or simpler. Starting with a customer whose performance expectations and willingness to pay are at the low end of the 53 Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution: Creating and Sustaining Successful Growth (Boston: Harvard Business School Press, 2003), pg 32. 54 Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution: Creating and Sustaining Successful Growth (Boston: Harvard Business School Press, 2003), pg 34.

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market, disruptive innovations can start to improve the product and eventually overtake the incumbents. In television, low-end disruption has started to form in digital content, which is of significantly lower quality than traditional television programming, but is much cheaper for consumers to access, often only requiring an internet connection. The delivery of this content through channels such as YouTube is also an emerging low-end disruption to incumbent cable providers. Customers can’t get everything through digital direct-to-consumer distribution, but it is largely free to access.

Within low-end disruption of television, it is important to discuss the incumbents’ sustaining innovations as well as new entrants in both content creation and distribution.

First, as mentioned, there has increasingly been pressure on incumbents to move toward higher-value content in a crowded market. In an attempt to increase the quality of offerings to consumers and break through the clutter, content creators and curators have resorted to higher spending on programming, both in purchasing existing content (such as sports) and in producing their own content. Because of this, cable providers are experiencing higher costs, which they have largely been able to pass on to consumers. In parallel, cable providers have increased their offerings to consumers, a sustaining innovation.

Secondly, as incumbents have moved up-market, lower barriers to entry in both content creation and distribution are affording new entrants the opportunity to take share at the low end of the market through new revenue models.

Since the advent of television, content quality (and cost of production and acquisition) has increased drastically, from grainy black and white to modern day sophisticated filming, special effects and storylines. In recent years, the cost of production of original content has increased dramatically, as well as the cost of sports programming– two areas that are driving content curators’ content quality and prevalence beyond consumers’ willingness to adopt.

A recent up-market move by content creators has influenced other players in the value chain. Content curators (networks) and audiences have become accustomed to higher-budget television, as some recent hits’ costs of production demonstrate. Many sitcoms have embraced big budget casts. By the time Friends wrapped, NBC was paying $10M per episode55 to air the show and each of the main actors was being paid $1M per episode.56 While Charlie Sheen was paid $1.25M per episode for Two and a Half Men, other sitcom stars’ salaries range from $100K-$400K per episode.57 Though this is low compared to Friends, it does represent a significant fixed cost that content creators must cover when selling content to curators. Even in reality series, once an area of relativity low cast budgets, many programs have attracted big names with large salaries; Ryan Seacrest is paid $15M a year for American Idol. Dramas have also moved toward big budget productions, led by special effects and elaborate sets. For example, when the Lost pilot was produced in 2004, it cost $12M, or $100K per minute.58

While broadcast networks initially led the charge on increased production and licensing costs, cable networks, many inspired by HBO, have recently moved up into premium original content. Cable networks previously were a low-end alternative to broadcast. For instance, when a Fox program, Sliders, was canceled in 1997, its production company was able to sell the series to the Sci-Fi Channel and reduce

55 Bill Carter, Desperate Network (New York: Doubleday, 2006), pg 217. 56 Ibid, pg 213. 57Stephen Battaglio, “Who Are TV's Top Earners?” August 10, 2010, http://www.tvguide.com/News/Top-TV-Earners-1021717.aspx, accessed April 2012. 58 Bill Carter, Desperate Network (New York: Doubleday, 2006), pg 272.

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production costs from $1.5M/episode to $750K/episode.59 More cable channels have moved into high-production cost original programming. Even HBO has moved up-market since its early original programming; when Sopranos was filmed in the late 1990s, the production team used existing businesses in New Jersey to film. More recently, Boardwalk Empire is being filmed on a custom built set in Brooklyn.60 As such, Boardwalk Empire, premiered with an $18M pilot, or $300K per minute in 2011.61

While HBO has used its premium original programming to drive subscriptions, other cable networks have followed the HBO content model to increase their attractiveness to advertisers and their necessity to cable providers, by renegotiating carriage fees with major cable providers. AMC, for instance, has used the success of Mad Men and other original programming to negotiate better terms for its carriage, elevating its per-user monthly fee from $0.21 to $0.24.62 While the networks may be paying more for content licensing or production, the cost of transmission is not increasing, thus making that segment more profitable as networks receive increased carriage fees.

The licensing of sports content by broadcast and cable networks has also driven curators aggressively up-market. For example, the cost of the rights to carry NFL games has increased dramatically over the last 20 years, with the deals since 1990 representing 6% p.a. growth.

EXHIBIT 13 - NFL TELEVISION RIGHTS FEES, 1990-2022

Time period Total TV fees Broadcast Cable Satellite

1990-1993 900.5 678.0 222.5 -

1994-1997 907.0 652.0 255.0 -

1998-2005 2,200.0 1,600.0 600.0 -

2006-2011 3,617.8 1,934.5 1,100.0 583.3

2014-2022 5,000.0 3,050.0 1,900.0 1,000.0

SOURCE: Compiled 636465

Broadcasters have viewed expenditure on sports as a necessity to avoid disruption from digital players who cannot afford this content, which is appointment viewing for many consumers, thus keeping ad rates high. As Deadline noted in 2011, “Broadcasters have their own challenges that would have made it risky to pass up even a high-priced deal with the NFL. It would have been ‘catastrophic’ for them if the rights 59 Richard E. Cave, Switching Channels (Boston: Harvard University Press, 2005), pg 149. 60 “HBO and the future of pay TV,” August 20, 2011, The Economist, http://www.economist.com/node/21526314, accessed April 2012. 61 Lesley Goldberg, “'Terra Nova': Will Fox's Dino-Sized Gamble Pay Off?,” September 26, 2011, http://www.hollywoodreporter.com/news/terra-nova-will-foxs-dino-239913, accessed April 2012. 62 Brian Steinberg, “Why 'Mad Men' Has So Little to Do With Advertising,” August 2, 2010, http://adage.com/article/mediaworks/mad-men-advertising/145179/, accessed April 2012. 63 Soonhwan Lee, D.S.M. and Hyosung Chun M.S.S., “Economic Values of Professional Sport Franchises in the United States,” 2002, http://www.thesportjournal.org/article/economic-values-professional-sport-franchises-united-states, accessed April 2012. 64 Joe Flint, “NFL signs TV rights deals with Fox, NBC and CBS, December 15, 2011, http://articles.latimes.com/2011/dec/15/business/la-fi-ct-nfl-deals-20111215, accessed April 2012. 65 “Late season games can be moved to Monday nights,” November 9, 2004, ESPN, http://sports.espn.go.com/nfl/news/story?id=1918761, accessed April 2012.

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had gone to an online player such as Google, Amazon or Apple, Moody’s Investors Service says. That ‘would have been the watershed event that negatively changed the landscape for television entertainment delivery and likely led to more such losses of exclusive sports programming.’”66

Cable and broadcast channels have pitched these increasingly large deals (ESPN’s NFL costs represent 7% p.a. growth since 1990) as a way to expand services to current viewers. When ESPN announced a new deal in 2011, they added several shows to complement their traditional sports coverage: an extra hour of Sunday NFL Countdown, beginning at 10 a.m. ET, and new daily show, NFL 32, on ESPN2.67 These are sustaining innovations for ESPN, as the average customer is served effectively by seeing their favorite team play and does not need additional content and in-depth coverage.

With curators incurring larger fees to acquire and create content, cable and broadcast networks have tried to negotiate higher carriage fees. As previously mentioned, AMC has used the success of Mad Men and other original programming to increase its carriage fee. Similarly, ESPN’s prevalence in a cable package has driven its carriage fee significantly higher in recent years. In 2005, ESPN received an average of $2.96/subscriber/month68, which has grown to $4.69 this year,69 annual growth of ~7% (which is interestingly in line with the network’s growth of NFL fees). From the consumer’s point of view, ESPN is simply increasing its already comprehensive offering, not adding new value which the consumers can appreciate. And, this incremental value is coming at an increased cost, which many consumers may not continue to tolerate.

Traditionally, broadcast networks did not receive carriage fees from cable providers. However, in recent years, several notable disagreements between station groups and cable providers have caused short-term blackouts and eventual retransmission fees granted to broadcast channels.70 Broadcasters have used their sports content to drive negotiations with MSOs, whose customers depend on being able to see their favorite sports team play live. By 2015, broadcast stations are expected to take in ~$3B in retransmission fees, with ~$1.7B of that going directly to the networks.71 NBC, which increased its NFL spend from ~$600M72 to ~$950M in its most recent contract73, was only receiving ~$21M in retransmission fees in

66 Patrick Hipes and David Lieberman, “Massive Increase For NFL’s TV Rights Throws Cablers For A Loss,” December 16, 2011, http://www.deadline.com/2011/12/massive-increase-for-nfls-tv-rights-throws-cablers-for-a-loss/, accessed April 2012. 67 “ESPN, NFL agree to eight-year deal,” September 8, 2011, ESPN, http://espn.go.com/nfl/story/_/id/6942957/espn-nfl-television-deal-keeps-monday-night-football-network-2021, April 2012. 68Michael Learmonth and John Dempsey, “Fox’s triple play,” October 16, 2006, http://www.variety.com/article/VR1117952034?refCatId=14, accessed April 2012. 69 Anthony Crupi, “Comcast, Disney Nail Down New Carriage Deal,” January 4, 2012, http://www.adweek.com/news/television/comcast-disney-nail-down-new-carriage-deal-137324, accessed April 2012. 70 Robert Marich, “TV faces blackout blues,” December 10, 2011, http://www.variety.com/article/VR1118047261, accessed April 2012. 71“Broadcast networks will rake in retransmission fees, report says,” November 1, 2011, Company Town, LA Times, http://latimesblogs.latimes.com/entertainmentnewsbuzz/2011/11/broadcast-networks-retransmission-consent-fees.html, accessed April 2012. 72 “NFL Media Rights Deals For '07 Season ,” September 6, 2007, Sports Business Journal Daily, http://www.sportsbusinessdaily.com/Daily/Issues/2007/09/Issue-238/NFL-Season-Preview/NFL-Media-Rights-Deals-For-07-Season.aspx, accessed April 2012. 73 Joe Flint, “NFL signs TV rights deals with Fox, NBC and CBS,” December 15, 2011, http://articles.latimes.com/2011/dec/15/business/la-fi-ct-nfl-deals-20111215, accessed April 2012.

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2011. Its new deals will bring in over $500M in retransmission fees by 2015.74 This will increase the cable providers’ costs, but not provide significant value to the consumer. As cable providers will likely continue to pass these costs on to the consumer, under the guise of better service, more consumers will likely look to lower-priced disruptive offerings.

With increased costs being passed on from content curators, the impetus to move up-market toward more profitable customers has become even stronger for cable providers. As such, many of these companies have increased cable package offerings (and fees) or moved to value-add services, which are both sustaining innovations. In the below example, Comcast has maintained a relatively stable rate for its basic cable package, while its expanded cable grew at a faster rate (9% p.a. through 2007).75

EXHIBIT 14: COMCAST MONTHLY SUBSCRIBER FEES IN OREGON

SOURCE: Metropolitan Area Communications Commission, “Cable Service Rates,” http://www.maccor.org/cable-rates.html, accessed April 2012.

On both the content creation/curation side as well as the distribution side, decreased barriers to entry online have provided a platform for disruptive innovators. Within content creation, new players have moved toward lower-cost production, avoiding the costly overhead of set construction, talent fees and special effects. For instance, Louis C. K, an Emmy and Grammy award-winning comedian who has his own television show on FX cable network, recently produced his own comedy show, available only through direct-to-consumer online distribution. “Louis C. K.: Live at the Beacon Theater,” within one week of release, sold 110K copies at $5 each, for $550K of revenue. With expenses of ~$350K, including production and development of the website, the comedy show had already netted ~$200K in profits, for a

74 “Broadcast networks will rake in retransmission fees, report says,” November 1, 2011, Company Town, LA Times, http://latimesblogs.latimes.com/entertainmentnewsbuzz/2011/11/broadcast-networks-retransmission-consent-fees.html, accessed April 2012. 75 Metropolitan Area Communications Commission, “Cable Service Rates,” http://www.maccor.org/cable-rates.html, accessed April 2012.

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margin of ~36%.76 With essentially no variable cost of distribution, any additional sales would net pure profit for the comedian.

There are other specific examples of talent moving into online, which gives them more control over their distribution and more opportunity for upside. Anthony Zuiker, whose CSI franchise has made over $6B in profits77, signed a deal with Yahoo to create a direct-to-digital 90-minute film to be shown in installments on Yahoo.78 The production company working with Zuiker, Dolphin Digital Media, also recently announced a deal with Cambio, an online content platform for teens, in which they are providing Cambio with $10-12M for 4-6 original scripted webisode series, a per series cost of ~$2-3M, the average cost of an episode on television79.

On the lower end of digital content, Maker Studios, which develops premium programming for YouTube, makes 300 videos for the online platform a month for $1000 each. Maker’s videos generate 500M videos per month at CPMs of up to $1080. Even at a $1 average CPM, Maker would have gross profitability of 40%. YouTube has also moved into content creation itself, announcing in February 2012 that it would invest $100M across 96 stations to create premium content.81

Implications and Advice Now that we have taken a close look at the forces shaping each segment of the television value chain, we can draw out the implications for leaders throughout the industry. What advice can we offer content providers, curators, distributors, and consumer device makers? How can existing companies utilize their capabilities to capture value in this rapidly-changing environment? In which segments do new entrants pose a disruptive threat? These are the questions we will consider now.

Advice for Incumbents

Focus on the jobs-to-be-done. The jobs-to-be-done theory presented earlier suggests that value will accrue to companies that build their operations to do a specific job extremely well. In the past, consumers have hired television to do many jobs: bring my family together, bring excitement into my life, keep me informed, and cure my boredom, to name a few. As noted previously, these jobs are immutable; they do not go away simply because consumers have access to new formats, devices and activities. However, the proliferation of competing solutions does mean that some of the jobs previously done best by television may be done better by new forms of content or delivery.

“Keep me informed” is a job that has undergone a dramatic transformation in the internet age. As recently as the 1980s, the morning paper and the evening news set the agenda for news consumption across the country. Today, thousands of credible online sources are competing to help consumers stay informed in

76 Dave Itzkoff, “Something for Louis C. K. to Smile About: His Internet Comedy Special Is Profitable,” December 14, 2011, http://artsbeat.blogs.nytimes.com/2011/12/14/something-for-louis-c-k-to-smile-about-his-internet-comedy-special-is-profitable/?scp=1&sq=louis%20ck&st=cse, accessed April 2012. 77 “CSI creator in bitter divorce to stop wife spending hundreds of thousands on his credit card,” October 24, 2011, Daily Mail, http://www.dailymail.co.uk/news/article-2052615/CSI-creator-Anthony-Zuiker-fight-stop-wife-spending-thousands-credit-card.html, accessed April 2012. 78 Dolphin Digital Media, “News,” http://dolphindigitalmedia.com/?page_id=32, accessed April 2012. 79 Ibid. 80 Ryan Nakashima, “YouTube bets $100 million on original content,” February 20, 2012, http://www.usatoday.com/tech/news/story/2012-02-20/YouTube-original-content/53170394/1, accessed April 2012. 81 Ibid.

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near real-time on a range of global issues. The proliferation of formats has taken a serious toll on the newspaper business, and it has also narrowed the scope of television’s role. Nightly news anchors may still enjoy more credibility than the average blogger, but the television format struggles to compete with the in-depth analysis offered by longer-form written content. Similarly, on-site video reporting is no longer the exclusive purview of the major news networks. These changes force news networks to do a narrower job in a more deliberate way. Merely providing information on the day’s events is no longer enough, since consumers have better candidates for that job.

At the same time, giving up certain jobs may free television to do other jobs more effectively. Trying to be all things to all people inevitably forces trade-offs and conflicts between various jobs. To take the nightly news example further, how can networks both inform the average viewer about the day’s major events and provide rich analysis of each event? With roughly 23 minutes of air time, doing both jobs is an optimization problem. In this way, the rise of on-demand news frees up television to focus more intently on its deeper journalistic mission. Rather than relaying the basic facts of each story, reporters can add depth, context, and clarity to questions raised by the first-pass news outlets. Each job lost by television is an opportunity to focus more completely on another job, setting aside tradeoffs to optimize the experience for consumers.

So which jobs should television focus on? When we consider the advantages of the television format, several jobs come to mind. Entertaining your family is certainly easier on a flat screen television than on a mobile handset with a 3.5-inch screen. Many activities can fill downtime, but if you want to fill downtime with inactivity, television is a great solution and very hard to beat. And for all the promise of the recommendation engines built by online platforms, television is still the best place to channel-surf, which means it is still among the best mediums for deciding what to watch. Finally, many of the jobs with a strong emotional dimension can be done better by a television series than almost any other format except books. As cultural critic James Wolcott recently observed, “The characters in a thick-tapestried, treachery-strewn series such as The Wire acquire dimensions, depths, personal flaws, moral failings, and discordant quirks that seem integral and variable, not pinned on like prom corsages. They’re given enough time to sit and stew, to mull over the next move, a luxury seldom extended to movie characters.”82 The television series enables a degree of character development – and therefore emotional engagement – that other formats struggle to match.

Of course, advances in distribution technology also provide content creators with access to new customer jobs. Smart phones and tablets, for example, offer mobile access to content on a scale that television devices could never hope to match. Consider the job of reducing boredom while you wait in line. Before smart phones, you might have hired a newspaper to do this job, or interacted with strangers, or simply thought through the day’s tasks. Television was not a candidate for this job, so content producers could not hope to be part of the solution hired to do it. Today, content creators can reach consumers virtually anywhere, and this ubiquitous access has given rise to short-form content that provides bite-sized entertainment. In this way, content creators can begin to compete for entertainment jobs television could never do before.

New media can also help television perform old jobs in a more compelling way. In an effort to engage millennials and other active social networkers in the original series Nurse Jackie, Showtime marketers set

82 James Wolcott, “Prime Time’s Graduation,” Vanity Fair, May 2012, http://www.vanityfair.com/hollywood/2012/05/wolcott-television-better-than-movies, accessed April 2012

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up a Twitter account on behalf of a character frequently depicted Tweeting. The account remained active between weekly episodes, and writers used the voice of the character to form personal connections with fans and build a network of engaged viewers.83 MTV is preparing to launch a show that will use the same strategy to maintain a dialogue with young viewers as the series unfolds.84 Such marketing efforts represent a clear departure from the traditional one-way distribution model.

The bottom line of this jobs analysis is that companies must stay focused on the jobs consumers need done and relentlessly optimize the solutions offered to do those jobs. Paying customers may tolerate cumbersome interfaces and obsolete delivery mechanisms for a while, but only until a competitor offers to do the same job in a better way. This does not mean companies should pursue innovation for its own sake. Quite the contrary, bells and whistles only add value if they help consumers with a readily identifiable job. The job must remain central in the product development process.

Identify threats, and turn them into opportunities. Perhaps the hardest part about identifying disruptive threats is that they often look too primitive to be truly threatening. From the perspective of sophisticated incumbents whose products were carefully refined over the course of years or even decades, new entrants often look like naïve upstarts who only serve the least attractive customers. When asked about the disruptive potential of newcomers, industry leaders often retort, “Those companies are in a completely different business.” Such commentary overlooks ample historical evidence that low-end players can and do move up-market.

Many leaders in the television industry believe low-end competitors pose little threat to their own businesses. Traditional content creators, for example, scoff at the notion that inexpensive production techniques or user-generated content might disrupt more integrated approaches. We believe this static view ignores the reality that low-end entrants are propelled steadily up-market in pursuit of higher margins.

In order to spot disruptive threats, we must adopt a more dynamic view of the market. Instead of asking whether low-end content creators can make polished primetime dramas today, ask whether their resources, technologies, and processes confer a cost advantage that threatens their nearest low-end competitors. If the answer is yes, why should they remain at the low-end of the industry when they can move up-market to claim higher margins? This process has played out in industries as diverse and unrelated as steel production, beef processing, photocopiers, automobiles, accounting software, medical devices, fast food, airlines and test preparation.85

To make this argument more concrete, we can take a closer look at content creators. Time Warner CEO Jeff Bewkes spoke for many in the industry when he wrote, “We believe there will always be demand for our company’s content: good stories, well told, that engage people’s minds and emotions. We have great confidence in the future of high-quality content, in our strategic position and in our ability to enhance stockholder value.”86 This quote is interesting because it is an implicit response to those who believe

83 Ken Todd, VP Digital Content Syndication & Mobile Development at Showtime Networks Inc., speaking at the Entertainment & Media Conference at Harvard Business School, February 12, 2012 84 Justin Danko, VP Branded Entertainment MTV Networks, Viacom, speaking at the Entertainment & Media Conference at Harvard Business School, February 12, 2012 85 Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution: Creating and Sustaining Successful Growth (Boston: Harvard Business Review Press, 2003), p56-65 86 Time Warner, 2010 Annual Report, http://ir.timewarner.com/phoenix.zhtml?c=70972&p=irol-reportsannual, accessed April 2012

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content creation can be disrupted. If everyone agreed that high-quality content will always enjoy healthy demand, why would Bewkes feel compelled to say so?

In considering the claim above – that people will always value good stories that engage their minds and emotions – it is worth revisiting the jobs-to-be-done framework. If we accept that people crave stories and a better understanding of the human experience, we might consider that an immutable job. So far, Bewkes is right on target: we should expect to see perpetual demand for good stories told in a compelling way. This of course bodes well for Time Warner in the near-term, but it does not settle the argument about whether content is vulnerable to disruption. The right question to ask is this: what if a company or even a handful of people came along offering to do the same job for a lower price? What if the price point was free? Should Time Warner still feel confident about its strategic position? We don’t have all the answers, but we believe disruption is possible even in the rarified world of content creation.

Having identified a company that poses a disruptive threat, how should incumbents respond? The short answer: buy it. Once the process of disruption has begun, there is no way to escape its eventual impact on cost structures across the industry. The disruptor is coming, and when it arrives, incumbents can either be its victim or its beneficiary. What does this mean in practice for companies across the television value chain? It means established content creators should have a stake in emerging content models. Cable networks should acquire promising online curation models. Cable operators should consider acquiring direct-to-consumer businesses that threaten the existing distribution system. This is not just about hedging one’s bets. It is the rational response to a world in which today’s low-end upstart is tomorrow’s industry leader.

After acquiring a disruptor, it might be tempting to shut it down so that it never threatens to cannibalize the core business. Unfortunately, such an approach is doomed to fail. The market notices when an emerging model is good enough for purchase, so even if the first disruptor is dismantled, others will follow closely behind with the same or similar profit model. Christensen argues that a better approach is to keep the disruptor and let it operate as an autonomous business unit. Doing so will prevent your core business from imposing its own culture, processes, and priorities on the acquired operation. Perhaps more importantly, preserving the autonomy of the disruptive business enables its leaders to maintain the perspective that they are engaged in an exciting growth opportunity, not an enterprise that threatens the core business. This is an important distinction. Mobilizing resources requires framing the disruptor as a threat, but managing the acquired disruptor effectively calls for framing that business as an opportunity. This is the most effective response to disruption.

Go where the value will be. We began this section with the claim that value is maximized when firms organize their operations to do a specific job very well. This is true, but industry dynamics also play a critical role in value creation. Commoditization can overwhelm the value-adding efforts of even the most customer-focused company. As discussed earlier, we believe existing distribution technologies will become undifferentiated commodities, as broadband speeds become fast enough for most consumer purposes, creating a natural limit to consumers’ willingness to pay.

Going where the value will be means gravitating toward segments where performance is still not good enough in some important respect. These segments resist commoditization because consumers are willing to pay a premium for performance improvements. In the curation segment, for example, cable customers paying more than $70/month in subscription fees have only one way to navigate the programming content: a remote control that operates a set-top box featuring a series of archaic and inflexible menus.

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The demand for an appropriately modern curation experience will only grow as the universe of available content expands.

In the consumer devices segment, we see problems with piecemeal device integrations that leave consumers confused and irritated. The ubiquity of suboptimal solutions presents an opportunity for device manufacturers who can provide a seamless, intuitive experience for discovering, accessing, and viewing content. Improving the consumer experience on this important dimension – simplicity – will pay handsome dividends to the company that offers a worthy solution. As one industry observer has noted, “Consumers buy solutions, not delivery technology. An online solution that gives them what they’re looking for – cost savings, ease of use, and reliability – will significantly disrupt the pay-TV status quo. The question is not whether someone will offer this, but when.”87 This is what it means to go where the value will be.

What about the doom-and-gloom scenario we paint for distribution companies? Are they destined to fail as bandwidth speeds outpace consumer willingness to pay? Not necessarily. They can – and should – move into adjacent segments that will resist commoditization. Some of the companies with a heavy footprint in distribution (Comcast, for example) have acquired curation assets, which means the company will still compete in segments that would benefit from performance improvements.

Watch out for “innovation killers.” New entrants and incumbents see the world from very different vantage points. Where a new entrant sees opportunity and growth, an incumbent may see uncertain growth and unattractive margins relative to those of the core business. In January 2008, three professors writing in the Harvard Business Review detailed three “innovation killers” that prevent leading companies from investing in innovation.88 Those three killers are:

1. Discounted cash flow analysis: DCF techniques often compare an investment scenario to a baseline that assumes revenues and profits from the core business will continue unimpeded. In reality, the consequence of failing to innovate is likely a steady decline in financial performance, so the do-nothing baseline should reflect that reality. DCF techniques also underestimate the value of disruptive cash flows, since those are much harder to predict than the cash flows of sustaining innovations.

2. Sunk cost analysis: When deciding whether to invest in a new technology, incumbents often focus on marginal costs (i.e., what additional costs must we incur to launch the new technology)? This total is then compared to the marginal cost of sustaining innovations, which look financially attractive because of sunk costs – the installed base of equipment and processes that can be deployed immediately in support of sustaining initiatives. Meanwhile, new entrants have no sunk costs, so they see the pure profit potential of new technology investments, and often enjoy a per-unit cost advantage after those investments are made.

3. Earnings per share focus: An obsessive focus on earnings per share can foreclose valuable investment opportunities and limit future profits. When companies choose to buy back shares rather than grow R&D budgets, for example, they may be sacrificing long-run competitiveness

87 Jon Giegengack and Peter Fondulas, “The New Age of Television,” CMB Consumer Pulse, Chadwick Martin Bailey, http://blog.cmbinfo.com/the-new-age-of-tv/, accessed April 2012 88 Clayton M. Christensen, Stephen P. Kaufman, and Willy C. Shih, "Innovation Killers: How Financial TOols Destroy Your Capacity to Do New Things," Harvard Business Review (January 2008)

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for short-term EPS improvement.

These core tools of financial analysis play an important role in the life of any company, but they ought to be used carefully by incumbent firms considering investments in innovation. Advice for New Entrants

In many ways, offering advice to new entrants feels superfluous: they are likely to succeed on the strength of their disruptive innovations. Still, it is worth highlighting a few general guidelines for new-growth businesses hoping to disrupt the television industry.

Look for evidence of over-serving. Where should new entrants focus their disruptive efforts? What are the tell-tale signs that a market is ripe for disruption? For low-end disruption, Christensen and Raynor offer two litmus tests:

(1) Are there customers at the low end of the market who would be happy to purchase a product with less (but good enough) performance if they could get it at a lower price?

(2) Can we create a business model that enables us to earn attractive profits at the discount prices required to win the business of these over-served customers at the low end?89

If the answer to both of these questions is yes, and the idea is disruptive to all significant incumbents, then the idea is likely to succeed. Keep in mind that over-serving occurs in segments where performance is already “good enough.” When incumbents are publicly struggling to find new features that command premium prices, performance is probably good enough, and disruption is a real possibility.

Focus on the job-to-be-done. This is the same advice issued earlier to incumbents, but it bears repeating for new entrants: consumers only care about your technology if it helps them do a job better than alternative solutions. It is not enough to have an interesting technology without a clear application. Fortunately, consumer demands for simplicity and ease-of-use offer an advantage to disruptors in the television space, since incumbents are burdened by obligations to legacy assets and businesses. Unencumbered by such considerations, new entrants have the freedom to imagine new television solutions designed solely to meet consumer needs.

Lance Podell of YouTube explains the potential impact of consumer focus: “When my kids watch TV, they don’t care who produces the content. They just want to like it. They also don’t care about format. In five years, they may be just as likely to watch a 4-minute clip on TV as they are to watch a half-hour program on a tablet.”90 Remarks like these are alarming for an incumbent, since they suggest that the current industry structure may have unnecessary players in it. For a new entrant, these comments describe an industry that is over-serving consumers, which means opportunities for disruption abound.

With this advice, incumbents and new entrants now have a better understanding of what it takes to adapt and succeed in the face of disruption, commoditization and other game-changing industry forces. Given what we now know, what might the future of “television” look like for consumers?

A Vision of the Future 89 Christensen and Raynor, The Innovator's Solution, p50 90 Lance Podell, Director, Global Head, YouTube Next Lab, speaking at the Entertainment & Media Conference at Harvard Business School, February 12, 2012

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Imagine it is the year 2020. Following a hectic day at work, you hop into your fully electric car and it drives you home. It pulls into the garage and automatically begins charging. As you get out of the car, the doors to your house unlock and the lights magically turn on. You walk into your bedroom and say “television on,” which changes the large picture of your family on the wall into an intuitive “home screen” that is wirelessly connected to your 5G wireless service. As you change out of your work clothes, you tell the TV to “Get me up to speed on what I missed today” and it reads you your emails and messages, plays personalized news video clips and reschedules tasks that you didn’t have a chance to complete that day.

You join your family in the kitchen where they are deciding what to make for dinner. Unsure of what to make, you start up your tablet and search for Rachel Ray recipes using the Food Channel app that automatically checks what ingredients you have in your refrigerator and cupboards. After finding a “mouth-watering” recipe, you push the play button and Rachel Ray teaches you – step by step – how to prepare the recipe. As your family sits down to enjoy the meal, you say “Play classical music on Pandora” and the tablet tells your “digital home” system to stream music to the wireless speakers in the dining room.

After dinner, the family crowds around the large flat screen television in the living room for some quality “bonding” time. You start a 3D basketball game that captures your motion as you shoot an imaginary basketball into a hoop. After inevitably losing the game to your young children, you decide to relax by watching an amusing program together on the couch. You pull up your favorite television app or streaming service, which recommends funny shows you might like based on similar shows you’ve liked in the past, shows that your closest Facebook friends are talking about and content with the highest customer reviews. When a hilarious moment occurs in the show, you pull out your smartphone and tweet out a short video clip to share with your followers.

As it gets later in the evening, your children slowly retreat to their own rooms to finish their homework. They open up their laptops while lying in bed to watch educational videos the teacher assigned for the following day and complete interactive assignments that provide immediate feedback on how they are doing. Back in the living room, an alert pops up onto the screen that lets you know your favorite local sports team just started a game. While cheering on your team, someone is injured so you pull up your fantasy sports team on screen and pick up a promising new player before your friends do.

However, the game suddenly pauses and begins recording in the background as a Skype video call shows up on your screen. It’s your boss, who has called to discuss an important last minute change to a presentation you have been working on. While still on the call, you fire up your laptop, access the document from the cloud and make it visible to both on the large television screen. As you walk through the changes, you both make minor adjustments simultaneously to the presentation.

As you climb into bed for the night, you set the TV in your bedroom to wake you at 6am the next morning to your favorite morning news show. Curious about the weather, you quickly see that it is supposed to rain and set a reminder for 6:30 to grab your umbrella. While you lay in bed trying to fall asleep, you struggle to imagine life before the internet and affordable electronic devices. How did people manage their hectic lives, connect with those they care about and simply relax prior to modern television?

It is clear from this futuristic vision that internet and networked devices have the potential to massively transform “television” as we know it today. As wireless transmission speeds rise to “good enough” levels, products and services reach mass affordability, user experiences become seamless across devices and

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companies leverage big data analytics, internet powered TVs will have the flexibility to address a much wider set of Jobs-To-Be-Done than it has traditionally been hired for. This represents an opportunity for industry players to expand into new solutions focused on fulfilling a larger set of important jobs as well as a significant threat as television sets provide compelling substitute activities to television programming viewing. However, the key factor that will decide winners and losers is whether today’s companies are willing to embrace the change brought about by the internet and make difficult decisions today to better position themselves in the future. Who will emerge victorious?

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