• by Brian Wieser , September 9, 2008

Earlier this month, a U.S. court overturned a ruling that barred a technology known as "network digital video recorders." Despite press suggestions that this judgment will lead to the destruction of today's television advertising business, the ruling is but one step in a multi-year process towards confirming the legality of an alternative, more cost-effective (to the cable operator) means of offering digital video recording. What's still unknown, is whether cable operators can develop business models around network DVRs that provide service as good as a set-top DVR in a cost-effective manner.

Cablevision Systems, which won last week's appellate ruling in a case that may ultimately end up in the Supreme Court, originally pursued this technology in order to avoid deploying set-top based DVRs. It now has subscriber base of approximately 30% DVR penetration by our estimates. Set-tops may offer superior latency (time lag between the remote's command and the impact on the screen), and the subscribers who are by now used to their existing DVR service may be happy to continue with it, especially as DVR services will continue as paid services, not free ones.

This latter point is key to the business model of DVR services. No model - least of all ours - should assume that continuously falling hardware costs present a deterrent to market penetration. Services are another story, however. Although a network DVR service can likely be built for less cost than a set-top solution at a certain minimum scale, we have consistently (and correctly) argued that there is no competitive rationale for a cable operator to offer free or low-cost DVR service. This is perhaps best proven out by the fact that Cablevision has experienced more competition from satellite and telco services than any other cable operator, yet continues to see industry-leading basic subscriber and advanced services growth rates (with DVR services still priced at $9.95 per month!). That DVRs remain fee-based services is what ultimately limits adoption to a sub-set of all multi-channel subscribers.

Given how far other cable operators are down the path with their conventional DVR set-tops, they will likely wait for Cablevision to prove out the technology and the business model, and then begin the gradual process of deploying the service by offering new subscribers access to this form of DVR (for a fee, of course) rather than through the set-top they might otherwise have been offered. Legacy DVR subscribers would not likely be impacted until they called the cable operator to replace a broken hard drive or moved to a new residence (a time when older equipment is typically changed out).

Network DVRs could contribute to marginally higher DVR penetration rates - for example, because of promotional periods where DVR services could be offered for free, much as HBO or Showtime are provided to new cable subscribers for a few months - but the fundamentals of DVR usage won't change.

Younger audiences with DVRs certainly time-shift popular programs in meaningful numbers, but the vast majority of these individuals still watch the vast majority of their television content through conventional means. Among the ~20% of households with DVRs in late 2007, 30% accounted for 71% of total DVR usage. Put another way, there is a subset of DVR users who are "power" users, but the vast majority of people use DVRs for a limited amount of programming. So although the frequency with which heavy DVR users can be reached is challenged, DVR proliferation does little to impact prime time network TV's status as the single most wide-reaching environment for advertisers.

DVR households consume about a third of prime time content in a time-shifted manner. We forecast that 35% of the population will have DVR services by 2011, and presuming all ads were skipped (and that there was no value to a skipped ad) this would equate to a reduction of 11% of prime time ratings points 10 years after the advent of the DVR. This is equivalent to about 2 years worth of erosion due to viewing patterns shifting from broadcast to cable. But even the notion of erosion is a false one, as both cable and DVRs contribute to higher total viewership of television.

So although the impact of DVRs and ad avoidance is real, the technology - and future iterations of it - primarily impacts the industry by focusing attention on the appropriateness of television as a marketing vehicle. But for brands whose goals are defined by reach and frequency, we paraphrase Winston Churchill: "Television is the worst form of advertising, except for all the others which have been tried".

New national-scale brands seeking awareness will continue to use and grow television budgets - and network prime in particular - because it remains the single most efficient means for reaching large audiences. But older, more established brands rightly will continue to migrate budgets away from television. Instead, and regardless of any future court rulings, these advertisers will continue to look towards forms of marketing which better target narrowly defined groups, much as they have since well before DVRs arrived.