• by Diane Mermigas , October 23, 2009

Hulu's online video platform may be a success with the masses, but it will have to begin charging for at least some of its content if it doesn't want to destroy the $185 billion television ecosystem it draws from.

Broadcast and cable TV are under siege by the very interactive digital technology that will extend their profitability. Television networks are finding it difficult to aggregate large audiences that generate ad revenues and fees to underwrite production. New platforms like Hulu could possibly help to ease that financial imbalance. However, the longer the ad-supported video hub remains free, the more it contributes to television's demise, according to a new report by Soleil Securities analyst Laura Martin. Her arguments and math are clear-cut.

Annual domestic TV ad revenue is about $65 billion and video subscription revenue is about $120 billion. The overall market cap of media companies participating in the TV value chain is an estimated $330 billion, Martin says. All is at risk due to a variety of factors, including $600 million in value transferred to Hulu by its owners -- General Electric's NBC Universal, News Corp.'s Fox and Walt Disney Co. -- for which they receive no payment.

For instance, unbundling the content from respective TV networks to allow Hulu consumers to cherry-pick shows discourages them from paying cable, satellite or Telco subscription fees, which in turn subsidize retransmission payments to broadcast networks. It also further diminishes TV viewership that is used to price and sell advertising time, which ultimately reduces ad revenues.

That chain reaction undercuts the networks' practice of securing advance payments to finance the creation of all TV programs (both hits and flops), either through upfront advertising commitments or affiliate fees paid by cable operators. "When content is moved to the Internet, risk moves to the content company. The consumer only watches the hit programs after they are produced and does nothing to fund the non-hit shows," Martin says.

The longer consumers get used to not paying for the convenience of free, on-demand Web viewing, the more difficult it will be to recondition them to pay for content. Only a mass platform can create a hit that can be monetized across other platforms, Martin observes. But the only way to recreate a mass audience in today's digital marketplace is by creating a uniform distribution ecosystem that preserves the content price/value to customers across all platforms -- from TV to Internet-connected PCs and smartphones.

Some Hulu rivals are trying. CBS' TV.com sells its aggregate viewers for programs regardless of where they are watched at the same network CPM of $35. Cable operators' new TV Everywhere will allow authenticated pay TV subscribers to password access subscription content on any platform or device for no additional fee. The Apple Store and iTunes sell content for an on-demand fee.

With nearly 40 million unique visitors and nearly 500 million online streamed videos in August, Hulu needs to establish its place in the emerging paid content ecosystem. Having set the gold standard for an easy and efficient online experience, Hulu has leverage to institute select content fees and possibly increase ad inventory.

Hulu offers just two ad slots that bookend the streaming video, compared with an average 16 30-second spots per half hour show on network TV. It has a willing domestic Internet audience, 82% of which viewed at least one monthly online video. The average single viewing for Hulu is one hour and 17 minutes compared to the average online video of 3.7 minutes.

But Hulu's economics are not taking advantage of that positioning.

Hulu has an estimated $200 million in direct costs for sales and marketing, research and development, bandwidth and general administration. In 2009, it will generate about $166 million in ad revenues -- three-fourths of which is paid back to its content providers, leaving it with $33 million in losses. There also are bigger hidden costs associated with Hulu, Martin contends.

For every 1,000 viewers who substitute the PC for the TV, Hulu's owners (NBC, Fox and ABC) lose $920 in ad revenues. That would amount to $425 million in lost revenues (at current user rates) in the unlikelihood that all viewing of network TV shows featured on Hulu transferred to the Web, per Martin.

As more viewers flock online, the broadcast networks especially will scale back the nearly $3 billion each spends annually to create high-quality programming, more than 90% of which never survives. One such cutback is NBC's decision to move Jay Leno to prime-time weeknights, since it costs less to produce than the scripted drama it replaces.

Because content on Hulu is not stamped with the screen logos of their originating networks, Martin estimates that about $3 billion of brand value is at risk at each of NBC, Fox and ABC when they move their most popular programs there. Such quantifiable and unquantifiable potential hidden costs could blow a hole in the media conglomerates' $330 billion TV value chain. It's happened before: The destruction of 80% of the market cap of newspaper and music companies in their botched transition to digital, she said.

Martin's report underscores the economic risks and challenges involved in the creation and transfer of value from traditional to new digital platforms. And her solution is correct: A distribution ecosystem must encompass consistent content pricing across all platforms and devices to preserve and grow value.

That involves a multitude of considerations and actions that can't begin too soon, such as the creation of new measurement and metrics, integrating social networks and users' personal relevance into the equation, and creating a new price/value proposition for marketers based on consumer targeting and e-commerce. Since three media giants have complete control of Hulu, they can begin the heavy lifting.