Upfront On Aereo And Broadcast Networks

It's January, so it must be time to start thinking about national TV buys that run from October 2014 to September 2015.No, seriously. It's time. This is the case because media agencies across Madison Avenue will very soon begin (if they haven't already started) establishing what are called "planning costs", which are first passes at estimating price increases and planning for various scenarios that might cause those estimates to change.

TV buyers may take a first stab at these estimates in these mid-winter meetings and then send them back to their colleagues in the planning department to tease out optimal media mixes which balance costs against various goals, some of which are objective and others of which are subjective. At minimum, planners spend much time with these costs as they work with their account team and their clients to estimate how many units of television they will need and what mix of packages of advertising from suppliers of cable, network and syndication inventory will be required to meet desired reach and frequency goals. Certain budgets will always be carved off for strategically important goals (for example, sports advertising or integration of brands into programs), and other budgets will be allocated for cross-media buys from media owners offering similarly strategic (or highly cost-efficient) inventory across various properties, although we believe such buys represent a minority of money committed by advertisers and their agencies to networks. Most budget commitments are made after tentative budgets have been approved by mid-May, and then negotiated and bought in packages (or bundles of ad units sold by the same media owner) as tonnage of a certain quality and flexibility in order to begin the execution of the media plan following the signing of contracts between advertisers and media owners in August or September.

For planners at agencies, there will always be a bias towards including the broadest reaching TV on a media plan first, because fewer high reaching individual units will mean less unintended duplication and a better balance of reach and frequency for a given amount of expenditure. This is why network TV is typically negotiated first, even if deals are sometimes announced between certain cable networks and agencies beforehand: the buyers generally know what their commitment will be with a given broadcast network based on the prior year's volumes and the planning work they do ahead of the negotiations. Meanwhile, cable is usually considered afterwards, with the primary purpose of the inventory as one which satisfies media goals at a relatively low cost, given the gap in pricing between network and cable inventory. Of course, this dynamic has changed to some degree, as most cable networks have introduced their own premium programming in recent years. However, we still see cable networks as generally disadvantaged given limited numbers of programs and related units of inventory with ratings that match those of the broadcasters.

Which leads us to an interesting situation: this year's Upfront planning process and subsequent negotiations will probably need to be resolved before the dispute between Aereo and the owners of the major broadcast networks is resolved. Fox and CBS have threatened to make their best content available only through cable (and not to the ~10% of homes who do not subscribe to pay TV) should Aereo win, while NBC and ABC have not made any such statements. The results of the case will not be pronounced upon by the Supreme Court until late June or early July, well after Upfront negotiations would normally have gotten underway (and after network TV Upfront deals have usually been completed).

If you were a planner, would you still pencil in the same amount of money to the two potentially cable-only "broadcast" networks knowing there was a good chance that a given media owner might fall short on the reach goals you have grown accustomed to and which generally receive premium pricing given the scarcity of the widest-reaching packages of television inventory? Or would you overweight your budgets towards those networks that are more likely to meet your reach goals? The answer seems simple: while you might want to see the broadcast-cum-cable networks prioritized over the legacy cable networks when it comes time to negotiate with national cable owners, you and most of your peers on Madison Avenue would probably allocate a larger share of your budgets to those broadcasters who commit to making their signals available to as broad an audience as possible. In short, presuming that today's broadcast-only homes stayed broadcast-only, ABC and NBC would capture a significant incremental share of a ~$9bn pool of money intended for inventory that reaches the broadest possible audience during prime time television. While the pool of money is not entirely fixed and most of the money that would go to CBS and Fox as broadcast networks would follow them to cable, a good chunk of it would stay with broadcast. On last year's volumes, if (for illustrative purposes) only ~10% remained with free-to-air broadcast networks, this would mean a loss of $400mm in revenue for Fox and CBS.

The reason for the potential of such a shift is that most large advertisers want to reach everyone. By our reckoning, well under 200 brands account for more than 90% of network TV advertising spending, and most of these brands sell to people who live in broadcast-only homes. Incremental points of reach make a difference in helping many brands realize their media goals and ultimately their business goals, and 10% extra potential reach from networks who retained their best content on a free-to-air basis would be worth extra for many, if not most, large advertisers. Put differently, most TV advertisers need to reach as many people as possible; if they only had a narrow target against which they intended to deploy the bulk of their media budgets they would have prioritized digital media in their media planning instead.

Given these considerations, our guess is that Fox and CBS will have to make their positions clear regarding their broadcast or cable-only status for their premium programming well before the court ruling. To do otherwise might mean losses of budget commitments amounting to hundreds of millions of dollars, far more than any damage that might be wrought by Aereo, which might amount to hundreds of thousands of dollars of lost retransmission consent fees in a worst case scenario over the next broadcast year.

We think they will ultimately back down (at least for the next broadcast year) from their prior positions as a result and commit, implicitly or explicitly, continuing to offer the bulk of their programming on a free-to-air basis. Still, things won't be all bad for network TV owners. Despite the ongoing rise of online video, traditional TV remains the most important source of video inventory, and pricing - as we discuss below - will probably be robust for the broadcast networks once again once May and June roll around. Material shifts of spending to online video are unlikely unless Google, Yahoo or someone else (but certainly not Netflix, per comments from their earnings call this week) make a game-changing commitment to investing in content akin to a meaningful NFL package or some other large-scale programming initiative around ad-supported content, equivalent to or better than what is presently on traditional TV.

In lieu of such a major programming initiative, few publishers with online video inventory will be likely to capture budget commitments that are directly funded from TV budgets in any meaningful way, except where online video sales are bundled with traditional TV (as is the case with Hulu and its network partners). While agencies will continue to focus publicly on their efforts to bridge traditional and digital video into a unified line item, many advertisers still want them to remain separate, and others would end up looking at online video as akin to a third tier (or worse) cable network given the limited inventory that is available and the challenges a buyer would face in proving that inventory's contribution towards awareness-based media goals, at least in relation to what they can achieve with traditional TV. Pure play online video will surely continue to grow in months ahead, but we continue to expect that allocations will primarily come from shifts of digital budgets or from print, where digital video may prove to be a more appealing way to satisfy an otherwise similar engagement-based goal.

As a result of all of the above, the negotiating dynamic in this Upfront will probably play out much as it has in prior years.Our historical assessment of the data has found limited correlations between economic conditions or any other variables and upfront volumes, but we have found strong correlations between upfront volumes for network TV and pricing on network, as well as relationships between pricing on cable TV networks in relation to network. If our starting point is to presume 0% to -2% volume growth for network TV, our upfront pricing model calculates a 7% CPM improvement for the leading broadcast network, or the one with the most inventory to sell. That network would probably be CBS if they remain a broadcast network, and our guess is they will be around throughout 2014-15 on a fully distributed basis to deploy a broadcast network-appropriate volume of money on their advertising inventory.

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