Bringing Networks To Digital Tiers

A new FCC ruling with significant implications for the broadcasting industry will be formally announced this quarter. "Dual Must-Carry" will potentially enable local broadcasters to ensure basic cable carriage for as many as six channels using a technology known as digital multicasting.

If Dual Must-Carry takes effect as envisioned by its supporters, MAGNA Global's independent analysis concludes that the introduction of new broadcast networks and the corresponding acceleration of viewer fragmentation will contribute to the following trends:

  • Converging (and falling) Broadcast CPMs relative to cable due to advertisers' improved leverage over broadcast networks, except for event advertising, where scarcity of supply will continue to drive CPM increases.
  • More opportunities for advertisers to narrowly target consumers.
  • New opportunities to invest in programming for advertisers who purchase stakes in new broadcast networks or who create Networks internally. Concurrently, charter advertisers will have better opportunities to develop content that closely align with marketing goals: because of the financial model associated with low-rated channels, start-up broadcast networks will seek new sources of low-cost programming. Client-supplied content (traditional entertainment, long-form commercials, home shopping or infomercials) will meet this requirement.



    Regardless of the near-term policy announcement, the issue will inevitably be contested through the Supreme Court and/or Congress and long-term media planning and buying will be affected by the final decisions. MAGNA Global will continue to monitor the status of the issue and provide updates periodically.


    The issue under consideration is how rules devised for analog technology will apply to the ongoing migration towards digital broadcasting standards. Specifically:

  • Local broadcasters were historically licensed to broadcast over 6 MHz of radio frequency, the amount of bandwidth required to transmit an analog video image and corresponding audio signals.
  • Local broadcasters are allowed to elect the mandatory carriage of their programming on cable networks ("Must-Carry") or can choose to negotiate with the cable operator for the right to re-broadcast its signal ("Retransmission Consent").

    The Opposing Views

    Because digital technology can squeeze as much as one HDTV signal and five standard definition video signals into 6MHz of bandwidth (a process known as "Multicasting"), local broadcasters claim that they are entitled to apply their Must-Carry rights to 6MHz of bandwidth, and not to only one video signal (HD or otherwise). The proposed "Dual Must-Carry" rule would then refer to the local broadcasters' rights to require cable carriage of both existing and new programming streams.

    Supporters of Dual Must-Carry suggest that this policy would do the following:

  • Facilitate the development of new free-to-air video or data services
  • Expand the number of free-to-air public affairs and educational channels
  • Place more control of the airwaves in the hands of local (rather than national) entities.

    On the other side of the issue are cable operators and independent cable networks. Cable operators protest that dual must-carry would violate their First Amendment rights and unfairly benefit local broadcasters. Cable operators' ability to allocate bandwidth to programming that viewers prefer to watch (i.e. the national cable networks) would diminish, and inexpensive / or high-single-revenue stream programming such as infomercials and home shopping would overtake the channels which currently reside on the basic cable tier. Independent cable networks have suggested that cable operators would substitute similar or competing services with Must-Carry rights (such as new PBS networks in place of Discovery or locally-based weather services in place of The Weather Channel) to avoid paying affiliate fees.

    A Final Decision Will Likely Be Made By Congress or the Courts

    Were it up to the FCC alone, broadcasters would likely win Dual Must-Carry. However, the strength of the cable operators' First Amendment claims suggest that the FCC may be unable to force the issue: the agency will need to devise a creative solution which overcomes the First Amendment issues in order to move ahead in the near-term. We note that most cable carriage agreements last five or more years, and as a result, any effect on the carriage of today's basic cable networks would be gradual.

    It is most likely that whichever side prevails, the decision will be contested. Consequently the issue may remain unresolved for several years, limiting the development of Multicasting in the immediate term.

    Effects of Dual Must-Carry

    While the future is notoriously unpredictable, MAGNA Global has analyzed the potential actions participants in the multichannel universe would take if Dual Must-Carry became effective. We have reached the following conclusions:

  • Local Broadcasters will benefit at the expense of cable operators.
  • Dual Must-Carry will lead to the creation of numerous new programming concepts as Local Broadcasters offer up to 6 video signals, including traditional fully distributed Broadcast Networks, locally targeted current affairs channels and lower-cost alternatives offering home shopping or infomercials.
  • Local Broadcasters will not gain negotiating strength with the Cable Operators per se. Most will elect Must Carry for their new networks and will generally lack the compelling programming required to negotiate fees for Retransmission Consent). However, they will clearly extract value that would otherwise have accrued to the cable operators.
  • Cable Operators will face a squeeze on bandwidth allocated to the basic cable tier if required to carry new channels on that tier.
  • Cable operators will choose between adding new channels to the existing basic cable package (and earning less because bandwidth cannot be allocated to other cable services such as high speed data or telephony) or offering customers the existing number of channels in the basic cable package, substituting new Must-Carry channels for less important cable networks.
  • Because of internal focus on financial returns, cable operators would probably prefer the latter choice, further accelerating current plans to forcibly migrate basic cable subscribers to more expensive and higher-value added digital tiers.
  • Broadcast Network Owners will continue to tie carriage of traditional cable networks and broadcast networks
  • Cable operators will increasingly pressure broadcast network owners to accept digital tier slots for their cable networks or risk losing carriage altogether when their cable networks' affiliation agreements expire. This strategy will be pursued for two reasons: to make more efficient use of bandwidth and to offer customers additional benefits from upgrading to the digital tier.
  • Broadcast networks will resist this push, and some cable networks will remain on basic. Cable operators will generally not risk dropping cable networks with vocal audiences, such as ESPN or regional sports networks).
  • As part of this process, some cable networks will ultimately be forced onto the digital tier sooner than others, especially lower-rated nets such as ABC Family.
  • Broadcast network owners will attempt to prevent the move to the digital tier by threatening to refuse retransmission consent of a primary network feed. However, the cable operators will risk the consequences of losing important channels because consumers will increasingly be tied to cable for bundles of video, high speed data and telephony. Broadcast networks will need to pick their fights carefully.
  • In some cases, broadcast network owners will prefer the trade off of advertising revenues gained from wide distribution versus affiliate fees and lower ad revenues from the digital tier's smaller viewing base.
  • Under these circumstances, it is conceivable that some cable networks would become broadcast networks by signing affiliation agreements with local broadcasters, who could secure fully distributed carriage with cable operators.
  • Independent Cable Networks will face additional pressure to sell to entities which hold the leverage associated with Retransmission Consent.
  • While Discovery will be somewhat shielded from these pressures (it is partially owned by cable operators Cox and Bright House), many cable operators will find that new offerings from PBS will attract similar audiences.
  • In an environment of limited capacity at the basic cable tier, carriage of Discovery and related cable networks is less compelling, especially considering the affiliate fees paid to Discovery: PBS is required by law to offer its programming for free, on a Must-Carry basis.
  • The Weather Channel will face similar pressures, as local broadcasters are already offering new, locally-based weather services via Multicasting. Cable operators will be hard-pressed to justify carrying a weather service for which they pay affiliate fees when several will likely be available to them for free.

    The choice made by cable operators is of particular interest to advertisers:

  • Scenario 1: Basic Cable Networks are Replaced by Multicast Channels
  • Under this scenario, we would temporarily observe defragmentation in individual markets for the following reasons:
  • Many channels would be replaced by others controlled by local broadcasters.
  • Because ratings expectations will be low , local broadcasters will offer low-cost programming on these new channels, ,
  • Inexpensive programming will be supplied by infomercial producers or home shopping networks, whose content will quickly fill much of the new basic cable tier.
  • With this reduction of entertainment programming, total viewing on basic cable will decline.
  • Broadcast networks will benefit for a short period following this move as viewers migrate back to them. These networks will likely reclaim their status as the primary providers of entertainment programming.
  • Cable customers' satisfaction with their providers will decline, but the gradual transition implied by this scenario would not lead to a mass exodus to DBS (DirecTV or EchoStar) for two reasons:
  • The bundling effect described above
  • Satellite providers will be faced with similar bandwidth constraints (although the issues facing DBS will be somewhat more complex given the option they hold to not offer services in all local markets).
  • Further, cable operators would not uniformly move all Networks to digital tiers: this transition would occur to different channels at different times (as affiliation agreements are renewed) and in different places (varying by cable operator and within individual franchises).
  • The absence of compelling programming on basic will cause many subscribers to upgrade to digital. Ironically, this will merely accelerate an underlying trend: cable operators (and the FCC) want all subscribers to receive digital cable, as cable systems operate more efficiently on an all-digital platform. To achieve this they will gradually eliminate analog services. (Set-top boxes will still allow today's televisions to view video signals.)
  • With more digital cable, there is, by definition, access to more channels, thus driving fragmentation.
  • Scenario 2: New Multicast Channels Supplement Today's Basic Cable Networks
  • Under this scenario fragmentation will accelerate with viewers able to access as many as 60 new channels.


    The New Reality Show: Converging (and Falling) Broadcast CPMs Decrease Networks' Revenues and Increase Advertisers' Leverage

    Advertisers will benefit from buying across multiple cable networks rather than broadcast networks. However, as the distinction between broadcast and cable networks blur, and as the difference in audience size narrows, we expect that pricing will ultimately converge.

    Coinciding with this ratings-induced convergence, advertisers' relative clout with broadcast networks will improve and further contribute to falling CPMs. Every $100 million spent today at a broadcast network with a 4.0 rating and $4 billion in annual revenue rating becomes increasingly important in the future if that network has only a 3.0 rating and $3.0-$3.5 billion in annual revenue.

    Mass Market Advertisers Will Need More Targeted Messages

    The importance of high-profile, high draw events like the Oscars and the Super Bowl will increase because of the mass audiences they draw. At the same time, advertisers will need to target messages to the small, but increasingly identifiable and growing groups of individuals now found watching cable networks today.

    New Opportunities to Invest in New Networks and Programming

    Investments in new networks could also provide advertisers with compelling opportunities to identify, develop and participate in programming concepts which are consistent with a marketing goal. Advertisers should consider the following options:

  • Supply local broadcasters with extended-form commercials or other content for their broadcasters' new channels
  • Invest in new Multicast networks currently under development by third parties
  • Develop a Multicast network in-house and concurrently arrange network affiliation agreements directly.

    Coca-Cola's relationship with the cable digi-net CSTV (College Sports TV) may serve as an example. Early in 2003, Coke made a $15 million investment (consisting of $10 million in cash and a $5 million integrated marketing commitment) for a minority stake which includes board representation. Coke will realize the following benefits from this relationship

  • Coke can identify itself with the network and the network's core product as its distribution grows
  • Coke will be positioned to integrate its marketing efforts as the programming is developed over time
  • Through its equity investment, Coke should stand to benefit financially if the network is ultimately successful in growing organically or selling out to a larger cable network (such as ESPN).

    Few advertisers (not to mention entrepreneurs) have ventured into this territory in the recent past. This is primarily because of the challenges presented by creating successful independent cable networks (especially those which will rely on carriage on digital tiers) However, the ability to create a network which would enjoy Must-Carry rights - even with low viewership levels - becomes a more compelling business case than one involving today's new digi-nets.

    The same benefits would also accrue from developing a Multicast network internally. DIC Entertainment (producer of cartoons such as Inspector Gadget and Strawberry Shortcake) has proposed developing a new kids' network using Multicast frequencies. DIC has recognized that if Dual Must-Carry is applied, a new Multicast-based network cobbled together from station groups across the country would immediately have the necessary clout - more than 65 million cable homes - to attract significant advertising revenues. Longer term, cable operators would re-evaluate the carriage of similar cable networks which lack Must-Carry rights, and a new Multicast network could then capture additional market share.

    Some examples of Multicast networks which may be viable in this medium include

  • An automobile-enthusiast network (supported by an auto manufacturer?)
  • A network targeting baby-boomers (supported by a pharmaceutical company?)
  • A home design / improvement network (supported by a DIY chain?)


    190 Stations Are Multicasting Today

    Among the 1,730 TV stations which are licensed in the United States and the 1,180 which currently broadcast digital signals, 190 presently Multicast digital content. In many markets, cable operators voluntarily carry signals offered by local broadcasters via Multicast. Some of these signals include:

  • Local news and weather
  • Public affairs
  • UPN (currently 12 UPN stations are carried by multicasting)

    Although most new business plans for Multicasting require the scale associated with cable distribution, certain alternative uses of digital frequencies are under development. Some of these plans would enable local broadcasters to offer Pay-TV services while bypassing cable operators (i.e. broadcasting video images to PCs or to a special purpose set-top box). Other plans involve alternative uses for the frequencies, such as data transfer services for businesses.

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