TV is fascinating: the content is compelling enough that Americans spend an average of five and a half hours a day consuming it (in various formats), but it’s also exceptionally intriguing from a business perspective.

Two weeks ago I laid out Aggregation Theory , which posited that the general pattern for value capture on the Internet was modularizing suppliers and integrating consumers and distribution. It’s a framework that explains Google, Amazon, Facebook, Uber, Airbnb and more.

TV, though, seems to be going in the opposite direction: over the last few weeks in particular discussion about “unbundling” has reached a fever pitch, culminating in Disney’s earnings call yesterday where the vast majority of time was spent on ESPN, the lynchpin of the pay-TV bundle. The trigger was this report in the Wall Street Journal early last month:

A decline in subscribers as customers trim their cable bills, coupled with rising content costs and increased competition, has ESPN in belt-tightening mode, people familiar with the situation say.

The company, majority owned by Walt Disney Co., has lost 3.2 million subscribers in a little over a year, according to Nielsen data, as people have “cut the cord” by dropping their cable-TV subscriptions or downgraded to cheaper, slimmed-down TV packages devoid of expensive sports channels like ESPN.

On the earnings call Disney CEO Bob Iger sought to make clear that the actual number of lost subscribers wasn’t that high, and was adamant that very few were lost to “skinny” bundles; rather ESPN’s decrease was due to fewer households subscribing to the pay-TV bundle. That, though, is precisely the problem, thanks to Netflix especially.

Netflix’s Limitation

Back in 2008 Netflix was primarily a DVD-by-mail operation with a just-launched streaming service that let you watch C-list movies on your computer. Starz, a premium television channel, saw the service as an easy way to make a few extra bucks on their vast library of movie rights, including the Disney and Sony catalogs. Bill Meyers, then Starz Entertainment’s president, said at the time a deal with Netflix was signed:

Over the next several years we clearly don’t expect to see people leaving their big televisions and big screens to watch Starz Play. This is a complementary service.

It turned out Netflix was not just competitive but downright superior. Starz’ offering, like every other TV channel, was constrained by time: only one movie could show on any one channel at a time, meaning the effective size of the Starz catalog at any given time was one. Netflix, on the other hand, made every movie in the catalog available instantly; the Netflix catalog, identical to the Starz’ catalog in theory, was in practice 10,000x the size. Meanwhile, the 2nd generation of the Apple TV, which had Netflix built in, had been launched the month before, and the first Roku box a few months before that: suddenly Netflix streaming was no longer constrained to your computer but could be enjoyed on the same “big televisions and big screens” as Starz and the rest of TV.

It truly was a fantastic deal for Netflix, and Netflix’s built-in customer base quickly took to the streaming service and convinced a whole lot of new customers to come on board, and while these new customers kept their pay-TV bundles, time is zero-sum, so they gave said bundle less of their attention.

It was the exact pattern you would expect from Aggregation Theory: Netflix delivered a superior user experience even as it commoditized time, but there was one small problem on the way to Netflix completely taking over your TV — that Starz contract had an expiration date, and for all the superiority of the Netflix user experience, customers would not be interested without compelling content.

Differentiation: Aggregation’s Kryptonite

The problem solved by Google, the biggest and most powerful aggregator of all, is right there in its mission: organize the world’s information and make it universally accessible and useful . It is the very scale of the problem that makes Google so valuable and, in contrast, the purveyors of said information far less valuable than they had been previously. It’s a matter of supply-and-demand: there is an effectively infinite supply of information on the Internet, which meant that Google could satisfy the demand of its users for answers without needing to compensate the information providers at all. Indeed, every time information providers have demanded money from Google — the latest example is news providers in Spain — within months if not weeks said information providers have come crawling back asking to again be included in Google’s results, no payment necessary.

A similar dynamic is enjoyed by the other aggregators I mentioned: retail goods for Amazon, people for Facebook, cars for Uber, and empty rooms for Airbnb. In every case the discovery problem solved by the aggregator is of far more value than any one unit of supply, which has freed the aggregators to focus on owning the end user relationship, confident that suppliers will have no choice but to tag along.

When it comes to TV, though, the equation is different: there simply isn’t that much compelling content out there. That is why Netflix’s response to the end of the Starz contract was not to brandish its subscriber base and wait for content providers to sign up for free, but rather the opposite: Netflix had to go and get content first , and pay a hefty price to do so, and only then turn its attention to attracting and retaining end users. It’s a fundamentally different dynamic, and it’s hard to imagine a company that is better at managing that dynamic than Disney.

ESPN’s Differentiation

Iger is widely considered one of the top CEOs in the world, and for good reason: Disney has enjoyed unprecedented success under his leadership, particularly in movies. Iger’s first major move upon assuming the CEO role was to acquire Pixar, and he followed that up with the acquisitions of Marvel and LucasFilm. The goal of these acquisitions was the establishment of what Iger called tentpoles: must-see movies that made money not only for the company’s studio division but also powered merchandise sales, theme park attractions, video games, televised spinoffs, etc. The entire premise of the strategy — and what makes Disney Disney — is highly differentiated content.

It’s becoming clear that over the last few years ESPN has adopted a similar approach. To be sure, the network has long carried popular sports, which has made ESPN the very profitable centerpiece of the pay TV bundle. Recently, though, ESPN’s appetite for exclusive rights to the most popular leagues and events has increased tremendously. The common assumption has been that this increased focus on rights was meant to secure that position in the bundle — and to secure the bundle itself — and perhaps that’s all there is to it. However, I found Iger’s characterization of ESPN on yesterday’s call striking:

[When] you think ESPN, you have to think about the NFL, the NBA, Major League Baseball, the best package available on College Football, College Football Championships, College Basketball, events like Wimbledon and U.S. Open et cetera.

To a greater extent than even before, ESPN is sports. It’s the only channel you need. In fact, its biggest problem is that there simply isn’t enough time in the day to view all of the inventory the network has rights to. That, though, is a solved problem: Netflix showed 7 years ago that streaming makes time constraints immaterial. Iger noted:

Those new deals all provide for more programming, more opportunity for content on digital platforms, which will enable us to increase consumption on digital platforms and grow that business even more and generally more flexibility in terms of how we distribute this product. So the NBA’s a great example. You can have a huge increase in essentially inventory on ESPN across its platforms. So while there is definitely increasing costs, there is a huge increase in terms of opportunity as well to reach more people, to serve advertisers more effectively and to grow our digital platforms.

For now Iger and ESPN are emphasizing digital content as an addition to the bundled network, but in my estimation ESPN is far better positioned for a world where they must go over the top to consumers than people give them credit for. The afore-linked Wall Street Journal article said that in order to maintain current revenue levels ESPN would need to charge $30/subscriber if the company abandoned the pay-TV bundle, which implies a customer base of ~20 million people. That’s a little over 20% of ESPN’s current pay-TV subscriber base, and if ESPN really does have all the sports that matter, I think it’s a very realistic target.

To be sure, ESPN still has work to do: they only have half the NBA rights, only one NFL game a week, missed out the World Cup and EPL, and have never had the NCAA tournament. Some of this, particularly the NFL, is remedied by the fact that the rest of the games are available on old-fashioned broadcast TV. That may go away eventually, but then again, ESPN’s competitors may falter eventually as well, allowing ESPN to snap up what they’re missing. Most importantly, though, “eventually” marks this entire discussion: the cord-cutting trend may be accelerating but I think Iger is right that there are at least a few years of viability left.

There’s one more question: might sports leagues go over the top directly, a la the WWE? It’s certainly possible, but I suspect most leagues benefit more from being available — and paid for — by “sports fans” broadly as opposed to hard core fans only; it’s the same “socialism that works” angle from the current bundle applied to a narrower sports bundle. Still, this is an important area where ESPN differs from Disney’s other properties: the network doesn’t own the content. Then again, said content has a relatively limited shelf life — and most sports fans like multiple sports. 1

The Future of Paid Content

That’s not to say that everything is rosy in pay-TV land. If anything, to fixate on the fate of ESPN is akin to journalism observers only caring about how the New York Times is managing the transition away from print to first the Internet and now mobile. Things aren’t going perfectly but the company is surviving and continues to produce an incredible amount of compelling journalism. However, things are considerably worse for regional papers without the cachet or resources of the Times: publications are going out of business all over the place, and the number of working journalists has been cut nearly in half over the last 25 years.

I suspect a similar shakeout is coming in TV: as the pay TV bundle erodes an entire slew of cable channels will whither away, their targeted content replaced by online video, particularly YouTube. Meanwhile there will be an intense competition waged by a few streaming giants — ESPN, HBO (a long-time master of differentiated content), Netflix, Amazon Prime Video (a particularly challenging competitor because of its orthogonal business model), and perhaps BAM Media — for consumer attention and dollars. That competition will largely work in the favor of content creators, who ultimately create the differentiation that end users are willing to pay for. Said end users, though, at least those with wide-ranging tastes, may not see much gain in their pocketbooks: ESPN at $30, HBO at $15, and Netflix at $9 isn’t far off from what consumers pay today for the pay-TV bundle.

Still, such an outcome should provide hope to content creators of all types: there is a way to escape from the commodification effect of Aggregation Theory, and that is through differentiation. In other words, the more things change, the more they stay the same.

1. Most leagues do have over-the-top offerings, but only make the full slate of games available to fans who do not otherwise have access to the broadcasts. This is because ESPN and regional networks pay significantly more than do said fans collectively, and I don’t see any reason why that would change for ESPN in particular. Regional networks, which are the most responsible for rising pay-TV prices, are another matter, but that’s more a problem for the sports leagues than ESPN — if anything ESPN’s guaranteed payments will become more valuable, not less [ ↩ ]