Good afternoon!
The Medium identifies a few key trends each fiscal quarter that reveal the most important tensions and seismic shifts in the rapidly and dramatically changing media marketplace. The key trends help you answer a simple question: "What's next for media, and where's it all going? How are the pieces lining up for business models to evolve, succeed, or fail?"
Read the three key trends The Medium will be focused on in Q3 2023. This essay focuses on "Legacy media companies are throwing in the towel on their bets to own the consumer relationship in streaming and beyond."
My monthly Medium Shift opinion column —“A Hopeful Sign for Big Media?” — went live a few hours ago. I wrote about how two business models emerge have begun to show promise: the "content, community and commerce" model and the "product company" model. The recent stories about Barstool Sports have highlighted the challenges of the first model for big media. Recent stories about The New York Times and Yahoo suggest why the second model may be more promising.
[Correction: Xumo is a joint venture between Charter and Comcast, only. Cox has been licensing the Xfinity Flex platform for its Contour Stream player. So the more accurate version of my argument is that Charter may be negotiating on behalf of Comcast and Cox via the shared Xfinity Flex platform, and not via Xumo. I apologize for the error.]
The recent, “not a classic carriage dispute" between Charter Communications and Disney, has resulted in an ongoing blackout of Disney channels on the linear carrier. The dispute hits on four recent themes of mailings from The Medium:
The Q3 2023 trend of “Legacy media companies are throwing in the towel on their bets to own the consumer relationship in streaming and beyond.”
AMC Networks Chairman James Dolan’s explanation of the need to evolve from a wholesale operational culture to a retail one;
Comcast’s recent Xumo Joint Venture with Charter, where it licenses its Xfinity Flex streaming platform, Flex-operated devices and associated voice-controlled remotes to those partners (all renamed with the Xumo brand); and,
Comcast’s upcoming call/put deal for Hulu coming up on September 30 2023 (originally scheduled for January 2024).
What I have yet to read is an analysis that touches on why four are all interconnected. The X-factor in all this is Xumo (no pun intended): Comcast and Charter reach 62 million broadband subscribers. Throw in Cox, which licenses the Xfinity Flex platform for its Contour Stream player, the reach is 68 million. Charter seems to be speaking for all of them in this dispute. That is what makes their offer to Disney less about the expected, and more about wicked gamesmanship from the Xumo trio of distributors, if not ultimately Comcast.
Media leaders like Comcast CEO Brian Roberts, Paramount CEO Bob Bakish and Warner Bros. Discovery CEO David Zaslav told this week’s Goldman Sachs Communacopia + Technology Conference that they have been preparing for this moment. But, excluding Roberts, I don’t buy that story.
The poker “tell” in all this is Charter’s offer to distribute ad-supported Disney+ for free. The broadband-focused offer is a brutal mirror on legacy media streaming efforts, to date, and a brutal mirror on their attempt to circumvent cable distributors with retail-first models.
Key Takeaway
I have seen multiple takes that Charter is putting the “squeeze” to Disney in this dispute. But I think Comcast is playing a much more ruthless, four-dimensional game of chess with Disney. That is reflected in the offer of free distribution for ad-supported apps.
Total words: 2,600
Total time reading: 10 minutes
A summary of the standoff
At the root of the standoff is whether the cable bundle should stay alive. Charter is the second-largest cable TV operator with 15 million video subscribers across the U.S., including in the New York City and Los Angeles markets. It delivers $2.2 billion in annual programming fees to Disney.
As per The Wall Street Journal, on a call with investors last Friday led by Chater CEO Christopher Winfrey:
“Charter said it was unwilling to keep paying for Disney’s traditional channels without offering access to its streaming content, given that Disney in recent years made most of its highest-profile content available on streaming, in turn decreasing the appeal of its cable channels, it said.
“We had to draw a line in the sand,” Winfrey told analysts. Disney’s cable portfolio has seen “significant viewership declines across sports, general entertainment and most dramatically in children’s programming” as a result of the entertainment giant’s prioritizing its streaming services over its traditional networks, Charter said in a statement.”
The piece later added:
“Charter’s Winfrey said the rising costs of video programming coupled with increased cord-cutting has made the cable company indifferent on the current business model. Charter warned analysts that if it doesn’t come to terms with Disney, there likely will be a further decline in video customers.”
Disney had asked for market rate increases on its linear channels and Charter granted those but with three additional requirements:
Lower penetration minimums to enable “à la carte” options for customers
“Inclusion of Disney’s ad-supported direct-to-consumer (DTC) apps within its packaged linear products for free “so the customer does not have to pay twice for similar programming”
Charter will market Disney DTC products to its broadband-only customers
Disney rejected the terms, and Charter declined to continue carriage until an agreement was reached.
1. Legacy media companies are throwing in the towel
I argued earlier this quarter that the licensing of libraries to third parties by Disney, Warner Bros. Discovery and others reflects a decision by these companies to give up on owning the consumer relationship. Valuable content offers valuable data insights into consumers — especially for advertising — and those businesses are willing to allow third parties to achieve those wins. Another version of that problem is “hard bundles” which I wrote about last month. Those exist when a streamer works with a local provider to give their customers immediate access to a streaming service as well as direct-to-consumer and à la carte distribution or sometimes a hybrid of all three" to achieve growth.
This dispute plays like a funhouse mirror on this Q3 2023 trend. Because it reflects how Disney both is and is not throwing in the towel.
Disney is throwing in the towel because it is willing to allow Charter to include its ad-supported apps in linear packages, a move that is basically the “hard bundle” strategy that Paramount has been pursuing, to date. Whether or not Charter ends up distributing the apps for free, Charter owns the customer relationship in a hard bundle model. It does not control the marketing of the apps to consumers, but it will be able to do so at zero marginal cost.
But, Disney’s demands for higher license fees and higher penetration minimums is basically a continued embrace of the wholesale model. The entire standoff makes it clear that, for all of Disney’s talk of a future where ESPN goes 100% direct-to-consumer, Disney's actions suggest it would prefer to delay that retail future while there is still billions in revenue and cash flow (28% margins in FY Q3 2023) from distributors like Charter. It betrays an internal skepticism at Disney of both its own streaming business and its long-term ability to pivot away from wholesale to retail.
2. Evolving a wholesale operational culture to a retail one
This calls back to something AMC Networks CEO James Dolan told investors back in February:
AMC has been a wholesaler, right, as most of the programming companies have been. And in wholesaling, somebody else takes care of the customer, somebody else watches the customer and somebody else actually ends up pricing to the customer.
When you go to DTC all those things become your responsibility and for an organization to move from wholesaler to retailer is to really significantly change its focus. Things they are paying attention to, things like the customer journey and churn, they are all part of becoming a good retailer.
He later added this is a “cultural change” for AMC Networks and others, including Disney.
Disney’s proposal is odd because this culture change has yet to take place at Disney despite the extraordinary scale of its streaming business ($19.6 billion in revenues in 2022). It is still insisting on the old wholesale bundle model and past, higher penetration minimums to Charter’s household base. It is doing so despite Charter’s insistence that it no longer wants to “force customers to pay for Disney content they opted out of, or don’t view and pay even higher rates, would negatively impact our connectivity relationships.”
Additionally, its agreement to Charter’s “hard bundle” deal reflects a lack of culture change. As I have pointed out in the past, the purpose of a retail-first, consumer-first business is to own the customer relationship. Charter here is saying that it owns the consumer relationship both in broadband and in video. So it is best positioned to preserve the value of Disney’s wholesale model with its customers, and also to market and convert consumers to streaming.
3. Comcast’s Xfinity Flex
It is reasonable to assume Charter’s negotiation stance speaks for the other cable distributors in the U.S.. It certainly speaks for Comcast and Cox via the shared Xfinity Flex platform. To remind you, Xumo is an over-the-top (OTT) play for aggregating third-party streaming services. It aims to solve a pain point for streaming consumers by making “search and discovery across live, on-demand and streaming video seamless and incredibly simple for consumers.”
I last wrote about Xumo in July’s “Imagining An EA Sports-ESPN Partnership”, where I predicted Disney CEO Robert Iger “will sign some form of a distribution agreement with Comcast that will help get ESPN’s DTC app maximum distribution in the U.S. on Comcast’s the Xumo Stream Box, which will be rolling out to Comcast and Charter customers this year.” That has certainly played out here: ESPN+ is an ad-supported app, and Disney is open to a cable distributor distributing and marketing the app along with other ad-supported versions of its apps, just not for free.
The broadband component of the negotiations — combined with the fact that Charter shares the same broadband streaming distribution platform as Comcast and Cox via Flex — suggests that this is not a negotiation in a vacuum. This is true both for Charter, which represents the Xumo joint venture, and Disney, which is serving as a proxy for other cable programmers. Whatever terms Disney will also have to be offered as “Most Favored Nation” to other programmers with both retail and wholesale strategies like Paramount, Warner Bros. Discovery and AMC Networks. That puts an unusually high burden on Disney to get the deal terms “right”.
As long as Disney needs Charter for both wholesale and retail distribution — and all signs from this negotiation suggest that it needs it badly for both — it also will need Comcast and Cox. Because, as I wrote in April’s “Comcast's Future Looks More Xumo Than Peacock”, Xumo is an aggregation play for streaming services with the potential to reach 68 million homes across all three distributors.
That reach is invaluable, if not existentially necessary, for ad-supported streaming services to succeed. We are witnessing the launch of more ad-supported tiers from other legacy media streamers because Hulu has proven that the economics can be lucrative. Ad revenue per user can be greater than the base subscription price resulting in a total average revenue per user (ARPU) that is greater than the ad-free tier price. Around two-thirds of Hulu’s U.S. subscriber base is ad-supported, and its ARPU is typically almost double the base price of its ad-supported tier (previously $6.99 and now $7.99 per month).
As I wrote in January 2022:
“Hulu reported an ARPU of $12.75 in FY Q1 2022 on a higher monthly price of $6.99 for its ad-supported offering. Assuming two-thirds of its audience chose the ad-supported model, again, Hulu generated $15.58 off of its ad-supported offering, or $8.59 in ad revenue per user over the quarter (up from $8.27 or 4% from Q1 2021).”
So Disney’s streaming service would benefit from scale. The cost, however, would be lost subscription revenues.
Charter is demanding to make those apps available at no cost to its customer in exchange for the wholesale price increases Disney is seeking. Effectively, it is a “cut off your nose to spite your face” type offer. That is what makes the Xumo JV so significant here: If Disney agrees to those terms, it will be sacrificing subscription revenue across Charter, Comcast and Cox homes. In doing so, it would be killing the economics and therefore the business rationale for offering an ad-supported tier.
4. Comcast’s upcoming call/put deal for Hulu
Comcast CEO Brian Roberts spoke at Communacopia earlier this week, and discussed the Charter-Disney standoff and Comcast’s strategy:
…ultimately, I hope people are looking at what is the consumer saying. And I think the consumer wants simplicity, somebody to help aggregate and have the most bang for their buck. And this dispute is putting tension around some of those issues. I hope they work it out. I think that's in the interest of consumers. I look at our company, we don't look at it as linear or streaming, we look at it as linear and streaming. We had the whole strategy, and again, I bet we talk more about it with Peacock and NBCUniversal and Xfinity is why we are the best aggregator. We have all the streaming apps, all the linear, all in one place.
He also announced that Comcast and Disney have modified their agreement to officially begin the process of deciding Hulu’s future ownership to September 30, up from January 2024. Disney owns 67% of Hulu and Comcast owns the rest. Under the original 2019 agreement, Comcast can force Disney to buy—or Disney can require Comcast to sell—the remaining 33% stake in January 2024, at a guaranteed minimum total equity value of $27.5 billion.
Roberts used the opportunity of the Communacopia appearance to push for a valuation above $30 billion:
The value of the bundle, we've seen Hulu with package with Disney and with ESPN+, you'd be able to stay in that bundle. That reduces churn like half for Disney and others. So that value goes with it. And we've seen analyst reports that a buyer depending on who they were, if it was to scale them up, they could have a couple of billion dollars or who knows what of synergy. Just that piece of the synergy and the churn benefit could be worth $30 billion. And that's before you ascribe any value to the actual Hulu.
These quotes reads like standard corporate talking points. But in light of the above, they are actually quite wicked. I have seen multiple takes that Charter is putting the “squeeze” to Disney in this dispute. Roberts is outlining a much more ruthless, four-dimensional game of chess with the offer of free distribution of ad-supported apps being the key move.
Roberts is saying that Hulu would have quite a bit of value to any streamer like Disney. Basically, “a couple of billion dollars” in synergies and reduced churn that, when growth multiples are applied, can be valued at $30 billion to a business. Now, that might be a stretch to integrate a Hulu for a struggling programmer like Paramount or AMC Networks, but it would not be a stretch for Comcast. An integration of Hulu into Xumo would instantly put Hulu in front of 54% more of the 44 million subscribers that it currently reaches as of Disney’s FY Q3 2023. The cost to Xumo subscribers would be marginal.
The members of the Xumo JV have been all too happy to remind them that they are also gatekeepers to Disney’s DTC ambitions. Roberts’ discussion of price implies Hulu would be a much better business in Comcast’s hands than in Disney’s. That may not be such a terrible outcome: Disney would end up with at least 3x more cash above its $11 billion as of its FY Q3 2023. That money would go a long way to paying down its $47.2 billion of current and long-term debt.
Without mentioning Xumo by name, Roberts seems to be suggesting that Disney's and Charter's dispute will benefit the Xumo joint venture. But, Comcast would need to come up with the cash by raising debt. It currently has $7.2 billion on hand and carrying $97.5 billon in debt. With interest rates high, raising additional debt would be expensive.
But, Roberts' discussion on lower churn and operational efficiencies from Hulu, plus a growth multiple to reflect those gains, suggests that the Xumo joint venture foresees both instant and long-term benefits from Hulu joining its bundle. The simplicity of Xumo's offering would be more compelling.
The Medium’s Interpretation of Charter’s Position
Disney has marketed Hulu + Live TV to Charter subscribers as an alternative for getting Disney’s channels. According to Deadline, it has seen a 60% bump in sign-ups above its internal expectations. But, the irony should not be lost on anyone: Charter subscribers will be using Charter broadband connections and the Xumo platform in order to use Hulu + Live TV.
So, in sum, I think this is what Charter is saying to both Disney and the broader marketplace:
“Disney, you’re still a wholesale business run by leaders who have a wholesale background, starting with your CEO. You wholesale guys still haven’t figured out retail yet. You’re still on a learning curve. You won’t anytime soon. And we think your ask for higher affiliate fees reveals that you are skeptical that you will anytime soon.
So we hear your talk about streaming profitability and your talk about Disney’s future being ins streaming and ESPN going 100% DTC someday and we’re going to raise you: Your ad-supported tiers will need scale to succeed. We think your best bet for achieving scale in ad-supported streaming will be to allow us to distribute it for free via Xumo. Our customers win, and you win.
We know what consumers want. They want simplicity. And your portfolio approach of wholesale distribution and retail distribution has been a mess for them.
Consumers will pay for simplicity, and they may even pay a premium. Let us solve that problem for them because that is what we do best. And you can solve the programming component because that is what you do best. Win-win, with the only loss being your DTC ambitions.
Oh, and one more thing... We also know that the agreement you reach will also be offered as “Most Favored Nations” terms to your fellow linear companies struggling with retail. So make sure they sign off on our agreement, too."
Charter—if not ultimately Comcast—has laid the groundwork is a brutal set of decisions facing Disney now. But it is one that its execution of Robert Iger’s streaming strategy (and failed succession plan) inevitably brought them to.