Easy Money

Capsule:  What new media products, pricing and packaging will initiate the next wave of sustainable growth and profits?  In preparation for the next big thing, big distribution should go hunting for quarters in the sofa cushions by carefully reviewing their current pricing execution. At the same time, the media can strengthen its core customer relationships by packaging up alternative content, including new home and business services, looking for relationship-based marketing and advertising opportunities. 

The Financial Times


Where's the next vein of easy money in the media goldmine?  It's possible, but unlikely, that nothing will ever be easy again.  Rather than admitting defeat, content and distribution should commit their minds to developing the next big thing in the unsexy world of pricing and packaging.

To start, it's worth a look at the current structure of TV subscription pricing and promotions.  Today's cable, satellite and telco TV pricing accommodates three players in a market where it must and two--cable and satellite--where it can.  With this small competitive field, as long as all two-to-three players are pricing comparably, the consumer surpluses--measured as the difference between a discounted package rate and its mature price after a timed promotional discount expires--are comparable.  Said differently: consumers feel that all subscription TV services are over-priced, except for those delicious introductory discounts for new subscribers.  Predictably, new discount-heavy entrants always look better than the old hat.

A consumer surplus is the difference between the price a customer is willing to pay for goods or services and the price that they actually do pay.  A producer surplus in pricing parlance is the increased revenue available by shrinking the discounts and bringing the price paid for a service up to or just over the peak of consumer willingness. 

Take as an example the mature or rate card $115 monthly price for a cable, satellite or telco TV package including: a digital version of expanded basic service (100+ channels, with the most highly rated ad-supported networks) and one network, like HBO or Showtime, as well as the standard high-speed data service. The introductory offer price for this service for new customer installations might be $75 per month for the first year of service. 

Let's assume that the mature rate card $115 price captures the fullness of what consumers are willing to pay for this package once they've formed a habit.  Let's also assume that newly installed or upgrading customers paying the reduced $75 monthly price need a discount to buy, as an inducement to choose one service provider over another or to upgrade their services and deliver more profit to the incumbent. 

Newly installed or discounted customers in this pricing scenario are enjoying a consumer surplus of $40 per month or $480 for their first year. The service provider has a strong incentive to increase its producer surplus by bringing the $40 consumer surplus group up to either the full rate card price of $115 ($0 consumer surplus) or up to an intermediate price point between $75 and $115, deflecting churn risk and reflecting what these originally discounted customers as a behavioral segment are truly willing to pay. 

The service provider is not using uniform pricing in making these distinctions.  Although rate cards will carry the $115 published price and promotional marketing to new and upgrade prospects will carry the $75 discounted price, a growing number of customers past their first year of service will be paying something between these two price points.  This reflects the service provider's pricing sophistication, aimed at maximizing profit by tailoring package prices to the price sensitivity of individual segments.  Said differently, the service provider knows that uniform pricing will preclude access to certain market segments who are unwilling to pay the mature price because of economic or competitive reasons but are willing to pay a lower price with a larger consumer surplus if they can get one.

If the newly installed discounted group is only willing to pay $100 for the digital TV and broadband package after their first subscription year, the service provider might bring them confidently up to the $100 level through a $25 rate increase after Year One and subsequently lift their price point to the $115+ full-price level.  New price points above $115 will be inevitable over time as rate increases are taken on the mature base that keep the mature price moving up.  This upward price momentum occurs according to the service provider's need to maximize profit and often reflects a substantial margin surplus over the service provider's revenue-related and operating cost increases each year.

A major pricing challenge in this common scenario is the delta between $115+, as it rises over time, and the heavily promoted $75 offer price, which most service providers are unwilling to raise for fear of missing out on customer growth and upgrades. On the pricing theory that there is a maximum effective price that each customer segment is willing to pay, this cable-satellite-telco-TV pricing approach introduces an increasing number of price points between $75 and $115+ over time assuming that growth and profits have been maximized by hitting the exact maximum price point for each group with discipline.

Price discount offers like the $75 used in this example come into the market with a new product introduction or to overcome a new competitor. The service provider introduces a new product, the benefits and efficiencies of which can only be realized if the new product penetration is maximized.  The new product is bundled with a popular traditional product, heavily discounted and heavily marketed.  For cable distributors, the arrival of broadband a decade ago and voice, on a scaled basis, five years ago marked the death of uniform pricing.  Double-play and triple-play bundles launched a pricing sophistication for cable that drove profitable customer growth and competitive pre-emption for many years.

Today, though, there are more than a few quarters in the sofa cushions of cable pricing--as well as satellite and telco pricing--that can be picked up by applying a simple and regular discipline to surplus measurement over time.  If the cable operator in our pricing example above was dealing with a simple, time-frozen delta of $40 between the full $115 digital TV and broadband package and a $75 discounted offer price, a comparison of the actual package ARPU (or monthly average revenue per package unit) and the mature full price will be revealing.

If the package ARPU being realized in this example is $105, the subscription mix between full price customers paying $115 and discount customers paying $75 is 75% at $115 and 25% at $75.  By looking at overall churn versus Year One churn over an average period, a service provider can comfortably set subscription price-ratio targets for full-price versus discounted prices that will maximize growth and profit.  If the package ARPU is less than $105, the service provider is not maximizing growth and profit because too many customers are likely paying an introductory price.  This happens, particularly in decentralized operating environments, because of an unwillingness to risk churn increases through consistent rate increase execution. 

Another potential cause for a large mature price versus real ARPU delta is a flawed pricing plan that has lifted the most loyal, longest-tenured customers up to extreme price points (e.g., well over $115 over time,) while continuing to use the low $75 discounted price for everyone new.  As the distance between mature price and offer price grows, individual customer segments will break out of their pricing plans, registering dissatisfaction by disconnecting or downgrading service.  Often, this type of churn goes un-noticed on a package-by-package basis until the elasticity problems are fairly advanced.

A simple model that compares real ARPU by package to the desired business mix of discounted versus mature pricing will reveal the state of each customer segment in terms of price sensitivity, as well as the efficiency of each operation in setting price targets and reaching them.  The best rate increase judgements--which are really pricing judgements in a sophisticated business--will be made knowing what's at risk according to what's performing well and what's under-performing.  An optimal result comes from capturing profit increases by making sure planned rate increases actually take place.  If the whole pricing system is working as intended, high rate increases on the mature price might not be necessary, decreasing churn and maximizing profit in the healthiest competitive way.

While quarters in the sofa cushions can be thrilling, they're not enough to hold onto the house.  For TV and broadband distributors to unleash new powerful growth engines, new products will be required.  The current practice of offering only home-grown internally billed products beyond TV programming over which the distributor has virtually complete pricing control should be modernized.  Netflix has just reach 11.1 million US customers, a 28% growth rate over 2008 and a 5% growth rate in the third quarter of 2009.  It's time to bring Netflix into the cable, satellite and telco TV fold by offering its interesting mix of products and services with a superior local service connection.

Netflix pricing begins with a $4.99 per month package for the rental of two new release DVD's per month delivered to home within 1-2 days of an order.  Successive pricing of $8.99 to $16.99 per month brings more monthly DVD's and the flexibility of renting one-two-or-three DVD's at a time.  In addition, the $8.99 to $16.99 packages include streaming video with unlimited viewing of classic movies, selected TV and a small number of new releases through Netflix enabled devices.  The enabled device list is increasing from Sony Playstation 3's to Microsoft X-Box 360's to Samsung and LG BluRay DVD players to Tivo DVR's to Sony and Vizio internet TV's.

If traditional digital TV distribution collaborates with Netflix to enable customers to decide how they want to watch their movies--through their combined choice of ad-supported or premium networks, VOD or DVD rentals or streaming Netflix video--an economic system could likely be created that maximizes profits by befriending the market's leading competitors.  As long as the Netflix service offered by the local distributor is better than Netflix solo--a goal easily achieved through content and local service advantages--the addition of Netflix could jump-start premium IPTV economically.  Even if only a cross-section of the rights for Netflix streamed video were legally available for multi-channel service providers, the cable or satellite or telco TV store would be stocked with the best alternatives for TV viewing.  And pricing could be managed to reflect a slight increase in service costs for transfering customer calls and arranging web service for the new Netflix content.

Netflix pricing fits well into the traditional distribution price-point schema just as satellite and telco TV pricing was built looking at cable price points.  The most important fit that a Netflix or similar alternative might bring would be new value through new products and traditional products in new forms.  New value creation well-packaged should increase the elasticity of the current gray box of cable pricing in all of its complexity and increasing vulnerability.

Similar distribution advances that create the best pricing and packaging platform for internet video of every stripe can pay dividends, especially to current broadband pricing.  Consumption-based pricing for broadband gives all of the power and control to the service provider who is measuring consumption and billing for it. This model works for utilities but runs afoul of the customer loyalty TV distribution requires in a competitive field with high content variation.  Placing the pricing pressure onto added internet video services sitting on top of both standard broadband and the TV Everywhere combination can enable distributors to charge more for internet video while sharing revenue with the internet video content providers, who will be many of the same companies currently producing digital TV.

As long as video alternatives, whether they're streamed, gamed (in a good way,) sold or rented, are available independent of cable, satellite and telco TV providers, there will be a strong competitive incentive to bring them inside traditional distribution's packaging and pricing model. Distributors will need a new perspective to get comfortable embracing the competition, especially since traditional multi-channel competition involves virtually identical core products.  A new model can expand the elasticity of the status quo by bringing different content and services--ultimately including home and business monitoring and energy management as well as health care record storage and more--into a tight pricing constellation that will benefit by addition. 

In order to prepare for more products with better economics, media content companies might bring to market two versions of their online products--one to be bought outside the multichannel distribution sphere and one to be packaged into it.  And distribution should tighten up their pricing and packaging, identifying easy money along the way, in preparation for an internet and service expansion aimed at powering profitable growth for years to come.