John McCain's Dream, Media Industry's Nightmare
There is understandably much attention on the pending expiration of the contract between the US actors’ union SAG-AFTRA and the studios via their trade association the AMPTP. If this occurs, it will almost certainly compound the impact of the strike involving the writers’ unions (the WGA), which has been ongoing since May, as it would effectively shut down studio productions for film and television in the United States. However, even if the actors do not strike, it appears that the writers’ are likely to continue their action for now.
As I noted at the beginning of the WGA strike, trends favoring consumption of streaming services will continue if the launch of new entertainment programming in the fall is delayed (not least as streamers will benefit from deep libraries of domestic and new international content) while a consequence of prolonged strikes will for marketers will be a more aggressive decline in the reach potential of ad-supported TV declining than might otherwise have been the case.
How much of an impact the strikes will have will depend in part on how long they continue, and I don’t pretend to have a view on when exactly they will come to an end.
However, an important question I raise when asked about the strike is: do both sides share similar expectations for the future of the business? In effect, they are fighting over how the cash generated by the industry will be divided up. It would be one kind of fight if the filmed entertainment business were set to improve. Unfortunately for the parties involved, this won’t likely be the case.
More specifically, we need to remember that the profit margin profile for the media business is only going to get worse from here. To illustrate, let’s consider Disney. Prior to the launch of Disney+ and the completion of the acquisition of Fox’s entertainment assets along with the consolidation of Hulu, during its fiscal 2018, the company’s media networks and film studios division generated $32 billion in revenue around the world with $10 billion of operating income – a 32% operating income margin. But during their fiscal 2022, despite revenue of $55 billion for the equivalent DMED segment, operating income was less than half as much, or just over $4 billion (an 8% margin). To be sure, margins were always set to improve once Disney+ moved past its initial investment phase, but it’s unlikely that they will get anywhere close to where they once were.
Why is this so? To explain in general terms, I recall back to when I was a very junior analyst covering the cable industry twenty years ago. At the time, Senator John McCain – then the Chairman of the US Senate Commerce Committee – advocated the idea that cable and satellite operators should make TV networks available on an a la carte basis.
Anyone who looked at the matter closely would have observed that while consumers might enjoy greater perceived choice, it would probably result in more expense for network owners (who would need to spend more on marketing and customer service in order to manage churn), less revenue for network owners (because they wouldn’t be able to realize revenue from consumers who never watched a channel), less diversity of content in households (as consumers would likely only choose the networks they anticipated in advance that they would want to watch) and higher costs for consumers (because with less reach of cable networks, advertising would bear a smaller share of the costs to run networks, and presumably these costs would be passed along).
Fast forward twenty years, and with a video world led by streaming services, we are effectively living out John McCain’s dream with the added issue of higher costs to deliver content, because it’s substantially more expensive to offer video one-to-one rather than on a one-to-many basis, as is the case with broadcast technologies.
Another way to think of it is as follows:
Spending by consumers on video in all of its forms in the United States has risen by only around 1-2% each year over the past five, ten or fifteen year time periods. It’s unlikely to change that trajectory, as consumers continue to cut their pay TV bills while shifting spending into streaming services. Meanwhile, video-based advertising - whether on connected TVs or via linear TV - is probably set to decline slightly. Let’s assume total pools of revenue will be flat for the foreseeable future. As consumer expectations for quality content will stay high, as the costs of top-tier sports rights continue to rise, and as the increased focus on streaming services means higher absolute costs for content delivery, marketing and customer service rises, margins have only one direction to go.
Arguably, in this environment, perhaps the unions realize it’s more important than ever that they do as well as they can now, while there might at least be some debate about some remaining growth potential, including some optimists within the studios about a return to the profitability of the past, at least for a while. On the other hand, in a world where there are alternative ways to provide entertainment services – more sports and news, more amateur-based content, more international content and deep libraries – and where factors beyond the cost of labor seem poised to drive profits down, it seems hard to imagine that whatever percentage of the industry’s revenue currently gets paid out to talent will go up any time soon.