The Changing Landscape of Pay Television : Cable: Now that the novelty has worn off and the number of VCRs and basic services has grown, the once-soaring market is flattening.


Throughout the 1980s, Home Box Office and Showtime were synonymous with the lure of cable television. The pay channels grew at a dizzying pace because viewers liked the novelty of watching uncut movies before they appeared on the networks. Eager subscribers literally chased the cable truck down the street to sign up.

But now pay TV has hit a wall. The business is having its worst year in history. Subscription levels at HBO and Showtime will be up marginally this year and will be flat or down at sister pay TV networks Cinemax and the Movie Channel.

“The pay TV business wheel had been leaking air” says Larry Gerbrandt, senior analyst at Paul Kagan Associates, a media research firm in Carmel. “Now it’s gone flat.”

Recent trends in pay TV are particularly bleak. Fewer cable subscribers are willing to pay the additional $10 to $20 a month for one or more pay TV channels. The number of homes buying pay channels, as a percentage of all cable subscribers, is shrinking.


“We are a maturing business,” acknowledges Michael Fuchs, the outspoken chairman of HBO who relishes his image as the bad boy of cable. “It now is flat enough that the industry is finally getting concerned.”

Last year, HBO had 17.3 million subscribers, and company officials say they will add only “a couple of hundred thousand” subscribers this year. Cinemax, HBO’s sister channel in 6.4 million homes, will lose subscribers this year for the first time. For Showtime, subscriber trends have been even worse. Showtime and its affiliated network, the Movie Channel, together lost 95,000 subscribers in the first three months of this year and are likely to end 1990 at little more than 10.5 million homes, gaining barely 100,000 over 1989.

The television landscape of 1990s is unrecognizable compared to the boom years for pay TV in the last decade. Pay TV’s strongest selling point--that it offered movies uncut and without commercials years before they appeared on network television--is no longer unique.

Probably no innovation in television has hurt pay TV more than home video, where blockbuster movies are released months before they appear on HBO or Showtime. Videocassette recorders, which were in only 5% of homes in the early 1980s, today are in 70%.


On top of that, pay TV is now competing with a stronger selection of “basic” cable networks and regional pay sports channels that are attracting a growing portion of viewers.

“Pay TV is flat to down because of the proliferation of more networks and more choices consumers have,” concedes Tony Cox, president of Showtime. When pay TV started in the mid-1970s, there were only four cable networks. Today there are 69.

Also in the future lurks pay-per-view, which can deliver movies into the home before they are available on pay TV.

As a result, the two dominant pay TV channels are taking different approaches to retard the slowdown in their growth.


HBO is positioning itself as a “brand name,” moving further into original programming, while Showtime is seeking radical changes in the pricing of pay TV.

Pay TV’s current woes can be traced to the heady days of the 1980s, when HBO and Showtime launched “exclusivity wars” to secure pay TV rights to Hollywood movies. The strategy, which sought to differentiate the rivals so that the same film would not appear on both channels, did not come without a steep price.

Showtime is committed to spend $2.3 billion for movies over the next seven years. Saddled with these programming costs, Showtime Networks Inc.--which is owned by Viacom Inc. and encompasses Showtime and the Movie Channel--lost money between 1987 and 1989. This year it expects to be marginally profitable.

“Even in good times, it’s not a great business,” concedes one senior Showtime executive.


HBO, which is owned by Time Warner Inc. and has revenues topping $1 billion annually, in recent years has seen its pretax profit margin bounce between 9% and 13%.

But the two pay TV rivals no longer can compete by bashing each other (although Viacom still has a $2.4-billion antitrust lawsuit pending against Time Warner and HBO).

Faced with stronger challenges from emerging cable channels, HBO and Showtime are trying to persuade the cable industry that pay TV is still viable.

Significantly, HBO and Showtime are not panicking about their programming. They continue to have good ratings, frequently beating out one of the Big Three networks during prime time in households that buy pay TV.


“There are still tens of millions of homes which don’t take HBO,” Fuchs says. “But I’m not going to get that business by making another made-for-TV movie. It’s only by banging away at those people.”

Along with more banging, Showtime and HBO are now focusing on subscriber retention. As much as 4.5% of HBO’s subscribers unplug each month, which means on an annual basis the pay TV channel must replace about half its subscriber base--ratios akin to the very mature magazine business.

Pay TV executives are quick to blame deregulation as the chief culprit for their problems. “The malaise in our growth is totally a function of marketing and positioning. We are victimized by the increase in cable rates,” Cox says.

Between 1980 and 1989, the average price of basic cable doubled to $16 from $8 a month, according to Paul Kagan Associates. Most local cable systems require customers to “buy through” the basic package before they can purchase their first pay TV channel, which typically costs an additional $10 a month.


“Basic prices have gone up dramatically, and that is the chief reason for the slowdown in pay TV,” contends HBO’s Fuchs.

Forcing customers to buy a package of basic channels--which could include channels the viewer has no interest in watching--has reached a ludicrous point in some communities. In some New York suburbs on Long Island and in Connecticut, for example, cable subscribers have to pay $60 a month before they can buy Showtime.

But Robert Klingensmith, president of Paramount Video, the studio’s arm that sells movies to pay TV, points out that VCRs have hurt pay TV too. “With home video, these films are no longer first in the home, so consumers are saying, ‘I don’t need all these services.’ ”

Still, most cable executives believe that “marketplace mechanics” are hampering pay TV, and that is why marketing has become pay TV’s new mantra. In effect, the pay services are finding it necessary to spend ever-larger sums of money just to stay even. Pay TV executives point out that this is no different from many mature products, for which companies typically budget 15% of revenue just to maintain market share.


The pay TV channels are relying on marketing partly because they have no other alternative.

“One of pay TV’s biggest problems is that the programming can’t be changed because the bulk of the cost is long-term output deals with the studios,” observes analyst Gerbrandt.

“They have no flexibility in that regard, and therefore the main thing they can directly affect is the marketing of the product,” he says.

HBO next year will spend $150 million on marketing, mostly for advertising and promotion. One-third of that is budgeted to buying commercial time on the broadcast networks for an “image campaign.” HBO has also become one of the largest direct-mail marketers in the country.


While HBO opens its wallet to promote itself, Showtime is working behind the scenes to change the pricing by which local cable systems package basic and pay TV channels. “I don’t think any amount of advertising on behalf of our brand can overcome the structural problems of our industry,” Cox says.

Showtime has proposed a radical revamping in the wholesale license fees that it charges local cable systems. Traditionally, Showtime and HBO charge local cable systems between $4 and $5 for each subscriber. The local system usually more than doubles that rate at the retail level.

But a new plan pitched by Showtime in recent weeks would charge local systems a small fee for every basic subscriber rather than the $4 to $5 fee only for those who buy the pay channel.

“The theory is that by bringing down the price, Showtime can substantially increase its penetration,” explains Mark Riely, a partner in the New York investment firm of MacDonald Gripo Riely.


So far, most local cable systems have given the Showtime plan a cool reception because it means cutting their margins in the short term. Few local systems, many of which are highly leveraged because they changed hands in recent years, can make that kind of sacrifice in the current economic environment.

Instead, local systems--the majority of which are owned by or affiliated with large “multiple system operators,” or MSOs--are toying with their own ways of marketing pay TV. United Artist Entertainment, a Denver-based MSO, is offering annual subscriptions for pay channels at some of its local systems around the country. Customers will be offered a discount for buying a year’s worth of the pay channel up front, a strategy that magazines have used for years.

“When a category moves into maturity, it is incumbent to come up with innovations in marketing,” says Jerry Maglio, senior vice president of marketing at United Artist Entertainment.

To a great extent, the fate of HBO and Showtime is in the hands of the MSOs and local cable systems over which they have no control. “The problem is that the pay networks have to market around the operators, and the operators have never been very good marketers,” confides one studio executive who has worked in the pay TV business for several years.


Pay TV executives also feel that MSOs and local cable systems favor basic over pay channels because in many cases the MSOs have an ownership stake in one or more of the basic channels.

Actually, local cable systems make more money off basic than they do pay because the margins for basic are much higher. About 70% of a local system’s revenues come from basic and 30% from the pay. And half of pay TV revenues off the top go to the network, compared to 20% to 25% for basic channels.

Through the early to mid-1980s, HBO and Showtime were frequently the incentive, along with better reception, to buy cable TV. Basic networks such as CNN, ESPN, USA Network, the Discovery Channel and TNT either had not yet been launched or could not afford the kind of programs that attract viewers.

“As basic channels become more successful and have better programming, it takes away (viewers) from both the broadcast networks and pay channels,” says Marc Nathanson, president of Los Angeles-based Falcon Cable TV. “Five years ago, HBO and Showtime did not have as much competition from cable itself.”


More troublesome could be pay-per-view. PPV, which is already available in 27% of cable TV homes, gives the viewer access to blockbuster films several months before they appear on pay TV for between $3 and $5 per viewing.

“PPV will take over the function that pay TV started out with in the 1970s and ‘80s: premium exposure of uncut films on TV,” Riely predicts. He sees pay TV evolving closer to basic networks by offering a wider variety of programs than movies and possibly including some form of advertising.

HBO has already moved in that direction. Although big Hollywood movies will remain the backbone of the channel, Fuchs is pushing the channel further into original series, high-profile specials and sports. These programs, especially the comedy specials and boxing matches, in turn are being promoted as “events” and used to lure subscribers.

“Now we have to do more provocative programs,” Fuchs insists, referring to the adult sitcom “Dream On” and documentary series such as “Real Sex.” One lingering advantage for pay TV is that it can put on programs containing violence or nudity that the networks and basic cable channels wouldn’t touch.


But few observers believe that sex, violence and sports will be enough to give pay TV the kind of growth it had in the 1980s. And HBO and Showtime are locked into long-term contracts to buy Hollywood movies, leaving very little money for alternative programming.

“Nobody put a gun to their heads,” observes analyst Gerbrandt. “They put a gun to each other’s heads.”