Those Go Daddy ads during the Super Bowl may come at a hidden cost

A reporter asked me about my thoughts on the recent CRTC pronouncements on simultaneous substitution (sim sub) and local channels. Representing independent producers, who tend to swim lower down the food chain, given our limited market power, I decided to try to be discrete and merely suggested, off the record, that “it could have been a lot worse,” since getting rid of simultaneous substitution completely may have gutted a big chunk of the revenue streams that support broadcasting in Canada. Thankfully the CRTC listened to concerns on that scenario and maintained sim sub for the most part.

However the more I think about it, the more I have to conclude that even so “it probably was worse, than I initially thought”, because of the intangibles that always come into play when the rules of the game get altered.

Sure getting rid of simultaneous substitution on the Super Bowl, so consumers can get to watch all the “action” on Go Daddy ads, may seem like a popular thing to do. But it requires a lot of stick handling around public policy goals and objectives to get there. U.S. networks just got the bonus to sell Canada to U.S. advertisers, at the expense of Canadian broadcasters, and at no cost to the U.S. networks. And all with no obligation to the Canadian system.

Eroding the value of legitimately acquired rights is never a good idea. To begin with the viability of commercial broadcasting around the world is based on the legitimate opportunity to monetize territorial and/or platform rights that a broadcaster acquires from program rights holders like the NFL, Hollywood Studios or independent producers. That is how the business of broadcasting still works. Rights protections and rights management may be boring but an orderly rights market supports new businesses like Netflix just as much as it does traditional broadcasters.

In the case of local broadcasters and big sportscasters like TSN such rights tend to be exclusive to maximize ratings and generate ad revenues that support the viability of these channels. The monies that flow from the exploitation of these rights supports shareholder returns, the ability to produce more original content and to meeting obligations like providing local or national news.

Historically this model has worked extremely well in North America, particularly in the U.S., where the problem of the retransmission of cross-border signals is not an issue like it is in Canada. In the U.S. distant channels that carry programs for which a local channel already has the rights are often blacked out over cable to prevent erosion of the local broadcaster’s territorial rights. The principle is pretty easy. Distant broadcasters don’t have the right to sell someone’s content/property in markets where these broadcasters never bought the rights to show it. Or put another way you can’t sell someone’s stuff without their permission. That is pretty easy to understand.

In Canada this principle has always been a little fuzzy because U.S. free over–the-air signals that leaked over the border got picked up without compensation by cable and then satellite decades ago. And, access to these channels helped drive cable penetration in the early years of the business. U.S. broadcasters, however, have always opposed this form of retransmission and continue to fight for compensation for distant broadcast signals through the World Intellectual Property Organization (WIPO). If they ultimately win the cost to Canadian consumers could be enormous.

While distant signals have been carried without compensation, program rights holders in the U.S. now receive “some” compensation under compulsory license under the Copyright Act. It’s messy but by adopting simultaneous substitution we ended up with a system of checks and balances where cable and satellite customers get more choice, while Canadian broadcasters got the protection needed to exploit exclusive territorial rights they legitimately acquired and thereby generate revenues that in part support Canadian news and other program obligations. That balance may have changed with Friday’s decision and we may see a lot of unanticipated collateral damage as a result.

The point behind simultaneous substitution was to ensure respect for a monetization of the exclusive rights Canadian channels acquire and that make their businesses viable and meet regulatory obligations. The CRTC has recognized this principle in general and has recognized how important and necessary it still is to support Canadian programming obligations and jobs. However, based on a number of consumer complaints, it is going to kill sim sub for the Super Bowl in 2017, and other sporting events immediately like the World Series on TSN. There is speculation that Bell, which has the exclusive Canadian rights to the Super Bowl and other events, may lose between $20 -$40 million because of this. So what’s the consequence particularly for creators and jobs, and in the end consumers who enjoy the content, U.S. or Canadian, that an orderly rights market supplies.

First, when Bell makes a dollar on its broadcast business $0.30 goes to Canadian programming, including things like local news. Take out $20 million and the incentive is to reduce spending by the full $20 million, including at least $6 million on Canadian programming, probably more. And that means less original content, job cuts or station closures. And we believe the cuts will begin to happen long before it impacts the Super Bowl in 2017. The reason is because ad revenues are already well down, and no one knows if this is a cyclical phenomenon or not. What is clear is that the recent decision has just made the business a lot more uncertain.

Second, while the CRTC suggested Friday that broadcasters had to look beyond profits and still meet obligations, because of the privilege of holding a license, which may be wishful thinking, if broadcasters figure the value of that privilege has been eroded significantly.

That is going to lead a fractious debate. Arguably the right measure is not only to measure losses on the local side of the business but cumulative profitability across specialty channels too. That has been our view and remains so. Today specialty channels still make double digit returns and under the CRTC’s Group License Framework revenues from specialty can be shifted to support content on local channels. But all that “may” have a short runway because by the spring the CRTC is expected to order all specialty channels unbundled and many anticipate a big drop in profitability for specialty channels as a result. No one can accurately predict how much, but losses are assumed. The more a broadcaster anticipates a loss, the less program expenditure and more job cuts are likely across the board even before the full impact of these decisions are felt.

Third obligations and profits are intrinsically linked by regulatory precedent. Obligations to serve are always linked by regulators to the “opportunity” to earn a reasonable return on investment as a quid pro quo. Cut that link and the social contract is broken. Broadcasters may now believe that the “opportunity” to earn continued “reasonable” returns is unlikely given the direction the CRTC is taking. If that is what they believe, even if that is not the Regulator’s intent, then broadcasters are going to respond according to what they “perceive” the damage to be.

So the gloves are off, and we predict that the creative sector and related will be collateral damage in the interim, And while the CRTC and broadcasters fight over how to measure ” reasonable” profitability, producers, talent and crews will feel the first cuts.

Fourth. The assumption that broadcasters will innovate faster to keep losing channels afloat, including some local stations, ignores the fact that broadcasting has been through a constant period of investment in innovation for 20 years (digital, specialty micro-channels, HD, PVRs, VOD) and ignores as well the investment realities and options available to vertically integrated companies in Canada.

Most of the share price value and market capitalization of these companies is now driven almost totally or substantially by wireless, broadband and cable; not broadcasting. Investors already attribute little value to content relative to networks. These integrated companies, like virtually all owners of broadcast properties, are businesses. They will behave as businesses first. And vertically integrated companies have options. Broadcasting (content not carriage) is already predicted to be threatened due to shifts to the Internet and predictions around the impact of unbundling. There is lots of debate on this but many experts would suggest there is a shift going on from broadcasting to broadband.

Time may tell but in the short-run broadcasters will base their business plans around the market as they see it and the signals they get from regulators. It’s fair to presume the view is currently negative, regardless of levels of earnings today. If an integrated business perceives itself to be facing diminishing returns, it is more likely that it will reallocate capital to network businesses (wireless, broadband) where returns are greatest, than to face an increased investment risk on the line of business (content) that is seen as delivering a lower opportunity for return in the long run. The converse on the broadcast side will be more direction to hold the line on, or reduce costs.

Fifth. There are two other very negative business consequences of limiting the opportunities to exploit legitimate rights. It increases fears about the impact of diminishing returns that were already expected as a consequence of unbundling and it underscores that there is no certainty in respect of future business contracts. The latter is a big intangible, and hard to estimate its impact. But business people generally agree that if you think the rules are unpredictable, it is harder to do deals.

Take the case of Bell who having paid the NFL millions of dollars for a long term contract and may now see that investment collapse in 2017, perhaps before the end of the contract, because the exclusivity it bought has been substantially eroded by the loss of sim sub protections on territorial rights. That type of contract has always been standard business practice but now that certainty has been undermined by a decision that at least in part calls into question the economic value of future contracts modelled on normal business practice on both sides of the border. The question for deal-makers then becomes, “what next”?

Reasonable expectations of returns from buying and selling rights have now been called into question by a decision that, albeit limited right now, clearly reduces the value of “exclusive” broadcast rights. What is more confusing in this case is that both the Canadian rights holder(the buyer) and the NFL (the seller) oppose this intervention.

Also, because there is now less of  a reasonable expectation of return with respect to what were once legitimate contracts, revenues become more unpredictable and broadcasters become more averse to doing deals with independent producers and making new investments, again to prospectively minimize risk, even if in hindsight the impact is less than feared. Our members tell us they already can feel that type freeze as broadcasters await the “Let’s Talk TV” decision and this decision we suspect will only make the broadcasters more hesitant to close deals on new shows or renewals.

Finally let’s think about some other intangibles that are lost when audiences shift to NBC or whatever U.S. network is now the channel of choice to partake in the spectacle of the latest Go Daddy ads. The Super Bowl produces one of the largest audiences available to Canadian advertisers and one of the best opportunities to promote businesses in Canada as well as promote the best upcoming Canadian shows or simply show certain important public service announcements like we saw last night. The value of that for all intents and purposes is gone, along with the audience, once the decision takes effect.

Bottom line. Consumer choice has to be a priority for the broadcast system. That is why the Government of Canada wants more pick and pay and why the CRTC will adopt it probably this spring. But the ability to fairly exploit rights is also a priority if we want to sustain a business environment that supports original content, news and jobs. All that is linked to revenues from those rights. The social contract should not have to boil down to sacrificing one priority at the expense of another but like most things in the real world finding the right balance requires a lot of complexity and nuance. Promoting goals is easy. Making it all work is the hard part.