ESPN, the sprawling cable TV company that has become the ubiquitous source of sports news across the country, has recently gained attention for its new eye towards cost-cutting. Bill Simmons is gone. Colin Cowherd is gone. Keith Olbermann is gone (again). Two weeks ago, ESPN announced that it is reducing its work force by 4% by terminating 300 current employees. And today, the contraction continued with the announcement that ESPN would soon be shutting the long-form website Grantland.com–the baby of Bill Simmons that matured into a collection of pop culture articles mixed with detailed 3,000+ word sports analysis articles.
If you read Disney’s annual report last year, you would encountered a few non-detailed passages about changes coming to ESPN that would focus on “streamlining performance”, finding “greater efficiencies”, and “leveraging the platform.” The vagueness and the corporate jargon of the annual report did not provide an observer with any substantive analysis of why cost-cutting is afoot at ESPN.
To understand why the big personalities and 300 jobs are leaving ESPN, you should pay attention to two things: the audience size at ESPN, and the costs associated with producing content.
Since ESPN’s debut in 1979, the growth in viewership had generally been persistent, non-stop, and extreme. Between 1979 and 1981, ESPN went from nothing to 10 million households with the sports network. Between 1981 and 1997, ESPN’s growth was unrivaled in the media industry: it grew from 10 million households to 70 million households. The late 1990s seemed to be the point of saturation, but ESPN kept finding ways to push the needle forward. The growth had slowed, but it was still growth: the 70 million household count in 1997 grew to the 100 million mark by 2011 and 2012.
That was it. That was the high water mark for ESPN’s subscriber count based on current population levels. When you can’t get more people to buy your product, you then have to focus on your bargaining power–charging more for your product, and trying to make sure that your “moat” is so strong that people stick with it.
In the past three years, ESPN has made two important tactical decisions: (1) it decided that it wanted to start increasing the amount of money it charged for access to its network; and (2) it sought to acquire broadcasting rights to premium sports games so that it would attractive high-paying advertisers and remain an essential channel in the typical American household.
Specifically, ESPN began demanding $6.50 per month from cable companies in order to provide access to the channel as part of a cable package. As part of the negotiation process, it conceded that ESPN would only be mandated to be included in at least 80% of the cable packages instead of the previous required penetration rate of 90%.
Most likely, Disney did not expect to see cable companies roll out packages that excluded ESPN because they imagined that subscribers would not choose to buy a product that excluded their network. My guess is that Disney is taken aback at the number of consumers that have chosen lower cost cable options that exclude the ESPN network. In the past three years, the number of American households that receive ESPN has declined from 100 million to just a little bit above 92 million.
The higher subscription fees have been enough to make revenues higher in spite of the lower subscription count, but that’s not the entire picture: we also need to analyze the costs of producing content.
The real reason why Disney executives are adamant about cost-cutting at ESPN is because of the rapidly escalating costs of producing content. Just as baseball contracts experienced a new paradigm after Curt Flood challenged the legality of reserve clauses and paved the way for the creation of free agency when arbitrator Peter Seitz ruled that Andy Messersmith and Dave McNally could sign with any team they wanted, the world of rights fees for sporting events experienced a revolution when ESPN decided that it wanted to compete with Fox, CBS, and NBC to air prime-time games. This has also occurred during a time of increasing dedication of Americans to their sports teams.
Take a good look at how much more ESPN is paying for rights fees compared to previous deals. The old MLS soccer contract cost $8 million per year; ESPN is paying $75 million per year starting this year for a 838% increase. Last year, it doubled the amount it would pay to air SEC conference football games from $150 million to $300 million. It also airs the College Football Playoffs, paying almost quadrupled the old rate–it pays almost $600 million per year starting last year, compared to the old rate of $120 million per year.
But those escalation of rates are chump change compared to ESPN’s overpayment for Monday Night Football, which set a precedent for overpaying to broadcast NBA and MLB games. After paying $1.1 billion annually to broadcast Monday Night Football, ESPN agreed to a $1.9 billion per year deal that started last year. This was a 73% premium. The industry scuttlebutt suggested that ESPN offered $500 million more to the NFL for the MNF rights compared to the next closest bidder.
This, in turn, prompted MLB to demand more for rights to broadcast its games (like Sunday Night Baseball) and MLB began collecting $700 million per year from ESPN last year compared to $296 million under the previous deal.
But if had to pick on one deal that really put ESPN in a bind, you should look to the company’s contract to NBA games. It used to pay over $500 million to bring basketball to the masses, but starting next year, it will be paying just under $1.5 billion per year to air basketball games. The rate is nearly tripling. There is no way that the premium advertisers, combined with possibly enhanced subscriber interest in ESPN, will be enough to make that NBA deal worthwhile. That $1 billion escalation in fees has forced Disney to look at laying off employees caught as collateral damage to undo the ill effects of the NBA deal (and ESPN’s overpayment for broadcasting rights otherwise).
As for Grantland, it is almost inevitable that ESPN would shut it down. Ignore for a moment the personal politics of ESPN executives not wanting to continue something associated with Bill Simmons. The uncomfortable fact is that high-quality journalism does not make commercial sense in the post-internet world.
This isn’t something limited to ESPN giving detailed sports accounts. Back in 2002, the Wall Street Journal published 210 articles that were over 2,500 words in length. You could count on finding some piece of long-form journalism in the WSJ at least four days per week. Now, that figure is down to below 20. You’ll be lucky to find two long pieces per month. Dean Starkman of the Columbia Journalism Review performed this analysis.
Also, the kind of people that are interested in long-form journalism don’t click on as many ads (though they tend to belong to a higher income social demographic and attract advertisers willing to pay higher rates.) But the amount of profit generated after paying a high-quality journalist to conduct a real, honest-to-God investigation of a niche topic can’t keep with the ten-minute infotainment articles that go “Here’s what a Kardashian did / then someone tweeted this / someone else tweeted that / and this is how they responded / Aren’t you outraged, too?”.
This is why Berkshire Hathaway Vice Chairman Charlie Munger argued that you need something like a modern-day Medici family to step up and subsidize the production of investigative journalism. The connection between the production of in-depth content and higher profits has been frayed, and the alignment of public good and shareholder value is trending towards mutually exclusive. We may not like it, but ESPN makes a lot more money paying someone $18 per hour to write a four-hundred word “Lebron said this, and here is the social media reaction” compared to paying an actual journalist $40 per hour to conduct an exhaustive inquiry into a topic that turns into a three-thousand word article.
When a company cuts back, the natural follow-up question is this: Was this a necessary move that signals a long-term change in the economics of the industry? Regarding Grantland, the answer is yes. The commercial value of deep content is limited, and media outlets that include it are driven by a desire to serve the public good rather than satiate shareholders. Hence, most long-form content gets cut.
The layoffs and removal of big personalities, however, are not so much necessitated by a changing industry, but rather, the mismanagement of broadcast rights. If ESPN had been more disciplined in securing its current MLB, NFL, and NBA contracts–with the NBA in particular–it could have avoided these cuts. Now, ESPN may have overpaid because it felt necessary to go on the offensive after seeing a plateauing subscriber count, but this particular move was the result of bad decisionmaking within an industry rather than a massive shift of the industry.