November 20, 2000

STEEP GROWTH

JEAN GRILLO

FORECAST for Digital CABLE CONTINUED GROWTH DEPENDS ON SUCCESSFUL MARKETING TO MSOs AND SUBSCRIBERS

Digital cable, when combined with newly invigorated premium pay multiplexes, could offer cable operators a powerful three-way win: a new revenue stream that reduces pay service churn while stemming or even reversing the exodus to DBS.

Offers of hitting such a trifecta play a large role in how HBO, Showtime and Starz Encore now market themselves to MSO digital players. The MSOs are eagerly listening, even agreeing on several key arguments. As always between buyer and seller, however, differing issues remain.

Make no mistake. The digital numbers are incredible. Russell Sapienza, partner, PricewaterhouseCoopers (PWC) Entertainment and Media Practice, sees "steep growth" for premium-based subscribers within digital cable households. Such growth has enormous financial ramifications.

PWC reports there were 3.6 million pay subscribers in 3.3 million cable homes in 1999. Those customers produced $302 million in revenue for cable operators. The consultancy sees those figures growing to 20 million customers spending $17 billion by 2002.

Equally significant for MSOs, Sapienza adds, "As digital cable gains penetration, DBS growth may slow." PWC, in its recent data book, Global Entertainment and Media Outlook: 2000-2004, predicts digital cable subscribers will be more than 10 times as large in 2004 than now.

Among the three major premium services, they're pitching both acquisition and reduced churn in meetings with MSOs, although some place more emphasis on the former. As a group, however, all of them see digital as an ace in the hole.

"There's a higher likelihood that our cable distributor, and others, will offer premium channels and put more emphasis on them in a digital environment," says Jeff Wade, EVP/sales & affiliate marketing, Showtime. "And we feel multi-channel premium services really are the driving engine for their set-top boxes and digital platforms."

"Digital offers us a way to package specific (programming) groups, while providing consumers more opportunity, more convenience and enhancing satisfaction," says Eric Kessler, EVP-marketing, Home Box Office, who adds, "The beauty for us in digital is it enables us to reach the underserved: Hispanic, younger viewers, families."

"The cable industry is going through such a transformation," adds Michael Hale, SVP-marketing, Starz Encore Group. "MSOs are now selling video, networks, telephone service. All bundled packages. The question for cable ops is who can get and keep that digital box into the home, and who can make more incremental cash flow? We're giving cable a tool to drive digital."

HBO is setting its digital-only sights on HBO The Works, launched in 1998 and containing family fare, comedy, action and adventure channels, as well as a Comedy zone, launched in 1999, and the new HBO Latino, which debuts this month.

Showtime, along with The Movie Channel, Sundance and Flix, offers the digital-only multiplexes, Showtime Extreme, an action/adventure channel launched in March 1998, and Showtime Beyond, offering sci-fi, horror and fantasy programming, launched in September. Together, Showtime and HBO can offer digital cable subscribers access to six, seven, even eight extensions of their premium pay offerings.

Starz Encore, in its MSO pitch, both recognizes the power of those long-standing HBO and Showtime brands while openly selling against those networks..

Hale points out that his Starz! premium movie channel, with 10.8 million subscribers, combined with the re-launched "New" Encore, showing first-run and hit movies, at 14.4 million homes, are second only to HBO/Cinemax at 36 million homes. Showtime says its four brands combined represent 24.2 million subscribers. Competitors say those comparisions are misleading, however, because Starz! and Encore are sold in many tier packages, while HBO and Showtime are primarily premium networks.

"HBO and Showtime are still thinking analog in a digital world," Hale says.

In Hale's view, the main reason cable subscribers switched to DBS was to get more movies, rather than additional unique programming. He argues that the "Wow" factor Starz Encore enjoys rests with the 67 million units of largely movie-driven fare that makes up Starz Encore versus the 35 million units in HBO/ Cinemax and 21 million units in Showtime/TMC.

"More movies are the main reason 60% to 70% percent of customers to Direct TV and EchoStar are coming from cable," Hale says. "DBS is growing by 250,000 to 300,000 per month. We're platform neutral, but what we're saying to cable is we're giving them a (retention/acquisition) tool."

Hale is pitching MSOs the Starz Encore Super Pak, launched in March, which consist of 12 distinct genre movie channels for $12.

"This is not just tonnage," Hale says. "It's new, better, different product (presented) in an organized way."

Showtime and HBO, however, while offering plexes of their own, insist original programming provides the critical kick.

"Viewers want incremental viewing options, something that's exclusive to them," says Wade. "Premium pay packages on digital offer consumers added value with no extra cost."

Both Showtime and HBO (each with high-definition feeds to heighten the allure) champion high-profile original fare. Ware describes Queer as Folk, Showtime's newest original series, debuting Dec. 3, as "The most talked about, most controversial program ever."

Showtime's boxing card, Ware says, is just as good as HBO's.

Meanwhile, HBO/Cinemax is placing a $100 million chip on the programming roulette wheel, convinced stand-out specials and series will keep pay customers from straying.

"We are fighting to get consumer attention from broadcast and the Internet," says Kessler. "We are clearly outspending everyone, and we are very aggressive in our advertising and promotion budget."

HBO, he adds, dropped $10 million in pushing its hit series, The Sopranos, alone.

This year, HBO's digital packages will include a new 10-hour mini-series, Brand of Brothers, created for HBO by Tom Hanks and Steven Spielberg.

"The enhanced value perception of the HBO brand is the difference in marketing digital to MSOs over marketing analog," Kessler adds. "The message we communicate is original programming and original movies. That is where we spend our money (with) consumers. Plexes just add additional choice."

Hale, however, insists programming alone isn't enough of an upsell to move non-digital cable homes, or pay TV resisters, toward handing over additional monthly fees, thus keeping all those add-on dollars away from cable's bottom line. DBS, too, he notes, offers additional choice, better picture, better sound as well.

Hale urges MSOs to reconsider the passion for movies that first drove households to cable, with that passion underscored by low cost and lots of film choices.

Maybe so, several cable MSO marketing executives reply. But they have several caveats of their own to add before they accept the premium channel pitch.

First, the good news for the premium networks. According to AT&T Broadband, Cox Communications, Comcast and Charter Communications marketing executives, digital cable homes with pay channels do indeed churn over less.

Says Doug Seserman, SVP-marketing, AT&T, "We have hard numbers showing disconnects and downgrades are less in digital homes, with the 7% to 9% monthly pay churn in analog homes dropping to 5% in digital."

Adds Lynne Elander, VP-video project management, Cox Communications, "We've seen 10% less premium service churn over the last 18 months in digital homes with eight screens than analog homes with one or two screens."

"When we upgrade customers to digital, we find their satisfaction rating improves," says Mary Pat Blake, Charter's SVP-marketing & programming, "and the earliest customers to take digital were the homes that had pay."

Charter, with 1.2 million out of its 7.5 mil-lion homes digitally ready, doesn't have exact numbers, but Blakes notes that "90% of our digital homes have pay churn rates that are lower."

AT&T says 90% of its 16 million cable homes are "serviceable for digital," with 2.2 million adding to the tier, a figure Seserman says will be "more than 2.5 million" by the end of the year.

According to Elander, 65% of Cox's 6.2 million cable homes are digital-ready, and she expects the MSO to have 700,000 digital subscribers by the end of the third quarter.

Of Charter's 6.3 million homes, 70% will have digital in front of them by year's-end.

Every one of these MSO marketers see adding digital platforms in their systems as stemming the flow of cable customers to DBS. The caveat, is none are ready to give premium pay plexes all the credit.

"We first launched digital in October of '97, and we've seen DBS growth in those markets drastically slowed," says Elander. "but is that specifically because of premium services? No. Do they play a role? Absolutely. But Cox has also been aggressive in that we offer more screens then DBS. With HBO, for example, our digital package has eight screens, DBS has six or seven."

While Starz Encore's Super Pak is gaining shelf-space within more and more MSO shops, the cost-value argument isn't always the reason.

"I applaud what Encore is doing with its $50 million national campaign," says Elander, "but they are promoting a price-point system that isn't going to work with us. In fact, I don't know of any system selling those 12 channels for $12."

Cox, she adds, is offering six of the Super Pak at $10. "A manufacturer's suggested retail price is not one supported by cable strategy," she says.

Says Andy Addis, VP-marketing and new products for Comcast, "Price-points are somewhat irrelevant to Comcast since we've launched Digital Plus."

This 33-channel platform debuted in August and features 12 of Encore's thematic offerings, along with Showtime Flix, among others, all for $14.95. HBO is offered on its own discrete tier.

"Encore subscribers were more limited in Comcast systems," Addis says, although he adds he offered HBO room on Comcast Plus as well, "but it didn't make sense to them."

What these MSO marketing executives want from the networks are partnerships, financial help and more interest in pushing digital cable service than in just pushing their own premium channel numbers.

"All the pay services are very large supporters of DBS," Elander says. "I see HBO as an arms merchant. They'll sell to anyone. I know they've got their businesses to run, but I think it is in their own self-interest to help cable drive digital. By helping Cox push VOD, for example, they give me an outstanding way to get non-pay customers to sample pay services."

Ditto for Cox's high-speed and telephone efforts, Blake says.

"I'm looking for a partnership to drive our digital business into the home," she says. "but the premium channels must join Charter's marketing strategies. We have particular ways we like to promote their services, and we need them to join in that and support us financially, with research, with ideas and perspectives."

"In the past, pay services provided us with promotions that just needed MSOs to insert their logos," Seserman adds. "The focus was on the pay service brand, not the MSO. Now cable is one of many premium service providers, and we need to differentiate ourselves."

As they do in the package goods, retail and consumer electronics world, Seserman is asking for more customized marketing from HBO, Showtime and Encore.

"We need them to have an AT&T plan, a Cox Plan, a Comcast plan," he says.

These MSOs have support from analysts who track cable and the consumer.

Joe Schramm, president and founder of Schramm Telemedia, agrees customized marketing is crucial but insists cable itself doesn't recognize how its own consumer is changing.

"In the 1980s, most households included parents and children," Schramm says. "But in the 1990s we're seeing households split into either one or two adults with no children or families. The something for everything approach cable used in the past in marketing pay won't work. What they need to pitch is something just for you."

Adds Glen Friedman, president, Ideas and Solutions, "I don't think cable operators can depend just on the premium services to woo customers back from DBS. All those plexes might help level the playing field somewhat, but it's not enough. The cable op has to do more: VOD, telephone, data bundling."

Seserman says AT&T is aware of changing cable demographics and needs.

"We now have a much more sophisticated database," he says. "We are absolutely aware of the family versus empty nester argument that Schramm discusses, and we are constantly updating our data to reflect that."

One of Schramm's key points about cable's current divide down the road is that while two-person and several-person households will remain distinct, each of their individual numbers will increase over the next decade, as boomers become seniors living alone and rising birthrates among Hispanics and Asians create not only larger cable homes with children, but larger numbers of multi-lingual homes.

"We certainly look at who else is in the home," says Comcast's Blake. "We have certain targets due to the geodemographic makeup. In some markets, a single dweller may be more important to us as a senior citizen or college student living alone."

Blake insists Charter is finding lots of DBS customers who want to come back to cable even without the lure of all those premium multiplexes.

"We don't have to do anything beyond aggressively marketing cable," she says, adding, "The jury is still out on whether or not premium plexes will hold digital pay customers over a long period of time."

Such thinking should give HBO, Showtime and Encore pause, except that these cable retailers know a crowd pleaser when they see it. They don't want outside brands trying to dictate in-store operations.

Elander sees all these powerhouse brands as much like breakfast foods.

"I see HBO as Kellogg's, Showtime as General Mills, Starz Encore as Post," she says. "Certainly they would love more shelf space, and each of them would love if they were our entire cereal line. But each of these brands speaks to a different consumer. What I look for is an opportunity for all to co-exist but with help through their own terrific national promotional campaigns which build their (individual) brands."