Author
Joel Espelien
Date
December 5, 2017

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TDG spoke with industry sources last week that confirmed Amazon is still working to launch a free skinny bundle of live TV channels as part of its Amazon Prime membership package in the first half of 2018. We’ve heard far too many rumors on the subject to jump at all of them, but these sources were particularly credible and seemed to contradict recent news that Amazon had ‘ditched’ these efforts.

There are many skinny bundles (i.e., vMVPD services) already on the market. Does it matter if Amazon enters the fray? In a word, yes. So what makes Amazon different and what would the rumored service mean for the future of TV?

A few thoughts.

1. Prime Feels Like Free
The core value proposition of Amazon Prime remains free 2-day shipping. For someone who orders habitually from the ecommerce giant, this is a very valuable benefit that by itself justifies the $99/year membership price. As a result, everything else that comes with Prime (e.g., the VOD service, the music, access to e-books, etc.) feels like it’s free. This is the essence of the Prime value proposition and you can be sure that Amazon knows it.

Amazon earns billions of dollars each year from Prime memberships, meaning it could recover some of the costs of a skinny bundle by carving out a share of the advertising inventory for itself. Jeff Bezos is not running this as a philanthropic endeavor, though in the mind of the customers the lack of a separate monthly bill for the base level Amazon TV service will create the perception that it is free.

This can only be tremendously disruptive to existing vMVPD services. Bundled packages of live TV channels has remained one of the few services that is available solely in a paid format. Even the now-defunct Aereo charged $8/month for access to streaming channels! TDG research has consistently shown that value is the biggest driver pushing consumers from higher-priced legacy pay-TV services towards lower-priced vMVPD services. It’s tough to get greater value than free, so one would expect such a service to (1) attract a lot of attention and awareness by consumers, especially Amazon Prime members; and (2) cannibalize at least some portion of the market that might have signed up for a different vMVPD service. Remember, unlike SVOD services, consumers only need or want a single MVPD or vMVPD service, so losing a subscriber to Amazon potentially means losing them completely.

2. Amazon Doesn’t Care About Margins Or Short-Run Profitability When Building A Business
Pay-TV has traditionally been a highly profitable business. Gross margins for traditional MVPDs used to be in the 50% range. Operating margins depended on scale, but the majority of MVPDs were (and are) highly profitable. There’s a reason cable companies have long been grouped with electric utilities and telcos by investors who value (large) dividends. The rise of vMVPDs is already highly disruptive to that model. The ‘skinny’ in skinny bundles is not just referencing the number of channels. It also refers to the profit margins on such services. Today’s vMVPD services operate on single-digit margins, at best. In reality, if all marketing and development costs are fully taken into account, most if not all vMVPDs have yet to see a profit (then again, most are still in startup mode so this is to be expected).

Amazon takes this margin compression to a whole other level. The current debate regarding the “will they or won’t they” of an Amazon service centers mainly on whether Amazon can make any money from such a service. Depending on its ability to squeeze unprecedented price concessions from broadcasters (on retransmission fees) and legacy channel providers (on carriage fees), the likelihood is that Amazon would almost certainly lose money on a free service if viewed as a standalone P&L. Advertising only gets you so far. There’s a reason no one has ever offered a free-with-ads pay-TV service before: the economics don’t work! However, in the case of Amazon, this very narrow view misses the point.

In my view, the question is not whether Amazon is willing to lose money to include a skinny TV bundle as part of Prime, but how much they are willing to lose and to what end. As long as the losses are relatively modest (by Amazon standards), and there is a path to eventual profitability via upselling additional tiers of channels (i.e., a paid bundle) and profitable premium channels (like HBO and Showtime) on top of said skinny bundle, Amazon may well do it, which should give existing players real pause about the future of this space.

Amazon has shown a willingness to lose money for exceedingly long periods of time in order to build scale and take market share. The pay-TV market has never seen a competitor like that, which brings us to our last point.

3. Amazon Could Eventually Make A Lot Of Money From TV
Amazon is all about scale. Every business at which Amazon has succeeded depends first and foremost on scale. Amazon Prime itself is a perfect case. At small scale, Prime is a horrible, money-losing business. At large scale, it’s one of the greatest money machines in the entire consumer economy.

Pay-TV could be the same. At small scale, giving away a skinny bundle is almost certainly a money loser. Think about what happens, however, if Amazon could use ‘free’ to capture a really large number of households. Prime customers actually start cancelling their existing MVPD or vMVPD services and rely instead on Amazon for basic TV. (Of course, people could still subscribe to Netflix or other SVOD services as well, just as we see today).

As mentioned above, this could potentially create a massive market for Amazon to upsell additional TV channels and packages on top of the free tier. It would also create a much larger viewing audience on Amazon Instant Video (or whatever video apps they end up creating around this) that could be monetized via advertising. (Those skeptical that this is a business should check out how well Roku is doing at this).

I’m not saying any of this would be easy, but is most certainly can be done. And giving away basic pay-TV for ‘free’ to Prime members seems like a pretty compelling, and awfully Amazonian, way to go about it. Realistically, Amazon may or may not be able to get this done in the next few quarters. Apple’s inability to lay stakes in this space has shown us that legacy TV providers are tough customers at the negotiating table, and unlikely to (easily) give away the store to Amazon either. The threat, however, is very real — much more so than Apple entering the market.

Conclusion
Pay-TV has always been a money-making industry. No one (and I do mean no one) has ever intentionally lost money providing ‘basic cable’ to the American public. Amazon is a totally different animal. The folks in Seattle are crazy like a fox in terms of being ready, willing, and able to lose money in the short run in order to capture very large markets in the long run.

Could pay-TV be next? Don’t bet against it.

Stick with TDG and stay ahead of the curve.

Joel Espelien is a Senior Advisor for TDG and serves as an advisor and Board Member to the video ecosystem and technology companies. He lives near Seattle, WA.

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