May 10, 2012

In an article published a couple of days ago, Forbes writer Erik Kain suggested that HBO’s president, Eric Kessler, called internet streaming distribution a “temporary phenomenon,” and then he blamed HBO’s supposed incompetence for causing the extremely high rates of piracy for its original content. It was a very misleading and shallow article.

Who would believe that the president of HBO is so dense that he would make such an absurd comment? It’s so unbelievable that I went to the primary source, a 40 minute video interview with Mr. Kessler, which draws a fascinating picture of HBO’s business strategy. After listening to the entire interview twice, I could not pinpoint where Kessler actually said “temporary phenomenon.” He hinted at the opposite, in fact, and then he articulately rationalized HBO’s position from a business perspective. (He did mention that the depressed economy was leading some people to cancel cable television, but he expects and hopes they will resubscribe as conditions improve.)

I personally believe that HBO’s long term viability is extremely grim, but their current strategy seems very rational to me.

In the interview, Kessler talks about why moving to internet distribution would deal a fatal blow to HBO’s business. The engine that turns people into subscribers is not sustainable when HBO is not directly packaged with cable TV affiliates:

We benefit tremendously from the existing ecosystem. […] There are 60, 70, 80,000 customer service agents on the phone every day, and you know what they’re talking about? They’re talking about HBO. The affiliate covers that cost. The billing systems. That’s the affiliates. If you watch HBO 5 minutes a month or 24 hours a day, 7 days a week, that’s not a cost we have. In addition, we benefit tremendously from the fact that the cable operator bundles HBO into existing packages. So if they offer double-play or triple-play, you know, they say, get HBO free for three months. The ability to market and bundle with the affiliates is very beneficial to us. So it’s very beneficial to us to keep that transactional machinery going. What you don’t want to do is to pursue a distribution channel over here [ed: the internet], where you think, well, let’s go around the affiliate and we’ll get a couple hundred thousand subs. But the promotional, and packaging support we get over here [ed: the affiliate networks], which, by the way, is the foundation of our 30 million subs and enables us to get 10 million transactions, if that dissipates, and that shrinks, then we will lose a lot of subs over here. Because with 10 million transactions, you have to generate a lot of subs every single day. You can’t afford to have that machinery slow down. So we’ll gain a little over here, and we’ll lose a lot over here, and we think there will not be a net gain, there would be a net loss. So it’s really about economics and a business issue.

Whether you agree with HBO or not, it is extremely difficult to argue with this philosophy that is driving the company’s decisions. It’s a classic problem that all soon-to-be disrupted companies face, and it is one that is impossible to solve elegantly.

Next, Kessler talks in detail about the branding implications that moving to a streaming distribution model has for HBO, and what makes subscribers feel that HBO is worth paying for:

Let me talk about the streaming environment. … let me tell you how we view that. When a consumer is sitting on their couch, and they’re sitting there and they’re watching their 50" flatscreen TV, and they’re watching HBO, the way they evaluate HBO and determine whether this is a good value, the reference set, the comparative set for determining that, is the other networks that are coming on that flatscreen. They say to themselves, they think about the broadcast networks, the basic networks, and the other premium networks, and they say to themselves, is this entertainment experience, is it better? Is it different? Is it worth paying more money for? So they compare the HBO experience to the other networks. If the consumer is now sitting on that same couch, and they got the iPad in their hand, and they’re on HBO Go, the reference set changes. And it changes because the dominant distributors of television content and movies – certainly of television content – on that device is not the networks. The dominant distributors of that content are aggregators. It’s Hulu, Hulu Plus, Netflix, Amazon, Apple, all of which have very different business models. It could be an ad-supported model. Hulu Plus is an ad supported model that you subscribe to. Netflix is a standalone subscription service. Amazon is a free service, part of the shipping deal that you used to use to get hard goods. Apple is of course an EST service, we’re embedded.

The business model that drives the dominant players in internet streaming today–the players who have the most distribution power, and the ones that would be required as partners to fund HBO–simply is not compatible with the way HBO works as a brand and as a sustainable premium package service.

Basically, HBO has to differentiate at a further abstracted plane than the distribution aggregators, because it doesn’t have the existing business infrastructure that normal networks have. Kessler continues:

We look at that comparative set, and we ask ourselves, how do we differentiate? How are we different as the consumer evaluates HBO Go against the aggregators. And there’s a couple ways we’re different. First of all, those services offer quantity. You know, you go to Netflix or any others, and there are hundreds of thousands of pieces of content that you’re streaming. We will never compete in that ballpark. We don’t want to compete in that ballpark. What we compete on is quality. If you want HBO programming, the only place to stream it is through Go or through our affiliate portals. If you want to stream our theatrical movies, in the paid television window, again, only through us. The content on those services, it’s basically non-exclusive. So much of that content is available on each other’s sites. Our content, exclusive. It’s the only place you can get it. And we believe there is value in exclusivity.

Kessler then talks about how HBO wants to do more than just stream content to mobile devices and televisions in the future. They want to enhance the experience of watching television with devices like the iPad. Other networks can’t do that when they license their content, because then they don’t own the entire experience. This is similar, in some ways to Apple’s philosophy of marrying the hardware and software into a single experience. HBO wants to marry the distribution technology and the content to create a single experience.

Lastly, those services are aggregators. They’re licensing content. What we do … we are content creators. And we believe in order to continue to differentiate the service … there’s a tremendous opportunity to marry this platform, to marry HBO Go and this technology, with the content creation skills of our network.

The entire interview is worth watching if you want to understand the intricacies of how HBO’s business works and why Hulu is currently attempting to create its own content (with a business model that is so far unsustainable, by the way, unlike HBO, which is hugely profitable).

When a news organization like Forbes publishes linkbait like this it is bad for everyone. But it is especially bad for journalism, which is already in a questionable state. I expect better from Forbes, especially for business analysis. It’s not really HBO’s fault that Game of Thrones is pirated so much. It’s the fault of the entire ecosystem.

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