By Daniel Frankel

Pay-TV's first quarter earnings reports came and went with no definitive evidence that cord cutting is about to go viral among the American consuming populace.

Sure, by Leichtman Research Group's tally, it was an historically bad quarter for cable, satellite and IPTV operators, with the sector growing its collective customer base by only 10,000 subs, a record low for the typically robust Q1 period. But growth is still growth, and analysts remain conflicted as to whether full-on cord-cutting panic should start.

Nonetheless, the signs are troubling. In fact, an examination of cratering linear TV ratings leads to an inevitable conclusion that television's disrupted, on-demand future isn't just inevitable, it's already here. After all, if people are beginning to watch significantly less traditional television, and more Netflix (NASDAQ: NFLX), Hulu, Amazon Prime (NASDAQ: AMZN), etc., how long can it be before we see a significant direct impact on video subscriber bases?

"I think reduced viewing is a leading indicator of future cord-cutting," said Joel Espelien, senior analyst for The Diffusion Group.

For pay-TV operators, the implications are clear: They must ramp up next-generation platforms, on-demand program availability and multiscreen access soon, and these services have to hit their marks with consumers. Otherwise, those cord-cutting metrics could get much worse very soon.

Linear TV's collapse: the numbers

In October, media analyst Todd Juenger caused a stir when he suggested the 4 percent drop in total day Nielsen ratings experienced by broadcast and cable programmers last summer was directly related to usage of Netflix, Hulu and other subscription video on demand (SVOD) Internet platforms.

Now fast forward eight months. In the first quarter, linear ratings dropped 11 percent across networks, and programmers like Viacom and A+E Networks experienced dramatic 20 percent declines in total audience across channels. Juenger's hypothesis has now achieved broad acceptance.

"When we first stated our view that SVOD was directly responsible for most of the decline in conventional TV audiences, we did receive significant push back, both from investors and from some of the companies themselves," Juenger said. "It didn't surprise me, because the implications of that view are so profoundly bad for businesses who rely on TV advertising."

These days, Juenger has few doubters among his peers, who themselves predict that SVOD will continue to exact its toll on the linear landscape, which last year saw only the 55+ age group as the only demographic not to recede.

"The demographics are just relentless," Espelien noted. "Linear TV audience is aging, and younger generations simply do not relate to linear TV at all. It has totally lost its cultural relevance, and there is no getting that back.

As viewing habits change, cable industry suffers

Nowhere is the impact of SVOD being felt more than in national cable programming, which grew exponentially in the 1980s and 1990s, hand in hand with the flourishing proliferation of pay-TV services in the U.S. (See Bernstein Research chart below)

For example, by the end of the '80s there were nearly 53 million pay-TV households. Cable programming networks increased from 28 in 1980 to 79 by 1989. And that growth continued to the point where pay-TV penetrated around 100 million American homes, and every premium program guide had well over 200 channels.

But in 2014, total day viewing on national cable fell by 9 percent on Nielsen's critical C3 audience rating, almost three times the rate of decline for 2013. General entertainment and kids networks that air a lot of repeats--programming that can also be found in abundance on SVOD services--fared worst.

"Cornerstone shows like Law & Order, NCIS, The Big Bang Theory and movie nights are falling fast, with few new hit products immediately available," notes analyst Michael Nathanson. "As such, the cable network model is moving to riskier and more expensive original programming, which will likely come at the expense of profit margins," he added.

Viacom, which bundles such channels as MTV, BET, Spike TV, Nickelodeon and Comedy Central, is perhaps most illustrative of this downward trend. With Nickelodeon enduring 15 percent year-over-year audience declines in key metrics last year, the programming conglomerate announced a $785 million write-off--and half of that write-off covered the "abandonment" of repeats that were significantly devalued in an era in which youngsters now stream Nickelodeon reruns via iPad on Netflix, rather than watching them on cable.

As Scripps Networks Interactive chief revenue officer Steve Gigliotti recently noted, selling repeats to Netflix "sounded like a good idea at the time" to a lot of program industry executives. "But now there are some misgivings about it."

Indeed, as Juenger said, people haven't stopped watching Viacom and Scripps programming, "they're just watching the shows in different ways."

For their part, top executives at the major programming conglomerates see the challenge posed by declining audience ratings as one of audience tabulation. For example, NBCUniversal CEO Steve Burke recently told investors that as much as 70 percent of viewing for The Tonight Show Starring Jimmy Fallon comes after the initial linear airing, with clips of the show getting virally distributed on platforms like YouTube.

"I think there clearly is room for improvement in terms of measurement," Burke said. "Here you have one of the hottest shows on television, and 70 percent of the views are in an area that we don't get credit for. That's not going to last forever."



(Source: YouTube / NBCU)

Beyond pleading with Nielsen for better measurement tools, NBCU's response--as well as that of its peers--is to fight streaming with streaming. The conglomerate is quietly developing an SVOD service that would feature clips and highlights from comedy programs like The Tonight Show and Saturday Night Live.

If successful, of course, it would be yet one more competitor to the pay-TV business model.

Cable turns to VOD, TV Everywhere, Hulu to stem the tide

As Nathanson notes, "About five years ago, when Netflix showed up looking for streaming content with large checks in hand, many senior media executives gladly cashed those checks as they convinced themselves that Netflix was 'additive' to the ecosystem."

With audience ratings now shot, and TV ad revenue share beginning a slow shift to digital platforms, it remains to be seen if subscription gambits like CBS All Access and NBC's aforementioned comedy platform will bear fruit.

Certainly, the launch of these OTT platforms isn't being viewed as additive to the pay-TV ecosystem anymore. Shortly after HBO and CBS introduced the first major SVOD services launched by programmers, Burke--seemingly speaking more for his parent company, Comcast--said: "They have to be very careful with cannibalization."

"I don't think distributing directly to consumers via the Internet is an easy thing to do," he added.

In a sense, pay-TV has been left holding the bag for programmers' decision to so aggressively proliferate their content to SVOD. Reacting to the resulting consumer demand for ubiquitous on-demand content, operators for years fixated on TV Everywhere--the cumbersome multiscreen initiative that hasn't beaten SVOD. These days, however, pay-TV operators are now joining Netflix and Hulu, integrating these services into their set-top software via revenue sharing deals.

Just within the last month, for example, Hulu has announced distribution agreements through Cablevision (NYSE: CVC), Suddenlink Communications, Mediacom and several other smaller cable operators.

"We have complementary catalogs with MVPDs," said Hulu distribution chief Tim Connolly at INTX in May. "They're focused on the most recent episodes, and our content is mostly back catalog and archival seasons. And presenting a holistic environment is something an operator like Cablevision wants."

Operators like Comcast (NASDAQ: CMCSA), meanwhile, are ramping up availability of VOD, with the No. 1 pay-TV operator recently revealing that shows can get as much as a 30 percent viewership lift over their C3 rating once cable VOD viewing is factored in.

And of course, operators including Comcast have invested in advanced cloud-based user interfaces, which integrate innovative features like voice-activated remote control into the TV-watching experience. There are also the so-called skinny bundles from operators like Verizon FIOS (NYSE: VZ), which are attempting to give consumers a bit more choice in the matter of what channels they get and don't get.

But it remains to be seen if any of these industry moves will turn back the coming tide of cord cutting.

As for the ratings, The Diffusion Group's Espelien thinks they'll get a lot worse before they get better.

"I do think it's all downhill from here," he said.