ESPN layoffs signal decline of cable industry

The moves that forced ESPN’s cuts
Media executives point to rights fees, loss of subscribers
By John Ourand, Staff Writer
Published October 26, 2015, Page 1

As the names of the roughly 300 laid-off ESPN employees leaked though the sports industry at the end of last week, many longtime executives reacted with a sense of disbelief.

These weren’t household names like Bill Simmons or Keith Olbermann, who left earlier in the year. In fact, none of ESPN’s on-air talent were part of the cuts. Rather, they were friends and colleagues. There were the producers who spent their entire career on the ESPN campus and executives who are raising families in Bristol, Conn. — hardly a hotbed for sports media.

The cuts sent shock waves through the sports and media industries, incredulous that a company seemingly rife with cash would have to lay off so many good people. This was not a case of cutting fat, ESPN insiders say. Many capable executives and talented producers were shown the door last week.

The moves continued a troubled period for the sports media giant that started when Disney CEO Bob Iger told CNBC that “the business model may face some challenges over the next few years.” His remarks led to a sell-off of media stocks during the summer.
Average annual value
NFL $1.1 billion $1.9 billion +$800 million (+73%) 2014
NBA $575 million $1.4 billion +$825 million (+143%) 2016
MLB $296 million $700 million +$404 million (+136%) 2014
College Football Playoff $123.8 million $608.3 million +$484.5 million (+391%) 2014*
SEC $150 million $300 million +$150 million (+100%) 2014
ACC $155 million $240 million +$85 million (+55%) 2013
Rose Bowl $37.5 million $80 million +$42.5 million (+113%) 2014*
MLS $8 million $75 million +$67 million (+838%) 2015
Additional deals, since 2013
– U.S. Open: 11-year, $825 million deal through 2025
– American Athletic Conference: 7-year, $130 million deal through 2019-20
– Mid-American Conference: 13-year extension valued at more than $100 million through 2026-27
– Allstate Sugar Bowl: 12-year, $80 million deal through 2026 game
– Little League Baseball: 8-year, $60 million deal through 2022
– Missouri Valley Conference: Nine-year extension through 2023-24
– Atlantic 10 Conference: Nine-year extension through 2021-22
– Gator Bowl: Six-year deal through 2019 game
* For January 2015 games
Compiled by David Broughton
Sources: Resource Guide Live, SportsBusiness Journal archives

SportsBusiness Journal talked to more than a dozen senior executives — both inside and outside of Bristol — about how ESPN got to this point. All seemed surprised at the severity of last week’s cuts. None wanted to speak on the record because of the sensitivities associated with the layoffs.

All the contacts pointed to a combination of skyrocketing rights fees and deep distribution cuts that put ESPN in the position where it had to shed about 4 percent of the company’s workforce.

“The cost of goods is going up and sales are going down,” one longtime industry executive observed. “That’s not a good trend.”

ESPN remains one of the most powerful entities in sports. It’s still in 92 million homes and makes a whopping $6.50 per subscriber per month. And it has long-term deals in place with most of the country’s biggest sports leagues. ESPN President John Skipper spent Wednesday afternoon walking ESPN’s campus, projecting an air of confidence during one of the company’s darkest days.

“These changes are part of a broad strategy to ensure we’re in position to make the most of new opportunities to build the future of ESPN,” Skipper wrote in a memo that was distributed on the company’s website. “I realize this process will be difficult — for everyone — but we believe the steps we are taking will ultimately create important competitive advantages for our business over the long term.”

But last week’s layoffs offered the clearest sign yet that all is not well for the Worldwide Leader in Sports.

Many past and present employees place most of the blame for the layoffs on the company’s huge NFL, MLB and NBA rights deals. The most frequent criticism heard last week dealt with the NFL contract, which is worth a whopping $1.9 billion per year — $800 million more than the NFL’s next biggest deal. Second-guessers believe ESPN had the leverage to cut a better deal and question whether another media company was within $500 million of ESPN’s offer. There aren’t many other networks that could afford to pay close to $2 billion per year for the NFL’s least competitive package.

“It’s been a total mismanagement of rights fees, starting with the NFL renewal,” said one former employee. “We overpaid significantly when it did not need to be that way, and it set the template to overpay for MLB and the NBA.”

ESPN doubled its annual payment for MLB to an average $700 million per year — a deal that gives ESPN just one playoff game per year. And next year, ESPN’s NBA deal takes effect. That’s the one that will see its average annual payout triple in cost to an average of $1.4 billion per year.

“I realize this process will be difficult — for everyone — but we believe the steps we are taking will ultimately create important competitive advantages.”
John Skipper
ESPN president, in memo on company’s website
“You can’t keep spending on rights at high levels when the business model and fundamentals have changed,” another former ESPN employee said.

The sports rights market at the time, however, was crowded, with NBC Sports Network launching in 2012 and Fox Sports 1 launching in the summer of 2013. These new TV channels needed live rights, and their bids caused right fees to escalate to stratospheric levels.

ESPN was the biggest and most powerful of all the sports networks, and its executives thought they had the budget to pay for these thanks to a license fee that is multiples higher than any other network. Sources said that ESPN created its budgets by basing its affiliate revenue on pay-TV subscribers remaining flat.

That, of course, hasn’t happened.

ESPN’s business model — the dual revenue streams of advertising revenue and affiliate fees — always has been its strength. It still is. But that model has had some challenges, mainly due to a decision ESPN made several years ago that has come back to hurt it. ESPN had several cable carriage renewals in 2012, including big ones with distributors Comcast, Cablevision and Cox.

At the time, ESPN wanted to increase the license fee distributors pay it to $6 per subscriber per month. So its executives cut deals that made sure that ESPN and ESPN2 would be on the highest-penetrated tiers of service — expanded basic. At the same time, ESPN lowered penetration benchmark levels from more than 90 percent of all subscribers to a number closer to 80 percent.

“That’s part of every cable negotiation I’ve done,” said one industry executive. “If you want to negotiate a higher rate, you have to have more flexibility on penetration.”

Over the ensuing few years, cable operators discovered the low-cost, skinny bundles and started marketing them without ESPN. Expanded basic still is the most popular tier, but the mini-tiers without ESPN have been gaining traction. As a result, ESPN wound up with a rate that was higher than they thought they would get. But they left themselves more vulnerable to subscriber losses than other cable networks.

ESPN’s subscriber losses, which have seen it lose nearly 8.5 million homes in the last 4 1/2 years, according to Nielsen estimates, or down about 8 percent, are at a rate that is declining faster than the rest of the industry.

“It’s not cord cutting; it’s cord shaving,” said one executive familiar with ESPN’s strategy. “ESPN is losing subscribers at a faster rate than others.”

In retrospect, one of the first signs that ESPN’s pockets are not bottomless came in the summer of 2013. That was when Skipper told NASCAR’s Brian France not to expect a bid for the sport’s next round of media rights. At the time, the thought that ESPN would turn down a chance to amass sports rights seemed farfetched, at best. Just two years earlier, ESPN broke the bank with the NFL. One year earlier, it doubled its average annual payout to MLB. And the following year, ESPN did its NBA rights deal.

Several sources said that Skipper told his longtime racing partner that he would not go public with his decision so that it would not hurt NASCAR’s bargaining position with other networks.

NASCAR wasn’t the only property ESPN gave up. In the ensuing year, it lost properties like the British Open to NBC, the U.S. Open golf tournament to Fox and the FIFA World Cup to Fox. ESPN did not even submit a bid for the English Premier League’s soccer rights or the NHRA.