In part one of this two-part series, we reviewed HBO’s present day dominance, as well as the reasons why the company will need to change and grow if it’s to extend its reign through the next decade. Here, we detail exactly which changes the company needs to make, why they won’t require the network to alter its identity, and how the company was addressing these changes long before it was acquired by AT&T.
#1 – Scaling Original Output
The argument that HBO can’t substantially increase its output while maintaining its quality discounts the company’s success to date and ignores precedent. HBO has been steadily increasing its volume of original series since the premiere of Oz in 1997, and few would argue quality has suffered. And though the network was responsible for nearly 25% of all Outstanding Drama and Outstanding Comedy Series nominations at the Primetime Emmys since 2013, the network’s domination would have been even greater were it not for the financial constraints imposed by its former parent company, Time Warner. Despite generating more than $1.5B in profits on $4.5B in revenue in 2011, for example, “financial circumstances” forced HBO to pass on House of Cards (an eventual Netflix Original which was nominated for Outstanding Drama Series at the Emmys in each of its five seasons). Similarly, the company told REDEF that it lost out on Glow (another Netflix Original that received an Outstanding Drama Series nomination at the Emmys) because it couldn’t afford the series order in 2016, only a pilot (despite $1.9B in profits on $5.9B in revenue).
Furthermore, HBO has a reputation for delaying many of its original series for purely budgetary reasons (e.g. fiscal year timing, waiting until older shows had aired their final seasons, etc.). Were these financial shackles eased, the network would be able to significantly ramp its original output simply by putting more series into concurrent production – no bar lowering is required. HBO’s status as the “preferred network” for many top creators also ensures that quality projects will always be available. And notably, HBO’s total output has barely grown over the past decade even as the industry benefited from an unprecedented influx of talent from feature films and abroad. As HBO CEO Richard Plepler told his team in June, what he wants from AT&T is to “never be in a position that we have to say no to what we want to say yes to. And we have had to say no to what we [wanted] to say yes to.” This is very different from saying yes to everything.
HBO’s bigger challenge to scaling is therefore not whether it can, but when. Most shows today take at least two years from greenlight to air-date. Both of HBO’s biggest shows, Game of Thrones and Westworld, took four. In addition, HBO is known to be the slowest network when it comes to development time, as well as the most selective. In recent years, HBO has produced and passed on pilots such as The Corrections (based on the Jonathan Franzen novel and starring Maggie Gyllenhaal, Ewan McGregor, Chris Cooper and Greta Gerwig) and Open (“a multi-character exploration of the complex, ever-evolving landscape of sexuality, monogamy and intimacy that was written and directed by Ryan Murphy), among others. HBO’s process drives quality, but it also makes it hard to quickly grow output. That said, the network’s unprecedented number of greenlights in both 2017 and 2018 suggests that HBO’s leadership anticipated that AT&T (or any other Time Warner buyers) would want to increase the network’s programming volumes. As such, HBO is likely 12-18 months into this ramp-up period already. And crucially, HBO’s Pay-1 movies won’t begin leaving the service until 2022, which provides more than enough time to substantially grow output under existing processes and standards.
In the short-term, HBO would also be able to scale its originals by “acquiring” them from third-party studios (as Netflix and Hulu did with the Emmy hits The Crown and Handmaid’s Tale), or to further scale co-licensing (which is how HBO secured The Young Pope and Amazon has Catastrophe). While these models still afford HBO the ability to influence creative, the company would have less control than it’s used to (and potentially none with some co-licenses). That said, The Young Pope (led by Sky and Canal+) showed this can be done without sacrificing quality or muddying the network’s brand, and most would say The Crown (which comes from Sony and has garnered Outstanding Drama Series nominations in each of its two seasons to date) would have met HBO’s quality thresholds. However, acquiring originals means paying 25-55% more per original series. For example, The Crown has an estimated $6.5MM per episode production budget, but Netflix pays Sony $10MM (who nets the difference as profit). As a result, a doubling of HBO’s budget wouldn’t necessarily double output. Co-licensing has a lower total cost, but that’s in exchange for fewer rights (e.g. no UK, no UK nor Germany, etc.), which affects the company’s global offering. There are no free lunches.
#2 – Diversifying Original Output (but Not Branding)
To grow its subscriber base, HBO will need to expand into additional content categories and pursue additional customer segments (notably, HBO is in roughly 33% of US homes versus Netflix’s 50%). This idea is particularly concerning to HBO’s fans today. However, the belief that this would be an existential threat to the network’s programming quality or development culture means one has misunderstood its identity. HBO is already a broad tent. We see this in its blockbuster Pay-1 deals (which brings titles such as Batman vs. Superman and The Fast & The Furious), as well as originals such as Ballers and True Blood, not to mention mega-hits like Game of Thrones. Not everything at HBO is The Wire, nor would the network be so successful if everything it made was. HBO’s business is based on outstanding programming, not a specific style or demographic.
It is true that HBO’s subscribers are relatively homogeneous (i.e. primarily urban, coastal households), as is the network’s programming style. However, this has a lot to do with the economic confines of the pay-TV ecosystem. There are only so many households willing (or able) to add three premium cable channels (at $30 per month) atop a $100 monthly pay-TV subscription that already includes 200+ channels. Offering a $15 à la carte, monthly subscription targeting those without pay-TV therefore allows the network to substantially grow its realizable customer base. HBO’s constrained original programming budget is also to blame for the network’s homogeneity. If you can only produce a dozen series per year, it’s better to repeatedly target similar viewers than to try to make only a few a year for each segment. And crucially, HBO-grade, event TV exists across all categories – Amazon’s The Grand Tour is a good example of a title in the unscripted category, as is ESPN’s 30-for-30 series in sports docu-series and ABC’s Black-ish in the single-cam sitcom model.
In addition, HBO will need to diversify its original content offering if it’s to retain its current subscribers through the next decade. Today, 40% of the network’s viewers watch only HBO’s licensed films (somehow, they don’t even watch Game of Thrones). However, the majority of this film content is likely to be lost by 2021 and 2022. And it follows that replacing these titles with more Veeps, True Detectives and Westworlds won’t meet the content needs of these film-only viewers.
To HBO’s credit, the network has also been growing its demographic, tonal and genre variety for several years. This includes titles such as Insecure, Random Acts of Flyness, Wynatt Cenac’s Problem Areas, Sesame Street, Vice News Tonight and Last Week Tonight with John Oliver – none of which look like the HBO of a decade ago.
But TV isn’t enough. HBO will also need to invest in higher-budget, less awards-focused original films. This doesn’t mean producing critically derided films such as Bright, but the network needs to move beyond The Immortal Life of Henrietta Lacks, Paterno and Recount. Netflix’s forthcoming $140MM film The Irishmen, which is directed by Martin Scorsese and stars Robert De Niro, may end up being a good example. And unlike Netflix/Amazon/Apple/Showtime, HBO can benefit from its sister-company relationship with one of the world’s largest film studios: Warner Bros. As a result, the network can more easily and more quickly build out a higher-budget original movies offering – and leverage Warner Bros. existing development pipeline and talent deals to ensure that these films meet HBO’s quality threshold from day one.
#3 – Cannibalizing the Best of WarnerMedia
WarnerMedia boasts one of the largest content catalogs on the planet. However, only a portion of this library has historically gone to HBO. This needs to change if AT&T wants HBO to continue to grow. In addition to its Pay-1 Warner Bros. deal, HBO should have automatic access to the entire Warner Bros. back catalog (The Dark Knight hit Netflix in August of 2018). Similarly, Turner (another WarnerMedia entity) currently operates its own film SVOD service, FilmStruck, which offers a sizable catalog of films for $7 a month, plus much of the prestigious Criterion Collection for another $3. Earlier this year, Time Warner folded Warner Bros.’ own SVOD film service, Warner Archive, into FilmStruck. The company’s next move should be to fold FilmStruck into HBO. This may eliminate an incremental revenue opportunity, but the financial impact on HBO’s pricing power, retention and acquisition likely would be greater (and would help to offset the aforementioned Pay-1 movies problem). And in contrast to the cable era, today’s competitive dynamics don’t reward media companies for operating handfuls of disparate video networks. In fact, the opposite is true thanks to the high acquisition costs and customer churn involved in operating unbundled monthly subscriptions.
Fortunately, WarnerMedia CEO John Stankey seems similarly minded. In June 2018, he told HBO employees there would likely be only a few viable D2C platforms over the long run: “It’s not going to be 10, probably won’t be two. Now is it eight, six or four? I don’t know, but if it’s four we need to be one of the four.” He added; “I don’t think you can be one of those select number of platforms that have a relationship with a customer without taking full use of your arsenal and capabilities.” HBO is AT&T/WarnerMedia’s best chance at being one of the eight, six or four major platforms. It needs to be the company’s priority. After all, many of the company’s Big Tech competitors are committed to buying their way in.
To that end, WarnerMedia should also be shifting some Warner Bros. feature content to HBO exclusives, rather than premiering them in theater and taking them to HBO nine months later (or at least do simultaneous theatrical and SVOD releases). Disney has already begun shifting some of its own feature slate to its forthcoming streaming service, and with time, the company is likely to transition its entire slate to day-and-date. At a minimum, Warner Bros. should produce incremental feature-grade titles for HBO and only HBO. And any features that the studio pulls from theatrical release (such as Mowgli, a blockbuster-budgeted live action film starring Benedict Cumberbatch, Cate Blanchett and Christian Bale) should go to HBO, not its competitors. Mowgli, of course, went to Netflix in July 2018.
Similarly, the company would do well to retain the rerun rights to Warner Bros. Television’s top series. Rather than license all 236 episodes of Friends or 156 of The West Wing (both to Netflix, no less), WBTV should offer those series to HBO. While they may not seem to fit HBO’s brand, each is considered one of the best ever series in its genre – and what better represents the HBO brand? (In fact, the creators of both Friends and The West Wing also created original series for HBO.) This same licensing logic extends to non-WarnerMedia content, but those licenses would come at a greater hassle and cost. Regardless, this isn’t a mass licensing play; HBO can be selective and still substantially grow its library. If it needs a sub-brand or separate section to further differentiate from these titles, so be it.
However, HBO shouldn’t just be the beneficiary of WarnerMedia folding other WarnerMedia assets into the network. HBO’s own scale (defined by reach, frequency of use, content catalog, user data) is hindered by the fact the company operates a second subscription channel, Cinemax, and splits its content rights across the two networks. Today, for example, Cinemax has 321 movies available on demand (roughly as many as HBO) including The Accountant (the most rented movie of 2017), 500 Days of Summer (Golden Globe Nominee for Best Musical or Comedy), and the Academy Award Best Picture nominees Fargo, Hacksaw Ridge and Psycho. Few of these 321 titles are on HBO today, though the two services’ catalogs occasionally rotate between each other. Cinemax also offers three or four original series per year (vs. HBO’s 15). Many of these series have a different, more action-oriented tone than HBO. However, they’re also popular, well received and closely resemble the tone of HBO’s Pay-1 film catalog (e.g. the Fast and Furious franchise) and serve the exact same viewers as HBO (few households have Cinemax but not its big brother). And in some cases, Cinemax’s original series (such as The Knick, which was originally developed for HBO and came from writer-director/Academy Award Winner Steven Soderberg and starred Clive Owen) fit so well into the existing HBO brand that they co-premiered on the network and are also rotated into the network from time to time.
Based on the logic above, one could argue that WarnerMedia should converge the entirety of its business into HBO, rather than just some of its films, some of its SVOD services, some of its networks, and some of its TV series. But it shouldn’t. For one, not all of WarnerMedia’s content and IP is best served in a general entertainment SVOD offering. WarnerMedia’s forthcoming DC Universe service, for example, is intended as a destination for everything DC Comics, including exclusive original TV series, books, news, merchandise, community and more. While many of the service’s forthcoming TV series (e.g. Titans) would likely be popular and valuable on HBO/Netflix/Amazon/etc., their ecosystem strategy is based around IP investment and cultivation – not IP exploitation. And to this end, there is likely to be greater long-term value in creating a multi-category, D2C IP ecosystem around DC, rather than piecemealing out adaptations. Crunchyroll, another WarnerMedia SVOD service, is another good example here.
In addition, it would take years for even half of WarnerMedia’s content to be placed into HBO. In the United States, for example, much of TNT and TBS will continue to go to Hulu through 2020, while CW and large portions of Warner Bros.’ film library are already obligated to Netflix. While these rights will revert over time, they’ll do so over differing timelines and sometimes even on a title-by-title basis. International is harder still as WarnerMedia has retained even fewer of its ex-US content rights. And not only have some of the media giant’s signature series, such as Gotham and The Alienist, been licensed to Netflix abroad, they’ve been rebranded as Netflix Originals. As a result, the “WarnerMedia Home Box Office” SVOD service would not only be less compelling than one might assume, its brand would be incommunicable and its internal programming strategy confused. Nothing could be farther from what has made HBO so successful today. While Disney will face some of these same challenges when creating its own consolidated offering, the company’s brand and programming approach is far more tonally consistent than that of WarnedMedia. And even then, Disney is sending much of its content, including most of ABC and Freeform, to another SVOD service: Hulu.
Certainly, Netflix makes a strong case study for the benefits of simply maximizing the volume of content available to one’s subscribers – and that a network’s brand need not communicate a specific idea as long as it has enough content to satisfy anyone. What’s more, there’s a tremendous amount of value behind the opportunity Netflix is pursuing (i.e. domination of the global subscription video market). But to point, the SVOD service that garners the largest number of subscribers and most hours of engagement is likely to dominate the market’s share of profits. This goal is not only in conflict with HBO’s culture, Netflix has a considerable first-mover advantage here – and is likely to be even farther ahead by the time HBO begin to consolidate all of WarnerMedia. Instead of fighting a game it has never played, HBO should affirm and grow its current business. It is already the most profitable single network in the world. As long as it continues to invest in its flywheel, HBO can continue to be a lucrative must-have service for all TV lovers – even if another service dominates total video hours watched, or generates greater profits (albeit on a vastly larger budget).
#4 – Aggressively Investing Internationally
Over the past decade, HBO has made significant progress in reclaiming its global footprint. The company has bought out a number of foreign joint ventures, such as HBO Asia, and launched HBO Now (its standard D2C tech platform) in more than 60 countries. However, HBO has also renewed several major foreign deals (e.g. Canada, UK, Germany, Italy) and consequently been unable to launch HBO Now in most of these same markets (i.e. Canada, UK, Germany, Italy).
These renewal decisions are largely attributed to Time Warner’s five-plus years preparing for sale (during which EBITDA and cash flow were prioritized rather than investment). Going forward, however, no new foreign licensing deals should be signed, nor existing deals renewed. Instead, the HBO should continue to focus on reclaiming its rights and launching its self-branded D2C offering (i.e. HBO Now). Where possible (and market-appropriate), HBO should even look to buy out or terminate foreign partnerships and licensing agreements early. This will be expensive (especially at a time when AT&T needs to pay down its Time Warner debt and grow HBO’s programming budget), but the strategic implications of waiting are likely to be greater. Furthermore, the benefits of this move on other markets (including the US) are hard to overestimate. This move also aligns with AT&T’s own professed scale ambitions (“I don’t believe having a 100 million customer base is sustainable in terms of scale over the long haul. You need to be at multiples of that,” Stankey told his employees earlier this year). Scale you rent instead of operate isn’t really scale, especially when it’s on other parties’ platforms.
To support this, HBO will also need to continue building out local content organizations (and series) around the world. This is already a key area of investment for the company (HBO has produced 56 international scripted series to date, 20% of which are current), but it’s also remains one of the most important and largest opportunities to generate globally relevant content. Most of these markets, after all, have never seen premium local series produced at even a fifth of HBO’s current cost per minute. But as The Crown, The Young Pope and Narcos have shown, they can be just as lucrative even when they’re as expensive as US-originated series.
#5 – Cutting Price (Kinda)
In a land grab or race for scale, adoption tends to matter more than ARPU and the latter tends to be easier to resolve than the former. Netflix, for example, continues to underprice its service but has also been able to grow its US base to nearly twice the largest premium cable network (i.e. HBO) despite raising prices $1 every six quarters. Given this, HBO’s price ($15-20 depending on the distributor) may be an obstacle to the network’s scale needs and ambitions. But it’s also a particularly hard obstacle to overcome.
When sold via pay TV, HBO charges distributors a flat fee (~$9) per HBO subscriber per month, and lets distributors price the channel as they choose. This model was a significant accelerant for HBO (and other premium cable networks) as it encouraged pay-TV providers to aggressively market the channel and enabled them to offer bundle discounts at their own expense. Given the network’s present-day influence and availability outside the pay TV ecosystem, HBO could probably demand the same per-subscriber fee (e.g. $9) with an only marginally higher subscriber price ceiling ($12). However, HBO can only reset these terms when its multi-year pay-TV distribution contracts expire. And due to the fact that most HBO subscribers acquire the channel via pay TV bundle, a cut in the price for the standalone HBO service would likely have little effect. More challenging still, HBO’s pay-TV contracts (which include numerous “Most Favoured Nation” clauses) essentially prevent the network from reducing prices on its unbundled D2C HBO Now offering, too. Were HBO’s price to fall below $14 (from $15 today), the major pay TV distributors would be able to reduce the per-subscriber fees they pay to HBO even if they continued charging customers the same $15+ price.
As such, HBO needs to either wait until its distribution contracts expire (which will take years) or return to its distributors to propose a reduction in both of their fees. While the latter proposal would likely improve pay-TV provider profits (as they primarily sell HBO via bundle and thus are only affected by their own per subscriber payments), the cost to HBO would be enormous as it would involve repricing all 30MM pay-TV subscribers. While this can be offset through subscriber growth, this would take time and impede other investments. What’s more, pay-TV providers may still pass on the deal – why help HBO build its D2C offering if the same move doesn’t also grow the company’s pay-TV one too? Given this, the network is likely better off maintaining its current price and, rather than draw down profitability through a price reduction, redirect this investment towards producing even more original content (which helps justify the high price).
But here, HBO can have its cake and eat it, too. Since April 2017, AT&T has been giving away HBO for free to AT&T Unlimited customers and offering the network for $5 to DirecTV Now customers (twice the discount offered on Showtime or Starz). As AT&T now owns HBO, the net impact of this sales strategy is the same as HBO massively cutting its price – someone has to pay for the forgone $10-15 per subscriber – but because the price is cut by distributor, not HBO, there is no “most favored nations” impact. HBO is still be able to collect its standard $9-10 per subscriber from Comcast, Spectrum, etc., even though the network’s owner is sell it at half that amount (or nothing at all). In addition, this discount is likely stealing HBO subscriptions away from these distributors, thereby providing AT&T-HBO with more “fully owned” (and digital-only) customers, or at minimum, forcing these distributors to discount HBO themselves. This degree of discounting is unlikely to last indefinitely, but some is likely to continue thanks to vertical integration. As a result, HBO is able to avoid cutting its price, while also benefiting from a lower one.
#6 – Improving its Product
Historically, a premium cable network cared about only three things: their subscriber base, their brand and their content. In the digital era, far more matters. And the area that has been hardest for all traditional media companies to embrace is the importance of product and technology. To point, it’s the one place where HBO often lags each of its peers (though HBO was first premium cable network to launch an OTT content service, as well as a D2C OTT offering). Compared to Netflix, Amazon, Hulu, Showtime and Starz, for example, HBO Go/Now is the only service to lack offline downloads and one of only two that lacks user profiles. For a brand-obsessed company operating in a brand-obsessed marketplace, this is a liability. Every experience and consumer touchpoint is significant and represents either a brand deposit or withdrawal. But even beyond that, the user experience is critical to driving content consumption and discovery. It’s no longer enough to assume that if one’s content is good enough, audiences will come (even if they already subscribe). And this will become even more important as HBO increases the size of its original and licensed content libraries.
This doesn’t mean HBO needs to program its content like a technology company. But it does need to establish a large engineering team and culture capable of building a product experience that lives up to content brand. This includes investing in cutting edge features like X-Ray (Amazon), contextual compression and predictive offline downloads (both Netflix), as well as launching now-standard features such as user profiles (critical for cross-device play, recommendations, etc.), offline downloads, auto-play next, algorithmic cover art, and personalized recommendations (the last two are particularly important if HBO wants to leverage its market-leading back catalog of originals). When an of episode of Game of Thrones ends, how many consumers want to watch X minutes of credits and then X minutes more of behind-the-scene feature – rather than jump right into the next episode? And when you play the next episode, why are HBO advertisements or trailers unskippable? And why does the nine-second “It’s HBO Go” and episode rating (e.g. TV-MA: Adult Content) introduction load separately from the content itself, thereby creating two opportunities for buffering? Why does an episode page not autoplay in the first place? If HBO wants to remain a market leader, they will need to solve these problems – and that means management needs to be thinking like a user, rather than just as development executives.
It will take years for HBO to develop true technology expertise – and even then, it will be hard to be a leader in OTT video UI/X (Netflix has more engineers and technology staff than HBO has total employees). However, HBO has two key advantages here. For one, it doesn’t need to be a pioneer in video delivery and technology. It can (and should) imitate Netflix’s own technology decisions (many of which are explained publicly and posted on GitHub). In addition, HBO benefits from the ability to leverage much of AT&T / DirecTV’s in-house technology stack and teams. This is unique. Each of HBO’s peers had to build and manage their own end-to-end video platforms and team from scratch. Conversely, HBO can focus only on what’s needed and how it should function and look – then leave the rest to AT&T. This doesn’t obviate the need to think like a tech company, but it alleviates much of the operational burdens from doing so.
Of Westeros and Essos (and Sothoryos)
Much of what HBO will (or might have been asked to) do is being interpreted by as a diktat from AT&T and/or a response to Netflix. However, almost all of this would likely have begun years ago were it not for Time Warner spending most of the past decade cutting costs, cranking up dividends and waiting for a sale. HBO has had the “launch codes” for years. And regardless, the need for change would have existed irrespective of whether Time Warner had been sold or HBO spun off.
The difference now is that HBO is hooked up to a well-capitalized company that not only wants to invest in the business unit, but also brings one of the highest-spend marketing operations in the world (Netflix’s new competitive frontier) and is willing to discount the service substantially (at its own expense) to win. That sounds like a great marriage, even if it was an arranged one.