May 20, 2010

Squawking Baseball

The Enigma That is MLB Network

by Shawn Hoffman

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MLB Network has quickly become a very enigmatic business. It had the biggest launch in cable history last January­—when it instantly entered almost 50 million homes—and reportedly exceeded expectations on the advertising side in its first year. It’s also been a hit critically, as it won a bunch of Emmys last month, and—in my opinion—has been a hell of a lot better than "Baseball Tonight" since day one.

Despite all that, the network’s business is going to be stuck in quicksand for the foreseeable future. Thanks to the deals MLB made to get those incredible launch numbers, the network now has its hands tied behind its back, and it’s going to be very hard for it to ever become the huge revenue producer most once thought it could be.

If it sounds like MLB essentially sold the network’s soul to the devil—well, yeah, that’s basically what they did. Back in 2007, MLB signed a huge deal with DirecTV to give the satellite provider exclusive rights to MLB Extra Innings. I was pissed, and so were thousands of other baseball fans, including Senator John Kerry. But MLB actually seemed to have everyone right where it wanted them—when the cable providers came back to the table, MLB had an offer: put MLBN on your basic tier (thereby forcing everyone who buys cable to pay a monthly fee for it), and you can have Extra Innings back.

It worked beautifully, and many people (including me) thought it was an absolutely brilliant maneuver. In fact, I still think it was pretty brilliant, except for one huge problem: MLB made itself a slave to the cable providers in the process.

Here’s why. Cable networks make money in two ways: 1) The cable providers pay them a monthly fee for every subscriber that has access to that network, and 2) Advertising. In most cases, the former is a much larger source of revenue than the latter; think about the last time you watched a commercial on the Fine Living network, or any one of the 500 other channels you pay for every month but never watch, and the math becomes pretty simple. As a result, there’s usually endless haggling between the networks and the providers on sub-fee rates, and most of the time the networks win—why should the providers put up a fight when they can just pass the costs on to their customers (us), who continue to pay insane prices every month no matter what?

At first glance, MLB Network would seem to be a prime candidate for a sub-fee fight; MLBN reportedly charges 24 cents per subscriber per month, which is less than half what the NFL Network gets. (For comparison’s sake, ESPN takes about $4 per subscriber per month. Yeah.) That seems like the perfect arbitrage opportunity for MLB—why should the NFL get twice as much for something that is so similar?

But that’s where the ghosts of 2007 come back in. MLB didn’t just give back Extra Innings; they also gave the cable providers substantial equity in the network (somewhere around one-third), and likely locked itself into that incredibly low sub-fee number. And while that wasn’t necessarily such an awful result (it’s always possible they could have ended up with no distribution), MLB really needed a blowout victory if it wanted MLBN to become its next billion-dollar business. Extra Innings was the real prize for the cable companies, and once MLB had signed it away for the long-term, its leverage was gone.

Now three years later, the cable providers are firmly in the driver’s seat. Without an increase in sub-fees—which the providers have absolutely no reason to grant—MLBN’s subscriber revenues are going to be stagnant, barring a deal with one of the few remaining holdouts, such as Dish Network. (Which I still think will happen, if for no other reason than it has to for MLBN to see any substantial growth this year.)

Plus, despite all of the critical praise and all the pub it gets on MLB.com, the network is still struggling to draw significant ratings—it has been getting about half as many viewers as Speed Network in primetime, and trails the NFL Network by a significant margin as well. It’s no mystery why: The network has gotten terrible placements on cable dockets, usually landing somewhere in the high-100s or worse. MLBN did supposedly beat their ad revenue projections last year, but only because they set incredibly low targets. And anyway, an extra $10 million here or there is not going to affect MLB’s overall business in the slightest way.

So MLBN is what it is, at this point. It will probably take in somewhere around $150 million in subscriber revenue and $50 million in ads again, give or take a few either way. That’s pretty damn good for a year-old network, but it’s not even half of what MLBAM is bringing in, and BAM itself is a pretty small piece of MLB’s overall business. Add in the fact that the network’s revenue is not going to be getting substantially higher any time soon, and you have to think there are owners that are going to feel shortchanged.

It didn’t necessarily have to be this way. The NFL has had a very tough time selling its network, but through sheer brute force, it’s managed to win about the same distribution as MLB, without the handcuffs. And remember, NFL Network is charging close to 50 cents per subscriber and is getting better ratings, so its revenue is likely more than double that of MLBN.

At the very least, MLB still has full operating control of the network, and that’s a crucial point. Given MLBN’s current predicament, MLB really should be running it as a break-even business that sends any surplus cash back to the 30 teams. With some subsidiaries, this wouldn’t be the easiest thing to do, but the model is actually pretty simple in this case: MLB can put more games on the network and charge a "market rate" for the rights fees, up to and until the point where the network is breaking even. After all, why leave money in the network, where the teams only own two-thirds of it?

Of course, that’s not the business model most people had in mind when the network was conceived. Cable is old media’s last major cash cow, and most figured that MLB would be able to make a lot of money out of it—at least until cable’s current pricing model dies. But instead, it looks like MLB Network will remain a nice side project. There are worse tragedies, but the league’s financial stakeholders should certainly be disappointed.

Shawn Hoffman is an author of Baseball Prospectus. 
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