ESPN Is Not Doomed

Last week, ESPN laid off 100 employees, including several well-known SportsCenter anchors and popular writers. This kicked off a round of dire proclamations that ESPN is “dying” and even that that its business is “collapsing,” in part, some say, because of the leftward tilt of its on-screen talent.

Some of this hyperbole stems from the modern journalistic convention to announce the end of any industry, company, or product that has arguably peaked and is in stasis or decline. By this measure, driving has died, clothes are dying, soda has been dead for a decade—even though tens of millions of cars and billions of soda cans are sold each year in the U.S. and there is no epidemic of public nudity.

The less hyperbolic story is that, over the last decade, ESPN built perhaps the most profitable business in media, and the future of its business will likely exist somewhere beneath that superlative. But as long as Americans enjoy sports—and as long as individual sports leagues see a financial benefit in selling access to an entertainment company rather than selling straight to consumers—there is every reason to expect ESPN will continue to be an extremely valuable network.

To understand what’s really happening, let’s start with the most basic question.

How does ESPN make money?

ESPN’s strength and vulnerability are intertwined with the complicated way that Americans pay to watch sports on television, which is very different from the way they pay to watch sports in stadiums.

The latter is simple. If I want to see the Yankees play at Yankee Stadium, I buy a ticket to attend the game. But to watch the Yankees play on ESPN, I pay a monthly fee for a bundle of channels from a cable company; the cable company pays a bit of that to ESPN; ESPN pays a bit of that remainder to Major League Baseball; and the MLB pays a bit of that sum to the Yankees.

Does that sound like a mess? Perhaps. But that mess has been, for a long time, the best business model for both networks and teams, as bundling created a marketplace where more than 100 million households, with diverse interests in entertainment, paid hundreds of dollars every single year to support even the channels they weren’t watching, creating enormous automatic revenue streams for many cable networks.

Nobody has more to gain from this arrangement than ESPN—which means nobody has more to lose. Every month, 90 million households pay about $8 for ESPN’s channels, which gives the company about $8 billion a year, and that doesn’t even include advertising revenues. Cable is such a massive business that in 2016 Disney’s cable networks (Disney is ESPN’s parent company) earned more operating profit than the company’s world-famous theme parks and movie studios combined.

This leads to an obvious follow up question:

If ESPN has such a good business, why did it just lay off 100 people?

Several years ago, ESPN’s president, John Skipper, told a room of journalists, including me, that the biggest existential threat to the company was weak income growth among its viewers, not cord-cutting. Many people at ESPN assumed—and many analysts agreed—that cord-cutting after the Great Recession was driven by economic concerns and would have only a moderate effect on cable TV’s prospects. “I know for a fact, they thought [their pay TV subscribers] were going to remain stable,” the former ESPN star Bill Simmons told Peter Kafka, a senior editor at Recode, earlier this year. “They never thought they were going to go backwards, ever.”

And then they went backwards. The number of homes getting ESPN has declined from about 100 million in 2012 to just under 90 million this year. Today, 23 percent of U.S. households have either cancelled cable or never signed up in the first place, according to a 2016 PwC survey. Many of them are swapping cable for internet TV: Since 2012, Netflix’s subscriber base has doubled from about 25 million to about 50 million.

This is the most important reason why ESPN is in such a challenging spot. Declining cable subscriptions might not be so grave if the network could easily cut costs. But its business model relies on buying the rights to live sporting events, and those are long-term contracts that require ESPN to pay sports leagues more money each year.

This year, ESPN will spend more than $8 billion on sports rights—including about $2 billion for men’s college football and basketball, $1.9 billion for the NFL, $1.4 billion for the NBA, and $700 for baseball. The network is locked into these contracts until at least the early 2020s, so they can’t shed them as easily as they can lay off a SportsCenter anchor.

Are ESPN’s costly sports rights the company’s greatest asset, or its fatal weakness?

Clay Travis—a sports writer, radio host, and fierce critic of ESPN—thinks that the network has become a victim of its own success. In a recent post, he memorably compared the network’s current crisis to a castle that builds a moat around itself for protection: For many years, expensive sports rights were the perfect moat, giving ESPN a programming advantage over its top competitors and guaranteeing its high cable fees. But as networks like CBS and sports channels like Fox Sports 1 and NBC Sports got more aggressive about bidding for rights, the cost of sports rights soared at the very time that ESPN’s subscribers were about to decline. The moat is now flooding the castle, Travis says.

But, to extend and modify the metaphor, sports rights aren’t ESPN’s moat; they are the entire castle. The right to air live sports and highlights is more valuable today than any on-screen or online talent in the world. Even Bill Simmons, who has no reason to defend the network that fired him, defended ESPN on this front. “I don’t think people fully understand how important it is for them to get unlimited NFL footage for all of their shows,” he told Kafka.

ESPN’s ability to stay profitable despite its billions of dollars in sports-rights deals is predicated on two things. First, it currently relies on the economics of bundling and the monthly income of households who pay hundreds of dollars for ESPN each year even though they don’t watch it. If pay-TV subscriptions continue to decline, ESPN will have less money to buy the very sports rights it proved were so valuable, leaving the door open for some other company—like CBS, or even Google or Amazon—to buy the rights, instead.

Second, in a more dire scenario, certain sports rights could prove to be an unsustainable bubble that no company could profit from buying. For example, what if the TV network that ends up with rights to Monday Night Football in the 2020s finds that there is no combination of subscription and advertising revenue that can earn back the cost? Perhaps some monstrously wealthy company, like Amazon or Google, could elect to lose money on the whole thing—a game ESPN won’t play.

Has ESPN made any mistakes—with its politics or its strategy?

It’s now fashionable to blame ESPN’s decline on its alleged lurch to the left, as several of its on-screen personalities have adopted liberal positions on sexuality and civil rights. There is some evidence that ESPN’s audience shifted to the left during 2016, but it’s not clear that this was the result of its personalities’ political views or a natural shift of Republican viewers to Fox News during a high-octane election. After all, there is very strong evidence that cable news has clearly siphoned off viewership from all sports—and, perhaps, all pay TV—across networks, with Fox News leading the way with its biggest quarter in company history early this year.

But it’s mostly silly to blame politics for ESPN’s financial decline. The network makes most of its money from subscription fees, not advertising, and it’s pretty absurd to imagine that a Trump voter would hear a pro-multiculturalism comment on SportsCenter and respond by cancelling his entire cable subscription (which would mean no more Fox News.)

On strategy, there are several criticisms. First, the SportsBusiness Journal reported that when ESPN was negotiating its contracts with cable companies, it pushed for higher fees at the expense of ensuring that it was reaching as many cable subscribers as possible. This allowed carriers to offer cheaper “skinny bundles” that didn’t include ESPN. (Disney’s CEO, Bob Iger, called this report “not factually correct.”)

Second, ESPN spent $175 million on a state-of-the-art facility whose primary purpose was to update SportsCenter for the multi-screen world. But SportsCenter has faltered in a media environment where highlights and fast analysis are widely available around the internet. The network arguably should have taken a page from Netflix, which added subscribers by making exclusive original content. Right now, ESPN produces very little that anybody would want to watch the following week, or following year, aside from its 30 For 30 documentary series. Perhaps ESPN should be spending more on prestigious sports documentaries and dramas that attract new audiences who don’t need a 6 p.m. highlight show.

Subscribers are down 10 percent since 2012, viewership is down, and politics has recently had better TV numbers than sports. So, why isn’t ESPN doomed?

ESPN’s profits are declining, but it is still profitable and its revenue and number of employees are still both growing. Even in 2016, as the presidential election pulled attention from everything else in television, ESPN ranked as the highest-rated cable network among men and adults between ages 18 and 54, and second among total viewers in primetime. As Bill Simmons told Kafka, “it’s weird that people think they’re in trouble. They’re not in trouble. They’re just not going to be making money hand over fist, like they did six years ago.”

Still, one of the most common biases in media is that reporters miss the forest for the forest fires, focusing on crises over more-important, yet less exciting, trendlines. In 2015, ESPN laid off about 300 people, and it was a big story. Last week, it laid off 100 people, including several prominent on-air talents, and it was an even bigger story. But in the 18-month interim, its global workforce actually grew by 500 to 8,000—and it wasn’t a story at all.

The simple truth is that cable television in the United States was a simply extraordinary business model, which made ESPN one of the world’s most valuable media properties, and led to a massive increase in the cost of sports rights. Now the cable-TV model is declining even as the annual cost of sports-rights contracts are continuing to grow. That probably won’t destroy ESPN, but it will require the company to transition to a new business model in the future.

So, what is the future of ESPN?

In short, more money from fewer people.

This future may come in two stages. In the first stage, ESPN’s affiliate fee from the cable bundle will likely rise, even as cable subscriptions continue to decline. In the second stage, ESPN—perhaps along with its parent company Disney—will likely have to distribute its programming through a streaming product to compete with (or partner with) the likes of Netflix and HBO Go.

There will be a race to build a direct-to-consumer model for sports—that is, to build a sports-TV product that can thrive outside of the cable bundle. Among television companies, ESPN probably has the inside track, as the largest sports aggregator today with the most brand awareness and expertise in producing sports television. Next up might be the tech companies—Facebook, Apple, Amazon, Netflix, and Google—any one of which might decide that owning rights to a major sport would attract new customers. Just as Netflix wanted to become HBO before HBO could become Netflix, the goal would be for, say, Amazon to become ESPN. The NFL and NBA, seeking maximum distribution for their product, probably won’t sell exclusive rights to any company that doesn’t have broad penetration (sorry, Twitter.)

In the long run, it’s conceivable that the sports leagues themselves might one day opt to go directly to consumers without selling any access to cable or internet companies. But that day, if it ever comes, is far away. It would require creating an entire technology, marketing, and payments apparatus to stream live sports around the world, which is both risky and expensive. Sports, like most programming, benefits from the existence of an aggregator—a single distribution platform to which millions of people can subscribe to watch their favorite entertainment without having to spend more for each individual game. Americans are moving away from the cable bundle that made ESPN fantastically rich for many years; but they are not moving toward a future where they stop watching sports on television.