HBO Is Doing Exactly What It Should Be Doing

By Trevor Gilbert , written on May 11, 2012

From The News Desk

Yesterday, news started cycling that the hit HBO show “Game of Thrones” is the most pirated television show in history. And while this might be a great talking point to use when arguing that “Game of Thrones” should be for sale on iTunes or on Netflix, it doesn’t make good business sense.

Before we all get out the pitchforks for HBO, let’s take some time to understand the company, and why ignoring the piracy is actually a savvy business move.

First off, HBO is not a standalone company -- it’s a subsidiary of Time Warner and a sister company to CNN, the Cartoon Network, WB, and others. So if a big decision is going to be made about HBO’s distribution strategy, the decision will be made by the bigwigs at Time Warner. Direct ire accordingly.

Second, badmouthing HBO, or Time Warner for that matter, isn’t like criticizing RIM for failing as a company. Time Warner is actually succeeding financially, and HBO is a big part of that. HBO and its sister broadcast stations netted $3.6 billion in revenue for the first quarter of the year, giving the company $1.2 billion in operating income. And yes, all this, despite the fact that its television show is the “most pirated show ever.” Time Warner itself saw nearly $30 billion in revenue in 2011.

But given that the television model is “broken,” how can that be?

The answer is found in how the HBO model is set up. With HBO, the company makes no money from a la carte sales, and it never has. Sure, historically the company made a fair amount of money from DVD sales after a season had wrapped up. That isn’t how HBO, or Time Warner, makes most of its money.

The company makes most of its money by negotiating large checks per cable subscriber per month from companies like Time Warner Cable, Comcast, and Cox. This revenue stream is amplified, as Time Warner gets a check for HBO and a check for every other channel it owns that it is bundled with, regardless of how many people watch the other channels. With such a reliable and sizable stream of revenue, the company should guard it from any competitive threats. What is the biggest risk to Time Warner right now? Cord cutters.

If HBO was to start selling its content on a per-episode basis via iTunes or online subscriptions to HBOGo, it would enable people to cut the cord. From the perspective of the Time Warner executives that run HBO, it is entirely reasonable to assume that people are being held back from cutting the cord because of HBO (for now). This means that not only are they keeping their HBO subscription, but that the customers are also likely paying Time Warner indirectly via CNN, Cartoon Network, and all of Time Warner’s other subsidiaries. That’s something the company -- financially speaking -- shouldn’t mess with.

At this stage, it may seem like Internet streaming as a business has been figured out. That’s not true, though. For instance, Hulu has had a hard time establishing a revenue line. Apple has been successful, but that is largely to do with the fact that it is shoved in the faces of hundreds of millions of people everyday. Cable companies can’t replicate that strategy.

Then there is Netflix. If Time Warner was to come along and put HBO as a standalone subscription service for the Internet, it would look a lot like Netflix. Even Netflix, though, is only successful because it has a critical mass of content from all creators. HBO wouldn’t have that luxury.

With these companies still figuring out their own strategies for business, it is completely reasonable for HBO to not want to dive into uncharted waters. Yes, it is distasteful for a company to slack off on the innovation front. Sure, it hurts theoretical customers. But from a business perspective it makes sense.

“HBO is probably right given how strong the value chain is at extracting large dollars on a monthly basis from the user/subscriber,” says Andy Liu, CEO of Buddy TV, a second-screen startup that deals with cable partners on a regular basis. “Until large swaths of users stop paying for cable, I can't see the model changing dramatically in the short term.”

Put yourself into the shoes of the executives at Time Warner. When the switch is flipped, there is no going back to the old model. So it is best to get it right the first time around. Going to iTunes may make customers happy, but that doesn’t mean it will bring in the same amount of revenue. This is difficult, especially since there are already millions of television subscribers that the current business model supports and can grow into.

When HBO does finally decide upon a new strategy, part of it should be to put a new executive in charge. Recently, co-President Eric Kessler said in a talk at VideoSchmooze: NYC that “you can't afford to have that machinery slow down,” speaking about HBO’s current business model. “So we'll gain a little” with iTunes and online distribution, and “we'll lose a lot over here” with television subscribers. Kessler believes that it won’t “be a net gain” but that it would be a “net loss.”

Kessler understands the reality today, but in ten years when we’ve passed the tipping point, HBO’s model won’t work. Eventually, cord cutters will be the majority, and Kessler probably shouldn’t be running the company then. For now though, Kessler is spot on when he says, ”it's really about economics.”