Why the NFL Network is using the wrong playbook

Are you ready for some vertically-integrated football?

Last year NFL Commissioner Roger Goodel hailed what he called the NFL's "tradition of being the most pro-consumer, widely available sport on television."  He wasn't talking about Thursdays.

Tonight marks the NFL season's first Thursday night game and fans hoping to watch the Falcons play the Ravens will scour their cable or satellite line-ups to see if they get the rarely-watched NFL Network. While many will be disappointed, the real problems will hit in two weeks, when the New York Jets host the Cincinnati Bengals. Both cities rely heavily on Time Warner Cable (TWC), one of several cable systems that do not carry the NFL Network.

Over the past five years the NFL managed to strong-arm most cable and satellite companies into forking over monthly subscriber fees to carry the NFL Network year-round, a trick it accomplished by holding out a mere eight games a season for the channel's exclusive use, most on Thursday nights. As with other cable networks, subscribers pay the fees: in this case, roughly 50¢ per home, whether or not they want or watch the channel.

On the surface, that might seem like a swell strategy for the league. Why cut the broadcast networks or ESPN in on the profits when you can distribute games yourself? As for getting revenue from people who never watch your product—what's not to love?

Yet even if the league's goal is to wring every dollar it can from its TV rights—and that's just capitalism, after all—its vertical integration strategy seems increasingly shortsighted and anachronistic.

Step back a minute to the early days of television. Back then, the mere ownership of a channel guaranteed astounding riches. The typical VHF TV station in the early 1960s earned a 200% after-tax return on capital every year, according to a study by Ronald Coase.  You don't have to be a Nobel Prize-winning economist like Coase to figure out why: broadcast channels were extremely scarce, and thus extremely valuable.

Fast forward to the 1990s, when Congress decided to force cable companies to turn over one of their valuable channel slots to any local broadcaster who wanted it. These "must-carry" laws drove the cable guys crazy, since back then most cable systems had a few dozen channels, and each one was still precious.

Now jump to today. Nobody much cares about must-carry anymore--the cable guys have so many channels that being forced to rebroadcast a local TV station on channel 682 is no big sacrifice. As cables, satellites, fiber-optics and the Internet deliver ever-more distribution capacity, the value of owning any one channel is falling further still.

In a few years, as we enter a world of essentially infinite channels, raw distribution capacity won't be worth a thing. Television's value will be captured by the owners of what will always be a scarce resource: high-quality shows.  The value of channels will be in the strength of their brand, not the reach of their distribution.

And yet the NFL, which owns perhaps the country's most valuable piece of content, seems set on playing in the distribution game.   It even has a slogan that touts its strategy: "You want the NFL? Go to the NFL."

By contrast, the league's deal with DirecTV (DTV) is a masterstroke of vertical non-integration. The satellite provider has an exclusive deal to offer NFL Sunday Ticket, which offers fans almost every out-of-market game during the season. DirecTV is willing to pay dearly, since it costs the satellite company a hefty $805 to acquire a single subscriber and the loss of Sunday ticket would surely send a huge group of it 19 million subscribers running to competitors. (Indeed, last quarter, nearly a quarter of DirectTV's new subscribers bought the NFL package.) DirectTV now pays $1 billion a year to the NFL for Sunday Ticket, up from $700 million two years ago.

The other benefit of such deals: it keeps couch potatoes' anger focused elsewhere.  By using a distributor like DirectTV the league can avoid direct fights over subscriber fees with companies like TIme Warner Cable.  Nothing ticks off fans like having key games blacked out because of a corporate squabble.

In Britain, where Rupert Murdoch gained exclusive distribution rights to Premier League soccer games, fans and regulators rebelled at what they saw as an abuse of market power. The European commission pushed the League into breaking up its exclusive distribution deal.  What if the U.S. passed a similar law, requiring the NFL to split its Sunday Ticket offering between DirectTV and another distributor or two?

Worrying about antitrust regulators, now that's a legitimate 21st century concern for a major sports league.  Bragging about  owning the channel that distributes your games—how very 20th century.