The Anderson School at UCLA POL 2003-7 Fox Entertainment Group (A): Vertical Integration in the Television Industry Copyright © 2003 by the Regents of the University of California. Daniel Granof (MBA candidate ’03) pre- pared this case under the supervision of Professor Olav Sorenson for the purpose of facilitating class dis- cussion, rather than illustrating either effective or ineffective handling of a business situation. Fox Television Network In 1985 Rupert Murdoch, after acquiring the Twentieth Century Fox studio for a total of $575 million through his holding company, News Corporation (NewsCorp), decided to start a fourth broadcast network on the advice of Barry Diller, the highly sought-after ex- ecutive recently recruited to Fox from industry leader Paramount Studios. NewsCorp purchased Metromedia from media mogul John Kluge, gaining control of seven key in- dependent TV stations in several large East Coast cities and Los Angeles. Fox quickly lined up 88 additional independent stations to become its network affiliates and launched the Fox Television Network in 1986. Initially the network reached only 60% of the coun- try and aired original network programming only one night a week, on Sunday. Everyone in the industry thought Diller and Murdoch crazy. At the time the big three networks had a combined television viewing share of 93%. To attract viewers away from them, Fox chose to go after two key demographics: youth, a group coveted by advertis- ers, and African-Americans. As Diller said, “We had to air shows that demanded your attention, that yanked you by the throat to get you to change the channel.”1 Peter Chernin, a loyal executive who would eventually become Murdoch’s second in command, concurred: “We’re in the attention-getting business. You have to be distinctive and com- pelling and unique and a risk taker.”2 Early shows included A Current Affair, a tabloid-style news magazine hosted by Maury Povich; America’s Most Wanted, which featured hokey dramatizations of lurid crimes; Cops, which eventually became part of pop culture for its unintentionally comical por- trayal of lower-class individuals’ confrontations with police officers; and Married With Children, a dysfunctional-family sitcom with plenty of sexual references and images.3 1 “News Corporation,” Bharat Anand and Kate Attea, Harvard Business School Case Study 702-425, 6/19/02, p. 6. 2 “The Rules According to Rupert,” Marc Gunther, Fortune, 10/26/98, Vol. 138, No. 8. 3 Ibid. Fox Entertainment Group (A) 2 POL 2003-7 Fox also created a half-hour sketch comedy show featuring the many characters of come- dienne Tracy Ullman. The show lasted just four seasons but more importantly featured short, animated vignettes drawn by cartoonist Matt Groening of a family called “The Simpsons.” Fox spun-off The Simpsons into its own weekly half-hour series in 1989 to enormous success. The series put Fox on the map and in the league with the big three networks. By 1990, Fox’s youth-oriented strategy had paid off. Nearly half of its audience was be- tween the ages of 12 and 34, compared to 35% for ABC, 31% for NBC, and 25% for CBS.4 Fox had also succeeded where the other networks had failed in staking out a strong brand image for itself as a hip, edgy, risk-taker. This image contributed as much by attracting creative talent as it did seducing viewers. Simpsons creator Matt Groening said in 1998, “I don’t think The Simpsons could have been done on any network other than Fox. Fox takes chances; the others don’t.”5 Experiencing Technical Difficulties Despite the initial success of the Fox Network in attracting young viewers, Murdoch wanted to expand and diversify Fox’s audience beyond young people. His aggressive pursuit of this vision began to cost him talented executives and hurt Fox’s overall per- formance. Diller left in 1992 when Murdoch would not give him any ownership of the business. In 1994, Murdoch fired network president Sandy Grushow and replaced him with John Matoian from the more conservative CBS network, which traditionally had played well with an older demographic. Matoian attempted to take Fox toward the mainstream by making moves such as signing a deal with Hallmark Entertainment to produce television movies. Though this material oriented the network’s programming more toward the mainstream demographics of tele- vision viewers, the new lineup failed to draw viewers. Fox’s rating growth stagnated and its brand image became blurred. Never one to be shy about spending money, in 1993 Murdoch also shocked the media world by outbidding CBS for the rights to broadcast NFL football games for the next five years, spending $1.6 billion in the hopes of acquiring a more mainstream audience. Many questioned Murdoch’s wisdom in paying so much, and also resented him for help- ing inflate prices for sports broadcast rights. Meanwhile, the studio’s television production arm lagged behind its rivals, especially in the lucrative situation comedy segment. In 1997 it ranked eighth among production com- panies with just five shows on the air.6 Its three biggest hits were The X-Files, NYPD 4 Ibid. 5 Ibid. 6 “At Fox TV, a Hot Spot for a Hotshot,” Bernard Weinraub, The New York Times, 12/29/99. Fox Entertainment Group (A) 3 POL 2003-7 Blue, and Party of Five, all hour-long dramas that had debuted in 1993 or 1994. This compared unfavorably with a studio like Warner Brothers, which had created Friends, ER, and Murphy Brown, or even Columbia-TriStar, which distributed the 1990s jug- gernaut Seinfeld. Fox, the innovator in reality television, turned back to the genre, airing controversial shows like When Animals Attack and Secrets of Magic Revealed, but the damage to Fox’s image more than offset the publicity they generated. These shows also failed to attract the advertisers Fox desired. According to Grushow, “Specials that were in the mode of When Animals Attack were getting killed in New York. There was no money in the marketplace for those kinds of shows; those types of specials were hurting the Fox brand.”7 About the same time that Fox began struggling, several important changes in the televi- sion industry occurred. Two key events – the rise of cable networks and the repeal of the Fin-Syn rules – set the television industry on a course of dramatic change. Rise of Cable Networks: The proliferation of multichannel television service greatly ex- panded viewing options for the television-watching public during the 1990s. In 1990, the number of national cable networks (including premium channels like HBO and pay-per- view channels) was 79. By 1995, that number had nearly doubled to 139. By 2000, with the proliferation of digital cable, the number would reach 231.8 As one research analyst explained, “The television audience universe is fragmenting as the number of television channels is increasing and more consumers are gaining access to large and diverse video programming lineups.”9 Today, multichannel television service, consisting primarily of either cable or direct broadcast satellite (DBS) service, reaches 96.2 million out of 106.6 million U.S. TV households.10 Television viewers enjoy an increasing array of program- ming choices, particularly with the advent of digital cable (explained in greater detail be- low). In 1999, the aggregate ratings share for cable networks surpassed that of broadcast networks (such as ABC, NBC, and CBS) for the first time.11 Traditionally, cable networks broadcast their signal in analog form at a specified band of frequency in the radio spectrum. In the past several years, however, technology has al- lowed analog television signals to be converted to digital signals and transmitted to con- sumers’ homes. A primary advantage of a digital signal is that broadcasters can compress it in order to send more information over the same amount of bandwidth. A standard analog-broadcast channel uses 6 mHz of bandwidth; through current compression tech- 7 “Once burned, twice shy,” Susanne Ault, Broadcasting & Cable, 7/24/00. 8 “Spotlight on Basic Cable Networks,” Spencer Wang, ABN AMRO Corp. research report, 2/1/02. 9 Ibid. 10 National Cable & Telecommunications Association “Industry Overview, 2002.” 11 “Spotlight on Basic Cable Networks,” ibid., p. 22. Fox Entertainment Group (A) 4 POL 2003-7 nology, digital signals can fit up to 12 standard channels in the same transmission space.12 Digital technology thus offers the capacity to deliver many more channels to viewers. Today cable companies can usually deliver over 200 channels of programming. A typical operator might offer a basic package of 60-80 analog channels, an additional 80 “digital basic” channels, and another 40 premium and pay-per-view channels. To receive the lat- ter two packages, a household would need to upgrade to digital cable, which essentially entails adding an advanced set-top box to decode the digital signals. At the end of 2002 an estimated 19.2 million households subscribed to digital cable and another 18.7 million homes received DBS service.13 One research analyst expects the number of viewers with access to digital programming to reach 67 million by 2006.14 Repeal of Fin-Syn: In 1970, the FCC implemented a set of rules aimed at limiting the market control of the three broadcast networks and increasing the diversity of program- ming on the airwaves. The Financial Interest and Syndication Rules, which came to be known as “Fin-Syn,” limited network participation in the production of most of the prime- time programs that they aired, and they also prohibited the networks from retaining fi- nancial stakes in those programs, meaning that networks could not earn any money from future airings of the shows in syndication.