TV UNBUNDLING:

AN ECONOMIC AND CONSUMER EXPERIENCE IMPACT ASSESSMENT

OF THE CRTC’S PROPOSED APPROACH ABOUT OLIVER WYMAN

Oliver Wyman is a global leader in management consulting. With offices in 50+ cities across 25 countries, Oliver Wyman combines deep industry knowledge with specialized expertise in strategy, operations, risk management, and organization transformation. The firm’s 3,000 professionals help clients optimize their business, improve their operations and risk profile, and accelerate their organizational performance to seize the most attractive opportunities. Oliver Wyman is a wholly owned subsidiary of Marsh & McLennan Companies [NYSE: MMC]. For more information, visit http://www.oliverwyman.com. Follow Oliver Wyman on Twitter @OliverWyman.

Oliver Wyman’s presence in Canada extends from offices in Montreal and Toronto across the country and draws from the strength of Marsh & McLennan Companies’ offices in 13 Canadian cities. In addition to advising private sector leaders, Oliver Wyman has provided expert advice and testimony in several Canadian regulatory and public policy initiatives: for example, interacting with the Canadian Transportation Agency, the Ministry of Transport, the Canada Mortgage and Housing Corporation, the Canadian Development Investment Corporation, the Office of the Superintendent of Financial Institutions, and the Ontario Securities Commission.

Oliver Wyman’s Communications, Media & Technology practice helps industry leaders anticipate shifts in consumer behavior and competition, develop value growth strategies, improve operations and maximize organizational effectiveness. Our global team has worked for all major multinational telecom groups, and have launched or re- launched over 60 telecom operators. This has provided us with a deep understanding of the wireline and wireless ecosystems, particularly in margin improvement across commercial and operational levers in the most competitive markets in the world.

Our team also advises media distributors, such as cable and satellite broadcasting distribution undertakings (BDUs), film and TV studios, publishers, broadcast and pay TV companies, Internet service providers (ISPs), digital distributors, gaming companies, consumer electronics brands, platform operators and private equity investors. We offer our extensive experience anticipating consumer behavior to redefine value propositions, offers and go-to-market approaches. The team involved in this study has supported 5 of the major cable BDUs in North America, 3 leading satellite BDUs, 3 global media conglomerates, 2 Hollywood majors, and 6 of the top publishers in North America, including supporting the launch of the industry’s digital distribution joint venture in both Canada and the US. The team has also directed Oliver Wyman’s role as New York City’s official knowledge partner for the media and hi-tech sectors for the past 5 years, leading MediaNYC2020, Mayor Bloomberg’s initiative to support the media and digital sectors in NYC, engaging with 70+ media-sector CEOs.

This paper was authored by: MARTIN KON, a Toronto native, Partner and Co-head of Oliver Wyman’s Communications, Media & Technology practice; KAIJIA GU, a Principal in the firm’s Communications, Media & Technology practice; and PHILIPPE BENICHOU, an experienced member of the Communications, Media & Technology practice.

Learn more at http://www.oliverwyman.com/what-we-do/communications-media-technology.html

2 INTRODUCTION

The global media and entertainment sector is experiencing major disruption in all sectors, and the Canadian television landscape is evolving rapidly as a result. Canadians have more choices available - and more choices to make - than ever before, and we are certain that this trend will continue.

The CRTC’s “Let’s Talk TV: A Conversation with Canadians” initiative is a worthy and important one. Understanding consumers’ views, preferences and ideas is the right starting point, and matching that understanding with knowledge about industry dynamics, competitive forces, and regulatory priorities is equally important.

Oliver Wyman feels privileged to contribute to this dialogue, and as a proud Canadian, I am honoured to lead our efforts. We are committed to supporting the development [email protected] of the communications, media and technology sectors for consumers, businesses and society as a whole, both generally and in Canada specifically. Our firm traces its origins back to a business that Canadian pioneer William M. Mercer founded in Vancouver in 1945, and, though we are now a global firm with offices in 25 countries, we remain deeply involved in and committed to Canada.

We have endeavored in this study to provide an objective and fact-based perspective on the impact of the CRTC’s proposed approach on both the economics of the television ecosystem and on the consumer experience. We have drawn extensively from our work with many leading BDUs, studios, broadcasters, and technology companies in Canada, the United States and Europe, and leveraged proprietary data on actual television viewing behaviour to try and predict future consumer behaviour. Our analysis necessarily makes a number of assumptions which we have made explicit throughout the document. In doing so, we have endeavoured to be conservative yet, at the same time, have conducted a range of scenario and sensitivity analyses to yield a broader spectrum of potential outcomes.

This is an extensive and complex topic, and this report can only touch on certain aspects of it. We hope it makes for an interesting and thought-provoking read, and provides a complementary and helpful perspective to the “Let’s Talk TV” conversation.

MARTIN KON Co-head of Oliver Wyman’s Communications, Media & Technology Practice CONTENTS EXECUTIVE SUMMARY

THE CANADIAN 1 TV INDUSTRY CONTEXT ECONOMIC IMPACT 2 ON STAKEHOLDERS CONSUMER EXPERIENCE IMPACT: CHOICE AND FLEXIBILITY – 3 A QUALITATIVE ANALYSIS

APPENDIX A. DETAILED EXPLANATION OF ASSUMPTIONS

APPENDIX B. SENSITIVITY ANALYSIS 1

1.1. A DIVERSE AND DEEPLY INTERTWINED CANADIAN TV INDUSTRY 5 1.2. CRTC’S TV CONSULTATION: PROPOSED CHANGES 9

2.1. SUMMARY CONCLUSIONS 11 2.2. KEY ASSUMPTIONS 19 2.3. SCENARIO A: ASSUMPTIONS AND IMPACT DETAIL 22 2.4. SCENARIO B: ASSUMPTIONS AND IMPACT DETAIL 27

3.1. MACRO TRENDS: TV VIEWING IS RAPIDLY CHANGING 30 3.2. GAP BETWEEN PERCEPTION AND REALITY 34 3.3. VALUE OF DISCOVERY OF DIVERSE CONTENT 34 3.4. PARADOX OF CHOICE 35

A .1. SEGMENTED IMPACT 37 A.2. IMPACT ON CONSUMERS 37

43 The television industry is rapidly changing, with explosive growth in the pool of available programming and an ever-increasing set of formats and consumption alternatives for consumers—from a la carte channels, theme packs, time-shifting, and Video on Demand (VOD) to over the top (OTT) options such as Netflix and myriad other internet-distributed content. This evolution is due partly to consumer demand for “anywhere, anytime, on any device” experiences, partly to technological advancements in digital distribution and device capabilities, and partly to increased competition and lower barriers to entry in both content production and distribution. In short, the marketplace is driving substantial change in the television experience. EXECUTIVE SUMMARY

This report presents the findings of a study are interested only in a limited number of programming conducted by Oliver Wyman, commissioned by services through Small Basic plus a la carte/BYOP Rogers Communications Inc. (Rogers) and Shaw options. For this minority of consumers, the savings Communications Inc. (Shaw), and draws from our would be in the range of 5% to 15% for the different work for various Canadian and U.S. distributors, studios, scenarios we tested, while the number of channels broadcasters and technology players. It focuses on received by these consumers would drop by the likely economic impact on both the consumer and approximately 59%. However, the majority of consumers the industry of the Canadian Radio-television and would experience higher bills (up to 12% depending Telecommunications Commission’s (CRTC) proposed on the scenario) and/or access to markedly fewer approach to unbundled packaging options for specialty channels, and a much smaller and less diverse “pool” and pay TV services in Canada, as well as the potential of programming (especially Canadian content), which impact on the consumer experience. The proposed would undermine the CRTC’s stated objectives. approach is designed to give consumers the option of subscribing to an entry-level “Small Basic” package, and Consumers who opt for a la carte/BYOP options would adding other channels on an “a la carte” or “Build Your lose much of the option value and potential enjoyment Own Package” (BYOP) basis. of discovering (or being directed to discover) new and diverse programming. Under the CRTC’s proposed Our overall conclusion is that, while intending to provide approach, the pool of programming services that more choice and flexibility to consumers, the CRTC’s many consumers have access to would be reduced proposed approach could actually hurt consumers and because fewer channels will be subscribed to in a Small the industry in several ways: by ultimately decreasing Basic + a la carte/BYOP environment, thus removing prices for only a minority of consumers while increasing the “occasional channels” that consumers would not prices for the majority who choose to stay with their proactively pay for on an individual basis, but that current package; by decreasing overall programming currently make up ~18% of their total viewing time. diversity as well as funding for Canadian program production, especially independent production; by Consumers would suffer from less programming limiting content discovery, and by negatively impacting diversity, given the financial sustainability of many profitability at most steps of the industry value chain. programming services would be at risk because of a loss of affiliate and/or advertising revenue coupled The specific conclusions of this report are as follows: with increased marketing costs. The dramatic growth in content made available to Canadian consumers over the Consumer impact past years could be reversed. Most consumers would fail to benefit from the CRTC’s proposed approach. A relatively small number of Canadian consumers might enjoy lower bills if they

1 Broadcaster impact and themed packages, under terms and prices that make sense for consumers and the industry, but economic The proposed approach would also have an adverse pressure from the proposed approach could constrain impact on the broadcasting sector. Subscriber reach the ability to innovate further. for many broadcasters would decline dramatically as consumers focus their viewing on a smaller number of mainstream channels, resulting in lower advertising Production impact and affiliate revenues for many. Moreover, broadcasters’ Given the potential loss of programming services marketing costs, already on the rise given content and declining revenues experienced by broadcasters proliferation and growing distribution alternatives, and BDUs, there would be a reduction in funding to would increase significantly as they would need to vie for the Canadian production sector, which today consumers’ explicit opt-in selection to mitigate declining generates significant employment and cultural benefit. viewership. To offset declining revenues and increasing The substantial portion of funding for independent costs, broadcasters would need to raise affiliate fees to Canadian production that stems directly from BDUs’ broadcasting distribution undertakings (BDUs), resulting contribution to the Canada Media Fund (CMF) and other in higher prices for consumers, and/or cut programming independent funds and broadcasters’ commissioned expenditures. The net result could be a vicious cycle, programming would decline, unless this shortfall were whereby broadcasters spend more to acquire fewer borne by public funding sources and the taxpayer. Given customers, are forced to cut back on programming the $1.3 billion that specialty services currently spend quantity and/or quality, and then suffer subscriber on Canadian content, the overall impact on Canadian churn and reduced viewership. production (both independent and non-independent) The ability of broadcasters to stay viable by cutting is much larger, both in value and in employment. programming expenditures or increasing affiliate fees The CRTC’s proposed approach could result in a $39 is limited. We estimate that as many as 26% of current million reduction of funding to Canadian independent channels could be at risk of becoming commercially production and a cumulated negative impact of $93 unviable in one of the modeled scenarios1. Furthermore, million on both independent and non-independent new channel launches would likewise be curtailed, as Canadian production. previously stable revenues for mature channels become potentially volatile, limiting broadcasters’ ability to Overall economic and employment impact invest in new concepts. Although we did not quantify this directly, even conventional channels would be Overall, the CRTC’s proposed approach could result impacted because they often share infrastructure, in up to almost $670 million of value loss from the programming acquisition, and production activities television ecosystem. As mentioned above, this will with some specialty channels within the same have an economic impact on all parts of the television broadcaster family. ecosystem. However, this impact will not only result in lower shareholder returns, but will undoubtedly result in job losses as broadcasters, BDUs and producers need BDU impact to respond to lost revenues and increased costs. In 2013, BDUs will face significant challenges if they are there were approximately 38,000 people employed by 2 required to offer Small Basic and a la carte/BYOP Canadian broadcasters and BDUs , and approximately options, because of the drop in subscription revenue 50,000 employed by the Canadian production sector as well as the increased costs associated with the and ancillary businesses. Although we have not CRTC’s proposed approach. This margin reduction quantified the precise impact, a significant value loss would be passed to consumers through higher prices, by these employers would result in the loss of a large to broadcasters in reduced affiliate fees, or likely a number of jobs in the ecosystem. combination of the two. BDUs are already creating more In addition, impacts modeled in this report are not static, consumer-relevant products and offers propelled by and none of the modeled scenarios is expected to be natural market and competitive dynamics, which will sustainable in the long term. Changes to any part of the undoubtedly include more flexible bundling options 2 CRTC 2013 financial results for specialty, pay, pay-per-view and video-on- demand television services (released on Apr 30th, 2014; CRTC 2013 financial 1 Scenarios will be defined in detail in Section 2. results for Canadian cable and satellite companies (released on May 15th, 2014).

2 ecosystem, such as economic conditions, as well as the revenue and cost evolution of programming services SUMMARY IMPACT and BDUs, will dynamically change the outcomes. We modeled impact for three different scenarios; This is a very dynamic, complex and deeply intertwined two extreme scenarios of different industry response, ecosystem, and negative impacts in one part would and one middle scenario: cascade through the whole system. The economic impact is also highly sensitive to changes in consumer behaviour, In Scenario A, broadcasters, BDUs, and production pricing, etc. For example, while we assumed based on businesses absorb any economic impact of the proposed analyzing current viewing behaviour and purely rational approach without passing any onto consumers in the decision-making that 35% of consumers would switch form of higher channel prices. This scenario challenges to a new a la carte/BYOP option this could ultimately be the economic sustainability of many players in the higher. If this switch-rate were ~65% instead, the overall long term. value loss in the ecosystem could be as high as $1.5 billion In Scenario B, industry participants ensure the economic rather than $670 million in our modeled scenario, with sustainability of their businesses by maintaining current obvious multiplicative impacts on employment. margins; they do so by increasing pricing to consumers, Innovation and investment impact both to those who choose the new a la carte/BYOP offers and to those who retain their current packages. Over the next years, the number of linear channels consumers have access to will become less relevant than In Scenario C consumers and industry participants share the ease with which they can find enjoyable content in the the economic impact. Total BDU subscription revenue is ever-increasing pool of programming available, even or maintained at the base case level instead of decreasing especially if they would not otherwise know about it. It is like in Scenario A, which partially offsets the impact that not advantageous for the industry or the CRTC to expect broadcasters, BDUs, and production businesses would consumers to be able to effectively pre-select all of what need to absorb. they might want to watch in the future when faced with Exhibit 1 is a table showing summary metrics for the hundreds of channel choices. estimated impact of the CRTC’s proposed changes for Furthermore, at this critical juncture where video Scenarios A, B and C. Scenario A shows fewer channels consumption is increasingly moving from linear, received and a decrease of the average consumer bill broad-appeal, appointment-viewing to time-shifted, triggering a negative economic impact for the industry. on-demand, personalized and multi-device viewing, In Scenario B, the industry impact is neutral, but generates the CRTC’s proposed approach would likely hinder the an increase of the average consumer bill for fewer channels industry’s ability to invest to satisfy evolving consumer received. Scenario C is an intermediate scenario, with needs. BDUs have been making significant changes to increased consumer rates to generate a similar monthly bill their offerings, driven by market demand and competitive despite fewer channels received and a negative economic pressures. In our view, BDUs need to make further capital impact for the industry, although the magnitude is lower investments on upgraded analytical capabilities, better than in Scenario A. and more intuitive interfaces, search and discovery approaches, as well as curation and merchandising capabilities, in addition to increasing their distribution capacity to handle higher definition channel formats , in order to maximize the value that consumers derive from the mass of potentially relevant programming that is available.

3 Exhibit 1: SUMMARY IMPACT ON CONSUMERS AND INDUSTRY

SCENARIO A SCENARIO B SCENARIO C Baseline Stay(*) Switch(*) Overall Stay(*) Switch(*) Overall Stay(*) Switch(*) Overall Take rate - 65% 35% - 65%*3 35%*3 - 65%*3 35%*3 - Δ Channels 70 - (44) (16) - (44) (16) - (44) (16) subscribed*1 Δ Monthly $52 - ($8) ($3) $6 ($3) $3 $3 ($6) - bill*2 Δ $ MM Δ % Δ $ MM Δ % Δ $ MM Δ % Δ Broadcaster 1,145 (223) -19% 0 - (200) -17% EBITDA*2 Δ BDU 2,095 (407) -19% 0 - (95) -5% EBITDA ($MM) Δ Independent 656 (39) -6% 14 +2% (13) -2% production*4 funding ($MM)

(*) Stay: Subscribers staying on their current package. Switch: Subscribers switching from current package to a la carte/BYOP: *1 In our base scenario, number of channels subscribed by consumers staying on their current package is lower than the 70 baseline average. *2 Monthly bill excludes equipment rental, PPV, VOD charges and tax. *3 % of consumers switching would be dependent on how BDUs pass price increase – if the price increase is the same in proportion to current packages and a la carte/BYOP, the % switching would not change from Scenario A (assumed in numbers shown). *4 Only includes impact on independent production funding. The non-independent production sector is larger in Canada, and the impact is further detailed in section 2.3.4.

The next sections of this report elaborate on these without much more sophisticated research and modeling. summary conclusions, drawing from both qualitative and We have endeavored to leverage actual consumer quantitative analyses. One caveat: This is a complex sector behaviour wherever possible and to make assumptions and consumer behaviour is notoriously difficult to predict that would test the extreme scenarios one might envisage.

4 THE CANADIAN 1TV INDUSTRY CONTEXT 1.1. A DIVERSE AND DEEPLY INTERTWINED CANADIAN TV INDUSTRY The Canadian television industry is a diverse and highly Canadian BDU subscribers paid $52 per month on interconnected ecosystem of participants, including average for TV services in 20133, and the average consumers, BDUs, broadcasters, content producers, subscriber watched 28 hours per week. However, video talent, and many ancillary industries. Change to one viewership on secondary devices such as tablets, PCs, part of this ecosystem has the potential to cascade to and smartphones is growing exponentially, both in-home any or all of the other players. Indeed, as a change in and out-of-home, making viewing an increasingly multi- one part cascades throughout the ecosytem, its effects faceted activity. In fact, a full 20% of all time spent on may multiply. Consumer revenue for TV services video consumption in Canada is no longer on a is not relevant just for the BDUs, but also for all the television screen4. subsequent parts of the television ecosystem. Consumers Of the approximately 14.2 million households in Canada, 98.3% have at least one television, and nearly three- quarters of these TV households have multiple sets. 3 $52 is the average bill for a subscription that includes only conventional, With 2.5 people per household on average, television specialty, and pay TV services. If PPV/VOD and other miscellaneous revenues fulfills diverse viewing demands for the whole household. are included, then the average monthly bill is $64 Source: 2013 CRTC BDU Filings data. 4 Source: http://www.newswire.ca/fr/story/1363727/new-tvb-research-study- confirms-commercial-television-is-the-dominant-video-viewing-medium- in-canada.

5 BDUs viewing experience. These costs are relatively fixed regardless of the number of channels an individual Canadian BDUs distribute television programming household subscribes to. services from conventional, pay, specialty, PPV, and VOD programming services via cable, satellite, and fibre. In Broadcasters 2013, BDUs generated approximately $8.8 billion in revenue from television distribution, 94% of which was The Canadian television broadcasting industry is subscription revenues from consumers. comprised of media companies that aggregate, license, and sell programming services to BDUs, and increasingly In recent years, BDUs have offered more options for through OTT services and direct to consumer (DTC) consumers than traditional TV packages. Thousands of forms of internet distribution. In 2013, the television movies and TV shows are available on BDUs’ VOD menus, broadcasting industry generated in addition to hundreds of a la carte programming and $7.3 billion in revenue6. themed mini-pack options.

The largest operating costs to BDUs are affiliate fees to broadcasters for the right to distribute their programming to subscribers. In 2013, affiliate fee payments constituted 37%5 of operating expenses for all reporting BDUs, which go directly to supporting the broadcasting and production industries. In addition, BDUs have high capital costs related mainly to the development of network capacity and technologies to improve the 6 CRTC Programming Services Financials. Total market including Conventional, 5 CRTC Broadcast Distribution Statistical and Financial Summaries 2013. Specialty, Pay, PPV, and VOD.

6 Canadian television broadcasters offer hundreds For specialty and pay TV broadcasters, programming of unique Canadian television services in the expenditures account for 75%7 of their current total following categories: cost base. In the interest of promoting and protecting Canadian content, the CRTC requires that all broadcasters •• Conventional: public and private services without devote minimum portions of broadcast time to Canadian any restriction to theme or content that are programs. Similarly, as a result of the CRTC’s requirements permitted to air a wide variety of news, information, relating to Canadian Programming Expenditures (CPE), entertainment, sports, and other programming on average approximately 36%8 of the previous year’s •• Specialty: private and publicly-owned services that revenue generated by pay and specialty TV services is are restricted to a particular genre such as news, directed to the acquisition or production of Canadian music, arts, sports, etc. programming. Promoting and protecting Canadian •• Category A: services that must be carried by all content are important objectives, and a reduction in the BDUs with the capability to do so; includes revenues of these pay and specialty TV services could channels with a higher Canadian content quota jeopardize the availability of a diverse selection of high- than Category B services quality Canadian programming. •• Category B: services that may be optionally carried by BDUs Independent production and employment •• Category C: national and mainstream news In the 2012/13 broadcast year, $2.3 billion was directed (must offer) and sports (optional carriage) services to Canadian TV production, supporting 20,000 direct •• Pay: premium-tier subscription-based services full time jobs and 30,900 additional ancillary jobs. Of •• PPV and VOD: services that subscribers purchase the $2.3 billion directed into Canadian TV production on an individual level (events or shows). in 2012/2013, $461 million came directly from private broadcaster license fees. In 2013, BDUs contributed For this study, we focused only on Specialty and Pay TV, $216 million to the CMF and $61 million to independent because those programming services would be most funds. Both of these funding mechanisms are based directly affected by the CRTC’s proposed approach. upon a percentage of regulated revenues and are reliant However, changes to these services could also have a on the continued financial health of Canadian private knock-on effect on conventional broadcasters, as they broadcasters and BDUs. often share infrastructure, programming acquisition, and production activities with pay and specialty services. Exhibit 2 is a bar graph from the Canadian Media Production Association. It identifies the different sources Specialty services generate revenue primarily from of Canadian TV production financing for the 2008/2009 to affiliate fees charged to BDUs (~65% of total revenues) 2012/2013 broadcast years. It shows that in 2012/2013, and advertising revenue from the sale of airtime $300 million came from the Canada Media Fund and $461 (~35% of total revenue). Thus, a reduction in BDUs’ million from private broadcaster license fees. subscription fees would have an immediate impact on specialty and pay TV programmers’ main revenue source. A reduction in their viewership would also negatively affect advertising.

7 Source : CRTC’s 2013 financial statistics: http://www.crtc.gc.ca/eng/ publications/reports/BrAnalysis/psp2013/psp2013.pdf. 8 Source : CRTC’s 2013 financial statistics: http://www.crtc.gc.ca/eng/ publications/reports/BrAnalysis/psp2013/psp2013.pdf.

7 THE CANADIAN TV INDUSTRY IS DIVERSE AND DEEPLY INTERTWINED

Exhibit 2: CANADIAN TV PRODUCTION FINANCING The CMF provides $300 million of funding to the $ MM Canadian production community annually. The CMF is funded through contributions from the Government of Other*2 Canada and from Canadian BDUs. 2,572 BDUs’ contributions account for approximately 2/3 261 2,320 Canada 2,231 media fund of the total funding of the CMF (approximately $200 2,154 200 303 9 271 2,041 million ), which represents ~ 9% of total funding 240 300 Foreign 234 213 to the production industry. Any reduction in BDUs’ 275 282 197 television revenues would have a direct impact on their 307 313 234 159 Canadian 258 distributor*1 CMF contributions. This would result in independent 160 156 197 128 producers having less financing for their productions, 732 and fewer Canadian programming options for 535 650 Tax credits 566 594 consumers.

221 221 Public Broadcaster 198 182 254 license fees The Canadian TV ecosystem is an interdependent ecosystem, where disruptions to one part have a 536 501 529 451 461 Private Broadcaster substantial impact on the others. If BDUs and/or license fees broadcasters saw a decline in total revenues, the overall 2008– 2009– 2010– 2011– 2012– 2009 2010 2011 2012 2013 funding available for independent Canadian program production would decline, as demonstrated above. If Source: Profile 2013 Economic Report on the Screen-based Media Production Industry in Canada. other public funding sources were not able to make up *1 These are not BDUs, but rather distributors of movies, etc. *2 Other includes “Other Public” ($19 million in 2013) and “Other private” for this shortfall, the overall system would see a lower ($181million in 2013), and the latter includes independent production funds number of productions being made and the quantity (BDU contribution) and broadcaster equity. and/or quality of Canadian programming would be Private broadcasters are required to devote a percentage compromised. Less funding in the system would also of their regulated revenues to CPE in the following year. make it even more challenging for Canadian producers These requirements, in the form of licence fees, direct to compete with well-funded U.S. competitors, who over $450 million dollars into the Canadian production enjoy a much larger, and less regulated, national market community annually. These license fees support a wide and more receptive international markets for their array of popular genres of programming, including commercially-focused programming. comedy, drama, documentary and children’s and youth. Any reduction in regulated revenues (either advertising or affiliate fees) would put direct pressure on private broadcasters’ ability to commission, invest in, and air original programming from Canadian independent producers.

9 Source: CRTC Communications Monitoring Report 2013, Figure 2.1.7: “41% of BDUs’ total $506MM contribution went to the CMF ($207MM) ”.

8 1.2. CRTC’S TV CONSULTATION: PROPOSED CHANGES In October 2013, the CRTC launched the first phase of The proposed changes would require BDUs to: “Let’s Talk TV: A Conversation with Canadians”, a public •• Offer a “Small Basic” package with just a selection dialogue about the future of Canadian television. Its of Canadian services, which the CRTC has defined objective was to assess how the Canadian television to include: local Canadian TV stations; section 9(1) industry can better serve consumers and better fulfill the (h) services such as the Cable Public Affairs Channel goals of the Canadian broadcasting system. Phase 2 of the (CPAC) and the Aboriginal Peoples Television “Let’s Talk TV” process presented Canadians with a survey Network (APTN); provincial educational channels; to determine consumer preferences regarding their community channels; and the services operated by television programming service choices. The majority of provincial legislatures. survey respondents claimed to prefer a flexible packaging subscription (a la carte or BYOP) model (more than 85%) •• Offer all other programming services on a 1) pick- over larger pre-assembled packages, suggesting that and-pay basis (i.e., choose channels on an individual, Canadians value more flexibility in the distribution and a la carte basis); and 2) a build-your-own-package packaging of television services. basis (also known as “pick-packs”, consisting of pay and specialty channels). However, the questions posed to respondents in the •• Continue to offer consumers the current packages “Let’s Talk TV” survey involved only limited economic and any further pre-assembled packages they create. trade-offs, leaving it unclear how prepared Canadians are to pay for increased flexibility10. All else being equal, An evaluation of these proposed changes must consider most consumers would lean towards a more flexible their economic impact on consumers and various subscription model than a more structured subscription participants in the Canadian TV ecosystem as well as the model. Less certain is whether consumers would continue impact on the consumer experience. In the following two to choose a more flexible model if it were associated sections, we will explore each in turn. with increased costs per channel. Therefore, we believe these survey responses do not necessarily reflect actual consumer behavior in a realistic environment where economic constraints affect pricing and programming quality.

In April 2014, as Phase 3 of the “Let’s Talk TV” process, the CRTC released a public notice describing its proposed approach to maximize consumer choice and flexibility11.

10 Question asked on Pick and Pay opton were fairly high level : “Considering their situations and perspectives, and your own television habits, which one of these three options would you choose and why? “Pick and pay - Large preassembled packages - pick a pack - other”. 11 Outlined in Broadcasting Notice of Consultation CRTC 2014-190: http://www. crtc.gc.ca/eng/archive/2014/2014-190.htm.

9 10 ECONOMIC IMPACT 2 ON STAKEHOLDERS 2.1. SUMMARY CONCLUSIONS To calculate the potential impact of the CRTC’s proposed if there would be economic benefit to either consumers approach, compared with the status quo which assumes or industry participants at either end. Understanding that the broadcasting industry continues to naturally evolve the reality will likely fall somewhere in between the two driven by market and competitive forces, we modeled extremes, we also modeled a “Middle Scenario” (Scenario two extreme scenarios based on the extent to which the C), in which consumers and industry participants share industry reacts to the changes: the economic impact – total subscription revenue is maintained at current levels, implying a slight increase In Scenario A, broadcasters, BDUs, and production in consumer bills compared to Scenario A, which partially businesses absorb all economic impact of the proposed offset the impact that broadcasters, BDUs, and the approach without passing any onto consumers in the production sector need to absorb. For this scenario, form of higher prices. This scenario would challenge the we have also assumed that half of the negative economic economic sustainability of many players in the long term. impact from maintaining the same EBITDA12 margin for In Scenario B, industry participants ensure the economic BDUs (as estimated in Scenario B) will be passed down sustainability of their businesses by maintaining current to broadcasters in the form of decreased affiliate fees. margins; they do so by increasing pricing to consumers, This economic impact must be considered as additive both to those who choose the new a la carte/BYOP offers to the natural evolution of prices and costs that can and to those who retain their current packages. be expected over time (e.g., inflation, rising content Neither of these extreme scenarios is likely to be the new costs, increasing marketing costs as more and more equilibrium, but for the purpose of this analysis, we have 12 Earnings before interest, taxes, depreciation and amortization (also known as first defined the boundaries of the spectrum to evaluate operating cash flow).

11 channels are already made available on an a la carte Programming diversity would be compromised, and basis, other regulatory changes, impact of unregulated approximately 26% of programming services could competitors, etc.). In other words, these impacts should risk insolvency, even with conservative estimates be considered relative to the status-quo that will itself be of the threshold (10% EBITDA margin) for financial changing due to market and competition forces. sustainability13.

Based on our assumptions of the price of Small Basic, Scenario A a la carte channels, and BYOP discounts (see Appendix Industry subsidizes consumers A), we estimate that ~35% of current TV subscribers would opt for a la carte/BYOP options. If we segment In Scenario A, where the industry bears all of the this total impact, consumers who choose the Small Basic economic impact of the CRTC’s proposed approach, + a la carte/BYOP options would pay slightly less than consumers on average pay a little less ($3 or 6% of their today ($5 less on video subscriptions). However, they current bill) to get far fewer channels (16 fewer channels would also receive less value, with 44 fewer channels on average and 44 fewer for those that switch). The (59% fewer) than before and thus much less diversity of Canadian TV industry overall will lose roughly $670 programming and ability to discover new content. By million, through both lower revenues and increased contrast, those who choose to stay with their current costs, resulting directly in $40 million less funding for packages (65% of total) could risk losing both the the independent Canadian production sector, and quantity and quality of the programs that they enjoy indirectly in job losses. The impact on overall Canadian now as the viability of more than one-quarter (26%) of production is much larger, as both independent and programming services could be in danger. non-independent production would be affected. 13 We recognize that 21% of programming services are already under this threshold today, and CRTC’s proposed approach will further exacerbate the situation and put more of them at risk.

12 This scenario would see a significant drop in both costs and subscriber losses. The latter would increase broadcasters’ and BDUs’ EBITDA (19% each). EBITDA is consumer bills for the same or even fewer channels. The expected to drop by $223 million for broadcasters and impact of these likely moves will be explored further in by $407 million for BDUs. Furthermore, if BDUs are not Scenario B and Scenario C. able to price-differentiate channels in BYOP options based on the cost/value of content, BDUs’ EBITDA It is also important to note that even though this analysis would drop further, by a full 29% ($554 million). Given is focused on specialty channels, the impact on these the EBITDA pressure on broadcasters, programming services would have a cascading effect on the rest of the investments would be cut, adversely impacting both ecosystem, including conventional channels. the volume and quality of Canadian programs produced If we assume that Scenario A were to unfold, and undermining the objective for programming Exhibit 3 shows the changes in average subscription diversity that the CRTC aims to uphold, unless public fees (weighted average of all subscribers) and average funding sources would make up the shortfall. The number of channels for consumers – both those who impact on Canadian independent production would be change and those who retain their current packages. approximately $40 million, while the overall impact on total Canadian production could be more than twice this Exhibit 3 is a bubble chart showing impact to consumers amount when including non-independent producers. for Scenario A. Average population receives 70 channels and pays $52 per month for TV services. 35% of subscribers This scenario is of course not a sustainable one. BDUs would save 15% with an a la carte/BYOP offer and receive would need to compensate their loss by reducing fewer channels to have their average bill reduced. 65% of affiliate fees or raising consumer prices, or both. The subscribers would stay on their current package and pay former would put more pressure on broadcasters, who the same monthly subscription fee. would already suffer from significantly higher marketing

Exhibit 3: SCENARIO A - IMPACT ON CONSUMERS AVERAGE MONTHLY BILL AND NUMBER OF CHANNELS SUBSCRIBED MONTHLY BILL IN $ 65

60 Staying on current package

55 3 Switching to BYOP or a la carte 2 50 Proposed changes 4 45 Current situation 40 1 Bubble size is a function of percentage of subscribers in 35 each pricing scheme 20 30 40 50 60 70 80 90 100 NUMBER OF CHANNELS SUBSCRIBED

1 AVERAGE STARTING POINT 2 SEGMENTED STARTING POINT 3 TRANSITION 4 END4 STATE • Average of $52 monthly bill • 65% of subscribers likely to • 35% select fewer channels • 65% keep their subscription, for 70 channels splits stay on their current package to save on their subscription pay same ($50.4) for same currently spend $50.4 for channels (68) 1 682 channels 3 4 • 35% switch to an a la carte/ • 35% of subscribers likely to BYOP subscription, receive switch to a la carte/BYOP fewer channels (30) for a currently spend $55.4 for lower bill ($47.0) 74 channels Source: Oliver Wyman analysis. Note: Monthly video bill excludes equipment charges, VOD, PPV.

13 ECONOMIC IMPACT ON STAKEHOLDERS

Exhibit 4 is a horizontal bar chart showing industry impact impact is -$39 million revenue and funding. Consumer bill for Scenario A. Broadcaster impact is -$223 million EBITDA. decreases by $3 on average. BDU impact is -$407 million EBITDA. Independent production

Exhibit 4: SCENARIO A - IMPACT ON THE INDUSTRY % CHANGE vs. BASELINE

Production rev/ -6% (-$39 M) funding Broadcaster EBITDA -19% (-$223 M)

Broadcaster cost*1 0% (+$12 M)

Broadcaster revenue -6% (-$212 M)

BDU EBITDA -19% (-$407 M)

BDU cost*1 0% (-$8 M)

BDU revenue -5% (-$415 M)

Consumer bill -6% (-$3) 6%

Source: Oliver Wyman analysis. *1 Besides affiliate fee costs, marketing and customer care costs, other cost components are assumed constant.

Scenario B consumers would pay a lot more (about 14%) for 44 Consumers pay for flexibility14 fewer channels (59% fewer). Obviously this outcome will not be the new equilibrium, as more and more Scenario B assumes that broadcasters and BDUs will consumers choose to stay with current packages as the be compelled by financial realities to support margins cost of new options rises, which would drive prices by both cutting costs and raising prices, in order to up even higher for those who opt for Small Basic + afford consumers the flexibility called for in the CRTC’s a la carte/BYOP. proposed approach. In Scenario B, we assume that industry players adjust pricing and costs to maintain Broadcasters will incur losses to affiliate fees and their current margins. advertising revenue, and see an increase in marketing costs under the CRTC’s proposed approach. So in order The average consumer bill will increase by approximately to maintain margin at current levels, they will need to 5% ($3) in order to compensate for higher costs in the TV increase revenues from affiliate fees by 8% and raise ecosystem, and consumers on average will still receive prices to BDUs. BDUs will have to pay not only these 16 fewer channels (22%). We assume that this price increased affiliate costs but also higher marketing and increase would be passed on to all consumers equally, customer care costs, while infrastructure costs remain in which case the percentage of consumers that choose fixed regardless of how many channels each customer to switch to a la carte/BYOP would remain the same as subscribes to. Thus in order to maintain current margin Scenario A. Alternatively, an argument could be made levels, they will need to increase consumer subscription that only those who choose to have more flexibility revenues by 5% overall. should pay a higher price. Under that scenario, those

14 Exhibit 5 is a bubble chart showing impact to consumers for fewer channels to have their average bill reduced. 65% of Scenario B. Average population receives 70 channels and subscribers would have to pay a higher subscription (+12%) pays a $52 per month for TV services. 35% of subscribers to stay on their current package. would save 5% with an a la carte/BYOP offer and receive

Exhibit 5: SCENARIO B - IMPACT ON CONSUMERS AVERAGE MONTHLY BILL AND NUMBER OF CHANNELS SUBSCRIBED MONTHLY BILL IN $ 65 3

60 Staying on current package

55 3 Switching to BYOP or 4 a la carte 2 50 Proposed changes

45 Current situation 40 1 Bubble size is a function of percentage of subscribers in 35 each pricing scheme 20 30 40 50 60 70 80 90 100 NUMBER OF CHANNELS SUBSCRIBED

1 AVERAGE STARTING POINT 2 SEGMENTED STARTING POINT 3 TRANSITION 4 END4 STATE • Average of $52 monthly bill • 65% of subscribers likely to • 35% select fewer channels • 65% keep their subscription, for 70 channels splits stay on their current package to save on their subscription and pay more ($56.5) for currently spend $50.4 for • Simultaneously, rates same channels (68) 1 682 channels 3 4 increase by 5% monthly, • 35% switch to an a la • 35% of subscribers likely to when BDUs try to preserve carte/BYOP subscription switch to a la carte/BYOP their margin and receive fewer channels currently spend $55.4 (30) for a lower bill ($52.4) for 74 channels Source: Oliver Wyman analysis. Note: Monthly video bill excludes equipment charges, VOD, PPV.

Those who choose Small Basic + a la carte/BYOP options end up paying more for the same level of service. end up paying slightly less for significantly fewer Effectively, the majority is subsidizing the benefit channels, while those who keep their current packages of the few.

15 ECONOMIC IMPACT ON STAKEHOLDERS

Exhibit 6 is a horizontal bar chart showing industry impact in revenue and funding (+2%). Consumer bill increases for Scenario B. Broadcaster and BDU impact is EBITDA by $3 on average (+5%). neutral. Independent production impact is +$14 million

Exhibit 6: SCENARIO B - IMPACT ON THE INDUSTRY % CHANGE vs. BASELINE

Production rev/ funding 2% (+$14 M) 1% Broadcaster EBITDA 0% ($0 M)

Broadcaster cost*1 6% (+$128 M)

Broadcaster revenue 3% (+$128 M) 8%

BDU EBITDA 0% ($0 M)

BDU cost*1 10% (+$377 M)

BDU revenue 5% (+$377 M) 5%

Consumer bill 5% (+$3)

Source: Oliver Wyman analysis. *1 Besides affiliate fee costs, marketing and customer care costs, other cost components are assumed constant.

Neither of the extreme Scenarios A or B is likely to be fully For this scenario, we have then assumed that half of realized, but it helps to demonstrate how even at the the negative economic impact from maintaining the extremes, the majority of Canadian television consumers same EBITDA margin for BDUs from Scenario B will be lose value under the CRTC’s proposed approach, and passed down to broadcasters in the form of decreased only a small minority see a financial benefit even in the affiliate fees. unlikely event that there were no industry adjustments to compensate for the adverse economic impact. Given Overall, the Canadian TV industry will lose approximately economic realities, we would expect the new equilibrium $316 million through an increase in costs. As in Scenario to be somewhere in the middle, and Scenario C A, programming diversity will be compromised, since illustrates how that might look.15 approximately 24% of programming services would still be at risk of financial unsustainability. In summary, even in this “Middle Scenario”, most consumers still pay more Scenario C for fewer channels, the Canadian TV industry still incurs The “Middle Scenario” losses, and programming diversity ultimately suffers. The impact on Canadian independent production To explore a potential equilibrium, we modeled a would be a loss of $13 million in funding, while the third scenario where the industry dynamics find a overall impact on total Canadian production would be middle ground (Scenario C). In this scenario in which more than twice this amount when non-independent consumers and industry participants share the economic producers are considered16. impact – total subscription revenue for BDUs is maintained at the same level as today – there is a slight increase in consumer average monthly bill, compared to Scenario A. This partially offsets the impact that broadcasters, BDUs, and production businesses need to absorb.

16 Estimated based on the CRTC published estimates of broadcasters’ spend on Canadian made content, released on April 30th, 2014.

16 Exhibit 7 is a bubble chart showing impact to consumers for fewer channels to have their average bill reduced. 65% of Scenario C. Average population receives 70 channels and subscribers would have to pay a higher subscription (+6%) pays a $52 per month for TV services. 35% of subscribers to stay on their current package. would save 10% with an a la carte/BYOP offer and receive

Exhibit 7: SCENARIO C - IMPACT ON CONSUMERS AVERAGE MONTHLY BILL AND NUMBER OF CHANNELS SUBSCRIBED MONTHLY BILL IN $ 65 3

60 Staying on current package

55 3 Switching to BYOP or 4 a la carte 2 50 Proposed changes

45 Current situation 40 1 Bubble size is a function of percentage of subscribers in 35 each pricing scheme 20 30 40 50 60 70 80 90 100 NUMBER OF CHANNELS SUBSCRIBED

1 AVERAGE STARTING POINT 2 SEGMENTED STARTING POINT 3 TRANSITION 4 END4 STATE • Average of $52 monthly bill • 65% of subscribers likely to • 35% select fewer channels • 65% keep their subscription, for 70 channels splits stay on their current package to save on their subscription and pay more ($53.5) for currently spend $50.4 for • Simultaneously, rates same channels (68) 1 682 channels 3 4 increase to maintain • 35% switch to an a la • 35% of subscribers likely to baseline monthly carte/BYOP subscription switch to a la carte/BYOP subscription fee on and receive fewer channels currently spend $55.4 average subscriber (30) for a lower bill ($49.8) for 74 channels Source: Oliver Wyman analysis. Note: Monthly video bill excludes equipment charges, VOD, PPV.

17 ECONOMIC IMPACT ON STAKEHOLDERS

Exhibit 8 is a horizontal bar chart showing industry impact Independent production impact is -$13 million in revenue for Scenario C. Broadcaster impact is -$200 million and funding (-2%). Consumer bill is stable. EBITDA (-17%). BDU impact is -$95 million EBITDA (-5%).

Exhibit 8: SCENARIO C - IMPACT ON THE INDUSTRY % CHANGE vs. BASELINE

Production rev/ funding -2% (-$13 M) Broadcaster EBITDA -17% (-$200M)

Broadcaster cost*1 +3% (+$80 M)

Broadcaster revenue -3% (-$121 M)

BDU EBITDA -5% (-$95 M)

BDU cost*1 +2% (+$95 M)

BDU revenue 0% ($0 M)

Consumer bill 0% ($0 M)

Source: Oliver Wyman analysis. *1 Besides affiliate fee costs, marketing and customer care costs, other cost components are assumed constant.

Exhibit 9 is a table showing summary consumer metrics for B generates an increase of average consumer bill for less the estimated impact of the CRTC’s proposed changes for channels received. Scenario C is an intermediate scenario, Scenarios A, B and C. Scenario A generates fewer channels with fewer channels received for the same monthly bill. received and a decrease of average consumer bill. Scenario

Exhibit 9: SCENARIOS A, B, C - IMPACT ON CONSUMERS

SCENARIO A SCENARIO B SCENARIO C Baseline Stay(*) Switch(*) Overall Stay(*) Switch(*) Overall Stay(*) Switch(*) Overall Take rate - 65% 35% - 65%*3 35%*3 - 65%*3 35%*3 - Channels 70 68 30 54 68 30 54 68 30 54 subscribed*1 % Change in - - -59% -22% - -59% -22% - -59% -22% channels subscribed Monthly $52.2 $50.4*4 $47.0 $49.2 $56.3 $52.4 $54.9 $53.5 $49.8 $52.2 bill*2 % Change in - - -15% -6% +12% -5% +5% +6% -10% - monthly bill

(*) Stay: Subscribers staying on their current package. Switch: Subscribers switching from current package to new offer created as a result of CRTC proposed changes. *1 In our base scenario, number of channels subscribed is lower than 70 channel baseline average for subscribers staying on their current package. *2 Monthly bill excludes equipment rental, PPV, VOD charges and tax. *3 % of consumers switching would be dependent on how BDUs pass price increase – if the price increase is the same in proportion to current packages and a la carte/BYOP, the % switching would not change from Scenario A (assumed in numbers shown). *4 Price for current channels remain unchanged, and the difference in monthly bill reflects the consumer mix, i.e. the mix of people who take basic packages vs. premium packages.17

18 Exhibit 10 is a table showing summary industry metrics for industry impact is neutral. Scenario C is an intermediate, the estimated impact of the CRTC’s proposed changes for with negative economic impact overall but less pronounced scenarios A, B and C. Scenario A shows negative economic than Scenario A for BDUs. impact for the industry. In Scenario B,

Exhibit 10: SCENARIOS A, B, C - SUMMARY IMPACT ON INDUSTRY18

BASELINE SCENARIO A SCENARIO B SCENARIO C $ MM Δ $ MM Δ % Δ $ MM Δ % Δ $ MM Δ % Impact on Broadcasters Revenues Affiliate fee revenues*1 2,374 -152 -6% 188 +8% -61 -3% Advertising revenues*1 1,297 -60 -5% -60 -5% -60 -5% Costs Broadcaster marketing costs*1 213 128 +60% 128 +60% 128 +60% Programming costs*1 1,947 -116 -6% 0 0% -49 -3% Margin EBITDA 1,145 -223 -19% 0 - -200 -17% Impact on BDUs Revenues Subscription revenues*2 7,211 -415 -6% 377 +5% 0 0% Affiliate fee costs*2 2,700 -172 -6% 213 +8% -68 -3% Costs BDUs marketing costs*2 583 58 +10% 58 +10% 58 +10% Customer care costs*3 879 105 +12% 105 +12% 105 +12% Margin EBITDA 2,095 -407 -19% 0 - -95 -5% Impact on independent production*4 Rev/funding Broadcaster contribution*1 379 -23 -6% 0 0% -13 -3% BDU contribution*2 277 -17 -6% 14 +5% 0 - Overall impact 656 -39 -8% 14 +2% -13 -2%

*1 CRTC releases 2013 financial results for specialty, pay, pay-per-view and video-on-demand television services (4/30). *2 CRTC releases 2013 financial results for Canadian cable and satellite companies (5/15). Gap between affiliate fee costs for BDU and affiliate fee revenue for broadcasters for scope (specialty/pay ) is explained by affiliate fee costs paid to non-Canadian broadcasters. *3 Based on CRTC public report and conversations with large Canadian BDUs. *4 Only includes impact on independent production funding. The non-independent production sector is larger in Canada, and the impact is further detailed in section 2.3.4.

The following sections will describe in greater They will also explore how these scenarios detail the methodology and logic we used to arrive would vary based on sensitivities to key assumptions at the scenarios. and uncertainties.

2.2. KEY ASSUMPTIONS

2.2.1. GUIDING PRINCIPLES18 to model actual subscription decisions under various offer and pricing scenarios, we felt that assuming In all of our analyses, we assume consumers will financial rationality would be the cleanest, most always make financially rational decisions. For example, objective, and most fact-based way to predict consumers will always choose the channels that they future consumer behaviour. watch the most often and choose the packaging options where they can get the most relevant channels at the We conducted our analysis on all specialty and pay lowest price. However, we are keenly aware that in the television programming services, as those are the real world, consumers usually fall short of completely services directly affected by the CRTC’s proposed rational behaviour, especially when presented with a changes. Conventional channels, which are included in all large number of choices. In fact, consumers are usually subscription options, will remain a part of any TV offer and “predictably irrational”. However, absent in-market tests thus will not be affected. Similarly, PPV and VOD services will continue to remain as discretionary options. 18 Specialty and pay services only.

19 ECONOMIC IMPACT ON STAKEHOLDERS

2.2.2. BASELINE The end-state scenario assumes that the BYOP option will be price-differentiated, or tiered, based on the Consumers today subscribe to an average of roughly 50 inherent value and cost of individual channels. For specialty and pay channels in addition to approximately example, premium sports channels would not be in the 20 channels identified by the CRTC as components of a same tier as niche specialty channels. Currently, these Small Basic service (see 2.2.4), making the total channels channels are often packaged based on genre or interest, available to the average consumer to be approximately and different theme packs are priced accordingly. 70. We arrived at this baseline number from available information from the CRTC for Canadian BDUs. For pay and specialty channels that are currently included in basic or discretionary programming Based on an analysis of 2013 CRTC BDU data, we found packages but will be forced to become a la carte, we 19 that the monthly bill is $52 per subscriber . Note that assumed a per channel price of $3, which is the general this ARPU includes only revenues from basic, specialty, retail stand-alone price of channels that are both and pay TV subscriptions, and reflects the range of included in packages and also offered a la carte. For promotions offered. The overall industry monthly bill is channels that are currently offered only a la carte, we actually $64 per subscriber, which includes revenues kept their respective tiers of pricing, which ranged from from PPV/VOD as well as other miscellaneous revenues, $3 to $15 per channel, driven by variances in wholesale but we based our analysis on the services that will be fees. We calculated an industry average a la carte affected by the CRTC’s proposed approach, leaving us retail price per channel of $3.7321, using a weighted with $52 that is in scope. calculation of a la carte pricing based on BBM data on weekly viewership reach at a channel by channel level. 2.2.3. END-STATE SCENARIO 20 This is a conservative approach to determining the bill impact of the CRTC’s proposed approach, based on the The CRTC’s proposed approach calls for BDUs to offer current rating and market dynamics. a small, all-Canadian basic bundle of programming services (Small Basic)20 and allow consumers to choose Although unlikely, we also conducted a slight variation all other programming channels on a stand-alone on this end-state scenario, assuming instead that the basis (a la carte) or a build-your-own-package (BYOP) services offered as part of the BYOP option were not basis, picking a set number of channels from a list for allowed to be price-differentiated, and that BDUs would a fixed fee. Because some consumers have indicated be required to charge the same retail price per channel that they are satisfied with their current subscriptions, ($3) regardless of the variation in wholesale prices. BDUs will be allowed to continue their current pre- That would cause BDUs’ margins at a per-channel level assembled offerings. to be much lower for those channels with high affiliate fees, producing a more pronounced negative impact on To simulate how the CRTC’s proposed approach will BDUs’ economics. affect the Canadian TV industry, we modeled how we would expect consumers to behave given the new range Note that the model is agnostic to how the packages of package options, and then calculated the industry- are marketed, and assumes that consumers have wide economic implications. We developed an end- perfect information about all of their choices and would state scenario against today’s baseline to calculate the make rational decisions accordingly. Actual marketing expected impact and then tested sensitivities around it requirements and activities will of course have an impact to show the range of possible outcomes. on the evolution of any scenario.

19 Monthly bill for video subscription excluding cost of equipment rental, PPV, VOD, charges and tax. 20 The Small Basic bundle would include only local Canadian conventional television services, 9(1)(h) services, and provincial educational services, as 21 This price is likely to be higher in reality, given that consumers are apt to choose well as in some cases the community channel and the provincial legislature more “premium” channels when they choose fewer channels. The current rating programming service. only reflects the viewing behaviour under current options.

20 2.2.4. SMALL BASIC ASSUMPTIONS those assumptions, we developed a simulation of how subscription options could be structured: Based on the CRTC’s guidelines, the Small Basic package should include only local Canadian conventional Channels will be offered on a stand-alone basis, priced television services, 9(1)(h) services, and provincial at $3.73 per channel per month. Recall that this is a educational services, as well as in some cases the weighted average of the stand-alone pricing for channels community channel and the provincial legislature that would become a la carte under proposed changes programming service. This led us to assume that (which could range from $3 to $15). The pricing for ~20 channels will be part of the Small Basic package. this would be: Small Basic ($25) + $3.73 * Number of channels chosen. We also had to define a starting price for the Small Basic tier. Based on our analysis of Videotron’s current BYOP options will have three tiers of choices. Consumers custom package offerings in Quebec and its public will have the option to choose 10, 20, or 30 channels out pricing structure, we derived that its default basic of a list (or a set of price-differentiated lists). The starting offering is ~$25 per month, which we assumed as a weighted retail price is still $3.73, but for each of the starting point. volume tiers we apply a volume discount to reflect that BYOP options would be made more financially enticing than pure a la carte selections. Our default assumptions 2.2.5. A LA CARTE AND for the BYOP packages are below. BYOP ASSUMPTIONS Small Basic ($25) + Choose 10 channels with Our starting assumption is that consumers will only 20% volume discount ($30) = $55 choose a la carte or BYOP options if the resulting monthly bill would be cheaper than their previous Small Basic ($25) + Choose 20 channels with monthly bill. We also assumed that if channel selection 30% volume discount ($52) = $77 decisions had a direct monetary implication, consumers would only opt-in to channels they currently watch Small Basic ($25) + Choose 30 channels with more than an average of five minutes per day (e.g., that 40% volume discount ($67) = $92 could be one half-hour TV episode per week). Based on

21 ECONOMIC IMPACT ON STAKEHOLDERS

2.3. SCENARIO A: ASSUMPTIONS AND IMPACT DETAIL Scenario A is built upon the premise that consumers Exhibit 11 is a flow chart describing the approach for benefit fully from flexible channel choices, and the calculating impacts in Scenario A. Impact starts with the industry absorbs all the cascading economic impacts. assumption that some consumers will accept a reduction Consumers get the flexibility that they say they want in the number of channels they receive to save on their and could pay less than before if they choose accordingly. monthly subscription fee. It then flows through assuming Industry stakeholders will then experience margin the TV industry will absorb the impact. pressure that may be unsustainable.

Exhibit 11: MODEL SCENARIO A – DRIVEN BY SUBSCRIBER’S CHOICES WITH IMPACT ON INDUSTRY Direction of impact BDUs Subscriber 2 Subscribers × revenue revenue per subscriber

Total revenue

Affiliate fees = affiliate payment revenue CONSUMERS INDEPENDENT Customer PRODUCTION 1 +12% Small Basic $25 care costs price Marketing + 1 +10% Funding costs 3 Avg. channels from BDUs 1 subscribed Total costs Calculations × 1 Margin Price per $3.73 channel Assumptions = BROADCASTERS Held constant 2 Revenue per Affiliate Funding from subscriber 2 payment 4 networks revenue Increase Auditing Advertising 1 viewing time 2 revenue Decrease Total revenue

3 Programming costs Marketing +60% from a la carte channels vs 1 costs Bundle channels

Total costs 4 Margin

2.3.1. CONSUMER ASSUMPTIONS of the major U.S. cable operators) to analyze viewing patterns. This data reveals the distribution of consumers AND IMPACT based on the number of channels they watch and the time they spent watching each channel. We assumed Uptake rate and channels subscribed that U.S. and Canadian viewing patterns are not To estimate the take rate for consumers, we leveraged fundamentally different in terms of number of channels a proprietary sample of actual viewing behaviour data and time per channel, though of course actual channel from more than 26,000 U.S. consumers (based on preferences (and selection) are distinct. household-level tuner activity on set-top boxes from one

22 We then applied these viewing patterns to Canadian 2.3.2. BROADCASTER consumer bill data, assuming that higher monthly bills correspond to those consumers who visit more channels. ASSUMPTIONS AND IMPACT We assumed that the more channels a consumer “touches” in any way, the more likely he is to subscribe Affiliate fee revenues will drop by to more expensive subscription tiers. While the reality of $152 million (6%) package subscription is more complex and can be based With the take rate assumptions leveraging U.S. on other factors (such as some consumers’ desire for consumer viewing behaviour data23, we calculated that the option value of having a wide array of programming 35% of consumers would switch to a new subscription available even if they watch very little), we verified based on the CRTC’s proposed approach. In other words, that this relationship holds true on average through they would subscribe to fewer channels than they do regression correlation tests. Thus, we have a good proxy today. Across the industry, then, many programming for each consumer’s current monthly bill based on services will lose a substantial portion of current 22 viewing behaviour . subscribers. This reduction will negatively affect affiliate We assumed that given the choice, consumers would fee revenues that broadcasters receive from BDUs. make an opt-in subscription choice for any channel For the 65% of consumers who stay with their current they watch more than an average of 5 minutes a day packages, we assumed that broadcasters will continue to (for example, one weekly half-hour TV episode). They charge the current rate for wholesale price per channel. would not pay for channels that they watched for less However, for the 35% of consumers who switch, we than that timeframe. We then simulated how much they assume that broadcasters will command a wholesale would have to pay if they switched (which depends on rate that is more reflective of the a la carte retail rate. how the new options are structured). We compared their In other words, since we calculated a $3.73 weighted a current package price to the hypothetical price of the la carte retail price, and since we found that in general new subscription created under the CRTC’s proposed the wholesale rate is 37% of retail rate24, we arrived at approach, and assumed that the consumer would make an estimated average wholesale price of $1.38. This the financially rational decision to stay or to switch. simulation is intended to be a first-order effect, where we The table below summarizes the outcomes of the assume that the industry does not react to renegotiate simulation engine, which then feeds into the economic affiliate fees (see Scenario B for a different perspective). model. More detail can be found in Appendix A. When we applied the respective calculations for the Exhibit 12 is the outcome of a simulation which estimates consumers who keep their plans vs. switch, we found that for base case chosen, under proposed approach, 65% of that industry affiliate fees drop by 6% (weighted subscribers will stay on the current package, 1% would only average). It is worth noting that this reduction affects subscribe to a small basic package, 15% would subscribe to some programming services disproportionately, and a small basic package and some a la carte channels and 19% would likely result in a concentration of revenues would subscribe to a small basic package and a BYOP option. amongst the larger programming services to the detriment of the smaller ones. Exhibit 12: SUMMARY OUTCOME OF SIMULATION ENGINE Advertising revenues will drop by $60 million (5%) SMALL SMALL SMALL BASIC BASIC AND BASIC KEEP ONLY A LA CARTE AND BYOP Based on our analysis on the U.S. subscriber sample, Take rate 65% 1% 15% 19% we estimated that by choosing options under the Average 68 20 24 36 CRTC’s proposed approach, subscribers would receive channels 59% fewer channels and reduce viewing time by 18% subscribed (associated with the channels they no longer receive) compared with their current situation.

23 Based on a U.S. cable operator’s set-top-box data. 24 Based on CRTC published Statistical and Financial Summaries for specialty 22 Calculations exclude the price for VOD, PPV, digital STB rental, etc. services and for broadcast distribution 2009–2013.

23 ECONOMIC IMPACT ON STAKEHOLDERS

Assuming that the subscribers who maintain their therefore assumed this 60% increase to be the industry current packages do not change their current viewing marketing cost impact of the CRTC’s proposed changes. behaviour, the weighted average loss of viewing time We should, however, point out that marketing costs across all subscribers would be 5%. (We used total are already on the rise for programming services as viewing time as a proxy for advertising revenue as a competition for viewership is intensifying given the rise simplification, knowing that in reality, it would not be of on-demand, time-shifted, and other alternatives for linear with audience decline). consumers’ attention. This increase would be additive to what is already happening naturally. The impact of decreased viewership on different programming services would be uneven. The average We also varied marketing cost increases to test the decreases ranged from 2% to 10% when we categorized sensitivity of marketing costs on broadcaster financials. programming services in 10 buckets built according These variations had an impact on broadcaster financials to AMA ratings. For smaller programming services, but did not change conclusions. unbundling will have a higher impact on viewing time, as many occasional viewers will stop subscribing to these Programming expenditures will drop by channels under the CRTC’s proposed approach. $116 million (6%) However, lower rated programming services are As a result of changing economics from decreased likely to experience a larger impact than mainstream affiliate payment revenue, decreased advertising channels. Customers will be less likely to purchase revenue, and increased marketing costs, broadcasters these services in an a la carte world, and advertising are likely to reduce programming expenditures to revenues will diminish. It is worth noting that despite maintain financial sustainability. lower ratings, some of these affected services are niche players that make a significant contribution to In Canada, operators of pay and specialty services programming diversity (e.g.,family, kids programming). generally devote 36%25 of their total revenues to The cascading effect on programming cost and the Canadian programming in the next year. Similarly, production industry will be explained later in the report. foreign programming is discretionary and we made the assumption that programming expenditures would Broadcaster marketing costs will increase by decrease in proportion to the drop in their total revenues $128 million (60%) (affiliate and advertising revenue). As a result of unbundling, broadcasters will have to increase their marketing expenditures to attract However, as premium content becomes more customers who have the option of not subscribing to expensive (see the “macro trends” section for a detailed particular services. Spending on cross-promotional discussion), with a squeezed budget, broadcasters material, billboards, television advertising time, and would face the difficult trade-off between offering very other marketing expenses is likely to increase. That hike few “premium” content options with a high price tag will occur regardless of how many subscribers choose to or offering lower quality content. This dynamic could leave their current packages. quickly become a downward spiral for broadcasters – the fewer premium program options and/or the lower We assume that under the CRTC’s proposed approach, the quality of the content, the fewer subscribers they programming services currently offered in a bundle will will attract, and affiliate revenue and advertising revenue have to increase sales and promotion expenditures to a will drop further, exacerbating the margin pressure and level similar to what a la carte channels currently spend. causing further cuts in programming expenditures. Using programming service financial data available In addition, certain programs such as sports services through the CRTC, we compared sales and promotion usually require long-term contracts that cannot be expenditures as a percentage of subscriber and easily adjusted from year to year. This would put further advertising revenue for channels sold in bundles versus pressure on broadcasters. a la carte channels. Mean expenditures as a percentage of subscriber and advertising revenue is 5.2% for bundled services and 8.3% for a la carte channels. We 25 Source: CRTC’s 2013 financial statistics: http://www.crtc.gc.ca/eng/ publications/reports/BrAnalysis/psp2013/psp2013.pdf.

24 Broadcaster EBITDA will drop by 2.3.3. BDU ASSUMPTIONS $223 million (19%) AND IMPACT The combination of the revenue and cost impacts described above will result in a 19% loss in EBITDA Subscription revenues will drop by margins for broadcasters. $415–$554 million (6%–8%) Given our take rate assumptions under the CRTC’s Programming diversity implications proposed approach, 35% of consumers would switch plans because doing so would allow them to pay In order to understand how the proposed changes less and pick the channels they want. Consequently, will affect Canadian programming, we segmented the the industry as a whole will experience a decrease in impact of affiliate revenue and advertising revenue for subscription revenues. different programming services, and then translated that into impact on programming expenditure. For the 65% of consumers who stay with current packages, we assumed the BDUs would continue We segmented the programming services into AMA to charge the current rate. However, for the 35% of rating-based deciles. The smaller programming services consumers who switch, we assumed that BDUs would with lower brand awareness are more susceptible to the charge a retail price that is more reflective of the a la changes and more vulnerable to the negative economic carte structure. We believe that undifferentiated pricing impact. We used this segmentation methodology to would be very challenging to accomplish across the full match buckets of services available in our U.S. sample spectrum of services, and therefore BDUs will create to buckets of services available in Canada. buckets of services for consumers to pick from. The In the current environment, affiliate revenues between weighted average a la carte price is $3.73. broadcasters and BDUs are usually negotiated as “make- Our calculations, which took into account the volume whole” contracts, in which BDUs guarantee broadcasters discounts of the BYOP offerings, suggest that industry a certain penetration rate, and thus a certain amount subscription revenues would drop by 6%. of affiliate fees. However, we believe that make-whole contracts will be significantly challenged under the In order to test the magnitude of the impact, we CRTC’s proposed approach, since penetration rates will ran a sensitivity analysis around BYOP with no price be much more volatile and make-whole arrangements differentiation by assuming a retail price of $3 for all would not be sustainable. In some cases, a programming channels. In that scenario, subscription revenues drop by service could experience a >50% drop in subscribers, 8%, or 33% more than in a price-differentiated scenario. and it is unrealistic to assume that it could expect a doubling in affiliate fees to compensate. Customer care costs will increase by We conducted similar de-averaging analysis on $105 million (12%) advertising revenue to derive the expected total revenue Given the new range of options available as a result of decrease. And as stated above, we assumed that regulatory unbundling, BDUs are likely to experience programming fees would decrease proportionately. higher customer care costs in order to manage the greater Based on this analysis, we estimated the negative impact complexity of their product offerings. We estimate that on different programming services. As expected, some customer care costs will increase by 12% as a result of the smaller programming services suffer disproportionately proposed changes. to the point that they might be at risk of financial The cost increase is based on bottom-up estimates unsustainability. While that threshold varies, if we make provided by leading Canadian BDUs, and relate mostly a conservative assumption that a programming service to additional staff required to handle the increased would require at least a 10% EBITDA margin in order to volume of customer education and order processing cover taxes, interest, and depreciation and have funds (mainly a la carte subscriptions and cancellations). to finance new programs, then approximately 26% of The estimated increase of 12% in customer care costs programming services will be at risk, potentially leaving does not include additional facilities or handling of consumers with fewer channel options. additional billing.

25 ECONOMIC IMPACT ON STAKEHOLDERS

BDU marketing costs will increase by 2.3.4. PRODUCTION ASSUMPTIONS $58 million (10%) AND IMPACT If the proposed approach is implemented, we anticipate that BDUs will need to spend more marketing dollars in Funding from specialty and pay TV will drop order to introduce and market additional subscription by $23 million (6%) options (Small Basic, extended list of a la carte channels, In the 2012/2013 broadcast year, specialty services different levels of BYOPs, etc.). Not only will BDUs need invested $1.3 billion in the creation of new television to spend more on website design, copy writing and programs made by Canadians and employed 6,120 direct mail, they will also need to create more frequent people. Specialty services paid $379 million to Canadian and more detailed marketing strategies to strengthen independent producers26. engagement. Doing so will increase the likelihood of consumers subscribing and will position the BDU to Assuming that the funding will decrease proportional to cross-sell channels. In addition, BDUs will attempt to broadcasters’ programming expenditure, it is estimated prevent churn as some consumers who switched to an that the independent Canadian production sector a la carte/BYOP option may be unhappy after realizing would lose $23 million from broadcasters, and the they value viewing the “occasional channels” they overall impact on Canadian production would be even previously received. higher (likely another $55 million, estimated at the same percentage decrease). After interviewing leading Canadian BDUs, we estimate that these companies may incur a 10% increase in marketing costs to bring proposed Funding from Canadian BDUs will drop by subscription options to market. $17–$23 million (6%–8%) This percentage assumption could vary depending According to financial information released by the CRTC on the strictness of the CRTC mandates. However, it on Apr 30, 2014, in the 2012/2013 broadcast year, BDUs is a conservative estimate, as the industry is already spent $477.7 million on the development of Canadian feeling pressure from new forms of competition and content. Of this amount, $216 million was directed to BDUs are already investing more in marketing to the CMF, $61 million to independent funds, $75 million compete effectively. to the Local Programming Improvement Fund and $125 million to cable-based community channels and other Industry EBITDA will drop by sources of local content. $407–$621 million (19%–29%) Assuming that the total contribution to the Canadian independent production sector ($277 million, the The combination of the revenue and cost impacts sum of contribution to CMF and independent funds) described above will result in a 19% loss in EBITDA is proportional to BDUs’ subscription revenue, it is margins by BDUs. If they are required to offer price- estimated that the BDU contribution to Canadian undifferentiated BYOP packages, EBITDA would independent production sector will decrease by drop by 29%. $17–$23 million (or 6%–8%).

Overall independent production funding will drop by $39–$46 million As a result of the funding decreases from broadcasters and BDUs, the overall funding for independent Canadian production will drop by $39–$46 million, or 6%–7% of current level of total private funding (BDU contribution and specialty/pay broadcaster contribution).

26 CRTC releases 2013 financial results for specialty, pay, pay-per-view and video-on-demand television services, Apr 30.

26 2.4. SCENARIO B: ASSUMPTIONS AND IMPACT DETAIL Scenario B is built upon the premise that industry Exhibit 13 is a flow chart describing the approach for stakeholders will protect their operating cash flow calculating impacts in Scenario B. Impact starts with the (or EBITDA) and redirect costs to the consumer through assumption that industry will maintain profitability despite higher subscription fees. This would result in a higher expected higher cost and lower revenue under proposed monthly bill for consumers who stay on their current changes and impact will be absorbed by consumers plan as well as for those who switch. through higher bills.

Exhibit 13: MODEL SCENARIO B – DRIVEN BY INDUSTRY WITH IMPACT ON SUBSCRIBERS’ BILLS Direction of impact

INDEPENDENT BROADCASTERS BDUs CONSUMERS PRODUCTION Audience Affiliate 4 Subscriber 3 payment revenue 1 viewing time revenue

Advertising Total revenue 2 revenue 3 Affiliate fees Small Basic price Total revenue Customer + 2 +12% costs Avg. channels 3 Funding 1 Programming 1 from BDUs cost subscribed Calculations × +60% from Marketing a la carte 2 2 Marketing +10% Price per Assumptions costs channels vs costs channel Bundle channels = Held constant Total costs Total costs Revenue per 4 subscriber Margins held Increase 1 Margin Margins held 1 Margin constant constant Decrease

27 ECONOMIC IMPACT ON STAKEHOLDERS

Production industry will keep its current level BDUs in aggregate will need to raise of funding subscription fee revenues by $377 million (5%) One of the key assumptions of this scenario is that the production industry will, at a minimum maintain its In order to maintain the current level of cash flow current level of funding; it may actually increase if BDUs (EBITDA) and offset the impact of increased affiliate fee generate more revenues by increasing subscription fees costs, customer care costs, and marketing costs, BDUs in order to maintain their current level of cash flow. would need to increase average subscription fees by 5%.

However, with the cascading impacts of reduced advertising revenue, instability and customer churn that Consumers in aggregate will pay 5% more are likely to occur, the production industry will suffer ($3 average bill increase) additional harm in the long term. The average monthly consumer bill will increase from $52 to $55, a 5% increase, in both scenarios. Canadians Broadcasters in aggregate will need to raise on average would be forced to pay more every month affiliate fee revenues by $188 million (8%) as a consequence of more “choice and flexibility”. Meanwhile, the average number of channels received In order to maintain the current level of cash flow by subscribers will decrease by approximately 30%. (EBITDA) and offset the impact of increased marketing Alternatively, if the total price increase is passed onto costs and lost advertising revenues, broadcasters would only those subscribers who choose BYOP or a la carte need to increase affiliate fees by 8%. offers, this group that values choice and flexibility would pay dearly; their subscription price would increase by more than 14%, and they would have received 59% fewer channels than before the proposed new approach.

28 CONSUMER EXPERIENCE IMPACT: CHOICE AND FLEXIBILITY – 3 A QUALITATIVE ANALYSIS

In the previous section, we explored the pure economic However, most consumers do not make purely rational impact of the CRTC’s proposed approach to TV decisions, nor are they aware of the full breadth of their unbundling. We saw that one significant impact is the occasional viewing behaviour. Consumers are generally potential for higher prices for many consumers to enable irrational, or as Professor Dan Ariely chose as the title lower prices for only very few, as well as greatly reduced of his book on behavioural economics, “predictably channel choice for many. irrational”. Moving from the current environment with a large pool of available programming to an a la carte It is equally important to assess the proposal’s impact scheme where one must predetermine all potentially on consumer experience. The option to pay only for relevant programming will likely result in lost value in those channels that the consumer decides are relevant is consumers’ TV viewing experience. Moreover, it bucks clearly intended to be a consumer-friendly proposition. the general trend we see in the marketplace of “all you It assumes that consumers have specific and regular can eat” access combined with intelligent search and viewing patterns, and that they possess all necessary discovery capabilities (for example: Netflix in video, information on their regular and future viewing habits Spotify in music, Next Issue in magazines, and the like). to make behaviourally and economically rational trade- off decisions.

29 3.1. MACRO TRENDS: TV VIEWING IS RAPIDLY CHANGING Macro trends in the TV marketplace are already video content is now being uploaded to YouTube every changing the viewing context. These trends have minute, more than a 5x increase from the 18 hours in significant implications for consumer behaviour, 2008, and more than 6 billion hours of video content and make TV consumption richer and more complex are watched there each month, reaching more 18–34 for consumers. year olds than any cable network28. This programming is increasingly competing for consumers’ TV viewing time and is now starting to be successfully commercialized. 3.1.1. SELECTED TRENDS Disney recently acquired YouTube network Maker Studio DISRUPTING THE INDUSTRY for up to $1 billion; YouTube is now marketing its top talent on giant billboards in NYC alongside traditional TV More content and more choice and film stars; and there are more than 40 independent creators earning over $1 million a year, circumventing There has been explosive growth in video content the traditional television ecosystem29. available to consumers. In Canada, the total number of TV services authorized to broadcast to consumers has grown to almost 750 in 201227. BDUs and OTT services offer a library of thousands of movies and TV shows on demand, and there is an almost unlimited supply of User Generated Content and semi-professional productions available via internet distribution. Over 100 hours of 28 Source: http://www.youtube.com/yt/press/statistics.html. 29 Source: Celebrity Net Worth: The 25 Highest Earning YouTube Stars 27 Source : Communications Monitoring Report, Section 4.3. Page 76. (March 9, 2014).

30 While many have prognosticated that this proliferation of Advertising Video on Demand, Over The Top (OTT) content will lead to a total fragmentation of viewing and services that distribute over broadband connections, audience, we are in fact seeing premium/blockbuster growth in Internet Protocol TV from telcos, web content commanding an even higher concentration of streaming direct from broadcasters, new entrants in viewership. Hollywood majors are making fewer but video production and direct distribution, and so on. bigger movies; only 114 films were released in 2013, down from 168 in 2008, while 12 releases had budgets As a result, “cord cutting” (cancelling one’s entire BDU of more than $150 million, compared to just five in 2008. video service) and “cord shaving” (cancelling some Sports rights are becoming more expensive: NBC will parts of one’s current video packages) are increasingly pay almost $1.3 billion for each of the next six Olympic common, as some consumers find programming that is Games, a 40% increase over the previous contract, and relevant to them at an attractive price and compelling Rogers’ recent NHL deal of $5.2 billion shows the value format from sources other than their traditional BDU. In of premium sports in Canada. Premium content rights Canada, TV subscriptions (cable and satellite) fell last are being bid up by new entrants: Netflix recently bid year, a relatively small decline that nevertheless marks upwards of $300 million a year to snatch Disney’s U.S. the first downturn after many years of growth. There Pay1 rights from Premium TV channel Starz, which had is also a growing group of “cord nevers,” the younger enjoyed them since 1993. That move forced Starz to generation that has never subscribed to a BDU service protect its Sony Pictures rights at all costs to prevent and has no intention of starting. According to a recent the same from happening there. The more fragmented survey by comScore, approximately 25% of Canadians available programming becomes, the more consumers between the ages of 18 and 24 describe themselves as flock towards common themes and blockbuster content. cord cutters (or cord nevers), a nearly 60% increase since 30 Thus there will be higher costs to secure premium 2010 . The market is clearly providing more options for programming that consumers demand in an increasingly consumers and putting pressure on traditional BDUs to competitive distribution environment, and audiences innovate to remain competitive. will become more concentrated around (typically U.S.- The increased viability of OTT alternatives has been produced) mainstream hits. enabled by the expansion of high-speed broadband. In short, broadcasters are feeling pressure from According to the CRTC, fully 90% of Canadian three sides; more channels to compete with, rising households have internet speeds higher than 5 Mbps, programming costs to secure blockbuster content, and and many households pay for much higher bandwidth increasing competition from the internet-delivered connections of 20 or even 50 Mbps. To put this in “long tail” content. Market forces are already putting perspective, less than 1 Mbps of download speed is substantial pressure on the production and distribution required for a standard internet-delivered video stream sectors in Canada, while consumers are enjoying both to a TV screen, and 6 Mbps reliably provides the absolute more quality and more choice. best quality HD stream. As a result, the industry has witnessed explosive growth of streaming services like Netflix, which since its Canadian introduction in 2011, More distribution options has rapidly gained share and now boasts as many subscribers as the largest BDUs (albeit offering only a In addition to the packaging and bundling fraction of the full television value proposition, with no innovations from traditional BDUs that have already live sports, news, local, etc.). If it follows the precedent changed the nature of the marketplace, there has set in the U.S., it could approach 40% penetration in the been significant growth in new formats for video near future (Nielsen estimates that 38% of Americans distribution – Subscription Video on Demand, subscribe to Netflix).

30 Source: http://www.huffingtonpost.ca/2013/07/11/cable-cord-cutting- canada-_n_3580860.html.

31 CONSUMER EXPERIENCE IMPACT

Exhibit 14 is a line chart showing the increase in Netflix Discovery and curation penetration in Canada from 6% in Spring 2011 to 29% in 2013. With the proliferation of programming and consumption alternatives, finding one’s way to relevant and enjoyable Exhibit 14: NETFLIX PENETRATION programming is more difficult than it once was. Navigation and discovery has evolved from a magazine AMONG CANADIANS 18+ IN % guide, to interactive program grids, to a multitude of different search, navigation, and recommendation 30 services (see Exhibit 15). Just as the explosion of web 20 pages in the mid-1990s demanded better search options, today the TV market has a dire need to simplify 10 the consumer experience and facilitate search and discovery – but in a way that reflects viewers’ more 0 passive mentality and desire to be entertained and Spring 2011 Fall 2011 Spring 2012 Fall 2012 2013 informed by what they are guided towards. Source: MTM 2013. Exhibit 15 is an illustration of time evolution of different Given the myriad DTC choices and internet-enabled Navigation and Discovery options starting from TV Guide options available, consumers already have the ability to in the 90’s to an interactive program in the 00’s to a self-aggregate their desired video service, and substitute proliferation of search and recommendation engines part or all of their current BDU subscription with other in the 10’s. options. For example, some consumers are happy to combine the conventional channel feeds available Exhibit 15: NAVIGATION AND through the digital tuner built into every modern TV DISCOVERY EVOLUTION set (which can include U.S. channels with U.S. ads for the 90% of Canadians living close to the border), with Circa 1990s internet apps like Netflix, NHL.com, MLB.com, and the like available through the broadband connection built into every modern TV set, with a user-friendly navigation interface from devices such as TiVo, Roku, or built into the TVs themselves. It is now possible for one individual to construct a “virtual BDU”; perhaps not easily at present, Magazine grid Universal highlights and recommendation but consumer-friendly solutions are sure to follow.

Distribution transformation does not end there, as Circa 2000s consumers are increasingly spreading their video viewing across multiple devices. TV screens are still the dominant device for video viewing, but 72% of consumers use mobile screens for video viewing each week31, and a full 20% of all time spent on video consumption in Canada is no longer on a television Interactive program guide grid screen32. Circa 2010s What this means is that there is more competition for viewing time and consumers’ video spend than ever before, and players in the television ecosystem will respond to remain competitive.

31 Source: http://www.ericsson.com/res/docs/2013/consumerlab/tv-and-media- Proliferation of search, navigation, and recommendation consumerlab2013.pdf. 32 Source: http://www.newswire.ca/fr/story/1363727/new-tvb-research- configurations; no “one stop shop” study-confirms-commercial-television-is-the-dominant-video-viewing- medium-in-canada.

32 What much of this is leading to is that the relevant All BDUs have developed “TV everywhere” applications “viewing unit” that consumers will be drawn towards to satisfy consumer desires for more viewing flexibility is becoming individual programs rather than linear (Rogers’ Anyplace TV, Shaw Go, to name a couple). channels. The core of many of these options is providing On the broadcaster side, many are offering exclusive a vast library of content to consumers available for content online and through smartphone and tablet viewing anytime, and providing the search and apps (such as Global Go, TMN GO, CTV GO, and discovery tools to navigate this pool of programming. Sportsnet NOW) to provide a more flexible and engaging Furthermore, once predominantly a family activity, experience and ultimately, more value for subscribers. TV watching is becoming increasingly individualized, given multiple TV sets and the proliferation of personal As consumers shift their viewing behaviour away from video-capable mobile devices in Canadian households. linear channels and towards individual programs on Household package decisions need to ensure a demand or time-shifted, an “all you can eat” approach comprehensive pool of programming is available for to a huge library of TV/movie content is increasingly the wide array of individual viewing demands in a necessary. Take Netflix, for example. For a relatively low single household. monthly fee, users have access to a large library of TV shows and movies, and benefit from advanced analytics Consumers already have exponentially more choices to and an intuitive user interface that helps viewers satisfy their video viewing demands than they did just discover the programming most relevant to them. VOD a few years ago, as competition for viewing time and subscribers do not generally complain about paying consumers’ wallets grows more intense. for the thousands of films and shows in the library they will not watch, because they value the options available to them in the huge pool of programming. They can be 3.1.2. IMPLICATIONS FOR guided to discover programming that is relevant and TRADITIONAL TV PLAYERS interesting to them but that they likely would not have Canadian BDUs clearly understand that they do not have a known about. Users have the flexibility and choice they monopoly on delivering high-quality and premium video crave without eliminating the wide range to consumers, and as such are already responding by of opportunities for discovery. innovating their product and packaging offers to reflect New entrants have not only given consumers more market and competitive dynamics. programming and additional choices but they have Though more tightly regulated, Canadian BDUs offer also set new expectations of the overall TV viewing subscribers considerably more choice than their U.S. experience in terms of navigation, discovery, ease of counterparts, according to one study conducted by David use, and breadth and depth of available programming. Keeble for the CRTC33. Canadian BDUs already offer Canadian broadcasters and BDUs have significant channels a la carte and in smaller bundles, or “theme motivation to invest in innovations to appeal to these packs”. Rogers and Shaw offer dozens of channels evolving consumer expectations and improve the in these formats in addition to their traditional pre- viewing experience for consumers. If they do not, they assembled packages. Videotron allows consumers to risk losing their competitiveness. We believe that the customize their packages by choosing from a list of 130 marketplace and intensifying competition will continue channels with a selection and pricing structures that to drive change, and produce products and services that make economic sense in its market. respond to consumer needs.

33 Consumer Choice in Linear Television Services, David Keeble, 2014.

33 CONSUMER EXPERIENCE IMPACT

3.2. GAP BETWEEN PERCEPTION AND REALITY The CRTC’s “Let’s Talk TV” research indicates that a If consumers are expected to make explicit decisions to majority of consumers desire to pay less in aggregate pay for individual channels, we can assume they would for a relatively smaller number of programming services likely not choose those channels that they watch for less of their choosing. However, the study was conducted than five minutes on average per day. These “occasional in an “unconstrained environment”. In other words, channels” would not be top of mind or perceived as consumers were not asked to make trade-offs between worth paying extra for. However, these channels make different options associated with various service up approximately 18% of their viewing time, and roughly selections and prices, nor were they made aware of the 60% of the total channels that they do enjoy from time potential implications of their choices on their overall to time. viewing experience. In addition, while TV viewing moves away from the The perception of many consumers today seems to be traditional family-room experience to personal and that they are paying a lot for television programming mobile devices, TV subscriptions are still defined at they do not watch. However, when we looked at actual the household level. As a consequence, the head of consumer viewing behaviour (analysis based on set-top household who is likely to make the TV subscription box data for subscribers from a U.S. cable operator), we decisions may not fully appreciate and reflect the found a sizeable gap between what consumers believe viewing interests of other household members if they watch and what they actually watch. prompted to make opt-in choices around programming. This is less consequential in a world of pre-assembled For example, according to a Nielsen survey of viewing packages, where marketers in BDUs endeavour to create behaviour, U.S. consumers tune into an average of 17 tiers and packages that reflect the full programming channels. This number has not changed much in several interests of various household types, but it is much more years. But when we analyze the actual viewing behaviour acute in a model where each channel will be individually of U.S. consumers based on tuner activity of their set-top selected and paid for a la carte. boxes, we find that they watch 35 channels on average, even after excluding channels that were watched for less than five minutes per month.

3.3. VALUE OF DISCOVERY OF DIVERSE CONTENT The sheer volume of programming available to individual tastes? In the wider internet, Google recognized consumers – be it through linear TV, on-demand services, that the real value was acting as a “pathfinder” rather than or online – is staggering. The average Canadian TV expecting consumers to predefine what they wanted, household has access to more than 200 unique channels. which had been the model of AOL and Yahoo. Very simplistically, ignoring repeats and duplicates, that amounts to 33,600 hours of programming every week. Thus, we believe that the relevant consumer “viewing Some may see this as paying for content that will not unit” will gradually shift from tuning to a channel to being be watched, but consider this: Deezer and Rdio boast enticed by a program. Currently, as mentioned above, 20,000,000 songs on their subscription music services, consumers neither recognize nor value the incredible which is highly appealing to consumers, even though any mass of programming choice that they have available to one listener will never listen to 19,999,000 of them. The them, primarily as there is no easy way to discover it. same can be said of Netflix: No subscriber would scratch To illustrate, let us take someone who is passionate about the surface of the full library of available films and TV wine. In today’s environment, she might choose to tune series, but the option value is core to the proposition. in to the Wine Channel… except there is no Wine Channel For consumers, search and discovery is becoming a much in Canada. And if there were, she would have to pay a few more critical part of the television experience, and where dollars extra each month for it. But is there programming we feel the real competition will take place: Who can best that would be relevant to oenophiles that they pay for guide consumers to content that will be relevant to their already? We recently conducted work in the U.S to look at

34 available programming that would be relevant for various For the hypothetical oenophile, there are 82 unique interests customers might have. The project required programs over just two weeks that she might find metadata and scheduling analysis as well as curation interesting – and that she is already paying for. However, capabilities to carefully determine which shows could be these programs are spread across 56 different channels, relevant for what interests. Exhibit 16 shows the number and she would likely not find even a small fraction of of programs (linear only in this analysis) broadcast over them. Furthermore, if she were given the choice to a two-week period in one specific market for various preselect the channels that she wanted to subscribe to random interests, including wine. a la carte, how many of these 56 channels would one assume she would proactively opt in for? Very few, in all Exhibit 16 is an illustrative table providing examples of likelihood, meaning that she would have significantly content review. In a two week period in one market, 82 less choice and a much smaller pool of relevant programs were related to wine in 56 different channels. programming to choose from.

Exhibit 16: ILLUSTRATIVE CONTENT REVIEW Our strong conviction is that there is a vast supply of (BASED ON U.S. CABLE DATA) TV programming available to consumers today that 2 week period, 1 market they should find appealing and valuable – but viewers ON HOW cannot find them. The race is on between broadcasters, UNIQUE MANY BDUs, OTT entrants, device manufacturers, and others CONTENT SERIES MOVIES CHANNELS? to develop the best way to guide consumers to the With 12 0 12 17 Steven Spielberg programming they will value. This next-generation directing? TV viewing experience will be focused on relevancy, With 64 50 14 27 curation, and discovery. The CRTC’s proposed approach Will Smith to encourage consumers to artificially constrain involved? the available pool of content could work against Related to 601 431 108 176 finance? this movement. Related to 82 66 10 56 wine? Related to 192 118 66 62 World War II? Related to 1,034 1,758 56 169 cooking?

3.4. PARADOX OF CHOICE In Barry Schwartz’s 2004 book The Paradox of Choice: Similar findings were recently shared by Dilip Why More Is Less, he concluded that having too many Soman, professor of marketing and Corus Chair in options often leaves consumers bewildered and less Communications Strategy at the Rotman School of satisfied after making a decision. One key insight is that Management, University of Toronto, at Banff 2014. too many choices can produce paralysis. Consumers According to Soman’s research, bundles of products simply do not decide at all, or they are less happy with and services promote more consumer sampling and their choice after they make it. Professor Sheena Iyengar flexibility (see the wine example above). of Columbia Business School described similar research in her 2010 book The Art of Choosing. By contrast, products sold as stand-alones have a propensity to result in unsatisfying experiences since people harbour unrealistic expectations for the single item34.

34 Source: https://cartt.ca/article/banff-2014-we-don%E2%80%99t-really-want- much-choice.

35 CONSUMER EXPERIENCE IMPACT

Netflix has recognized that its growing programming In summary, we believe that the media industry is choices are becoming harder to navigate, and has moving towards a new paradigm, where choice hinges announced the development of “personalized” TV. on access to a broad and deep pool of programming, Instead of expecting subscribers to choose between with the right navigation and discovery tools and thousands of discrete options, it will provide them with guidance to find what is or could be relevant and a personalized continuous stream of programming-- interesting. The CRTC’s proposed approach could, basically, a personalized linear TV channel, on demand. counterintuitively, decrease choice for many consumers, That seems like an oxymoron, but it indicates the and undermine the natural evolution of the industry, paradox of TV viewing: Consumers want personalization, driven by market and competitive forces. but they do not want to have to make all of the choices themselves.

One of the unintentional consequences of the CRTC’s proposed approach could be that consumers will be overwhelmed by individual channel choices and will end up making suboptimal subscription choices, thus losing a lot of quality programs that they enjoy today or might enjoy in the future.

36 APPENDIX A. DETAILED EXPLANATION OF ASSUMPTIONS

A.1. SEGMENTED IMPACT Exhibit 17 is a summary table following the logic of consumer groups: staying on current package, switching to Exhibit 9, but providing a more segmented view of a small basic subscription only, switching to a small basic summary consumer metrics. It shows the number of subscription and a la carte channels, or switching to a small channels received and bill impact for each of the following basic subscription and a BYOP.

Exhibit 17: SEGMENTED CONSUMER IMPACT FOR SCENARIOS A AND B

SCENARIO A SCENARIO B Small Small Baseline Stay(*) BYOP A la carte basic only Overall Stay(*) BYOP A la carte basic only Overall Take rate - 65% 19% 15% 1% - 65% 19% 15% 1% - Channels 70 68 36 24 20 54 68 36 24 20 54 subscribed*1 % Change in - - -64% -49% -23% -22% - -64% -49% -23% -22% channels subscribed Monthly $52 $50*3 $59 $33 22% $49 $56 $66 $37 $24 $55 bill*2 % Change in - - -13% -19% -34% -6% +12% -3% -9% -27% +5% monthly bill

(*) Stay: Subscribers staying on their current package. *1 In our base case number of channels subscribed by keepers is slightly lower than 70 channel average This is only explained by a different subscription behaviour from. *2 Monthly bill excludes equipment rental, PPV, VOD charges and tax. *3 Price for current channels remain unchanged, and the difference in monthly bill reflects the consumer mix, i.e. the mix of people who take basic packages vs. premium packages.

A.2. IMPACT ON CONSUMERS Our user choice simulation leveraged a proprietary data A.2.1. DESCRIPTION OF THE source containing all tuning events (remote control clicks and DVR activity) from a sample of U.S. cable DATA SOURCE: THE “VALUE OF subscribers. This data source of viewing behaviour CONTENT ENGINE” allowed us to estimate how many services consumers Our data source is made up of set-top box return-path would be interested in and, as a consequence, their data from one of the major U.S. cable operators over a preferred subscription choice (current package, one month period in March 2013, resulting in more than Small Basic + BYOP, or Small Basic + a la carte). 1 billion data points containing detailed information on viewing events. In order to reduce processing time, we fed the simulation engine with a random sample of the overall dataset, capturing detailed activity for 26,451 customers. That sample size ensured statistical significance for the calculations at the level of aggregation

37 we were considering. We then structured the database (program description), content universe (available and enriched it to create what we call the “Value of programming), and subscriber information (equipment Content Engine”. identifier, video subscription, data subscription, monthly bill). Exhibit 18 gives an overview of the level of detail we Each record contained information for a given viewing can extract from the Value of Content Engine. “event”, defined as the smallest increment of viewing activity, with boundaries defined by either a tuning Exhibit 18 is an illustration of the concept of “viewing DNA”, event (remote control click, DVR switching channel) it shows an example of viewing activity of a specific U.S. or the beginning/end of a program. The resulting data consumer mainly switching between different basket- set contains information on event activity (timestamps ball games. for start/end, program and channel name), metadata

Exhibit 18: VIEWING DNA n o s t s e r n d o e o o p l y 2 o m S e t e e i

N N e Warner Y t k k C k n N O C X S S C i S P P F N e c c s m f B i B i i B B N S S B M Y p i B O X i O A A C C N S T T S N N C E E F F I L D H

2:00pm on Nickelodeon 2:40pm switch to CBS Sports

3:58pm switch to CBS 3:00pm switch to TBS • Last 2 minutes of CBS News • NCAA Tip o • Then 2013 NCAA Tournament 4:34pm switch to TBS • 2013 NCAA Tournament From 4:34 to 9:30pm • Switch between TBS and CBS • Watching NCAA Regional Semi Finals for South and Mid West 7:59pm SYFY • 2x2 games simultaneously on CBS and TBS • Very likely DVR activity in parallel − Kansas – Michigan • Recording last 30 sec of Cyclops − Florida – Florida Gulf Coast • Then 2 hours of WWE Smackdown − Louisville – Oregon • Then first 4:30 min of Robot − Michigan State – Duke Combat League

09:30pm TBS only • 09:30–10:00pm Inside March Madness • 10:00–10:30pm Family Guy 11:34pm switch to ESPN • 10:30–11:00pm Family Guy • Sports Center until 11:42 • 11:00–11:30pm Seinfeld • Last event until 9:59 next day • 11:30–11:34pm Seinfeld

38 A.2.2. DATA SOURCE RELEVANCE offered, and price variations tend to be higher between different players in the same market rather We believe that while markets and program line-ups than between the two markets30. differ between the U.S. and Canada, there is little difference between the two countries when it comes 3. The same report states that U.S. distributors tend to to broad viewing patterns. offer more channels than Canadian BDUs. However, according to a Nielsen study, the number of channels Several arguments support this point of view: viewed per household has not been affected by the increase of channel availability in the past 5 years, 1. Time available to watch TV and the duration of leading us to believe that differences in availability of programs does not change fundamentally from one content between U.S. and Canada would not have a country to the other, leading us to assume that there large bias on viewing patterns. is no structural reason to believe viewing patterns should differ. Exhibit 19 is an illustration from Nielsen which states that, 2. A recent report by the CRTC states that it found no as the number of channels available for subscription has evidence that Canadian BDUs and television service increased (129 to 189 between 2008 and 2013), the number distributors charge different rates for services of channels tuned by consumers has remained stable at 17.

Exhibit 19: CHANNELS RECEIVABLE AND TUNED PER TV HOUSEHOLD

129.3 136.4 151.4 168.5 179.1 189.1

17.8 17.5 17.5 Average channels receivable 17.3 17.7 17.8

Average channels tuned 2008 2009 2010 2011 2012 2013

Source: Nielsen.

A.2.3. METHODOLOGY FOR We then applied the same approach to rank-order consumers according to the number of channels they CHANNEL SUBSCRIPTION watch above certain duration thresholds, to isolate SIMULATION “occasional viewing”.35 All simulations have been performed at the household Setting the “occasional viewing” threshold to an average rather than single set-top box level, ensuring that of five minutes per day (equivalent to a half-hour insights collected can directly translate into subscription program each week) leads to 17 channels viewed on decisions, which are also made at the household level. average, which matches the Nielsen research referenced Since the Value of Content Engine contains all viewing below. Our interpretation is that using this threshold events, we started by cleaning the noise and removed would allow us to draw the line between all channels all events that had a cumulative viewing time of less watched and channels that are relevant enough to than five minutes over the whole month. This essentially consumers to declare in a diary and/or explicitly guarantees that the data set is not polluted by transitory select in an a la carte environment. See Exhibit 20 for viewing as viewers click through several random channels the distribution of consumers by number of channels moving from one channel of interest to another. viewed, with and without this threshold.

We rank-ordered consumers according to the number of channels they currently watch in total. Distribution varies around 35 channels on average (watched more than five minutes per month).

35 Consumer Choice in Liner Television Services by David Keeble.

39 Exhibit 20 is an illustration with two distribution line charts. distribution of all channels viewed more than 5 minutes per On the left, the distribution of all channels viewed in a day shows an average of 17 channels. month shows an average 35 channels. On the right the

Exhibit 20: DISTRIBUTION OF NUMBER OF CHANNELS VIEWED ALL NETWORKS NETWORKS WITH VIEWING TIME > 5MIN/DAY # NETWORKS VIEWED IN MONTH ON AVERAGE 120

80

40 Average 35 channnels Average 17 channnels 0 Viewers Viewers ALL CHANNELS INCLUDED WITHOUT OCCASIONAL CHANNELS Applying a 5 min/day threshold decreases the average from 35 channels to 17 channels Assuming that the ability to watch relevant content •• Viewing pattern of each subscriber in the sample would be the primary driver for service selection under allowed us to estimate how many channels they the CRTC’s proposed changes, we selected this approach would want to keep if they had to make individual and this threshold level to determine which channels subscription choices. would or would not be subscribed to if they were offered •• Given pricing assumptions, we simulated the a la carte. Since the Small Basic service would be offered monthly bills for these new subscription options to all consumers, we had to adjust our dataset and and compared the results to the monthly bills under remove the U.S. equivalent of a Small Basic package. We current packages to determine if a subscriber would worked by analogy and removed the following channels keep or switch his or her current package. Since we from the dataset: ABC, CBS, FOX, NBC, CSPAN, and assume subscribers are financially rational, they PBS. We then overlaid Canadian consumer bills on this would select the subscription that gives them the sample, using an estimated distribution of monthly lowest bill. spend and assuming that the more channels subscribers •• Applying this logic to each subscriber results in watch, the higher their bill. While the reality of package uptake rates for the different subscription options subscription is more complex and can be based on other (BYOP, a la carte) and average number of channels factors (for example the option value to have access to subscribed for each. any channel available even if never actually watched), we validated that this relationship holds on average through •• The same logic was then applied to estimate the regression analyses. change in viewing time resulting from changes in subscription volumes. We then simulated the likelihood to change subscription under the CRTC’s proposed approach using the following logic: •• Monthly bill assumption is available for each subscriber in the sample if they stay on their current package.

40 Exhibit 21 illustrates the subscription selection logic distribution of U.S. consumers by number of channels that we used. viewed. The two other lines represent Canadian monthly bills estimated for consumer’s current package and Exhibit 21 contains multiple line charts overlaid. X-axis simulated if consumers were to switch to an a la carte/BYOP represents number of channels viewed. Primary y-axis subscription. It shows areas where consumers would save represents monthly video bills. Secondary y-axis represents by switching and areas where they would pay more. a distribution of consumers. One line represents a

Exhibit 21: SUBSCRIPTION SELECTION LOGIC MONTHLY BILL IN $ SUBSCRIBER BASE IN %

140 3.0 Distribution of US sample Simulated bill is lower Subscribers will move to an a la carte/BYOP offer 120 *1 Canadian monthly bill on current package 2.5

100

2.0 80

60 1.5

Canadian monthly bill*1 simulated for a la carte/BYOP offer 40 1.0 Simulated bill is higher Subscribers will stay 20 on current package 0.5

0 0 0 10 20 30 40 50 60 70 80 90 100 # CHANNELS VIEWED IN MONTH

Two things are worth noting on this chart: •• The simulated monthly bill displayed is an average for a given number of channels viewed. In reality, •• The subscriber sample does not distribute evenly each subscriber at a given level of channels watched on a given number of channels, which explains the is different, and the simulated curve oscillates around higher variability in the far right of the chart. the average displayed. The model effectively accounts for individual differences.

41 42 APPENDIX B. SENSITIVITY ANALYSIS

To develop the scenarios, we devised a set of consumer bill increase when we vary assumptions on, assumptions based on proprietary analysis and various respectively: Small Basic price, discount rate for BYOP data sources, including U.S. cable viewing data, packages or the a la carte channel price. The fourth one financials published by the CRTC for both broadcasters provides overall impact of the same three drivers. and BDUs, publicly available information on various Canadian BDU websites, and discussions with select The first illustration below has been detailed to provide Canadian BDUs and broadcasters. In order to test more explanations about how the dynamic works. the model and understand how various assumptions The X-axis represents the number of channels subscribed affected the model output, we developed a range of while the y-axis represents the monthly bill for consumers. sensitivity analysis for the key variables. Bubble size represents the percentage of total subscribers While varying in degree, in all tested scenarios, the that keep their current packages or choose a la carte/ conclusion still holds true – a few consumers can benefit BYOP. The base case data points are in green and financially while most consumers lose – they either pay sensitivities are represented in gray. The independent a little less for a lot fewer channels (Scenario A), or they variable represented below is the volume discount rate pay more for the same programming and services. In for the 10 channel BYOP. The base case sets this discount addition, programming diversity is likely rate at 20%. to be compromised. In the base case, the model suggests that 65% of The ranges for key assumptions are: subscribers will remain on their current package. The “keepers” of their current packages have a monthly •• Small Basic package price (ranging from $20–$35, video bill36 of $50 and they subscribe to 68 channels. with base at $25) Similarly, 35% of subscribers are likely to select a BYOP •• Price for a la carte channels (entry price ranging or a la carte channel subscription. They would select from $2.40–$3.90, with base at $3.00) 30 channels on average thus reducing their bill to $47 •• Discount rate for BYOP packages (discount for pack on average. of 10 ranging from 10%–40%, with base at 20%) As sensitivity drivers vary, data points move following •• Broadcasters marketing expenses (increase ranging the direction of arrows. Going from 20% to 30% discount from 40%–140%, with base at 60%) rate assumption means 56% of subscribers - down from •• BDU customer care expenses (increase ranging 65% – are likely to remain on their current package. from 10%–40%, with base at 12%) Compared to base case, monthly video bill and number The impact on the Canadian TV ecosystem ranges from of channels subscribed are lower for suscribers keeping $400 million to $1.5 billion (base case impact is ~$670 their current package. The explanation is this driver million). Similarly, in Scenario B, the overall average change makes the BYOP offer even more attractive consumer bill increases from ~4.5% to ~6% (base case compared to the a la carte, and disproportionately attracts impact is 5.2%). higher spenders/viewers. The resulting population, which keeps its current package, therefore suscribes Uptake rate for those who choose to migrate to Small to fewer services and spends less. Basic plus a la carte plus BYOP options ranges from ~12% to ~66%, and the base case is 35%. Similar dynamics would affect the yellow data points (consumers are likely to switch to an a la carte or Exhibits 22–32 show the details of sensitivity analysis. BYOP offer). For each scenario, the first three exhibits show the uptake rates, number of channels subscribed and 36 Excluding equipment, video on demand and pay per view purchases.

43 As BYOP discount rate increases, video bill of population Exhibit 22 is a bubble chart illustrating sensitivity analysis switching does not increase linearly as it is the result of consumer impact in scenario A when BYOP discount of conflicting forces : higher viewers are attracted by rate varies from 10% to 40%. X-axis represents number of offers and subscribe to more channels but they get a channels received and y-axis represents monthly video larger discount. bill. Impact is represented for consumers likely to stay on their current package and consumers likely to switch to a la carte/BYOP.

Exhibit 22: SENSITIVITY ANALYSIS - IMPACT OF BYOP DISCOUNT RATE ON CONSUMERS – SCENARIO A MONTHLY VIDEO BILL MIN BYOP DISCOUNT RATE*1 $ 65 10% 20% 30% 40%

$ 60 40% 30% 20% 10% $ 55 10% 20% 30% 40% Bubble size is a function of $ 50 percentage of subscribers in each pricing $ 45 scheme

$ 40 Current base case Subscribers switching to Subscribers staying on BYOP / a la carte current package Variations to $ 35 base case 20 30 40 50 60 70 80 90 100 NUMBERS OF CHANNELS SUBSCRIBED

Source: Oliver Wyman analysis. Notes: Monthly video bill excludes equipment charges, VOD, PPV. *1 It is assumed that an additional 10% discount is offered for every additional 10 programming services in the BYOP packages. E.g. 30% for 10, 40% for 20 and 50% for 30.

44 Exhibit 23 is a bubble chart illustrating sensitivity analysis of bill. Impact is represented for consumers likely to stay on consumer impact scenario A when Small Basic subscription their current package and consumers likely to switch to a fee varies from $20 to $35. X-axis represents number of la carte/BYOP. channels received and y-axis represents monthly video

Exhibit 23: SENSITIVITY ANALYSIS - IMPACT OF SMALL BASIC PACKAGE ON CONSUMERS – SCENARIO A

MONTHLY VIDEO BILL SMALL BASIC PACKAGE PRICE $ 65 $20 $25 $30 $35 Subscribers switching to BYOP / a la carte $ 60 $35 $ 55 $25 $20 Bubble size is $30 a function of $ 50 $25 percentage of $30 subscribers in $20 $35 each pricing $ 45 scheme Subscribers staying on current package $ 40 Current base case

Variations to $ 35 base case 20 30 40 50 60 70 80 90 100 NUMBERS OF CHANNELS SUBSCRIBED Source: Oliver Wyman analysis. Notes: Monthly video bill excludes equipment charges, VOD, PPV. Exhibit 24 is a bubble chart illustrating sensitivity analysis bill. Impact is represented for consumers likely to stay on of consumer impact scenario A when minimum a la carte their current package and consumers likely to switch to a price varies from $2.4 to $3.9. X-axis represents number la carte/BYOP. of channels received and y-axis represents monthly video

EXHIBIT 24: SENSITIVITY ANALYSIS - IMPACT OF A LA CARTE CHANNEL PRICE ON CONSUMERS – SCENARIO A

MONTHLY VIDEO BILL MINIMUM A LA CARTE PRICE*1 $ 65 $2.4 $2.7 $3 $3.3 $3.6 $3.9

$ 60 $3.3 $3.6 Subscribers switching to BYOP / a la carte $ 55 $3.6 $3 $2.4 Subscribers staying on Bubble size is current package a function of $ 50 percentage of subscribers in each pricing $ 45 scheme $2.4 $2.7 $3 $3.9 $ 40 Current base case $3.9 $3.3 $2.7 Variations to $ 35 base case 20 30 40 50 60 70 80 90 100 NUMBERS OF CHANNELS SUBSCRIBED Source: Oliver Wyman analysis. Notes: Monthly video bill excludes equipment charges, VOD, PPV. *1 Prices for all other a la carte channels, including the premium ones, willincrease proportionately.

45 Exhibit 25 is an horizontal bar chart showing total varies from 10% to 40%, Small Basic subscription fee varies cumulated economic impact for Scenario A, on BDUs, from $20 to $35 and minimum a la carte price varies from broadcasters and production when BYOP discount rate $2.4 to $3.9.

EXHIBIT 25: SENSITIVITY ANALYSIS – TOTAL IMPACT ON BDUs, BROADCASTERS AND PRODUCTION SMALL BASIC PRICE

$ 35 $ 30 $ 25 $ 20

-1,000 -800 -600 -400 -200 0 +200 +400

ENTRY LEVEL PRICE*1 FOR A LA CARTE PROG SERVICES

$ 3.9 $ 3.6 $ 3.3 $ 3.0 $ 2.7 $ 2.4

-1,000 -800 -600 -400 -200 0 +200 +400

DISC RATE FOR BYOP PACK OF 10*2

40% 30% 20% 10%

-1,000 -800 -600 -400 -200 0 +200 +400 VARIATION IN TOTAL IMPACT $ MM All sensitivities as absolute differences to base case: $(670) MM impact Source: Oliver Wyman analysis. *1 Prices for all other a la carte channels, including the premium ones, will increase proportionately. *2 It is assumed that an additional 10% discount is offered for every additional 10 programming services in the BYOP packages, e.g. 30% for 10, 40% for 20 and 50% for 30.

46 Exhibit 26 is a bubble chart illustrating sensitivity analysis bill. Impact is represented for consumers likely to stay on of consumer impact in scenario B, when BYOP discount their current package and consumers likely to switch to a rate varies from 10% to 40%. X-axis represents number of la carte/BYOP. channels received and y-axis represents monthly video

Exhibit 26: SENSITIVITY ANALYSIS - IMPACT OF BYOP DISCOUNT RATE ON CONSUMERS – SCENARIO B

MONTHLY VIDEO BILL MIN BYOP DISCOUNT RATE*1 $ 65 10% 20% 30% 40%

40% 30% 20% 10% $ 60

$ 55 Bubble size is a function of $ 50 percentage of subscribers in each pricing $ 45 10% 20% 30% 40% scheme Subscribers switching to Subscribers staying on $ 40 BYOP / a la carte current package Current base case

Variations to $ 35 base case 20 30 40 50 60 70 80 90 100 NUMBERS OF CHANNELS SUBSCRIBED Source: Oliver Wyman analysis. Notes: Monthly video bill excludes equipment charges, VOD, PPV. *1 It is assumed that an additional 10% discount is offered for every additional 10 programming services in the BYOP packages, e.g. 30% for 10, 40% for 20 and 50% for 30. Exhibit 27 is a bubble chart illustrating sensitivity analysis of bill. Impact is represented for consumers likely to stay on consumer impact scenario B when Small Basic subscription their current package and consumers likely to switch to a fee varies from $20 to $35. X-axis represents number of la carte/BYOP. channels received and y-axis represents monthly video

EXHIBIT 27: SENSITIVITY ANALYSIS - IMPACT OF SMALL BASIC PACKAGE PRICE ON CONSUMERS – SCENARIO B

MONTHLY VIDEO BILL SMALL BASIC PACKAGE PRICE $ 65 $20 $25 $30 $35

$35 $ 60 $20 $25 $30 $35 $ 55 $30 $25 $20 Bubble size is a function of $ 50 percentage of subscribers in Subscribers switching to Subscribers staying on current package each pricing $ 45 BYOP / a la carte scheme

$ 40 Current base case

Variations to $ 35 base case 20 30 40 50 60 70 80 90 100 NUMBERS OF CHANNELS SUBSCRIBED Source: Oliver Wyman analysis. Notes: Monthly video bill excludes equipment charges, VOD, PPV.

47 Exhibit 28 is a bubble chart illustrating sensitivity analysis bill. Impact is represented for consumers likely to stay on of consumer impact Scenario B when minimum a la carte their current package and consumers likely to switch to a price varies from $2.4 to $3.9. X-axis represents number la carte/BYOP. of channels received and y-axis represents monthly video

EXHIBIT 28: SENSITIVITY ANALYSIS - IMPACT OF A LA CARTE CHANNEL PRICE ON CONSUMERS – SCENARIO B MONTHLY VIDEO BILL MINIMUM A LA CARTE PRICE*1 $ 65 $2.4 $2.7 $3 $3.3 $3.6 $3.9

$ 60 $2.4 $3 $3.6 $3.6 $3 $2.4 Subscribers staying on current package $ 55 Subscribers switching to Bubble size is BYOP / a la carte a function of $ 50 percentage of $2.7 $3.3 $3.9 subscribers in each pricing $ 45 $3.9 $3.3 $2.7 scheme

$ 40 Current base case

Variations to $ 35 base case 20 30 40 50 60 70 80 90 100 NUMBERS OF CHANNELS SUBSCRIBED Source: Oliver Wyman analysis. Notes: Monthly video bill excludes equipment charges, VOD, PPV. *1 Prices for all other a la carte channels, including the premium ones, will increase proportionately.

48 Exhibit 29 is a horizontal bar chart showing total cumulated to 40%, Small Basic subscription fee varies from $20 to $35 economic impact for Scenario B, on BDUs, broadcasters and minimum a la carte price varies from $2.4 to $3.9. and production when BYOP discount rate varies from 10%

EXHIBIT 29: SENSITIVITY ANALYSIS – OVERALL CONSUMER BILL INCREASE (RESPONSE B) SMALL BASIC PRICE

$ 35 $ 30 $ 25 5.2% $ 20

-0.6 -0.4 -0.2 0 +0.2 +0.4 +0.6 +0.8 +1 ENTRY LEVEL PRICE*1 FOR A LA CARTE PROG SERVICES

$ 3.9 $ 3.6 $ 3.3 $ 3.0 $ 2.7 $ 2.4

-0.6 -0.4 -0.2 0 +0.2 +0.4 +0.6 +0.8 +1 DISC RATE FOR BYOP PACK OF 10*2

40% 30% 20% 10%

-0.6 -0.4 -0.2 0 +0.2 +0.4 +0.6 +0.8 +1 VARIATION OF CONSUMER BILL INCREASE IN % All sensitivities as absolute differences to base case: 5.2% impact *1 Prices for all other a la carte channels, including the premium ones, will increase proportionately. *2 It is assumed that an additional 10% discount is offered for every additional 10 programming services in the BYOP packages, e.g. 30% for 10, 40% for 20 and 50% for 30. Exhibits 30 and 31 show the overall industry impact and expenses. Changes in these expenses do not change the consumer bill increase when we vary assumptions for consumer uptake rate in Scenario A. However, it has a broadcaster marketing expenses and BDU customer care different impact on overall consumer bills in Scenario B.

49 Exhibit 30 is a horizontal bar chart showing total cumulated from 10% to 40% and Broadcaster marketing cost economic impact for Scenario A, on BDUs, broadcasters increases from 40% to 140%. and production when BDU customer care cost increases

Exhibit 30: SENSITIVITY ANALYSIS – TOTAL IMPACT ON BDUs, BROADCASTERS AND PRODUCTION BDU CUSTOMER CARE COST INCREASE

40% 30% 20% 12% 10%

-300 -250 -200 -150 -100 -50 0 +50 +100 BROADCASTER MARKETING COST INCREASE

140% 120% 100% 80% 60% 40%

-300 -250 -200 -150 -100 -50 0 +50 +100 VARIATION IN TOTAL IMPACT $ MM All sensitivities as absolute differences to base case: $(670) MM impact Source: Oliver Wyman analysis.

50 Exhibit 31 is a horizontal bar chart showing total cumulated from 10% to 40% and Broadcaster marketing cost economic impact for Scenario B, on BDUs, broadcasters increases from 40% to 140%. and production when BDU customer care cost increases

EXHIBIT 31: SENSITIVITY ANALYSIS – OVERALL CONSUMER BILL INCREASE (RESPONSE B) BDU CUSTOMER CARE COST INCREASE

40% 30% 20% 12% 10%

-1.0 -0.5 0 +0.5 +1.0 +1.5 +2.0 +2.5 +3.0 +3.5 +4.0 BROADCASTER MARKETING COST INCREASE

140% 120% 100% 80% 60% 40%

-1.0 -0.5 0 +0.5 +1.0 +1.5 +2.0 +2.5 +3.0 +3.5 +4.0 VARIATION IN CONSUMER BILL INCREASE IN % All sensitivities as absolute differences to base case: 5.2% impact Source: Oliver Wyman analysis. Finally, we ran the sensitivity analysis on the EBITDA Exhibit 32 is a horizontal bar chart showing percentage of threshold under which a programming service channels at risk of being economically unviable when the would be “at risk”. threshold for making such an assessment varies from 0% to 30% EBITDA margin.

EXHIBIT 32: SENSITIVITY ANALYSIS: % OF PROGRAMMING SERVICES “AT RISK” EBITDA THRESHOLD FOR PROGRAMMING SERVICES

30% 20% 10% 0%

-10 -5 0 +5 +10 +15 +20 +25 VARIATION OF SERVICES AT RISK IN % All sensitivities as absolute differences to base case: 26% programming services at risk Source: Oliver Wyman analysis.

51 ABOUT THE AUTHORS

This paper was authored by MARTIN KON, a Toronto native, Partner and Co-head of Oliver Wyman’s Communications, Media & Technology practice, KAIJIA GU, a Principal in the firm’s Communications, Media & Technology practice, and PHILIPPE BENICHOU, an experienced member of the Communications, Media & Technology practice, supported by two consultants.

MARTIN KON is a Partner of Oliver Wyman and co-head of the firm’s Communications, Media & Technology practice, based in New York. A native Canadian, over the past 18 years, he has advised clients from the firm’s Toronto, Munich, and London offices, and served as head of the General Management Consulting office in New York. Mr. Kon has advised some of the world’s leading media, entertainment, technology and communications companies, with a particular focus on customer-led business transformation, leveraging in-depth understanding of customer behavior and profitability to drive substantial bottom-line value impact; and the development/realization of new transformative business designs.

Mr. Kon has led several studies on consumer demand for emerging sectors such as VOD, digital publishing, interactive TV, VoIP, and Mobile Entertainment, and he continues to lead MediaNYC2020, an ongoing effort for Mayor Bloomberg’s Administration in NYC to collaborate with a group of ~70 industry CEOs to define public/private initiatives in order to enhance industry prospects and maintain NYC’s role as a media capital. Mr. Kon’s perspectives have been featured in publications such as The Wall Street Journal, The Financial Times, The New York Times, The LA Times, The Chicago Tribune, Forbes, Business Week, The Boston Globe, CBC, Harvard Management Update, Marketing Magazine, Telephony, Symphony, Wireless Week, Media Week, and Business 2.0, and Mr. Kon has spoken at numerous industry conferences.

A citizen of Canada, the UK and Germany, Mr. Kon has lived and worked throughout EU and North America, including the US, Canada, UK, Germany, France, Switzerland, Spain and Portugal. He worked previously at Robert Bosch GmbH in Germany and Spain, and was educated at Upper Canada College, where he was an Ontario Scholar and recipient of a Hector Andrew Fitzroy MacLean Scholarship, McGill University, where he earned a Bachelor of Commerce (with distinction), and Queen’s University, where he earned an M.B.A. (Dean’s List) and was awarded a D. I. McLeod Entrance Scholarship and the Tom Burns M.B.A. Prize in International Business.

52 KAIJIA GU is a Principal in Oliver Wyman’s New York office, and a member of Oliver Wyman’s Communication, Media and Technology practice. She has led a variety of projects in broadcasting, cable and publishing and has experience in a broad set of media, technology and consumer goods businesses in North America and globally, with expertise in business design, strategy, offer optimization, marketing, international market entry and supply chain. She is a key member of the MediaNYC2020 project in New York.

Ms. Gu has a Master of Public Administration from Cornell University, as well as a Bachelor degree in Economics from Peking University in China.

PHILIPPE BENICHOU is a member of Oliver Wyman’s Communication, Media and Technology practice, based out of the firm’s New York office. For the past 11 years, Mr. Benichou has delivered various projects mainly in the cable & telecoms space, developing deep expertise in data-driven decision making, including the challenges of TV service distribution and evolving consumer behaviour.

Mr. Benichou’s recent experience includes a major value proposition refresh for a European Pay TV player, leading an initiative to leverage television viewing data to understand consumer behaviour and determine the true value of content, helped a major North American cable MSO optimize their high speed Internet value proposition and strategy, and managing various consulting assignments in the wireless and cable space leveraging analytical processing of behavioural consumer data (acquisition investment, offer redesign, top-up, bad debt management, offer migration).

Mr. Benichou holds a Master degree in General Engineering from Ecole Centrale, France and a Master degree in International Business and Strategy from ESSEC, France.

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Report qualifications/assumptions and limiting conditions

Oliver Wyman, Inc. (Oliver Wyman) was commissioned by Rogers Communications Inc. and Shaw Communications Inc. to conduct an independent assessment on the likely economic impact on both the consumer and the industry of the Canadian Radio-television and Telecommunications Commission’s (CRTC) proposed approach to unbundling options for specialty services and pay TV offered by cable and satellite companies in Canada.

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