Horizontal and Vertical Integration
EMT PROGRAM
Horizontal and Vertical Integration
“Whether serious local competition can sustain itself over time or whether, in the long run, the industry will revert to monopoly fiefdoms of service – the character of cable and telephone in the past – is an open question and will likely remain so for a number of years.”[1]
The Economics Of Cablevision
Cablevision is a vertically and horizontally integrated entertainment company that has attempted to leverage its regional concentration and customer base across its businesses.
The heavy capital expenditures necessary to establish the initial infrastructure and subsequent technology upgrades raise high barriers to entry into the cable industry. (See Exhibit 1) “Concentration of ownership and concomitant market control may cause or exacerbate barriers to entry, making it difficult for new companies and new products to enter the market.”[2] In addition, the provision of physical cabling has given the Cable companies characteristics of natural monopolies. One characteristic of a natural monopoly is a declining long-run average cost curve where average total costs of "production" declines with each additional unit produced. With expansion, the fixed capital costs are distributed across a greater number of units and the production cost of each decreases. However, the emergence of wireless cable poses a threat to existing players and it is uncertain what the competitive landscape will look like in the future.
Horizontal Integration[3]
“Horizontal integration in the cable telecommunications business nationally is about the amalgamation of business across sectors, distribution or program production, for example. To create the broadband networks that the information highway requires will take immense amounts of capital and the ability to sustain operating losses over long periods while businesses mature. Profit margins are shrinking and economies of scale will become increasingly important as a part of improved operating efficiencies. In the cable industry there are several manifestations of the accelerating concentration of ownership. At the local level, there is an industry-wide movement to consolidate or cluster local and regional systems to achieve greater economies of scope and establish strong are-wide brand identification. Beyond clustering, the popular perception that only large companies can survive in the new economic order has motivated some medium and small firms, or larger companies with only marginal interests in cable to sell their properties and leave the business.”
Cablevision is horizontally integrated in that it provides a broad variety of telecommunication services to its customers. The products and services in the company’s portfolio were either acquired or developed internally. These products and services span a range of cable and entertainment products. By doing this, Cablevision is not only able to experience synergies across the spectrum of its businesses but also able to generate higher revenue per customer. Further synergies include additional outlets for marketing its products and services through The Wiz retail stores and Clearview theaters. From a revenue standpoint, the broader service and product portfolio allows Cablevision to diversify its revenue base thereby reducing the risk of revenue concentration. The company has redefined its strategy and is now refocusing on geographic concentration in the New York area. It has sold its operations in Kalamazoo, Michigan, Cleveland, Ohio and Boston, Massachusetts. Furthermore, it has purchased subscribers from TCI in New Jersey and in Connecticut. Cablevision has also expanded its offerings to include cable, telephony, internet access, entertainment venues and programs (i.e., sports and Broadway shows), and consumer electronics. By providing a broad portfolio of services to customers, Cablevision is attempting to provide “one stop shopping” convenience to its subscribers. In addition, the portfolio allows Cablevision to have a diversified revenue base as shown in Table 1 and Exhibit 2.
Table 1: Business Segment as Percentage of Total Revenues
Vertical Integration
A company that is (fully) vertically integrated owns or controls goods from the point of manufacture through distribution and into the retail outlets. Many Multiple System Operators (MSOs)[4] are vertically integrated in that they own not only the cable infrastructure but also programming content. However, there are varying degrees of vertical integration where the company may not own the entire process from manufacture of goods through distribution. Instead, the company will own a portion of it (i.e., manufacture and distribution but not full ownership of retail outlets). Many of the major cable networks are fully or partially owned by cable operators. In addition, joint participation of MSOs in the ownership of programmers is common, leading to the situation that eventually everyone is financially related to everyone else. One issue that this situation raises is the potential for anticompetitive practices in the industry. “Specifically, there is worry that distributors today have unhealthy control over the creation and distribution of cable programming by virtue of these relationships.”[5] MSOs can create special incentives for content providers such as giving privileged channel positions. They can also bargain for discounts not available to other distributors.
Cablevision’s Acquisition Trail – Vertical and Horizontal Integration
Cablevision has been on an acquisition trail over the past few years and has managed to acquire businesses that not only expand its product portfolio but also allow the company to take advantage of synergies resulting from the acquisitions and/or partnerships. In addition, Cablevision’s geographic concentration has allowed it to experience efficiencies associated with smaller management, fewer operating personnel and lower infrastructure costs. Due to its vertical integration, Cablevision has successfully earned its position as a leading telecommunication service provider. Cablevision owns the cable technology, content and distribution. Cablevision’s operations include: CSC Holdings and Optimum TV (core cable business); Rainbow Media Holdings Inc. (programming content); Optimum Online (high-speed internet access), Lightpath (local telecommunication services to the business market), Madison Square Garden (theatrical production, sporting events content, and sports teams – New York Knicks and Rangers), Clearview Cinemas (movie theaters); and The Wiz (consumer electronics store chain). The company is focused on providing its customers with a broad portfolio of services that range from telecommunications to entertainment.
Complementing its core cable business is Cablevision’s subsidiary Rainbow Media Holdings which provides the cable operations with quality programming content through “niche” programming. Well-known channels include American Movie Classics, Bravo and The Independent Film Channel. To expand its content, Cablevision acquired New York City’s Madison Square Garden properties to provide customers with televised sporting events and Radio City Entertainment to provide access to theatrical events. Consumers have the ability of purchasing a “total package” from Cablevision with the availability of high-speed Internet access and local telephone service. Rounding out its entertainment offerings, Cablevision also owns the Clearview Cinema Group of community-based movie theatres, which primarily operate in the New York Metropolitan area’s suburbs and provides motion picture exhibition services to customers. The final component of Cablevision’s business is its ownership of The Wiz, the largest consumer electronics retail chain in the New York Metropolitan area. The Wiz provides Cablevision with an opportunity to promote new products as a means to increase the penetration of its products. By owning its local content and distribution channels, Cablevision has a competitive advantage since many Direct Broadcast Satellite (DBS)[6] competitors rely on national content and distribution.
Synergies
With the ownership of both product and distribution (i.e., programming content and cable infrastructure), Cablevision is able to experience synergies between the two businesses. Integral to Cablevision’s programming needs are Madison Square Garden LP and Radio City Entertainment. Cablevision’s ownership of the famed MSG properties, including the New York Knicks and Rangers, has solidified its leadership position in the cable television and entertainment industries. The acquisitions reflect Cablevision’s objective to increase consumers' entertainment choices and make them more available via its state-of-the-art distribution system. Cablevision’s strategy is to realize the synergies between its live venues, regional and national programming channels and state-of-the art distribution system in the New York metropolitan area. Synergies are seen with The Wiz - The Wiz will host HDTV events in conjunction with MSG at various locations throughout the metropolitan area. The Wiz expands Cablevision’s reach by being “one stop shopping” for services as well as hardware. The Wiz will showcase new digital technology, sell tickets to events at Madison Square Garden and Radio City Music Hall, and be a location where customers can sign up for cable service and pay bills. With regards to Radio City Music Hall, the venue was to fuel the arts side of the company via homegrown production (Rockettes) and Broadway shows (The Scarlet Pimpernel) that had the potential to be aired on its AMC, Bravo and Independent Film channels. Cablevision recognizes the long run potential of turning Radio City into a TV and music brand name hosting live shows that will potentially help fill its arts programming pipeline. Cablevision’s also experiences synergies through its strategic acquisitions by leveraging its strong local presence into a larger national one (e.g., Fox Sports and @ Home partnerships). With the purchase of the Wiz and Clearview Cinemas, Cablevision has purchased businesses that have a common customer base with its cable systems. The Wiz provides a distribution outlet and a platform to showcase its new video products to its customers. The Wiz would give Cablevision the opportunity to demonstrate the @Home product and even how to install the cable modem on an existing PC. Cablevision is capitalizing on its ability to not only create original content but also distribute the final product.
Exhibit 1: Capital Expenditures (in millions)
Source: Cablevision Systems Corporation 10-K SEC filings
Exhibit 2: Business Segment as Percentage of Total Revenues
Exhibit 3: Business Segment Operating Statements (in millions)
Source: Cablevision Systems Corporation 10-K SEC filings
Exhibit 4: Income Statement (in millions)
Source: Cablevision Systems Corporation 10-K SEC filings
Exhibit 5: Balance Sheet (in millions)
Source: Cablevision Systems Corporation 10-K SEC filings
Exhibit 6: Cable Net Revenues (in millions)
Source: Cablevision Systems Corporation Press Releases
Exhibit 7: Estimated Cable Revenue Breakdown (in billions)
PPV: Pay-per-View; NVOD: Near-Video-on-Demand; VOD: Video-on-Demand
Source: Patrick R. Parsons and Robert M. Frieden, The Cable and Satellite Television Industries, (Needham Heights: Allyn & Bacon, 1998), page 159.
1
Sonya Park wrote this case under the supervision of Professors Sam Craig and William Greene. The case is intended to serve as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. The case was developed for the Stern School of Business’s Entertainment, Media and Technology Program, August 2000.
[1] Patrick R. Parsons and Robert M. Frieden, The Cable and Satellite Television Industries, (Needham Heights: Allyn & Bacon, 1998), page192.
[2] Ibid., 189.
[3] Ibid., 192-194.
[4] MSOs are companies that operate more than one cable system.
[5] Patrick R. Parsons and Robert M. Frieden, The Cable and Satellite Television Industries, (Needham Heights: Allyn & Bacon, 1998), page196.
[6]DBS can send pay and basic channel signals to small receiving dishes owned or leased by viewers and thus bypass the need for a cable system’s transmission services.