As operators look to 2007, they are wondering what the premium services have up their sleeves and how they will help boost business. The big three—HBO, Showtime and Starz, along with their multiple offshoots like Cinemax, The Movie Channel and Encore—have long served as money machines, sharing with affiliates the fees consumers are willing to pay for their slate of feature films, specials and original programming.

How much money is involved? The revenue split between a premium network and an operator varies, says Deana Myers, a senior analyst with Kagan Research. There are two basic arrangements: flat fee and revenue share. “Revenue share is generally a 50/50 split,” she says. “Flat fee depends on the deal. It could be a flat fee regardless of the number of subs, or a fee per actual household that gets the service.”

Myers notes that Showtime and Starz operate under both models, while HBO uses revenue share only. In any event, the aggregate numbers are huge. Kagan Research says that retail revenue from full pay services in 2005 was approximately $9.8 billion. The wholesale number (what the premium networks pocket) was $4.8 billion. That left a hefty $5 billion for operators.

But continued growth is not guaranteed, especially since premium cable is a mature business. Challenges are coming from proliferating technologies like broadband delivery and video over portable devices, and now from the sudden emergence of user-generated content.

The industry’s best response in recent years has been VOD, which appears to have slowed the premium services’ dreaded churn rates—in addition to giving cable an edge over other delivery media. There are close to 32 million set-tops in the U.S. connected to servers disseminating VOD content, according to Rentrak, which collects and reports aggregate VOD usage data. “We’ve seen very good performance and considerable growth in subscription VOD over the last 18 months,” says Cathy Hetzel, a Rentrak SVP. “Midyear 2005 to 2006, the total number of subscription VOD orders grew by more than 37%.”

HD is also poised to benefit the premium services and help cable retain subscribers. In addition to enhancing visual resolution, HD will differentiate cable from the low-res, small-screen format of YouTube and video iPods.

For the premium nets, it’s more than just technology. The key is maintaining the creative energy to produce and market programming that consumers will continue to pay for.

At Showtime there’s a desire to get operators more engaged with the content. “One of the challenges we have is that cable operators are now much more focused on telephony and high-speed access, and aren’t focusing on video as much as we’d like,” says Matt Blank, Showtime chairman and CEO. “Premium requires focus, marketing and good proprietary programming.”

Starz, with its main focus on feature films, considers HD to be one of the drivers of future growth. “As prices for HD sets come down, more people will want HD content,” says Starz Entertainment president and COO Bill Myers. “On demand has been our focus for several years. Now we’re looking at the HD market. There’s value there. When consumers see what HD is like they’re willing to pay for it, but I don’t know what that price point is.”

Over at HBO, president of sales and marketing Eric Kessler is optimistic. “What it comes down to for HBO and all premium services is that we provide programming that is unique and worth paying for,” he says. “Programming that the consumer looks at and says, ‘Wow, that’s worth my extra 10 to 12 bucks a month.’”

Then there’s also the issue of the premium nets getting into broadband distribution. While expansion into downloadable content over the Internet is an inevitable part of their growth plans, such moves could affect the premium nets’ relationships with their affiliates. Take, for example, Starz Entertainment’s Vongo, a subscription-based movie download service. Starz positions Vongo as a competitor to Blockbuster and Netflix rather than to TV services like Starz’s own channels, or those of HBO and Showtime.

“Dialogue with cable operators continues as Vongo seeks to drive the emergence of this emerging portable ecosystem,” a Starz executive says, but it still remains to be seen whether cable affiliates will sell Vongo alongside high-speed data and other services.

Meanwhile, Showtime is moving aggressively into downloading. Earlier this year, for example, it announced availability of several of its original programs via Apple’s iTunes service for $1.99 apiece. “We are aggressive and proactive in our use of broadband as a distribution platform for our programming,” a Showtime official says.

HBO has dabbled in providing downloads of Sex and The City and Entourage episodes to mobile phones for $4.99 apiece, but has been mostly silent about plans. Look for an announcement in 2007. “We’re exploring the broadband platform with our cable operators as well as all our affiliates to determine the best business model for HBO,” an HBO executive says.

What’s a cable operator to do in this changing landscape? Short term, here are snapshots of the premium nets’ plans for 2007. Long term, watch these pages in the new year for updates on their broadband strategies.

HBO

The Shows

Wisely not tampering with the formula that has led to slow but steady growth year after year, the largest and richest of the premium programmers again will present its time-tested mix of movies, specials and original series in 2007. “The basis of our service is theatrical product,” says Eric Kessler, HBO’s president of sales and marketing. “But in terms of original product we’re moving into 2007 with a lot of momentum.”

He cites returning series The Wire, Rome, Extras, Big Love and Entourage. And after several false stops, the new year will really witness the end of The Sopranos, says Kessler, adding that the series finale will be a “big, noisy event.” Deadwood will also receive a send-off toward the end of 2007.

New programming includes Tsunami: The Aftermath, a two-part, four-hour miniseries starring Toni Collette centered on a group of fictitious characters in Thailand whose lives are transformed by the natural disaster. Tsunami will run near the Dec. 26 anniversary of the tragedy.

In addition, “numerous pilots are in production,” says Kessler. New original drama series include John From Cincinnati, set in the world of surfing and created by Deadwood writer/producer David Milch; Tell Me You Love Me, a show about relationships, sex and intimacy among couples in their 20s, 30s and 40s; and True Blood, a vampire-themed show from Six Feet Under creator Alan Ball.

HBO has also slated several original films for 2007. Among them: Bury My Heart at Wounded Knee, based on the Dee Brown book, starring Aidan Quinn and Anna Paquin; As You Like It, director Kenneth Branagh’s interpretation of Shakespeare’s play, with Kevin Kline, Alfred Molina and Bryce Dallas Howard; and Life Support, a drama about the AIDS crisis in the African-American community starring Queen Latifah and Jamie Foxx.

Value Propositions

Like the other premium services, HBO has found VOD to be the most significant enhancement to its service during the past few years. Subscribers perceive it as a major added value to the linear programming they’ve been receiving, Kessler says, and cable operators have benefited from VOD’s apparent ability to retain customers and reduce churn.

“HBO On Demand is now an integral element of our programming and scheduling strategy,” he says. “We view it as an opportunity to continue to enhance the overall satisfaction of our service to subscribers, and therefore its value to the cable operators.”

In addition to allowing viewers to watch HBO’s programming at times other than their linear airings, HBO On Demand offers original content. “For The Sopranos, The Wire and Rome, we created behind-the-scenes material and interviews you can only see on the on-demand service,” Kessler says.

“The on-demand platform is also a way to broaden our scheduling opportunities,” he adds. “Earlier this year we premiered a single episode of Rome on HBO On Demand prior to its premiere on the linear service. Because of that success, and because of the support we received from the cable operators, we decided to premiere every episode of this season’s The Wire on the on-demand platform six days before it appears on the linear service. This use of on-demand gives operators a reason to aggressively promote the service.”

Most operators include HBO On Demand in the cost of the HBO service. “However, among select operators, Cablevision in particular, and at some Time Warner systems, our on demand is sold from low-res, small-screen format an extra $4.95 to $6.95 per month.”

But such incremental revenue generated by on demand is the exception rather than the rule. Operators benefit from HBO On Demand in other ways, says Kessler. “No. 1, the on-demand platform is a point of difference versus the satellite operators,” who don’t have the technology to allow viewers to pick from thousands of stored programs at any time.

“No. 2,” he continues, “operators benefit because HBO is an important part of their revenue stream and on demand makes it even more satisfying for their subscribers.” And third, operators also benefit from HBO On Demand by using it as an enhancement to help sell other services. “When they’re trying to convince consumers to buy digital television, high-speed data and telephony, they can offer it as part of a promotional package.”

Showtime

The Shows

Showtime chairman and CEO Matt Blank believes his premium network has finally turned the corner with its original programming. “Over the years we always expressed our plans in terms of our hopes and dreams,” he says. “This year our hopes and dreams are recognized. We’ve got our act together.”

  Tom Christie, EVP, affiliate sales, Showtime

Blank is referring to the success of original series like The L Word, Weeds, Brotherhood, Dexter, The Underground and Sleeper Cell, which have gained traction for Showtime among viewers and critics. Despite some disappointments like the canceled Huff, Showtime has used the programs to raise its profile and enhance the value of its Showtime On Demand service.

Like HBO, most of Showtime’s schedule is taken up by feature films; and increasingly like HBO, Showtime is using original programming to brand itself in the public mind. Upcoming originals on which Blank is pinning his hopes include The Tudors, staring Jonathan Rhys Meyers as a young, rakish Henry VIII; and This American Life, a six-episode adaptation of the Chicago-based National Public Radio program hosted by Ira Glass.

Value Propositions

Showtime is no exception among the premium nets in making VOD its mantra du jour. “There’s approximately a 15-20% increase in viewing to our linear programming among on-demand viewers,” says Blank.

“I would expect VOD to continue to grow,” adds Tom Christie, Showtime’s EVP of affiliate sales. For Christie, the value of VOD lies less in any tangible direct revenue it may generate today or in the future and more in the stability it provides for premium services and cable operators by reducing churn. “On demand adds so much convenience to the viewer that it makes it a little tougher for them not to keep purchasing us,” he says. “There’s a lot of buzz about Showtime programming and people don’t want to miss the things they’re hearing about.”

As on demand grows, Showtime continues to experiment with it. For example, on Dec. 10, the debut of Sleeper Cell’s eight-episode second season will be accompanied by the availability of the entire series on Showtime On Demand the same day.

This will allow Sleeper Cell aficionados to pull an all nighter, watching the entire series without having to wait eight weeks to see how things turn out. Showtime will promote this unusually accelerated VOD availability through the consumer press as well as promos on Showtime itself and spots produced for cable operators by Red Group, Showtime’s in-house creative agency led by Showtime EVP Len Fogge.

In addition to compelling programming and the buzz it generates, Christie stresses the importance of Showtime’s “hard-working field force that’s hustling to help the operators grow our businesses together,” as well as special promotions in conjunction with other types of services.

In one such promotion, MSOs including Cox and Comcast offered a period of free Showtime service to subscribers who ordered voice service. “It’s no secret that digital phone is a priority for cable operators,” says Laura Palmer, Showtime’s VP of distributor marketing, “so we developed a campaign that leverages Showtime to help cable operators drive phone service through a special offer.”

“Premium is becoming an interesting value-add component to operators’ dual- and triple-play offerings,” adds Christie. “Telephones and high-speed are very profitable businesses. They’re focused on promoting them and we see more operators using Showtime to add extra value to one of those packages. When they do that, the take rate goes up, as does retention, because when you look at what the consumer pays for all these products, Showtime helps justify the overall price. An a la carte pricing model would kill the proposition.”

The question remains whether customers will continue with Showtime service after the free promotional window of, say, three months is up. It’s too early for results from this specific campaign, says Palmer. “We know that by using Showtime as a hook in a promotional offer—as was done with the push to upgrade to digital three years ago—the stick rate is far and away better than what you would get if you hadn’t done the campaign,” she says.

Starz

The Shows

Unlike HBO and Showtime, which have branded themselves with original programming, Starz stands out by identifying itself almost exclusively with movies. “We are in only one line of business: the premium movie business,” stresses Bill Myers, Starz Entertainment’s president and COO. “Feature films are the primary product we sell, and that’s the content we use to drive value to the cable affiliates and to consumers.”

Ed Huguez, EVP, affliate sales and marketing, Starz Entertainment

“We’re very different from the two other large premium services,” adds Ed Huguez, EVP of affiliate sales and marketing. “HBO has movies, but what people really buy into is their original programming. If you take a look at what’s available from them on demand or look at what they’re promoting to the consumer, it’s their originals.

“Our approach is very simple. We’re all about movies. That’s our differentiation. We’re totally complimentary to HBO, and also to Showtime, which has followed a very similar model as HBO,” says Huguez.

That’s not to say that Starz is now and forever devoid of non-movie programming. “In the future you will see us augment some of our programming with original content that will fit well on certain demographically driven channels,” says Myers.

For example, three original comedy series are set to premiere in 2007, including Martin Lawrence’s 1st Amendment Stand-Up, which is shot in front of a live audience. Starz will use the new originals to supplement the movies on its multiplexed Starz Comedy service, which presents humorous films and skews toward a younger demographic.

Value Propositions

Like its premium competitors, Starz offers a robust VOD service, Starz On Demand. And like his counterparts at HBO and Showtime, Myers agrees that VOD’s primary benefit to cable operators is the reduction of churn through an increase in the premium service’s perceived value among consumers. “We have seen data from our affiliates indicating that in those systems that have Starz On Demand, churn is down by about 15-20%,” he says. These numbers are identical to the estimates reported by Showtime.

“That’s a real added value to the cable operator,” Myers continues. “They spend a lot of money getting their customers. They need to keep those customers, and adding value via on demand is one of the ways to do it.”

“Even though cable operators have been successfully rolling out high-speed data services, and now phone services, video services are still the industry’s primary revenue driver,” says Huguez. “When a cable operator is trying to attract new subscribers, or trying to grow ARPUs for current subscribers, the premiums are still the primary services that are offered.”

Huguez adds that Starz helps operators by “creating excitement, advertising campaigns and promotions that cause the phone to ring—which the operator can convert into a sale.” Tactics include special offers, but nothing can replace hard work in the call center, Huguez adds. “We help train the cable operators’ salespeople and customer-support people to become more effective during the time they’re on the phone with the consumer, to articulate what our message is a quickly as possible.

“We have approximately 100 people in our group, and one of the reasons is that we spend a lot of time in the field, at the systems that are selling video services and all the other services they offer,” Huguez says, adding that selling a premium service to consumers is more challenging than selling a basic service. “We don’t have the benefit of just being bundled into a package. That’s why we have to participate with our distributors day in and day out to drive customers—not just at corporate, not just at the regions, but at each and every system, and each and every call center.”