Facebook Vs. NFL: Right Battle, Wrong Battlefield

| About: Facebook (FB)

Summary

Facebook's recent decision to withdraw from the NFL bidding because it was required to show ads was a sound one.

However, the NFL's decision to insist on ads was also sound.

Facebook and the NFL would still make great partners, but they should focus on a different category of football content than exclusive nationwide games.

The conventional view that sports is a natural place for ad breaks is not wrong, but it is incomplete. There is substantial potential for an ad-free sports service.

Facebook's willingness to invest heavily in providing such a service is, I believe, an extremely bullish indicator for the stock, even if it missed out on this round.

Introduction

It certainly wasn't an outcome anyone saw coming. For years, media analysts have wondered when the major tech players would break down the old Pay-TV walls and yank away a major sports contract into the digital realm. Not long ago Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Verizon (NYSE:VZ), Yahoo (NASDAQ:YHOO), and Apple (NASDAQ:AAPL) were all fighting for the privilege, with Facebook supposedly in the lead.

However, it then decided to back away from the bidding. Somewhat surprisingly for an advertising powerhouse, Facebook refused to agree to allow any commercials during the broadcast. When the NFL wouldn't go along with an ad-free experience, Facebook backed out. The deal ultimately went to Twitter (NYSE:TWTR), a name that had hardly been mentioned before then, and for maybe a tenth of what others were offering.

Facebook Live

Facebook CEO Mark Zuckerberg has made it clear he sees ads as a non-starter in Facebook's new Live platform. On the one hand, whether he is right or wrong that users will not put up with ad interruptions in a modern service is not the point. The CEO thinks ads will kill the experience, so ads are not coming to the service for the foreseeable future.

On the other hand, Zuckerberg may well be correct in his belief that ad breaks, even rich ones like the NFL's, are not worth the blemish on the customer experience. Netflix (NASDAQ:NFLX), the king of video streaming, has never had them, and its customers frequently list ad-free viewing as one of the biggest benefits of their Netflix subscription. Amazon Prime Video, another ad-free service, has vaulted to second place in streaming video, just behind Netflix and ahead of Hulu Plus despite the fact that Hulu is two years older. Is that because of its lack of ads? Hulu itself seems to think so - it recently announced its first completely ad-free offering.

NFL Dealmaking

But at the same time, the NFL's reticence to disrupt the advertising paradigm of its content is understandable. A deal with Facebook's ad-free format would have been highly problematic for three reasons.

First, finance. 30-second ad spots are going for north of $700,000 each on Sunday Night Football right now. Which, extrapolated over 256 regular season games with twenty in-game commercial breaks, four 30-second ads per break, plus half-time commercials and playoff games, yields an annual advertising income of well north of $1.5 billion per year. Just for the advertising. That is roughly $60 million per game. Facebook's reported offer of less than 10% that amount was not worth taking the first step on a slippery slope that might disrupt that business.

Second, politics. Facebook was bidding for the digital rights to a set of games that had already had their linear rights sold to CBS (NYSE:CBS) and NBC (NASDAQ:CMCSA), broadcasting powerhouses who would never agree to drop their ad breaks. NBC is even owned by Comcast, the company at the heart of the Pay-TV ecosystem Facebook, Netflix and company are busy trying to disrupt.

So far, Comcast has considered the NFL one of its best partners in keeping sports content locked behind the paywall and holding off the coming tsunami of internet TV. A deal with an almost Netflix-like format would have set off alarm bells that might hamper future agreements - and king's ransoms - from its Pay-TV partners. If NBC/CBS are broadcasting with ads, and Facebook is broadcasting ad-free, would people really keep putting up with the ads on Pay-TV, or would they turn their TVs off, their tablets on, and move over to Facebook? Twitter's willingness to leave most of the broadcasters ad inventory intact on their streams made doing a deal far easier.

Third, the nature of sports programming makes it a natural home for ads. Unlike TV shows, which are filmed in advance and already finished by the time customers start watching them, sports are live-broadcast. There are times in the game when nothing is going on and viewers lose nothing by cutting away to an ad. If they weren't watching an ad they'd be just as bored watching players standing around, like when a coach's challenge is underway and referees are reviewing tape, for example. And that is not limited to football. Think of a pitcher warming up after a pitching change in baseball. Facebook's suggestion of eliminating ads is a little more complicated in the world of sports than in TV dramas or comedies.

Does this mean that an ad-free Facebook has no path to sports content for the foreseeable future? Hardly. It doesn't even mean that it has no path to NFL content. But it does mean it needs to re-calibrate its approach.

Thursday Night Football is what is called an exclusive national window. That is, not only do CBS/NBC buy the games themselves - the rights to the games they are broadcasting - they also buy the entire window of time. They get a promise from the NFL that they will be the only ones broadcasting a game that night. For hard-core football fans who desperately want a game, any game, to watch, they will only have one place to go. That works out well for TV stations desperate for ratings. It also works for an ad-supported Twitter. It wouldn't work so well for ad-free Facebook, even if it had won the rights.

Time Well Spent?

For any streaming service, especially one that runs ad-free, customer engagement is the name of the game. Netflix spends $5 billion a year on content, and given the wide range of customer tastes each subscriber is probably only interested in a small fraction of it. When viewers binge-watch four episodes of a mystery series ad-free on Netflix on Saturday night, Netflix doesn't make them take the hour-plus they saved and watch a rom-com.

When a subscriber finds something on the service they like, Netflix likes to have more of the same ready, to keep them engaged and more likely to renew. There's a reason Netflix buys whole TV shows. Imagine if Netflix bought the first ten episodes of West Wing but then told them it didn't have the other 150-some when they were done.

Obviously it will run out of West Wing episodes eventually, and then it will have to guess at something similar to recommend it hopes they will like. When it does, Netflix's recommendation engine will try to find something will similarities to what it already knows the customer likes. Maybe another political show, maybe something else with Martin Sheen, maybe something else with multiple strong female leads. But none of these will be quite like West Wing, and if it guesses wrong too many times the subscriber might leave. Netflix certainly isn't going to chance that until it has squeezed every bit of customer satisfaction it can out of the show it already knows they enjoy.

Netflix's recommendation engine is very good, and it has a lot to do with what makes Netflix so successful. All the same, it is still guessing. At the end of the day it only knows one thing for sure: the customer would like more of what they are already watching. When people purchase a particular form of entertainment, they are essentially signaling the market that they prefer that content to other content. Anything else, no matter how similar, will presumably be not quite as enjoyable. Ideally, if given extra time by eliminating ads, they would like to re-invest it in that same content.

But if there is only one NFL game on Thursday night, ad-time savings cannot be used to watch more NFL football. Since sports are almost always enjoyed live - exactly what makes them so attractive to advertisers - old recordings of games won't help either. And yet, the passion of so many fans suggests that if there was a way to enjoy more games, they would probably be eager to do so.

What Facebook needs is sports content which features multiple games simultaneously.

Possibilities

A few obvious candidates leap immediately to mind. The NFL itself, of course, has only one multi-game timeslot: Sunday day games. The NFL recently concluded an eight-year extension of its exclusive multi-game package with DIRECTV (NYSE:T), now owned by AT&T, so Facebook would have to come to an agreement with them to drop their exclusivity. Or, college football also plays multiple simultaneous day games on Saturday. And the NCAA brings more than just football to the table. Another major multi-game package is the NCAA March Madness tournament in March. In fact aside from the NFL playoffs, March Madness is one of the biggest events on TV every year. Last year 17 million people tuned into the final game on cable. The year before, CBS's broadcast brought in 28 million. Record-setting highs in March Madness Live online indicate that viewers are not averse to following the sport onto the Internet, and many of them would probably welcome the option to watch more games and less ads. Ad-supported broadcasts could still be maintained for those who only want to see one game and don't want to pay extra subscription fees to cancel out ads.

Conclusion

There is major potential for an ad-free revolution to come to sports, just as it came to television via Netflix over the last few years. There is no reason, however, to insist that that revolution start in the worst possible place - single-game broadcasts in exclusive windows. And considering how nervous any sports league would be about leaving the safety of a multi-billion dollar revenue stream for the unknown of ad-free digital, there are more than a few good reasons not to. But ad-free sports are coming. And if the response by primetime viewers to Netflix is any indication, Facebook's willingness to invest heavily in them has the potential to pay off in spades. Although Facebook missed out on this round, I believe Zuckerberg has exactly the right idea.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FB over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.