U.S. TV nets need to make a profit.

The burning question: Cut programming costs, or make advertisers pay more?

Pity the U.S. TV networks. Programming costs are rising, the networks' primetime share of viewers is declining, competitors are multiplying and digital TV is knocking. And the fact that network television isn't attracting new viewers is making the future even more problematic. Despite all this, the Big Four networks are determined to rake in more profits.

A few factors favor the networks. The percentage of households using television (HUT) climbed marginally over the last year, from 60.3 percent to 60.6 percent. Viewers still watch network television, but not all together in large numbers as in the past. The networks' own local TV stations are highly profitable. And those affiliates that the networks don't own are accepting the new reality that they have to help defray some network programming costs, especially in sports. Also, network television remains the most effective way to reach a mass audience, and advertisers are willing to pay a premium for this reach. Cable only reaches 67 percent of the country, and satellite TV is still in its infancy. The Big Four managed to squeeze an extra nine hours and 44 minutes of commercial time into shows in the first 10 weeks of last season alone. And the Big Four will end up owning more of the programs they broadcast, while the number of internally produced series will increase; the back end for such programming will be in the U.S. syndication market. In syndication, the most valued programs to advertisers are the off-network shows. At the same time, up to eight of the networks' 22 weekly primetime hours are now being filled with their own news and branded information shows; this allows them to cut costs. In the news information genre, NBC's Meet the Press made $25 million in profit last year.

But other changes are in the air. First in line is the ratings system. The networks have been complaining about the results garnered by A.C. Nielsen, and they have collaborated with a few syndicators to develop SMART (System for Measuring and Reporting Television), an alternative to Nielsen Media Research's controversial viewership data. The broadcast networks have also begun to explore the possibility of an alliance with the Television Bureau of Advertising, a New York-based trade group that represents local TV stations.

Second, expect some changes in the way programs are developed. In The New York Times, ABC President Robert Iger said: "We still sell shows the same way [we have for 40 years] We schedule them the same way. We order shows the same way. Why are we all developing shows at the same time? All the scripts come in in March. All the pilots come in in May. Are we crazy?" One problem is that, on average, 120 half-hour series are produced annually for the Big Four, draining the talent pool. ABC, CBS and NBC are each spending a reported $2.2 billion a year on programming, while Fox, which airs fewer hours, is spending $1.3 billion.

Third, the network cards may soon be reshuffled. To begin with, CBS is reportedly on the block. But there's a catch: Westinghouse, the corporate owner of CBS, is apparently interested in selling only the network, without the more profitable station group attached. If Sony Pictures goes public (as Sony Corp's CEO Nobuyuki Idei has hinted), it could raise $10 billion with which to finance a CBS network acquisition. Of the potential buyers, Sony, from Japan, and Universal, a Canadian company, are the most attractive, since current FCC regulations prevent foreign companies from controlling TV station licenses. Networks, on the other hand, are program providers and thus are not subject to government approval.

However, if Senator John McCain (R-Arizona) has his way, foreign companies might ending up owning TV stations too, provided that these countries reciprocate with respect to U.S. TV ownership abroad. If McCain's plan comes to fruition - and McCain's potential presidential candidacy only increases the chances of this - Canadian companies will descend on the U.S. TV station business.

Fourth, now that Barry Diller is in the U.S. network business with his USA Networks (a mix of local broadcast stations and cable affiliates), one can expect some changes in the nature of the relationship between the networks and their affiliates. Diller's strategy is to bring inexpensive local programs to a network audience. As pointed out in Video Age's April '98 issue and as confirmed by The Economist, Diller is counting on producing drama series for up to $90,000 per half-hour, compared with $600,000 in Hollywood. The programs will be produced at 13 production facilities that Diller plans to build in different cities. In the Miami TV market, for example, Diller is looking to reach "Generation N," the Hispanic equivalent of Generation X.

Compounding the problems of the Big Four is the imminent launch of yet another network: Pax Net, which will join upstarts UPN, the WB and Diller's USA Networks. In addition to further fragmenting the audience, the smaller networks pose a threat on the programming and affiliate fronts. Indeed, both UPN and the WB have been more than willing to pick up shows that the Big Four have canceled; in this way they are able to ride ratings performances that, for the new networks, are more than satisfactory. With its local production, Diller's USA Networks is exploiting another weakness of the Big Four: the almost total absence of local programming (other than news) at their affiliates' level. Were it not for this plethora of networks, the Big Four would have already conscripted affiliates into sharing programming costs, basically parroting the Australian network model. However, in the U.S., competition for TV stations can be very expensive. In 1997, the WB paid an estimated $85 million to wrest a batch of stations from the UPN.

The introduction of digital television, meanwhile, means additional costs for the networks, for their owned stations and for affiliates. For the affiliates, the Big Four have set up a digital assistance plan. Fox, for example, has earmarked $30 million to help meet digital TV requirements.

Finally, the networks, more of which are owned by studios (e.g. ABC, the WB, UPN, Fox), are concerned with rising talent costs. On average, the costs of producing shows for primetime increase at a rate of about 10 percent a year. Conversely, the big issue for creative people in this new wave of consolidation is whether or not they will realize (read: earn) the profits owed to them. This issue has resulted in an explosion of litigation and increased inefficiency in the system, as management spends more time on "gray area" issues. According to Steven Sills, a partner in Sills and Company, a film and television auditing firm, the current cozy arrangement between the studios and the networks creates opportunities for "self-dealing" Such negotiations may negatively affect the profits that talent would have realized through non-related companies, whose dealings would have been on an arms-length basis.

Ultimately, though, each major network is a $3 billion-plus-a-year enterprise involved in a high-risk business, and each is determined to make a profit for itself, rather than serve other parts of the group. Reportedly, while the CBS network made little or no profits last year, the stations it owns registered a 95 percent increase in profits.