Warren Buffett’s 1991 letter perfectly explains ESPN’s troubles
On Wednesday, a brutal round of layoffs at ESPN resulted in roughly 100 employees being fired, including a number of high-profile on-air talent and reporters.
The firings came after a long-term downtrend for ESPN’s fortunes as a decline in subscribers and ratings have hit the company’s bottom line.
The so-called “Worldwide Leader in Sports” has been struggling to navigate its future in a world with streaming services, readily available sports highlights, and sky-high costs for rights fees.
As is many times the case with stumbling business models (see Buffett’s Sears prediction from 2005), the reason behind much of ESPN’s current troubles was pretty excellently summed up by Warren Buffett in a letter to Berkshire Hathaway’s shareholders.
“The economic strength of once-mighty media enterprises continues to erode as retailing patterns change and advertising and entertainment choices proliferate,” Buffett said.
Buffett noted that the media business had come to “resemble businesses more than franchises in their economic behavior.” These are two terms that Buffett uses to describe businesses built to last versus those that are not. Here’s a breakdown of the differences:
Franchise: “An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to have no close substitute and; (3) is not subject to price regulation.” With those advantages, Buffett said, a business can increase their costs without much concern and tolerate poor management.
Business: “In contrast, ‘a business’ earns exceptional profits only if it is the low-cost operator or if supply of its product or service is tight,” Buffett wrote. Additionally, the letter said, these businesses have no room for poor management.
Essentially, ESPN for years was the only place to find things like sports highlights and many live sporting events. While it still commands a considerable number of live sports rights, the need to watch programs like SportsCenter – once ESPN’s flagship program – has diminished with the advent of online highlights and social media.
Additionally, the once hard-to-find analysis provided by ESPN has spread to a bevy of sports media start-ups and even well researched posts on places like Reddit.
At the same time, ESPN draws a large part of its revenue from cable carrier rights, essentially a fee paid by cable providers to ESPN to have the channel on its air waves. With the rise of cord cutting, ESPN has seen its subscriptions slide. Previously, subscribers needed to have ESPN as part of their package in order to get basic cable. With skinny bundles and a host of options beyond cable, there are fewer subscribers to point to for ESPN to justify the high fees.
Thus, looking at Buffett’s franchise definition, there is both a close substitute for much of ESPN’s programming and the need to have ESPN as part of a cable bundle has diminished.
Add in the fact that ESPN is becoming more dependent on live sports rights, which means the leagues it contracts with can demand even more in fees, and there is a cost problem brewing as well.
Now the layoffs most likely are marginal cuts for the network that pays billions in sports rights every year, but they clearly signal that ESPN’s business model is no longer unassailable and prove that they have shifted from Buffett’s definition of a “franchise” to a “business.”
“In the business world, unfortunately, the rear-view mirror is always clearer than the windshield,” Buffett wrote.