Here's Why Over-the-Top Services Are A Trap

Sling TV offers just 13 channels at launch, but how many will it offer next year? Source: DISH Network.

There are a number of new services set for release this year that are expected to produce a substantial impact on cable subscribers. The first of those services came to market already, DISH Network's Sling TV. The service offers a slim bundle -- so to speak -- of channels including ESPN and recently added AMC to its $20 per month over-the-top service.

Both Verizon and Sony are working on similar services that deliver live television streams over the Internet. These services all offer alternatives to traditional pay-TV -- a service both Dish and Verizon offer. But what's stopping these slim bundles from turning into the bloated cable bundles people are cutting the cord to get away from?

Cable used to be just like Sling TV in a wayTwenty years ago, expanded basic cable cost just $22.35 per month, according to the FCC. That's about $35 in today's dollars. For that price, customers received 44 channels.

In 2009, the industry started shifting, and the number of channels in the average cable bundle started to skyrocket. The number went from 73 channels in 2008 to 160 channels in 2013. During the same period, the average price for service climbed from $49.65 to $64.41.

Sling TV is a service similar to what people were purchasing from cable companies 20 years ago, when DISH Network originally disrupted the industry. The forthcoming services from Verizon and Sony promise to offer a similar product. The only differences are the delivery mechanism and the screens we're watching them on. And even those differences are pretty similar still.

The problems that will eventually confront Dish, Sony, Verizon, and any other company (think legacy pay-TV companies) will undoubtedly be the ones facing cable companies today. The content companies continue to raise prices and shove more channels into the basic bundle because of the relatively inelastic demand for television entertainment. The end result is higher prices for consumers.

Will more competition keep prices low?With the shift to more over-the-top services, the competition is no longer limited by physical boundaries that keep cable companies from competing effectively with one another. That means we should soon see a bevy of national competitors offering slim bundles to anyone who's fed up with their bloated cable bill.

That competition should theoretically keep prices low, as everyone competes for customers.

On the flip side, some providers may elect to offer different channels in their slim bundle, or perhaps simply offer more channels. And that results in rising prices for consumers.

The same FCC study referenced earlier showed that in markets with effective competition for pay-TV, the average basic expanded cable subscription price was about 5% higher than non-competitive markets. That's because the competitive markets see the average service providing significantly more channels in an effort to differentiate its services.

Sony already has plans to start at the high end with PlayStation Vue, which will cost $60 per month and offer 75 channels. It's notably missing content from Disney and AMC, though. That price becomes much more reasonable with the addition of Disney channels, but it's not significantly different from regular cable.

A low-margin land grabSling TV is fortuitous to be one of the first to market in the growing over-the-top television market. Verizon stands to gain from low-margin subscribers by up-selling them on data plans for its phones or Internet service for their homes. Sony stands to benefit from sales of its hardware. Dish, on the other hand, is cannibalizing its own business, and it won't see any additional benefits from Sling customers over Dish customers. The best it can do is hope that its early entry will result in anlargeshare of the market.

Dish currently has about 14 million customers spending an average of $84 per month. Those customers carried an average operating margin of 12% through the first nine months of 2014. With Sling TV carrying an average subscription price of about one-fourth Dish's ARPU and margins, which are extremely thin, any significant cannibalization of Dish's existing customer base could be bad for the stock.

Prices for slim bundles like Sling TV could remain low for some time as they penetrate the market, but add in some more competition and rising prices from content owners, and some companies will find it difficult to turn a profit without raising prices.

The article Here's Why Over-the-Top Services Are A Trap originally appeared on Fool.com.

Adam Levy has no position in any stocks mentioned. The Motley Fool recommends AMC Networks, Verizon Communications, and Walt Disney. The Motley Fool owns shares of AMC Networks and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.