AT&T to Undercut Everyone in Pay TV

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The average cable subscriber paid $69 per month in 2014.That's before accounting for additional fees for set-top boxes or DVRs. And that was two years ago.

AT&T (NYSE: T) wants to cut that price in half.

Next month, the company will launch its DirecTV Now over-the-top service -- featuring 100-plus channels -- for just $35 per month. Not only is it below traditional distributor prices such as those from Comcast (NASDAQ: CMCSA), but it's also below competing services such as Sony's (NYSE: SNE) PlayStation Vue and DISH Network's (NASDAQ: DISH) Sling TV. AT&T is undercutting everyone in pay TV.

The secret is scale

With AT&T's purchase of DirecTV, it became the largest pay-TV provider in the United States. That scale enables AT&T to spend less on programming per subscriber than anyone else. That includes Comcast, which owns NBCUniversal. AT&T is able to use its existing customer base as a tool to get networks to provide better pricing for its streaming service.

On top of that, AT&T will have lower customer acquisition costs than a competitor like Sony. AT&T already has a billing relationship with over 100 million customers through its wireless, television, and broadband services. Additionally, it already has strong brand awareness compared with PlayStation Vue or Sling TV outside its customer base.

Those advantages allow AT&T to keep prices comparatively low. Even DISH Network doesn't benefit from the same benefits of scale as AT&T. About the only competitor that could do the same thing is Comcast, which hasn't indicated any plans to support a large streaming bundle like DirecTV Now.

AT&T says it will work to keep prices low

AT&T probably won't make much of a profit, if any at all, at $35 per month. The programming costs alone will cost the company more than $30 per month, according to UBS analyst John Hodulik, as reported in The Wall Street Journal. Considering there are additional costs involved with the streaming service and that programming prices usually increase every year, AT&T will have a hard time keeping its $35 price point. Nonetheless, CEO Randall Stephenson says it intends to do so.

AT&T will be able to save on installation costs, since it won't have to send someone out to homes to hook up customers' phone lines or mount a satellite dish. That's how DISH Network says it can afford to offer Sling TV packages for as little as $20 per month. The lower operating expenses allow it to make a similar operating profit per customer whether that person is a full-fledged satellite subscriber or a streaming subscriber.

But Stephenson also says AT&T will look into new ad models that allow it to keep its price in check. Digital streaming offers the potential for better ad targeting and possibly more advertising opportunities compared with traditional linear television. If AT&T can generate higher ad revenue per subscriber compared with its U-Verse or satellite subscribers, it will offset the associated costs.

A land grab

Stephenson points out that there are about 20 million households that either never subscribed to pay-TV or removed themselves from the ecosystem (i.e., cut the cord). But AT&T isn't just going after those 20 million households. It's after customers that are still considering cutting the cord -- a number that's growing larger every year.

Even if it achieves a massive scale with DirecTV Now, it won't be easy for the service to turn a profit alone. AT&T, however, can use it as a loss leader to upsell customers to other services such as wireless or broadband. AT&T already has plans not to charge AT&T's mobility customers for the data they use watching DirecTV Now. It could offer similar benefits to broadband customers.

The risk facing consumers is that AT&T starts raising prices on DirecTV Now after it establishes a dominant market share and forces smaller competitors out. It's tough for a company to forgo profits in the face of Wall Street. Considering AT&T's mobility segment isn't performing well compared with its competitors, it may be pressured to earn a larger profit from its entertainment segment relatively soon.

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Adam Levy has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.