(FORTUNE Magazine) – ACCORDING TO Robert Wright, CEO of the National Broadcasting Co., here's how network television works: ''We're buying the most expensive programming available and taking it off the air quickly.''

If that sounds like a crazy way to run a business, it's no crazier than a lot of other industries in which exploding costs, rapidly changing fundamentals, uncertain regulation, and kamikaze competition are raising executive anxiety daily. Most managers seem to think the business of broadcast network TV takes place on another planet, but lately it looks like a case study for any company trying to cope in the fast-moving Nineties. By some measures the industry's picture has never seemed darker. Barely three weeks into the season, the webs -- TV-speak for the broadcast networks -- were pulling the rip cord on new shows. The audience share for ABC, CBS, and NBC, at 65% of prime time viewers, is the lowest ever. The average couch potato has 30 channels staring back from the Big Eye and the prospect of nearly twice that within a couple of years. New technologies, including improved versions of direct satellite broadcast, threaten to chop the audience into bite-size pieces. Hits -- and try to find a new one this year -- such as The Cosby Show cost so much that the rationality of paying for them is suspect. Sales in the so-called scatter market, the second round of advertising buys, are at a ten-year low. Ancient regulations keep the networks locked out of such profitable businesses as syndicating old shows to local stations. Tune in again tomorrow, if there is one. Except that by other measures, things don't look half bad. Last year the industry, including the three traditional broadcast networks plus Fox Broadcasting Co., took in $9.4 billion in advertising and kept about $700 million pretax, according to Paul Kagan Associates, a media research firm. More important, the decade-long assault that cable, prerecorded videos, and independent stations have mounted against the networks is finally losing a little steam. ''We have reached the crest as far as competing media are concerned,'' says Daniel Burke, the very circumspect CEO of Capital Cities/ ABC. Cable is available to 85% of America's homes, and another 10% are too remote to get it. In other words, virtually every TV fiend who wants cable has it. The fundamental irony of network television, the absurdity, is that the value of the network audience rises as it shrinks. In 1986, for example, it cost advertisers $6.81 to reach a thousand homes on nighttime network television. This year the cost is $9.74. That is because the broadcasters' loss has been no one in particular's gain. ''The audience simply fractionalized,'' says Alan Wurtzel, senior vice president of research at ABC Television. Most cable shows garner a 0.5% or 1% rating, and even the big pay cable networks rarely hit double figures. The webs are attracting three to ten times the audience of any single competitor, and this ratio is critical to the medium's value. Says Richard Kostyra, head of media at J. Walter Thompson: ''The networks are still the single largest available audience in the strongest vehicle in the strongest medium. A major advertiser cannot not use them.'' Although total network revenues did not increase as much as inflation last year, the media research firm of Veronis Suhler & Associates figures that network advertising should outpace it in the next five years, rising an average of 6.6% annually. THE CHALLENGE is making a profit on the resulting revenues (see table for last year's results). Despite punching out enormous amounts of overhead in highly publicized pilloryings of their news departments and elsewhere, the nets still spend like Hollywood moguls for programming that few people watch. More than 70% of new television shows don't make it to a second season. When a show flops, the nets must provide tons of additional advertising time to their clients to make up for audience guarantees. Because the networks are dividing up a smaller piece of the audience, the game increasingly tends to be winner take all: ABC's hit inevitably means the other two will lose money in the same time period. No one wants to do that for long, so the product cycle is quickening. ''New programs are not given the opportunity to build an audience. If they don't hit a homer out of the box, they're gone,'' says Wurtzel. CBS benched one series with single-digit ratings, E.A.R.T.H. Force, three weeks into the season, rather than pay for any more production. Compare that with 1981 when NBC renewed Hill Street Blues at a 22 share, then the lowest number for any show ever picked up for a second year. The move paid off brilliantly. Without new hits, the networks face rising expenses and declining returns over time. Reason: Most network contracts with producers specify an annual increase in fees, and the makers of an established hit can demand the world at renegotiation time. Cosby producer Carsey-Werner Co. reportedly exacted a $2- million-per-episode tariff from NBC, or about $52 million a year. NBC can sell advertising on the show that will be worth about $70 million after agency commissions. This leaves the network with $18 million before overhead expenses. Not bad, but Cosby has to cover the duds in the NBC schedule too. ''I think the fun went out of Cosby for NBC,'' says a rival executive. Yet as new hits are ever more important, finding them is ever harder. In the Milky Way of cable, broadcast, and independent programming, individual stars have a tougher time shining through. The networks believe that most of their problems can be solved in three words: additional revenue streams. The widest stream is dammed up in Washington by 20-year-old regulations that the Federal Communications Commission is reconsidering. While complex, the rules basically prohibit the broadcasters from owning most of the programs they show or from having any financial interest in domestic syndication -- selling them to individual stations after their network run. As a result, the nets have to rent most of what they broadcast. Typically, they pay the producer a license fee for the right to run each program twice in a year. Then the producer, who owns it, can syndicate it himself. The FCC passed the rules after reasoning somewhat fuzzily that without them, the networks would show only programs they had produced themselves or had bought from producers who were willing to hand over the syndication rights. This would presumably be a small number of producers, and since the vast majority of U.S. TV stations were network affiliates, went the argument, the viewers would see precious little of the programming diversity the FCC was supposed to make sure they got. Diversity? As things worked out under the rules, about 70% of network prime time programming is produced by or through affiliation with eight Hollywood studios. THE BROADCAST networks point out further that the dozens of cable channels have rendered program diversity a non-issue. In short, the market is taking care of it. Of course the TV programming business is not a pure market animal -- get real, it was created in Washington and is run out of Hollywood -- and applying market reasoning isn't necessarily logical. But the early betting is that the networks will get the leash lengthened. Any rule modification will likely provide a second source of income. For instance, if the feds permit the networks to be partners with producers, the nets could take a cut of foreign sales and domestic syndication. If allowed, the nets will undoubtedly insist on owning part of their shows. That way, says ABC's Burke, ''we will accumulate the equivalent of a fraction of one of the studio's libraries. We'll own things that have extended value instead of two runs and out. So we can build stockholder value over a more extended time horizon.'' In this scheme of things, distribution, a.k.a. the network, becomes the starting point rather than a place where the product vaporizes in a blast of electrons. On Saturday morning, for instance, a broadcaster could produce an animated cartoon show, syndicate it, develop a stage show a la Teenage Mutant Ninja Turtles, and peddle accompanying merchandise. The networks also cast a covetous eye on the $13.5 billion that consumers spend on cable subscriptions each year. Virtually all cable systems carry the three network affiliates free of charge, although they are no longer required to. Getting some of the subscription money would let the networks offset costs -- or be more aggressive bidders for programming. Of all the networks, industry leader NBC is most busily repositioning itself to go beyond the traditional business. The company defines itself not solely as a broadcaster but as a programming company whose mission is to intercept the audience at every distribution point. So the Peacock has spent more than $150 million to develop businesses in cable, satellite, and pay-per-view.

NBC's goal is to hang on to the shelf space it has in the entertainment supermarket by developing new brands and products. While the NBC network was one of three places on the dial, in the multichannel world NBC might have six or more stops to make contact with audiences. Says Thomas Rogers, president of NBC Cable: ''We are defining ourselves as a networks rather than a network company.'' The company is part-owner of the Bravo network, a national cable channel, and a partner with Cablevision in nine regional Sports Channel networks, as well as a regional news channel on Long Island, New York. The company is also a partner in SkyCable, a direct broadcast satellite service. The idea is to create profitable matchups between audiences and programming. Cable offers an opportunity to blend national, regional, and local content in a form that can be sold to advertisers big and small. This national-local interaction is getting interesting. NBC plans to provide the cable operator in Evanston, Illinois, a Chicago suburb, with a five-minute neighborhood newscast carved out of the news program on the company's owned and operated station in Chicago, WMAQ. An advertiser on the news can cover all of Chicago (via WMAQ), just Evanston (via the cable system), or Chicago plus Evanston (via both). NBC wins in any event. The company's most ambitious move in cable is CNBC, a national cable network that focuses on consumer and business issues. The service is seen in 17 million homes but needs nearly twice that to show a profit. The company is paying some cable operators $3 a home to reach this audience, with the hope of breaking even in three years. NBC says the venture is on track. In the emerging business of pay-per-view, NBC has developed a plan to sell more than 600 hours of programming on the 1992 Summer Olympics to subscribers. The plan is as ambitious as any PPV program ever conceived. Most PPV events are one-night shows such as boxing or wrestling that cable subscribers order and pay for through their local cable operators. NBC has to persuade cable operators to clear three channels on their systems for two weeks, a tough task given the limited availability of channels. While some industry types scoff at the notion, NBC anticipates that it can be profitable by attracting 2% of the TV homes in the country, about two million. There's also a certain amount of synergy at work: NBC already owns the broadcast rights, so the overhead is in place. & The last piece of the pie is direct satellite broadcasting, and NBC's play there is SkyCable, a partnership with Hughes Communications Inc. (not corporate parent GE), Cablevision Systems, and News Corp. As NBC sees it, DBS is a potential niche player, the exact opposite of broadcasting, attractive to the cable audience as well as to remote viewers who need dishes to see much of anything. A new technology called satellite compression will allow the viewer to use receiving dishes perhaps as small as nine inches in diameter. To these folks the company would bounce a limitless menu of programming, beginning in 1994. Alumni organizations, chess clubs, duck lovers, duck haters, duck eaters -- to each his own program, transmitted from a central location. NBC believes that with two to three million subscribers, it can make a profit. COMPARED WITH NBC's multichannel vision, CBS is a Cyclops. The whole company earned $296 million last year on sales of $3 billion, but about half the earnings came from interest on a $3 billion cash hoard CBS built mostly by selling assets. CBS CEO Laurence Tisch doesn't think he has a choice of directions. His predecessors could not successfully diversify into cable, so Tisch is going to stay at home and fix his network. ''The easiest thing today, while we're in third place, would be to give the executives at CBS an opportunity for a new toy,'' he said in a speech earlier this year. ''The only thing the new toy would do is ensure we'd be in third place forever.'' CBS has been the prime time loser for three years because it has not been able to inject enough successful new programming into its aging schedule. In January the company brought in Jeff Sagansky from Tri-Star Pictures to change that. Sagansky is a former senior vice president of series programming of NBC and was involved in hits like Cheers, Miami Vice, and The A-Team. He also has to shore up CBS's late-night schedule, a chasm into which he is throwing original programming to compete against NBC's Tonight Show and ABC's Nightline. Sagansky doesn't have to fix CBS News's troubles, otherwise known as ''the Rather problem.'' That job goes to Eric Ober, recently brought in to replace David W. Burke as head of CBS News. Built by William S. Paley, who died recently at 89, CBS used to dominate TV journalism. But it has lost its cachet to ABC and CNN. The taciturn Rather, the managing editor, has sometimes turned the operation into a battle of wills between himself and the CBS brass. % CBS may not be able to entice an audience with entertainment, but it may be able to buy one. The company is handing over about $3.6 billion to the pashas of baseball, football, and basketball for the broadcast rights to such glamour events as the Super Bowl, the World Series, and the NCAA basketball playoffs. The company also bought rights to the next two Winter Olympics. With its audience dwindling and aging, CBS needed something big to attract younger viewers. The audiences for sports are more reliable: Throw 22 lugs on a football field and it's a sure thing that 15 million men will tune in to the mastodon ballet. The contract CBS signed with Major League Baseball is a measure of how far the company is willing to go to catch up with its competitors. The Tiffany network, as it was known in its heyday, paid a Fifth Avenue price of $1.06 billion for four years of baseball rights, at least $200 million more than NBC or ABC was willing to part with. According to a rival executive's analysis, CBS will score as much as a $100 million deficit in each year -- if everything goes well. Talk about being behind in the count. Why would CBS make such a deal? The network itself is its main advertising medium, so CBS can use its coverage of big sports events as a platform to highlight its regular programming. So far the ball has not bounced CBS's way. Having won the first week in this season's ratings, CBS had to interrupt its schedule to show the baseball playoffs. The league championships featured one blowout, Oakland beating up Boston, and a contest between Pittsburgh and Cincinnati of interest to nearly everyone living along the Ohio River. Bad went to worse in the World Series, when Cincinnati scored a stunning four-game sweep of the defending champion Athletics, depriving CBS of as many as three additional games. JUST KNOWING that it will not have baseball for at least four years, and maybe never again, has changed NBC's programming strategy. Brandon Tartikoff, chief of NBC Entertainment and a baseball nut, pitched two miniseries based on books by Jackie Collins and Danielle Steel. Aimed at women, this is spikes- high counterprogramming, the most aggressive challenge to the Series ever. Says he: ''In previous years, if you dented the World Series you would have to sell off those ratings the following year. CBS has it for the next four years, so if I dent the World Series they've got make-goods this year, and then they will be selling at a lower base next year. The red ink will get redder.'' Nice guy. ABC is not as adventurous as NBC in new technologies, but it is solidly positioned, both strategically and demographically. Last year the company earned $165 million in operating profits on network sales of $2.4 billion. Although trailing NBC in prime time, ABC says it added younger viewers whose characteristics are most appealing to advertisers. The ad folks covet 18- to 49-year-olds because of their propensity to part with money, and ABC was providing them in goodly numbers. ABC's strength is its eight owned and operated stations (O&Os). Last year they contributed about $420 million in operating profit on sales of about $750 million, a luscious 56% operating margin. That's almost three times the network's income on about one-third of the revenue. Numbers like that ask why the company needs the network. Burke sees the two as being linked, much like in the oil business. Says he: ''You hope you can produce profit with explorations, but you are quite confident you can produce satisfactory profits with refining and gas stations.'' Five of ABC's eight gas stations are in America's biggest markets, New York, Los Angeles, Chicago, Houston, and Philadelphia. Four of those lead their markets, and the other, KABC in L.A., is second. The local newscast is the key lead-in to the network's national newscast, now top ranked. That sets up an audience for each station's highly profitable syndicated shows at 7 P.M., which feeds viewers into the network at 8, the vital hour. That's why in prime time, ABC's O&Os generally outdraw the rest of the affiliates. Capital Cities' reputation as being tight with a dollar is unlikely to diminish. Previous management bought ABC a piece of cable. Burke may make a selective addition to that, but he isn't going to take a flyer on more advanced technologies such as DBS just yet. ABC earns money from its 80% ownership of ESPN. The company also owns 38% of the Arts & Entertainment cable network, a sort of commercial PBS, and 33% of Lifetime, a cable network aimed at women, with such shows as Attitudes. The company has demonstrated a practical approach to the industry's cost problem. The network whose use of sports programming in the Seventies was central to its rise in ratings has only Monday Night Football left among the big sports. (The sports department is now known as ABC Sport, singular.) Burke coughed up $925 million this year to continue the privilege for four years. The network will at best break even, but Burke was facing two problems: He would have had to come up with three hours of new programming if he lost football, and then he would have had to compete against it. Says he: ''I assure you we'd rather have football than have someone else beating us over the head with it. That's how they sell these things, you know.'' AS FOR THE Fox network, it's a sort of 1990s hybrid. While appearing to be a broadcast network, it is a creation of cable. The wiring of America rescued the Channel 43s of the world, the hard-to-receive ultra-high-frequency stations; suddenly they had buttons on the home cable box just the same as your local network affiliate and showed up just as clearly on the screen. The only difference was the programming, and Fox CEO Barry Diller aimed to fix that when he rounded UHF stations up as affiliates. Rupert Murdoch was bankrolling. Fox has attracted an impressive 11% of the audience this season but is nonetheless in some trouble. It couldn't make good on its plans to expand programming to five nights from three. The company just didn't have the programming for the fifth night. Worse, though it has hits like The Simpsons, Fox has an entire kennel of program dogs such as American Chronicles that sit at the bottom five spots in the Nielsen ratings, with nothing in line to replace them. The company guaranteed big audiences to advertisers, and now has to hand out gobs of free time to make up for the shortfall. For all the concerns about competition, program costs, and regulation, broadcast executives believe they can survive. At least that's what they tell Wall Street. They expect their declining share of the audience to level off between 55% and 60%. Making money won't be easy in those circumstances, which is why NBC and ABC are smart to diversify into other technologies. CBS could still prosper, of course, but it's betting the ranch on programming genius, a highly perishable commodity that is always in short supply. The best news for all three networks would be a decision from Washington giving them at least part of what they want. But the best way for them to ensure their survival is to give consumers what they want.

CHART: NOT AVAILABLE CREDIT: SOURCE: BROWN BROTHERS HARRIMAN; NIELSEN MEDIA RESEARCH CAPTION: NO CAPTION