Netflix: To Improve Economic Outcomes and Business Model Changes, Content Must Improve

 

This week, Netflix started trialing advertising between shows on its service. The development is predictable, necessary, and will become widespread.

A paradigm shift is underway where content libraries have declining values. Historically, there’s been a tendency for many investors and the public to view media studios and networks as virtually undifferentiated assets. Whether a show was on ABC, NBC, CBS, or FOX, was basically inconsequential for a long-term investor - the assets were similar, the relative ratings of the networks were cyclical, and therefore they could be valued within a range.

That is now the wrong way to look at it.

It turns out people produce content, and some people are better at their jobs than others. Unusually competent people at AMC Networks put 3 of the best shows in history on the air at the same time; Unusually competent people at CBS won prime-time viewership for a decade; Unusually competent people at FX emerged with so much good but diverse content it spawned multiple networks (albeit maybe not the best idea in retrospect); And unusually competent people at HBO win more Emmy’s per dollar of content spend than any other network almost every year.

From a strategic perspective, if the analysis starts with content and the aim is to develop a business strategy that maximizes long term return on the investment, it turns out there are only a few possible strategies for a streaming-only service. A service with great content can release episodes at a weekly cadence, keep subscribers with fewer shows, and therefore be more considered about approving new shows - improving the probability of creating more great content. If there are more than a few shows produced in any year, it may maximize long term value by allowing subscribers to only consider spending on the one service, but it creates significantly higher pressure to create great content.

Producing less than great content produces a different profit maximization path. To provide subscribers value, releasing shows all at once rather than over time is necessary. By producing binge-ready shows, the number of shows needed to keep a subscriber over time is higher and therefore the required content cost per subscriber is likely higher.

When there’s only one of each type of service, both can achieve an attractive ROI. However, as more services make it to market, the “OK Content” service is far more stressed. Not only is it harder to stand out amidst all the other mediocrity, but the value of older, mediocre, stored, content declines – stressing the value of that legacy spending. It also means that traditional media’s “marketing the heck out of content on the first run” skill– much like a movie or traditional television - is increasingly important. TV it turns out, isn’t just displacing movie viewing, it’s also likely requiring a similar marketing skillset. And to enable that skillset, it requires weekly talk shows, advertising while you’re on the service, and event (celebrity) programming.

That’s probably not great for the business’ economics. It may even require that services also run 3rd party advertising on their streaming service to compete and make the numbers work…making it all look a lot like traditional media….unless, of course, they can reliably make high quality content….

Basil