The Future of Media

Disruptions, Revolutions, and the Quest for Distribution

 Published: July 2018

Published: July 2018

Game over, Disney? With Netflix and Amazon holding key advantages in a disrupted marketplace, distribution and scale may matter more than legacy business models.
 

The curious thing about disrupted industries is that very often, when you’re living through them, it’s hard to recognize just how monumental the changes truly are. Case in point: Media and entertainment. The changes are rapid and the magnitude is enormous, but it’s difficult to assess the scope of the revolution. And that’s what makes it so exciting.

Of course, even if you’re just an outside observer, you have to know the writing is on the wall: Cord-cutting is accelerating faster than expected[1], box office receipts have fallen to three-year lows[2], studio heads are scrambling, all while streaming platforms are exploding in ubiquity. Netflix, for instance, boasted an impressive 125 million subscribers worldwide as of the end of March 2018[3]. Meanwhile, Amazon's Prime service is now the third most popular video-streaming service behind Netflix and YouTube[4].

If you’re an investor immersed in innovative disruption—as we very much are—some context is necessary to comprehend the scope and nature of this particular disruption. Specifically: What happens to the studio model? What do cable companies and other incumbents need to do in order to survive and evolve? Can Disney’s soon-to-be-launched streaming platform succeed? Where do upstart streaming services fit into the matrix? And how much growth can be expected from Netflix and Amazon? Summed up: Where are we now—and where do we go from here?

It’s impossible to predict with precision each of these individual questions will be answered, much less surmise how the CEOs of legacy media businesses will adapt to the new era of Internet-enabled TV and film. But there is one prediction we make with high degree of confidence: In the end, there will be massive winners, and there will be equally massive losers. Huge market share will be gained—and huge market share will lost. If you’re an investor, you essentially have two options: Sit out the revolution out and watch it unfold on the sidelines. Or enmesh yourself in the disruption and participate. As investors, we choose to participate.

Where are we now?

“History doesn’t repeat itself,” Mark Twain is said to have once quipped, “but it often rhymes.”  To get a sense of where things are headed—and where we are now—let’s jump back in time.

On December 1, 1945, the first Army-Navy football game was broadcast on live television for the first time in history—except no one was really watching. In 1945, televisions had tiny screens and were almost prohibitively expensive. The RCA “Monticello,” for instance, had a 10-inch screen and cost $595—approximately $8,300 in today’s dollars. At the time, movie moguls pretty much laughed off the medium altogether.

 "Television won't last, because people will soon get tired of staring at a plywood box every night,” Darryl Zanuck, the founder of 20th Century Pictures, infamously predicted in 1946.  Not exactly. By 1960, there were about 50 million sets in American homes. Today, according to Nielsen, about 99 percent of American homes have a television.

The point is: The current wave of digital, Internet-based streaming content disruption mirrors the introduction of the television in the 1940’s.

Both disruptions radically redefined content platforms, business models, and customer habits. And perhaps predictably, both disruptions were met with cynicism by incumbent executives and spectators who simply laughed them off. Blockbuster’s former CEO, Jim Keyes, told[5] the Motley Fool in 2008 that Netflix isn’t “even on the radar screen in terms of competition.” By 2010, Blockbuster had gone bankrupt.

Again: History doesn’t repeat itself, but it does rhyme.

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Now, a decade later in 2018, Netflix and other Internet-based streaming providers are on another path of disruption, and it’s no longer the DVD rental businesses they’re after. In their crosshairs, they have set out to capture the entire trillion-dollar Hollywood ecosystem. In a truly disrupted vertical, incumbents get tied to old business models, fail to innovate, and let upstarts capture market share in winner-take-all dynamics. In other words, if this were a Hollywood production, the stage is being set for an all-out war for media domination.

Netflix in particular has thrown itself headfirst into disrupting established Hollywood business models by serving customers with unparalleled amount of great content for absurdly low monthly fees. They have done this not just by licensing content, but by buying and creating their own content—which they have begun to do with unprecedented scale.

As In 2017, Netflix spent $6.2 billion on original and acquired programming, according to data from MoffettNathanson. In 2018, the company plans to increase content spending with a focus on global series and films. And with good reason. There’s plenty of market opportunity out there. Morgan Stanley now predicts[6] that within a decade, Netflix will grow to 300 million subscribers. The reality is, that number could be even higher.

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Amidst the spending boom and the land grab for market share, Hollywood executives, who are yoked to traditional studio models of production and distribution have been left floundering. “I think there is more fear than bad blood; probably a mix of fear and envy,” one film executive said of Netflix recently.[7] “They’re disrupting the industry.”

So how, exactly, are Netflix and other streamers so disruptive to the modern media landscape? Let’s take a closer look. It comes down to three core factors.

1. They have already have massive scale—with plenty of room for growth overseas.

•        As of March 2018, Netflix had 125 million subscribers. As that subscriber-base expands, especially internationally, Netflix poses even more of an existential threat to its competitors. Why? More paying subscribers infuses Netflix with more capital, which allows Netflix to then create more content. And more content means more customers, because people are drawn in to niche programming or hit movie. As BTIG analyst Richard Greenfield said in a recent research note[8]: "While it took Netflix 10 years to reach 100 million streaming subscribers, we expect it to take only 2-1/2 years to reach the next 100 million.

•        The virtuous circle of more subscribers at higher prices is enabling Netflix to invest in more/better content that is attracting more subscribers who are willing to pay more per month."

For example, the upcoming release of The Irishman, a Martin Scorsese-directed film that will premier only on Netflix, has the potential to draw in scores of new customers—both domestically and internationally. 

•        Another factor to watch closely: The growth of international and foreign language programming. Netflix has clearly dominated the American market—more than half of American adults have an account[9]—but the opportunity abroad is what’s particularly exhilarating as investors, since penetration is still modest. “What’s really exciting is that the content we’re producing for the world, both in English and in local languages, has proved to be very global,” Ted Sarandos, Netflix chief content officer, said last last year. 

 2. An explosion of content—much of it customized—creating an incredible value proposition. 

•        In 2018 alone, Netflix CEO Reed Hastings said Netflix will spend over $10 billion on new content, release 80 new films, and premier an astonishing 700 new television shows[10]. For context, the top six movie studios released 75 movies in 2017—combined. From a customer’s point of view, this an unprecedented value proposition: For the price of two lattes per month, you gain access to some of highest-rated and most-watched television shows and movies on the planet.

•        From the industry perspective, this is what drives studio executives and networks insane: Netflix uses its war chest of capital to buy and finance new projects, often out-bidding other buyers of content and acquiring international rights. Amazon is ramping up its buying spree as well—in late 2017, Amazon spent a staggering $250 million to purchase the Lord of the Rings franchise. Netflix, too, captured headlines when it signed Ryan Murphy, the prolific producer behind some of television’s biggest hits, to a $300 million overall deal. “Netflix is not afraid to outbid competitors for shows it wants,” notes Sahil Patel of Digiday. “it’s buying more shows and more episodes than other streaming platforms and TV networks; it’s more hands-off with creators, giving them the room to make the show they want; and its successes have put Netflix in the running for Emmy Awards with the likes of HBO, AMC Networks, broadcast networks and Hulu.”

•        Perhaps even more importantly, though, the content isn’t just created—or marketed—in a vacuum. For streamers like Netflix, mining viewing data is an essential part of the approach, and analytics play a pivotal role in not just the selection of content to produce, but how to recommend content to current and prospective customers. Netflix CEO Reed Hastings once quipped, “If the Starbucks secret is a smile when you get your latte, ours is that the website adapts to the individual’s taste.”

3. Distribution—who else in the media ecosystem has a direct line to 125 million paying subscribers?

•        Taking a step back, what are movie studios if not just middle men for content? Be it Disney or Universal, a studio’s role is to create content for consumers—but they are not directly involved (at least not yet) in the distribution and sale of that content to consumers. Instead, studios are forced to distribute content through theatrical releases or platforms they don’t own (like Apple’s iTunes, for instance). This puts studios and other incumbents at a dramatic disadvantage in an ecosystem where their SVOD competitors can go directly to the customers, and monetize directly from their audience.

•        Similarly, television networks are vulnerable because their model is predicated on advertisements—in a world that increasingly eschews traditional 30-second TV ads. Theoretically, even if ABC, for instance, created a slate of great content—the content isn’t actually the product that’s sold to the buyer. The audience is the product: viewership is packaged and sold to advertisers.

•        Cable networks, which long-relied on bundling networks, might even fare worse through this disruption. According to eMarketer, the pace of the decline is even faster than expected. In early 2018, the number of pay TV subscribers dropped 3.4% from a year earlier, the highest rate of decline since the trend of cord cutting emerged in 2010.

•        By owning the direct relationship between customer and content, Netflix and the other subscription-based streamers have an incredible advantage. In any business, customers go to the providers with the best value proposition—and right now, over-the-top (OTT) streaming has the best value. Netflix wouldn’t dare sully the viewing experience with clunky, annoying advertisements. And because of their subscriber-based business model, they don’t have to.

•        Now, recognizing this dynamic, some of the established studios and content providers have begun trying to build their own subscription services—and essentially become platforms of their own. In 2019, for instance, Disney plans to launch its own direct-to-consumer subscription service. Time will tell if this will work, but it’s our view that it’s too little too late. Yes, Disney holds the keys to lucrative properties within Pixar, Marvel, LucasFilm, etc. And launching the service with a Star Wars movie or television show will certain get some traction. But by 2019, that “distribution ship” will likely have already sailed. Netflix and Amazon will have hundreds of millions in combined viewers, and Disney will be starting from scratch. While the Mouse House may certainly find a core audience hungry for their content, its own subscription service may not justify itself—and it would not be shocking to find Disney looking for a distribution partner in someone like Amazon, who will already has over 100 million Prime subscribers.

Looking ahead—some trends to watch

Overall, this is how we view disruption taking place in the media landscape right now: A disruptive technology (i.e. the Internet) has arrived and the upstarts have sent the incumbents (i.e. Hollywood studios, TV networks, and cable companies) into chaos.

At the crux of the disruption lies a simple yet elegant advantage for the new upstarts: their business models are built purely on subscriptions, they do not rely on advertisers, and they go directly to their customers with their products. That model enables the disruptors to focus 100 percent of their efforts on building a library of content that their customers actually want—and continue to grow.

If you’re an investor looking for opportunity, the landscape for wealth creation couldn’t be more attractive. But with massive change comes massive peril.

What comes after this wave of disruption? We have some ideas. In a future column, we’ll explore the role of artificial intelligence, machine learning, and virtual and augmented reality as potential disruptors to this cycle of disruption. Because that’s the beauty of disruptive innovation: There’s always something down the pike that seems insignificant today, but could become the standard tomorrow. As Clayton Christensen says[11], “No idea for a new growth business ever comes fully shaped. When it emerges, it's half-baked, and it then goes through a process of becoming fully shaped.”

 

Disclosures:

Worm Capital, LLC does not accept responsibility or liability arising from the use of this document. No document or warranty, express or implied, is being given or made that the information presented herein is accurate, current or complete, and such information is always subject to change without notice. Shareholders and other potential investors should conduct their own independent investigation of the relevant issues and companies involved in this article. This document may not be copied, reproduced or distributed without prior consent of Worm Capital. Arne Alsin and Worm Capital clients are currently long Amazon (AMZN) and Netflix (NFLX) stock and call options and stand to benefit if the trading price of Amazon or Netflix increases. 

The opinions expressed herein are those of Worm Capital, LLC and are subject to change without notice. This information should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the investments or strategies referenced were or will be profitable, or that investment recommendations or decisions we make in the future will be profitable. Past performance is no guarantee of future results. Worm Capital reserves the right to modify its current investment views, strategies, techniques, and market views based on changing market dynamics. This article contains links to 3rd party websites and is used for informational purposes only. This does not constitute as an endorsement of any kind. Worm Capital, LLC is an independent investment adviser registered in the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Worm Capital including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request.  WRC-18-06

 

[1] http://deadline.com/2017/09/cord-cutting-accelerating-faster-expected-emarketer-research-firm-1202169220/

[2] http://variety.com/2017/film/news/2017-u-s-box-office-three-year-low-1202648824/

[3] https://www.engadget.com/2018/04/16/netflix-subscriber-count-hits-125-million/

[4] http://www.businessinsider.com/amazon-prime-video-gaining-viewers-but-still-lacks-awareness-versus-netflix-2018-5

[5] http://www.businessinsider.com/bosses-mocked-new-technologyand-got-it-wrong-2017-6

[6]https://www.cnbc.com/2018/04/10/two-big-wall-street-banks-just-raised-their-netflix-stock-forecasts-because-of-its-global-opportunity.html

[7]https://www.hollywoodreporter.com/lists/what-matters-hollywood-today-today-entertainment-newsletter-5-8-2018-1109421

[8] https://www.investors.com/news/technology/click/netflix-could-top-200-million-subscribers-by-2020-analyst/

[9] http://variety.com/2017/digital/news/netflix-dvr-us-households-survey-1202002673/

[10] https://www.cnbc.com/2018/04/23/netflix-proxy-statement-ceo-reed-hastings-paid-24-point-4-million-in-2017.html

[11] https://www.brainyquote.com/authors/clayton_m_christensen


Noelle Roth