Q: What sparked the streaming wars?
In November 2019 Disney took on Netflix by creating Disney+. With Amazon Prime Video, Apple TV+, and Warner Bros.’ HBO Max in the mix, we were off to the streaming wars as services fought to gain consumers’ attention. There was a massive investment cycle to produce original content that would entice us to sign up or switch services.
The pandemic pulled forward a ton of consumer demand. Projected subscriber growth accelerated in 2020 and 2021 because we were all stuck at home with fewer things to spend money on. But now, subscriber growth has flatlined in the U.S. The streaming wars have hit a moment of détente as companies wrestle with slowing growth and now need to figure out the right level of content spend to put behind these businesses.
Q: What’s at stake for the companies?
It used to be that 100 million Americans paid $80 a month for cable or satellite. That was a $100 billion industry. The cable and satellite distributors took half. The remaining $50 billion was basically divided among the five main media companies producing content. No one overspent on content because as long as you were in the bundle you got paid.
Then things changed. Netflix created this model of using the internet to deliver video on demand to your TV or computer. They originally built their business on second- and third-run content. Consumers were able to watch shows they knew and liked, when they wanted, with no commercials for $9.99. We went to Netflix for Friends or The Office. The media industry willingly and stupidly gave Netflix the content they needed to build their business for much of the 2010s.
People started to cut the cord. Today 80 million households pay for TV, and we expect that to drop to 60 million in a few years.
Netflix moved up the ladder and started making their own content. And the legacy media companies decided to get into streaming. But with streaming, no content owner one gets a free ride the way they did in the cable bundle. You need to have consumers sign up directly, which is a much more challenging task than simply giving your content to Comcast and letting them deliver it. You have to earn subscribers by competing on content and price. But if you don’t have the revenue base to invest in creating original content, your streaming service becomes a loss leader.
Netflix has about 70 million subscribers in the U.S. and 220 million globally. Over a decade, Netflix accomplished something with its scale, but now everyone else has just rushed into it. And I don’t understand why many legacy media companies are blowing up their old business model [of producing content for broadcast and cable TV as well as movie theaters], which is what they are doing, to get into this one.
The risk is that 8 to 10 streaming services creates too much choice. Consumers don't have unlimited funds to spend on streaming platforms. Netflix is a base platform. Amazon is a base consideration because it comes with Prime, but after that, maybe you take one or two other services. So they're all competing to be that third or fourth service we pay for every single month.
And the companies are all raising subscription prices because Wall Street is now demanding higher returns on their capital, finally, but those higher prices causes higher subscriber churn. Churn is to me the biggest risk and something we pay a lot of attention to. Right now, they’re all trying to figure out where they fit in the marketplace.
Q: Is it clear where they fit? Are they competing directly with each other? Is YouTube in the same business as Netflix? Are Amazon Prime Video and Apple TV+ really going up against Disney+?
That’s complicated. Netflix exists only in the streaming universe. The others are part of larger companies. For Apple, streaming video is just a pathway to get you to upgrade more and more devices in your home. Personally, I get Amazon Prime for the shopping; streaming is just a free good that comes with it. The challenge I have analyzing Amazon and Apple is that they are playing a different game than the media companies. That has never been part of the industry’s dynamics before. Usually, media companies all have the same shared economics. One possibility is that Amazon’s and Apple’s streaming services will have unlimited funds to invest in content relative to the other companies.
Q: But they’ll still be spending more than YouTube.
YouTube is the second biggest streaming service in the U.S., right behind Netflix. Some months consumer hours on YouTube via the TV is as big as Netflix. Yet they don’t produce a thing. It’s incredible.
We’ve been waiting for YouTube to start investing in premium content, but they don’t seem interested in paying for scripted shows or getting sports rights. They’re happy just being the repository of all this user-generated content and simply revenue sharing everything.
They have been one of the biggest beneficiaries of the streaming wars, because YouTube is a must have, so it’s included free in everyone’s service. The risk that Wall Street sees now relating to YouTube isn’t from a streaming service competitor, it’s whether TikTok will usurp its power.
Q: Where does Disney fit?
Disney owns ESPN, Hulu, ABC, and content studios like Marvel, Pixar and Lucasfilms. Some of their businesses are declining, but streaming offers Disney the ability to market, build awareness, and absorb some of the cost of investing in premium content. So in theory, Disney and some other big players coming out of the old media industry have advantages that Netflix doesn’t have. But consumers have accelerated their cord cutting which hurts their traditional networks. In the long run, how much will their legacy channels help the streaming business?
What they don’t have right now is enough revenues from streaming to invest solely in streaming content. Every week Netflix is releasing new shows. Netflix’s genius is that they have so much original content that they limit churn through sheer tonnage. Not everything is Stranger Things, but the other streaming companies’ ability to produce content is not nearly as built out.
Q: The way you are describing producing content, it sounds like a factory. But isn’t there always a risk that movies or shows will flop?
The film business used to be a business of big bets and real risk. There’s still risk, no doubt. But if you’re doing the seventh film in a masks-and-capes franchise, there’s brand awareness. That’s why Disney owns Marvel and Lucasfilm, why WarnerBros owns DC. When I was growing up in this industry, film was a much riskier business—there were a lot more releases, many were story-driven titles, and they were not based on previous IP.
Given the size of the budget to make a film, they’ve tried to minimize risk by using proven franchises. TV is less expensive to produce, so they’re more willing to roll the dice.
Netflix produces so many shows that they don’t really ever know in a given quarter what’s going to break or not. They didn’t realize what they had in their hands with Queen’s Gambit when it hit so big. Or that Squid Game was going to be an international phenomenon. HBO didn’t know what it had with Game of Thrones or The Sopranos.
Q: Going back to the era of The Sopranos and HBO as a cable channel making prestige shows—did that shape the model Netflix uses now?
HBO produced prestige shows, but they managed their business to a high cash flow margin and stable growth. They had a focus on profitability and never overproduced. HBO was a premium channel. They knew there was a set number of consumers in America willing to pay for anything more than basic cable. They never got bigger than something like 40 million subscribers.
HBO made one or two great pieces of content every quarter but mostly they were rebuying movies from studios. That model held onto customers while driving a margin in the range of 30%. Netflix’s margins have hit 20%, but it’s very possible they have peaked.
Netflix took a very different approach; they basically replicate the whole TV bundle. If you want documentaries or kids or movies or originals, they give you something for every night. Netflix is in 190 countries. They produce local content in many of those countries, so Netflix in South Korea looks very different than the Netflix in the U.S. HBO never did that. That wasn’t their mission. It was a different era.
Back then, media was a well-organized oligopoly. It was incredibly non-diverse. And it was really hard to tell stories that the gatekeepers didn’t want to tell. That structure led to better returns for investors because the gatekeepers all worked together, but it was much worse for democracy and for actually portraying the reality of people’s lives.
Netflix broke that logjam. Now stories come from anywhere, the volume of content has never been higher, the quality has never been better. As far as I’m concerned, there’s never been a better time to be a consumer of media. But one of the challenges of this job is to look at business models, not companies we like because of their content or whether we think something is good or bad for society.
Q: Where does cable fit in the overall media landscape?
Linear pay TV is declining, but within that decline, we still see strength for sports and news. Companies focused in those areas can be long-term winners.
The most important piece of content in the pay TV bundle is the NFL. There are five rights holders. This year, three of them—Amazon Prime Video, Paramount+, and Peacock—will allow the NFL games to be watched without a pay TV subscription. That’s a lot of the best content leaking out of the bundle. The two other rights holders, Fox and Disney, have said they will only show games on pay TV, but if they do eventually let people stream games, pay TV will have a real problem.
There’s huge overlap between those that pay for linear TV and those that stream; there’s a cohort of people who just like entertainment. I’m one of those people. I like certain types of entertainment live and like other pieces on demand. So, I’m paying more as a consumer than I used to. Many people are.
Unfortunately, that means other types of entertainment are hurt. We go to the movies less, we go to the theater less, we don’t buy DVDs. Overall consumer spending on entertainment is now going to grow more slowly, but there’ll be share shifts within that allocation of spend.
Q: What’s next for the streaming business?
This has to become a less competitive industry. For most of my time covering media industries, the different segments were run by three or four or five companies. There are five major movie studios. There were three broadcast networks. There are three cable news networks. There’s the New York Times, the Wall Street Journal, and USA Today.
“At some point someone’s going to step in and shrink the number of services. I think it’ll be Netflix, Disney, and Amazon and then a jump ball for whoever wants to consolidate what’s left.”
Media has always been run as a concentrated industry where the economics really benefit the consolidators. So at some point someone’s going to step in and shrink the number of services from 8 or 10 to 3 or 4. I think it’ll be Netflix, Disney, and Amazon and then a jump ball for whoever wants to consolidate what’s left.
It’s going to have to happen because the returns in this industry are not that strong. We’ve been notably bearish on Netflix historically because, for all it has accomplished, Netflix never actually made that much cash. For the longest time that wasn’t a concern, but investors are now pressing companies to make some money. And not operating profits, but true cash flow. To do that they need to consolidate, reduce their spend, maybe even find three or four partners and re-bundle.
Q: How much will the broader economy influence what happens in the industry?
We may be seeing a perfect storm: companies caught between investors wanting results and consumers hitting a limit. To create another revenue source, they’re lowering the price of subscription if consumers accept ads. Even Netflix is going to do it. But now advertising seems weaker because where there’s inflation there’s less discretionary spending.
Netflix had turned a blind eye to password sharing. But when your stock starts to get pummeled and you run out of U.S. growth, the 30 million homes that are probably password sharing start to look like an opportunity. We’ll see how they handle the crackdown. Netflix has gone very slowly rolling it out, but I think it’s inevitable that all companies will do it. I also think it’s going to bring a lot of anger. It will remind people that the model that Netflix built is not today’s streaming model. It’s a brave new world. Typically, people who own IP get paid. If you want to watch something, you’re going to pay up. Streaming, which was seen as a great consumer product, will become less of that.
The next couple of years could be tough. So not surprisingly, as analysts, we don’t really think this is a great time for media investors.