Big Media Isn't Ready to Fight Back (Netflix Misunderstandings, Pt. 5)

At the end of 2018, a familiar narrative began to circulate around Wall Street and Hollywood: next year Big Media will finally start to fight back against Netflix.

And to be fair, 2019 looks right – if just because of the moves made by Big Media’s most storied giant: Disney. This year, The House of Mouse will launch both its long-anticipated SVOD service, Disney+, and take control of the second largest SVOD service in the United States, Hulu. The former will not only contain many of the most valuable franchises in history, it will bring an end to more than a decade of Disney content being licensed to (and creating value for) Netflix. Even bigger changes seem likely for Hulu. The service has never been growing faster than it is today and should be supercharged by the shift from a multiple personality disorder board to one controlled by a single company: Disney. In addition, Disney has begun providing Hulu with access to its vast IP stores (February 2018 saw Hulu put four Marvel series into development) and has already announced plans to take the service worldwide (today, it’s only in the United States, having sold Hulu Japan in 2014).

In 2019, AT&T’s WarnerMedia will also be launching its own corporate SVOD service – one that builds upon HBO and the rest of WarnerMedia’s signature assets, including TNT, TBS, Adult Swim, Warner Bros TV and Warner Bros. And HBO, which Netflix long identified as its primary competitor, is also stronger than ever. After years of constrained budgets under Time Warner’s Jeff Bewkes, the premium cable network (which ranks behind only Netflix in total subscribers, domestically and abroad) will see its original programming hours grow by 50% over 2018.

2019 will also see the end of Lionsgate’s movie deal with Epix, which will allow the company to shift this catalogue to premium cable network Starz, which it bought in 2016. Starz, along with CBS-owned SVOD service Showtime and CBS All Access, are also growing their original programming budgets by 30 to 40% each (CBS is promising that All Access will soon have new Star Trek series year-round). Furthermore, these three networks are all continuing their expansion into English-speaking foreign territories. Viacom’s $340MM purchase of PlutoTV also suggests plans to begin holding back their content in order to distribute their content directly to consumers (and for free!). NBCUniversal has announced plans to launch their own ad- and subscription-based OTT service across the United States and Europe. Each of these decisions will reduce Netflix’s existing library of licensed content, increase the cost of future licenses and, in many cases, eliminate the opportunity to license many titles in the first place (Netflix often co-finances series produced by Showtime/HBO/Starz in exchange for select foreign rights to these series as Netflix Originals – but as these networks expand globally, they’re retaining more of these rights).

That sounds pretty threatening. And yet in the face of this competition, Netflix recently chose to raise prices by an unprecedented amount: $2. While Netflix historically raises prices by 14 to 18% every six quarters – making this $2 increase look like business as usual – many see this decision as a strange move. Most companies don’t respond to increased competition and worsening offerings by…increasing prices by nearly 20%. Yet competitively, 2019 won’t actually look very different from 2018, or 2017, or 2016, or 2015, or 2014. Nor will 2020, really. And this matters.

It’s always year n+1

Disney+ , for example, is broadly seen as Netflix’s biggest new threat. I’m personally bullish on the service and expect it to acquire more than 5MM subscribers by the end of the first year (Later Edit: This is before Disney announced the service would have a slate of originals, versus just catalogue, began buying previously-licensed catalogue back at high markups, and priced at close-to-half of its initially-suggested pricepoint). But given its family focus and low-volume output, it’s unlikely to steal subscribers away from Netflix. Instead, it’s more likely to take time away – if just because some blockbusters titles presently on Netflix will transition to the service. Growing watch time is frequently identified as Netflix’s primary objective: it helps to drive pricing power, lubricates additional discovery/viewing, and aids retention. However, it will take years for the service to steal meaningful watch time from Netflix.

For one, Disney+ won’t launch until 2019. Furthermore, it will take until mid-2020 for the service to have more than a few new theatrical releases (Disney only has the rights to new films released in 2019, typically with a six-plus month hold after leaving theaters). Signature Disney+ originals, such as Star Wars’ The Mandelorian TV series and the live action adaptation of Lady and the Tramp, won’t launch until 2020. It will also take until 2021 or later for Disney to regain the rights to recent theatrical releases, such as The Avengers: Infinity War and Black Panther, both of which are on Netflix today. In addition, it’s not clear if Disney will have full (or exclusive) access to the first nine Star Wars films (and two spinoffs) until 2024. And despite its purchase by Disney, 21st Century Fox’s feature films will continue to go to HBO until 2022, with that year’s releases staying on the service until 2023 and 2024. Accordingly, Disney+’s first few years will primarily consist of deep library titles such as Snow White and Finding Nemo – Tier 1 content, to be sure, but also aged hits that have already been rewatched countless times and are thus unlikely to drive substantial subscriber growth or watch time. Catalogue is important, but originals and recent hits are the core of any SVOD service. And at launch, Disney+ will only be available in select international markets (many of which will have further rights limitations). As a result, it’s likely to affect fewer than 50% of Netflix subscribers.

WarnerMedia’s SVOD service faces similar constraints (and notably, it will only “beta” release in Q4 2019 – the proper launch is in 2020). Original content won’t hit the service until late 2020 at the earliest, and regardless, all new Warner Bros.’ feature releases will continue to go to HBO for 18 months before hitting the broader SVOD service (at which point titles like Aquaman will be more than two years old). WarnerMedia will also be stuck in pre-existing content deals for some time, such as The Dark Knight Trilogy on Netflix and Rick & Morty being stuck on Hulu (likely for the next 5+ years). In addition, WarnerMedia has yet to announce plans (let alone a timetable) for an international release. As a result, WarnerMedia’s SVOD service (and the decision to withhold content rights) will only affect the US third of Netflix’s worldwide business in the near future.

Kevin Reilly, President of WarnerMedia’s TNT & TBS television networks and Chief Creative Officer of its forthcoming SVOD offering, has said that the “core” of the service will be HBO. While this offsets some of the need for WarnerMedia exclusives, HBO too is on a bit of a delay. Many of the network’s signature greenlights (e.g. The Time Traveler’s Wife, its two forthcoming series from J.J. Abrams, its Joss Whedon series, and the Game of Thrones prequel) won’t hit until 2020 or later. And while HBO’s 50% year-over-year increase in original hours is substantial, the network has been clear that this increase is an outlier and additional increases shouldn’t be expected. Furthermore, HBO will remain stuck in international licensing deals for years to come. In markets such as the UK, Italy, Germany and Canada, HBO’s content is distributed via other networks. As a result, additional investment in the business unit (or its role supporting WarnerMedia’s SVOD service) will directly affect Netflix in only select markets.

NBCUniversal’s AVOD play is expected to have broader international availability thanks to its acquisition of Sky. But as an ad-supported product requiring pay-TV subscriptions, there are limitations to how much time (or consumer spend) it’s likely to steal from Netflix. Especially since it’s not expected to launch for 18 months.

Hulu appears to be Netflix’s fastest growing competitor in terms of subscriber and budget growth. And later this year, it’s likely to surpass both Showtime and Starz in the United States, making it third to Netflix and HBO. However, there’s scarce evidence that Hulu threatens Netflix’s subscriber growth (which has been predictable and stable domestically even as Hulu has accelerated), rather than its watch time and pricing power. To point, Hulu has spent most of the past year focused on its non-SVOD product, Hulu with Live TV (which includes Hulu’s SVOD offering at no additional cost).

And despite its revitalized governance structure, Hulu faces its own growth challenges. While much of Hulu’s press attention over the past two years has concentrated on its success with Handmaid’s Tale, most of its success is attributed to the service’s focus on accumulating a massive library of TV (a year ago, Hulu boasted 75,000 TV episodes – more than Netflix and Amazon combined). This was aided by the fact Hulu’s four backers (Disney, Fox, Time Warner, NBCUniversal) held an effective monopoly on library TV rights. But as NBCUniversal and WarnerMedia shift to their own services, this library will continuously shrink. And on the Originals front, Hulu hasn’t had much success beyond Handmaid’s Tale. This will change as Disney-Fox’s influence and investment grows, not to mention access to Disney-Fox’s IP. But as always, there’s a large lag here. It will take 18-24 months for Hulu’s increased investment, governance enhancements and originals to have a material impact on the end-consumer marketplace. This is particularly true internationally. Not only does Hulu lack the rights to many of its branded-originals outside the United States (The Looming Tower is an Amazon Original in the UK, Handmaid’s Tale is owned by myriad different networks internationally), Disney and Fox have sold many of their rights abroad too (e.g. Fox holds international rights to The Walking Dead, but has licensed them to Netflix). Furthermore, it will take years for many film and TV rights deals to expire – and even then, Hulu will have to outbid competitors just to launch them. Put another way, Hulu can’t replicate its US library in foreign markets for years to come – if ever.

The Cost of Loss

Irrespective of when and to what degree the new Big Media OTT services compete with Netflix, the SVOD giant will be negatively affected by the loss of titles such as The Avengers: Infinity War or Friends. It’s foolish to argue otherwise. But there are also reasons to believe these losses won’t be as voluminous nor as impactful as feared.

#1

First, there is considerable evidence of how hard it is for Big Media companies to withhold their content from Netflix (or more directly: to say no to Netflix’s sizable cheques). WarnerMedia’s decision to renew its Friends licenses with Netflix through 2019 should never have happened, but it’s not clear whether this content (or hit CW series such as Riverdale and The Flash) will be exclusive to WarnerMedia’s service come 2020 (and thus leave Netflix). In December 2018, AT&T’s CEO Randall Stephenson said that “[Friends] is content that we would definitely want on our platform, and it is obviously very important to Netflix as well…. Is it necessary to be exclusive to WarnerMedia on their product? No, it’s not necessary, it’s just important that we have the content.” Two months later, Reilly said that audiences should “expect the crown jewels of Warner [to] ultimately end up on our new service. Pulling it away [from Netflix]? It’s certainly something we’re willing to do,” adding that “I think for the most part, sharing destination assets like that is not a good model to share — my belief is that they should be exclusive.”

Only four days later Stephenson went on to tell Peter Kafka the exact opposite. When asked if “[Shows like Friends] can be sold to two people, yourself and somebody else,” Stephenson replied, “Oh yeah. Yeah, especially that kind of content, for sure you can.” Further, he seemed to fundamentally disagree with Reilly’s “destination asset” definition: “I think Friends is an example where you look at that and you say, ‘Is that going to drive unique subscriber acquisition capabilities just by having it exclusive?’ Probably not. But do you need it in a library, yes. So why would you not license it out on a non-exclusive basis.” This was reiterated by Bob Greenblatt, WarnerMedia’s new Chairman and Head of Direct-to-Consumer. who told The Hollywood Reporter “Part of me would love to have [Friends] exclusive on the service but I’m not sure that is the right answer yet.” It is hard to see a brand new, for-pay service that shares the rights to one of the most watched titles on Netflix (the most consumed and subscribed to network in the world) as much of competitive threat.

What’s more, Stephenson has even boasted that some of WarnerMedia’s best new content might end up on third party services eventually, telling Recode, “I’m not saying this is what we’re doing but just as an example of where you might go: Aquaman. Thing just did a billion dollars in the box office. And it comes out of the window and at some point you can put it on your on demand service, is it conceivable that for a period of time it’s exclusive to your on-demand service? Yeah, I think there is. Does it need to be exclusive indefinitely? Probably not.”

This isn’t just a WarnerMedia challenge. In 2018, The Information reported that during 2017, NBCUniversal had considered pulling The Office off Netflix to make it exclusive to its new comedy-centric SVOD service, SeeSo. In response, Netflix offered to raise its license fee by tens of millions of dollars – but only for exclusivity to its platform. NBCUniversal accepted the deal and a year later shut down SeeSo. Notably, NBCUniversal had never taken the financial hit required to make its most valuable content exclusive to SeeSo. Series such as Saturday Night Live continued to be available for free viewing on Hulu and YouTube, and Parks & Recreation was non-exclusively licensed to Netflix and Hulu during that time.

To be fair, NBCUniversal has acknowledged that it made mistakes with and learned from SeeSo. Its forthcoming service is also a much bigger priority. But the same concerns persist. NBCUniversal’s CEO Steve Burke was asked by The Hollywood Reporter about whether it would be pulling shows like The Office from Netflix. He replied that “The Office is often the No. 1 show on a monthly basis on Netflix. Netflix has The Office through 2021, and when the time comes we’ll look at our existing direct-to-consumer service and what kind of volume it has and how much we could expect to make if we moved it over, and we’ll have a discussion with Netflix and we’ll decide what’s right for the show.” Put another way, Netflix might lose library content… but not all of this loss will be of their most important library content (and specifically because it’s so valuable to Netflix).

This hits on the unavoidable challenge every Big Media company will face in trying to take back their content – that of comparative monetization. To justify the decision, every content owner will need to generate long-term net profits well in excess of the licenses they would have received by licensing their titles out. WarnerMedia, for example, will need Friends to drive more than $100MM a year in net profit for the streaming service (this is more true in aggregate than per title, but you get the point). This will be a severe challenge for late entrants. Netflix can justify such high fees because this spend is amortized against 150MM+ subscriptions – the total dollar cost of the license is high, but against massive usage, it ends up being economical. If WarnerMedia finishes its first year with 4MM subscribers (CBS All Access amassed 4MM after five years), it will have spend $50 per subscriber per year (or $4/month, compared to Netflix US’s $0.14) for just a $100MM show. The services, of course, know this – as do shareholders. But that’s the challenge. After decades of record profits, it’s hard for old media companies to dig as deep and as long as will be needed to thrive in SVOD. In addition, Netflix’s ability to economically outspend competitors continues to grow. As a result, the cost of not licensing the series may actually widen, not shrink, over time. Comcast CEO Brian Roberts seems to recognize this challenge, which helps explains why NBCUniversal’s approach is rooted in the traditional Pay-TV ecosystem, telling The Hollywood Reports “Lots [of our content] will monetize best with [our OTT service]. And [other content] will [monetize] best on third party platforms”. As a result, NBCUniversal is “very much focused on not, like others have, just going cold turkey and taking it (content) off all the other platforms.”

#2

Second, content does deprecate eventually. The popularity of Friends and The Office is, in part, due to the many pre-teens, teens and young adults who have come of age after the show’s initial airing and had never watched the series on linear TV. While these series remain incredibly popular, much of this has to do with the pent-up demand caused by 15 years of linear-only availability (which starved those 30 and older of rewatching and functionally prevented those under 30 from watching). This pent-up demand is ultimately finite, even if new generations continue to discover the show. After all, interest and relevance does diminish over time – the predecessors to Friends and The Office, such as Cheers and ER, are nowhere near as popular. There’s a reason, after all, that streaming services amortize titles on an accelerated basis (i.e. correlated with viewing) rather than on a fixed per-year basis. Consumption is ultimately finite. Every minute of Friends watched in 2019 is a minute that, ceteris paribus, mostly won’t be watched in 2020 or beyond. And thus by the time these titles leave Netflix, if they do at all, they’ll be both less valuable to Netflix and Netflix will be less reliant upon them.

#3

Finally, the impact of the licensed titles Netflix is expected to lose tends to be exaggerated. There are a few reasons here. For example, most third party estimates say that The Office (owned by NBCUniversal), Friends (WarnerMedia) and Parks & Recreation (NBCUniversal) are the “most viewed” shows on Netflix.

This ranking is based on streams – not time. As a result, one hour of watching time generates only one “stream” for hourlongs such as Orange is the New Black, but two for The Office. It’s also worth highlighting these major library licenses are typically for 10+ seasons of 22+ episodes. Netflix’s originals, having only been released since 2013 and with more modern 7-to-13 episodes per seasons, thus provide fewer available hours to audiences. While this doesn’t artificially skew the data, it does mean that a purely streams or hours-based analysis can be misleading Stranger Things offers only 17 episodes (or hours). Friends has 236 episodes (or 118 hours).

Similarly, viewing doesn’t mean valuing. New, exclusive Originals tend to drive acquisition and intentional viewing behavior. Licensed re-runs, meanwhile, typically drive engagement – which is mostly important as a pricing driver. As a result, the loss of high-volume reruns is more likely to affect Netflix’s pricing growth and subscriber economics than its subscriber growth (Wall Street’s primary concern). To this end, alarmism around Netflix’s library losses tends to miss the company’s job to be done. Quality content loss matters – but this has been happening for years in the US, and not without notice by customers. Yet Netflix’s engagement has been steady, as has subscriber growth. The truth is, Netflix has simply become a low-cost form of entertainment that most families (Netflix averages 3+ user profiles per account) have simply absorbed into their month expenses and rarely consider cancelling. To point, it’s often overlooked that the average American watches more than five hours per day of video. Not all of this time is spent watching Emmy-winning, high-quality entertainment. Much of it is just intended to passively pass the time while cooking or on the treadmill – and as such, the specific title watched doesn’t really matter.

The reports that estimate Netflix’s reliance on licensed content are also suspect and, even if true, decreasing in relevance. Many of the research agencies producing these reports, such as JumpData, base their estimates on browser-only consumption…in the US. This data inherently skews older (perhaps explaining the popularity of Friends and Frasier) and only affects 40% of Netflix’s subscribers (and only 20% of annual growth). Put another way, the loss of titles like Friends matters less than popularly shared charts and headlines suggest. In addition, Netflix’s Originals library is massively larger outside the United States. As a result, Netflix’s reliance on second-run licenses (and therefore unsustainable differentiation) like Friends and The Office is mostly isolated to the US.

To 2020 and Beyond

Competition is inevitable in any industry. And certainly, Netflix will feel more competitive pressures in 2019 and 2020 than ever before. But there are many reasons to be skeptical of when and to what extent these new entrants will harm Netflix in the foreseeable future. And ultimately, having a strategy, roadmap and content pipeline is only part of what matters. Culture, talent and corporate alignment is obviously critical. However, NBCUniversal only re-organized for its D2C future in January of 2019 and WarnerMedia in March 2019. Lots of uncertainty remains. Even Disney is only a year into its D2C realignment – and has yet to codify its post-Fox acquisition org structure.

Beyond personnel, Big Media also tends to struggle to invest deeply for long-term results. This is somewhat understandable given its been decades since these giants had to do so – but it’s a problem when fighting a company like Netflix. Not only has the company promised multi-billion dollar losses for “many years”, it’s both the dominant category leader and one growing its budget by 50% annually. It doesn’t help that Disney, AT&T (owner of WarnerMedia) and Comcast (NBCUniversal) now hold more corporate debt than ever before in the history – and have promised to sustain their dividend programs. To this end, it’s even worth highlighting the marketing spend gap. In 2019, Netflix will spend close to $2.5B promoting its service – more than any of Disney, WarnerMedia or NBCUniversal are likely to spend on content in their first year.

And then there’s product and technology. Even if the above issues are put in order, Big Media tends to overlook (and be particularly bad at) software experiences. This is an area where Netflix is particularly strong. And this, added to Netflix’s already-dominant position, means that they can often build up sizable audiences for mediocre shows. It’s hard to beat a company that’s better distributed and able to outperform with inferior content.

Regardless, it’s clear that Netflix isn’t concerned about unprecedented increases in competition in its most competitive market. Were that the case, it wouldn’t have raised its prices, let alone by more than ever before. This doesn’t mean Netflix made the right call. But consider the implications. By the time competition arrives in earnest in 2020, Netflix is likely to be spending close to $20B per year (8x HBO and 50% more than Disney+Fox spends on non-sports TV) and putting out truly unprecedented volumes of content – “at bats” that will inevitably produce numerous hits. To this end, Netflix’s price increase will aid the company’s efforts to outspend its competitors before they enter the SVOD market. 2020 will also see Netflix release several series from each of Shonda Rhimes, Ryan Murphy and Kenya Barris. And during 2019, Netflix is expected to add at least 30MM subscribers according to BTIG – more than Disney, WarnerMedia and NBCUniversal are likely to add in their first years combined. Between this and its price increase, Netflix’s revenue is therefore likely to grow by $4.5B in 2019 – or more than 70% of Home Box Office (including Cinemax).

2019 might look like the year Big Media fights back against Netflix, The Usurper. But it won’t be. And 18 months is a long time, especially in consumer digital. If you think Netflix is strong today, just wait until 2020.

Matthew Ball (@ballmatthew)