How Streaming Turned the Traditional Content Economy Upside Down
An essay on streaming business models, the content licensing process, and industry disruption.
Bear with me for some context setting…
Historically, Media & Entertainment companies had two main options for distributing their content (be it TV programs, movies, etc.); these companies could opt to distribute via first-party “owned and operated” (or O&O) channels and/or third-party licensing deals. Said differently, MediaCo X could share its new movie with consumers directly (e.g., by putting it in theatres, selling DVDs, etc.) and in doing so assume the majority of financial upside (with small percentages shared with the theatres, hardware partners, and the like); alternatively, MediaCo X could license the rights of the movie to a third-party distributor (like Netflix) and receive a fixed (typically annual) fee from this distributor for their use of the content with steady cash flows, but limited upside. Furthermore, MediaCo X was not limited from pursuing both avenues; for example, it could distribute the movie exclusively in theatres for six months to cash in on box office revenues before then licensing it to Netflix for a streaming license deal in order to maximize monetization across both streams.
At the start of the “streaming era,” the scenario described above was quite common for traditional Media & Entertainment companies like Disney, Paramount, and others. There was still significant upside in the theatrical market, and as the early leader in the digital space, Netflix was a go-to partner for streaming distribution deals to reach this growing audience segment as well. At the time, this model seemed to be mutually beneficial to both traditional players (who got increased revenues and reach) as well as Netflix (who got access to cross-company premium content). Netflix in particular benefited enormously, as it distanced itself from nascent, earlier stage streaming companies (e.g., Hulu), experienced massive user growth, and received “tech-level” valuation multiples from Wall Street. Across town however, and especially in light of the COVID-19 pandemic, traditional media companies faced increasing pressure from the likes of cord-cutting and theatrical shutdowns. They were in need of growth, and streaming appeared to be the answer.
Why the Streaming Wars Hurt Everybody
The “streaming wars,” typically dated back to the start of the pandemic in early 2020, was a wave of intense competition that arrived to the Media & Entertainment industry as legacy players (including Disney, HBO, and others) introduced new O&O streaming services to compete with the likes of Netflix.
Quickly, the streaming market grew crowded with “Plus-es” and “Max-es” as legacy players unveiled their new streaming services in rapid succession. Though initially well-received, reports of consumer frustration and “streaming fatigue” quickly emerged. Content was increasingly becoming fragmented across the various, recently launched streaming services - each of which carried their own cost. What had previously been a simple process for consumers (i.e., navigating the program guide of your single-cost cable package to find something to watch) was now a challenge of knowing what title existed on what service, which in itself was a frequently moving target.
The underlying cause of this shift and consumer frustration was going on behind the scenes as new market entrants jockeyed for position in the now highly competitive streaming market. When seeking to differentiate themselves, these companies had two key levers at their disposal: price and content. Given the significant cost pressures from launching and maintaining these services, most focused on the content lever as their key differentiator.
Where Media & Entertainment companies previously had a single third-party option for streaming distribution (typically Netflix), they were now presented with a new option to reach digital audiences - their own services. In fact, not only was Netflix not the only option anymore; they were now a direct competitor. The reaction to this development was fairly consistent across new entrants: pull previously licensed content from Netflix and introduce exclusive “content silos” on their own streaming services to buoy subscriber sign-ups. Even content that previously would have been launched on traditional TV or in theatres began to launch directly on streaming platforms - either in tandem with the traditional option or with streaming as the sole channel. In other words, the only way to find and stream Disney (or NBCUniversal, or HBO) titles was quickly becoming Disney+ (or Peacock, or HBO Max).
The Apparent Streaming Solution = $$$
As these Media & Entertainment companies raced to differentiate their streaming services with content silos, market-leading Netflix was forced to react. Not oblivious to the high-performing licensed shows disappearing from their platform (e.g., The Office, Parks & Recreation, etc.), Netflix embarked on a new path that paved the way for early streaming economics: heavy investment in original content.
Quickly, Netflix pivoted from its licensing-based content strategy and leaned heavily into original content investment; additionally, analysts expect Netflix to continue allocating more and more spend towards originals (vs licensed or acquired content) in the years to come. This past year in 2022, we saw this new strategy come to life with as the list of Netflix’s highest performing titles was littered with originals including:
Continued investments in original Netflix franchises with Season 4 of Stranger Things
Launches of high-profile docuseries like Dahmer – Monster: The Jeffrey Dahmer Story
High-profile, made-for-streaming movies including The Gray Man
In both FY21 and FY22, Netflix spent ~$18bn on content, an investment somewhat justified due to increasing market competition and financed through the company’s profitable streaming business (per Q3 FY22 earnings, Netflix is expected to make ~$5bn in operating profit this year). This is true especially when benchmarking Netflix’s content spend against its new-to-streaming peers, which we will get to.
Again, Netflix’s seemingly successful strategy provided a North Star for competing streaming services, and quickly, their proprietors began to follow suit. Heavy investment in original content launches provided much needed buzz for the early-stage streamers as they continued to chase down Netflix’s immense subscriber scale and growth, and with it “tech-level” trading multiples from Wall Street. A striking example was Disney’s ~$30bn in content expenses (notably including sports rights) in FY22, which they are expected to maintain in FY23. At this point in the streaming era, the digitally-native entertainment platforms had experienced seemingly untapped growth, forecasting subscriber increases quarter after quarter, and justifying both high expenses as well as the high valuations received from Wall Street. However, in April 2022, Netflix announced its first expected domestic subscriber losses and forecasted more to come, calling into question the viability of the streaming business model and flipping the industry on its head.
Back to the Basics: Profitability in Streaming
Wall Street’s reaction to Netflix’s forecast was swift and rippled across the industry. Coming off of years of gains in the stock market, Media & Entertainment companies’ market caps dropped precipitously over the remainder of the year, expected to have fallen nearly ~50% YoY in 2022.
People have interpreted this “crash” in one of two ways:
Bears: Streaming is not the “golden ticket” for growth at Media & Entertainment companies in the way they had originally proclaimed. Valuation drops are justified and indicate the need for additional innovation and new business models, which are yet to be seen.
Bulls: Though growth and adoption are not occurring as quickly as expected, streaming is still essential to the digitally-native future of Media & Entertainment. The “crash” is a necessary re-valuation to indicate a longer timeline to market maturity and an important nudge toward profitable approaches to streaming, rather than solely chasing subscriber growth.
Regardless of your interpretation (I’m partial to #2!), the call for change was clear. The scale required to generate a profitable streaming business with just subscriber revenue is possible, but the losses incurred to get there have the potential to be catastrophic under the shifted POV on Wall Street.
Today, we are now starting to see leading Media & Entertainment companies introduce alternative monetization approaches to their streaming services, specifically with advertising revenue. We have seen Disney and Netflix join HBO in deviating from the “pure-subscription” or SVOD (subscription-based video on demand) business model with the introduction of ad-supported tiers in Q4 2022. Similarly, players like Paramount and NBCUniversal have introduced “free” options - referred to as FAST or “Free Ad-supported Streaming TV” channels in industry jargon. These cheaper, ad-supported streaming alternatives to pure SVOD are expected to take off in the coming years, especially as consumers face economic uncertainty in 2023.
Streaming’s Next Correction
We head into 2023 tentatively optimistic for streaming in the Media & Entertainment industry, as leaders make necessary business adjustments for longer-term financial stability and viability and as consumers adopt ad-supported services.
However, this positive outlook neglects to address one key party in the streaming ecosystem: the content creators themselves.
Historically, media “participants” (e.g., writers, actors, producers, etc.) shared in the financial upside of content monetization. Through “participant fees,” a small percentage of all future profits generated by the content (negotiated by participants’ agents) would be allocated to participants over time following the production’s release. Similar to granting equity to employees, this incentivized participants to take a meaningful stake in the future success of the movie or TV show they are working on.
The subscription model to streaming changed that, as the profits associated with SVOD streaming platforms proved hard to allocate to a single title. For instance, how are we to know how many subscribers Netflix gained through the Stranger Things franchise? What about for actors who appeared in just one episode in Season 4? There are ways of estimating, but the implications of those estimates would dictate large financial swings - both in terms of Netflix’s P&L as well as the individual earnings of participants.
Preempting this challenge, Netflix (and other “pure SVOD” players) initially adopted a model which entailed buying out all participant fees up front; i.e., they paid a large sum when developing or purchasing content which was then allocated to participants as a fixed one-time payment, rather than as variable payments over time depending on incurred profit. At the time, this made sense to all parties; however, as streaming becomes increasingly dependent on new revenue streams like advertising (which can be directly tied to engagement of a single title, season, or even episode), this participant payment mechanism is being called into question once more.
A strike is anticipated among the Writers Guild of America in 2023, with this participant payment issue being one of the key drivers. Given streamers’ continued dependency on high-quality content as a differentiator and anticipated spend increases next year, the outcome of this strike may well be the next important correction in the trajectory of the Media & Entertainment industry. In short, this past year exposed many of the underlying challenges in the first iteration of the streaming business, and 2023 will be instrumental in determining the efficacy of changes made by leaders in the space, as well as defining the business’ infrastructure to support a strong, streaming-centric content economy in the digital age.