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Netflix Flexes – Stratechery by Ben Thompson

The impact of Netflix

Fowl Field, the Netflix unique movie, began streaming on December 21 whereas I used to be on trip. That maybe explains why nearly all of my publicity to the Netflix Unique got here by way of NBA Twitter — and most of that publicity had completely nothing to do with the movie, no less than indirectly.

For instance, the Memphis Grizzlies had a Chook Field-inspired contest for courtside seats:

The Minnesota Timberwolves promoted an upcoming recreation with the Los Angeles (née Minneapolis) Lakers:

I personally fairly loved this tweet from the Atlanta Hawks, which got here in the midst of a 144-112 shellacking by my Milwaukee Bucks:

Talking of the Bucks, I couldn’t resist getting in on the meme both:

Probably the most significant Fowl Field tweet, although, was from Netflix:

Took off my blindfold this morning to find that 45,037,125 Netflix accounts have already watched Hen Field — greatest first 7 days ever for a Netflix movie!

— Netflix Movie (@NetflixFilm) December 28, 2018

That was fairly the flex, and Netflix was solely getting began.

The Chook Field Flex

There’s an argument that Fowl Field viewership numbers — which, as of Netflix’s earnings report final week, are as much as 80 million Netflix member households — will not be notably significant. Positive, taking the wildly conservative assumption that one family=one viewer would imply that 80 million viewers was the equal of a field workplace haul of over $700 million; growing that to 2 viewers per family would suggest an equal field workplace haul that may rank within the prime 10 of all time.

The issue, in fact, is that none of these 80 million households truly paid explicitly for Fowl Field: they received the film for “free” with their Netflix subscription, and it looks like a stretch to assume that the majority of them would have paid field workplace costs which are roughly as costly as a month of the streaming service, to see the film on objective.

This critique is each true and misses the purpose — three factors, truly. First, it isn’t as if Netflix is relying on field workplace receipts: to level out that the corporate isn’t incomes $700 million or $1.four billion or no matter is much more of a moot level than the variety of folks that watched Fowl Field. Secondly, and relatedly, Netflix is relying on subscription income. To that finish, producing a bit of content material that 58% of its subscriber base seen in a single month is by definition a triumph (and sure, value ~$700 million). Third, and most significantly, the success of Fowl Field drives the virtuous cycle that Netflix has as an aggregator in a number of methods.

Netflix the Aggregator

Begin with crucial aspect for an Aggregator — the demand aspect. Hen Field and different profitable content material does triple obligation for Netflix:

  • For present clients, Hen Field offers two hours of leisure and a move into well-liked tradition. It’s a value of products expense.
  • For potential clients, Chook Field makes Netflix extra engaging for a similar worth. Or, to take a look at it one other method, it lowers Netflix’s buyer acquisition value. It’s a advertising expense.
  • For marginal clients, Hen Field is a cause to remain on the platform. It lowers Netflix’s buyer retention value. It’s an working expense.

The latter two factors are important items of what makes an Aggregator an Aggregator; from Defining Aggregators:

As soon as an aggregator has gained some variety of finish customers, suppliers will come onto the aggregator’s platform on the aggregator’s phrases, successfully commoditizing and modularizing themselves. These further suppliers then make the aggregator extra engaging to extra customers, which in flip attracts extra suppliers, in a virtuous cycle.

Because of this for aggregators, buyer acquisition prices lower over time; marginal clients are interested in the platform by advantage of the growing variety of suppliers. This additional signifies that aggregators take pleasure in winner-take-all results: because the worth of an aggregator to finish customers is regularly growing it’s exceedingly troublesome for rivals to remove customers or win new ones.

That is in distinction to non-aggregator and non-platform corporations that face growing buyer acquisition prices as their consumer base grows. That’s as a result of preliminary clients are sometimes an ideal product-market match; nevertheless, as that match decreases, the excess worth from the product decreases as nicely and shortly turns unfavourable. Usually talking, any enterprise that creates its buyer worth in-house shouldn’t be an aggregator as a result of ultimately its buyer acquisition prices will restrict its progress potential.

The query, then, is why do suppliers come onto Netflix’s platform?

The primary purpose is that Netflix pays probably the most. From a provider perspective that’s definitely simple, however the query as to why Netflix pays probably the most is an fascinating one. There are a number of causes:

  • First, Netflix is promoting content material to the whole world. Meaning its buyer base is bigger than different content material consumers, giving Netflix larger shopping for energy
  • Second, due to the demand-side dynamics I simply described, Netflix isn’t merely promoting to in the present day’s subscribers, however the subscribers it anticipates attracting over the subsequent a number of years, giving Netflix larger shopping for energy once more.
  • Third, as a result of Netflix just isn’t monetizing any specific piece of content material in isolation, however somewhat as a part of an general subscription providing, it will possibly extra simply take up failures on one hand (its clients produce other exhibits to observe), and seize extra worth on the opposite (as a result of the lifetime worth of consumers is way larger than a single film ticket). Because of this Netflix’s danger, relative to conventional distributors, is considerably biased in the direction of the upside, justifying larger costs.

Secondly, Netflix has lengthy appealed to the opposite motivations a provider may need, notably artistic management. What the success of Hen Field exhibits, although, is that Netflix is uniquely able to driving an viewers as nicely. Positive, the corporate spent cash on advertising Fowl Field, however the actuality is that Chook Field was well-liked as a result of it was on Netflix. That’s what drove views, and what drove Hen Field into the favored consciousness, and whereas all suppliers like getting paid, artists particularly wish to be seen.

And so we now have a virtuous cycle: Netflix’s management of demand attracts suppliers, which will increase demand, and so it goes.

The Pricing Flex

Between the Hen Field announcement and Netflix’s earnings (the place the corporate introduced comparable stellar viewership numbers for quite a few different exhibits) got here another piece of stories: Netflix is elevating the worth on U.S. subscribers by $2/month; new subscribers can pay the brand new worth instantly, whereas present subscribers shall be phased in over the subsequent a number of months. CEO Reed Hastings stated on the corporate’s earnings interview:

With respect to the worth modifications…you’ll see that impression over the course of the yr, and what meaning is that may clearly influence the speed of internet addition progress within the first half of the yr. However commensurately, you additionally see ASP domestically enhance over the course of the yr and that’s what we expect will drive an acceleration in income progress over the course of 2019. And that’s what additionally we consider drive working margin larger sequentially over the course of the yr to allow us to hit that 13% goal for the complete yr.

One of many apparent challenges for Netflix, notably in the USA, is saturation. The corporate has 60 million subscribers within the U.S., which as of 2017 had 126 million households; given widespread account sharing, the corporate’s penetration is nearly definitely properly over 50%. There’s nonetheless room for progress — round 100 million households have conventional multichannel video programming (i.e. the cable bundle) — however by definition households with out Netflix are both exceptionally exhausting to succeed in (which is why Netflix has partnered with MVPDs to promote the service) or exceptionally frugal. Elevating the worth will definitely additional inhibit the latter with their presumably excessive worth elasticity.

On the similar time, Netflix is clearly assured that the worth elasticity of its present clients could be very low: the corporate doesn’t seem to anticipate any undue churn, which is cheap provided that earlier worth will increase went off and not using a hitch. Extra broadly, it speaks to the significance of understanding how it’s that Chook Field and different Netflix unique content material impacts demand:

This can be a graphical illustration of the purpose I made above: present clients are much less worth elastic, and marginal clients usually tend to stick round or enroll. Critically, this can be a win for each a part of the worth chain: subscribers get extra worth, Netflix will get extra income, and there’s extra money for suppliers.

The Streaming Worth Chain

A lot of that is apparent, a minimum of at this level, however it’s notably noteworthy within the context of Netflix’s rivals. The normal MVPD worth chain, for instance, has 4 members: suppliers, networks, distributors (cable, satellite tv for pc, or digital), and finish customers. This made sense when the chief constraints have been time and the necessity to truly run a cable into the again of an finish consumer’s tv, however it’s a vital handicap in a world the place there isn’t any time constraint and the place distribution is over the Web.

Think about the current announcement from NBC; from CNBC:

Comcast’s NBCUniversal plans to debut a free, ad-supported streaming service to anybody that subscribes to a standard pay-TV service, together with rivals similar to Constitution, AT&T, Cox and Dish, within the first quarter of 2020, the corporate introduced Monday. For people who don’t subscribe to a pay-TV service, the streaming product, which can embrace 1,500 hours of NBC TV exhibits, comparable to SNL and Parks and Recreation, and tons of of hours of Common films, will value someplace round $12 a month, an individual accustomed to the corporate’s plans advised CNBC. The service might be run by Bonnie Hammer, the corporate introduced Monday.

This sounds suspiciously like TV In all places, the plan to permit MVPD subscribers to log into devoted apps with their cable account. The issue is that the MVPD worth chain ensured that TV In all places can be an entire mess:

  • As an alternative of there being one app, shoppers needed to obtain an app per community
  • Not all networks supported TV In all places, or did so inconsistently
  • Not all cable networks supported TV All over the place, or did so inconsistently

Briefly, TV All over the place was an try to use a worth chain that was created round cable tv to a basically new paradigm, which launched large quantities of misalignment and inefficiency, most of which was borne by the top consumer. And oh, by the best way, the previous enterprise mannequin of promoting as properly.

The MVPD value chain

Distinction that to Netflix which has created a worth chain completely attuned to the streaming paradigm.

Netflix's value chain

Netflix’s integration of manufacturing and distribution additionally dramatically will increase its flexibility and addressable markets in relation to each provide and demand. On the demand aspect, as famous above, Netflix can attain customers each everywhere in the world in addition to into the longer term. Simply as importantly, on the availability aspect Netflix can accommodate all types of content material on all types of deal phrases. Hastings stated on the earnings name:

Our important aim is to make the most effective content material. And we’ve stated in earlier quarters that that may be a mixture of a number of totally different enterprise fashions relying on who owns the IP. So, what we’re going to do is make the perfect present and never be caught on the enterprise mannequin, as a result of the buyer actually doesn’t perceive that or we even need to spend any time excited about it.

So by means of instance, final yr, we had 140 totally different exhibits around the globe that premiered on a community someplace and on Netflix all over the place else on the earth. Subsequent yr, it’s extra to nearer to 180. And these are mixture of co-producing with native producers in different nations; it exhibits that then air on a community in that nation after which premier on Netflix. However once I say co-production, I imply, we are available on the script stage, we are available on the first cash stage, we’re concerned creatively with the manufacturing of that present.

Netflix has exhibits it owns utterly, exhibits it personal first-run rights to, hybrid exhibits like Hastings described, second-run exhibits — it runs the gamut. Critically, whereas some fashions are extra worthwhile than others, all make the service extra engaging to Netflix’s clients.

This can be a specific problem for a corporation like Disney: the corporate is staking a superb portion of its future by itself streaming service pushed by its personal IP, however has not prompt a willingness to scale provide like Netflix has. That, by definition, will restrict the corporate’s upside with regards to shopper attain and in addition long-term pricing energy.

The Competitors Flex

These two factors are associated: tighter integration in the midst of the worth chain means extra flexibility and modularity on the sides. Netflix is aware of this, which is why the corporate didn’t even hassle labeling Comcast or Disney its rivals. From the corporate’s letter to buyers (emphasis mine):

Within the US, we earn round 10% of tv display time and fewer than that of cellular display time. In different nations, we earn a decrease proportion of display time because of decrease penetration of our service. We earn shopper display time, each cellular and tv, away from a really broad set of rivals. We compete with (and lose to) ​Fortnite​ greater than HBO…

Our progress is predicated on how good our expertise is, in comparison with all the opposite display time experiences from which shoppers select. Our focus just isn’t on Disney+, Amazon or others, however on how we will enhance our expertise for our members.

That is maybe the most important flex of all: Netflix is so assured in its place it’s successfully stating that if clients select to observe TV, they may select Netflix. The corporate is aware of its mannequin is that a lot better.

I wrote a follow-up to this text on this Day by day Replace.