(Stratechery, 2017-1-18)
(Pic.)
To say that the Internet has changed the media business is
so obvious it barely bears writing; the media business, though, is massive in
scope, ranging from this site to The Walt Disney Company, with a multitude of
formats, categories, and business models in between. And, it turns out that the
impact of the Internet — and the outlook for the future — differs considerably
depending on what part of the media industry you look at.
THE OLD MEDIA MODEL
Nearly all media in the pre-Internet era functioned under
the same general model:
Note that there are two parts in this model when it comes to
making money — distribution and then integration — and the order matters.
Distribution required massive up-front investment, whether that be printing
presses, radio airplay and physical media, or broadcast licenses and cable
wires; the payoff was that those that owned distribution could create
money-making integrations:
(pic.)
Print: Newspapers and magazines primarily made money by
integrating editorial and advertisements into a single publication:
(pic,)
Music: Record labels primarily made money by integrating
back catalogs with new acts (which over time became part of the back catalog in
their own right):
(pic,)
TV: Broadcast TV functioned similarly to print; control of
distribution (via broadcast licenses) made it possible to integrate programming
and advertising:
(pic.)
Cable TV combined the broadcast TV model with bundling, a
particular form of integration:
(pic.)
THE ECONOMICS OF BUNDLING
It is important to understand the economics of bundling;
Chris Dixon has written the definitive piece on the topic:
Under assumptions that apply to most information-based
businesses, bundling benefits buyers and sellers. Consider the following simple
model for the willingness-to-pay of two cable buyers, the “sports lover” and
the “history lover”:
(pic.)
What price should the cable companies charge to maximize
revenues? Note that optimal prices are always somewhere below the buyers’
willingness-to-pay. Otherwise the buyer wouldn’t benefit from the purchase. For
simplicity, assume prices are set 10% lower than willingness-to-pay. If ESPN
and the History Channel were sold individually, the revenue maximizing price
would be $9 ($10 with a 10% discount). Sports lovers would buy ESPN and history
lovers would buy the History Channel. The cable company would get $18 in
revenue.
By bundling channels, the cable company can charge each
customer $11.70 ($13 discounted 10%) for the bundle, yielding combined revenue
of $23.40. The consumer surplus would be $2 in the non-bundle and $2.60 in the
bundle. Thus both buyers and sellers benefit from bundling.
Dixon’s article is worth reading in full; what is critical
to understand, though, is that while control of distribution created the
conditions for the creation of the cable bundle, there is an underlying
economic logic that is independent of distribution: if customers like more than
one thing, then both distributors and customers gain from a bundle.
WHEN DISTRIBUTION GOES TO ZERO
A consistent theme on Stratechery is that perhaps the most
important consequence of the Internet, at least from a business perspective,
was the reduction of the cost of distribution to effectively zero.
The most obvious casualty has been text-based publications,
and the reason should be clear: once newspapers and magazines lost their
distribution-based monopoly on customer attention the integration of editorial
and advertising fell apart. Advertisers could go directly to end users, first
via ad networks and increasingly via Google and Facebook exclusively, while end
users could avail themselves of any publication on the planet.
(pic.)
For Google and Facebook, the new integration is users and
advertisers, and the new lock-in is attention; it is editorial that has nowhere
else to go.
The music industry, meanwhile, has, at least relative to
newspapers, come out of the shift to the Internet in relatively good shape;
while piracy drove the music labels into the arms of Apple, which unbundled the
album into the song, streaming has rewarded the integration of back catalogs
and new music with bundle economics: more and more users are willing to pay
$10/month for access to everything, significantly increasing the average
revenue per customer. The result is an industry that looks remarkably similar
to the pre-Internet era:
(pic,)
(pic,)
Notice how little power Spotify and Apple Music have;
neither has a sufficient user base to attract suppliers (artists) based on pure
economics, in part because they don’t have access to back catalogs. Unlike
newspapers, music labels built an integration that transcends distribution.
That leaves the ever-fascinating TV industry, which has
resisted the effects of the Internet for a few different reasons:
• First,
and most obviously, until the past few years the Internet did not mean zero
cost distribution: streaming video takes considerable bandwidth that most
people lacked. And, on the flipside, producing compelling content is difficult
and expensive, in stark contrast to text in particular but also music. This
meant less competition.
• Second,
advertisers — and brand advertisers, in particular — choose TV not because it
is the only option (like newspapers were), but because it delivers a superior
return-on-investment. A television commercial is not only more compelling than
a print advertisement, but it can reach a massive number of potential customers
for a relatively low price and relatively low investment of resources (more on
this in a moment).
• Third, as
noted above, the cable bundle, like streaming, has its own economic rationale
for not just programmers and cable providers but also customers.
This first factor, particularly the lack of sufficient
bandwidth, has certainly decreased in importance the last few years; what is
interesting about TV, though, is that it is no more a unitary industry than is
media: figuring out what will happen next requires unpacking TV into its
different components.
THE JOBS THAT TV DOES
In 2013 I wrote a piece called The Jobs TV Does where I
posited that TV has traditionally filled multiple roles in people’s lives:
• TV kept us
informed
• TV
provided educational content
• TV
provided a live view of sporting events
• TV told
stories
• TV
offered escapism, i.e. an antidote to boredom
It was already obvious then that the first two jobs had been
taken over by the Internet: only old people got their news from TV, and there
was better and broader educational content on YouTube or any number of websites
than TV could ever deliver, even with 200 channels. The question I asked then
was how long TV could maintain its advantage when it came to the last three
jobs:
The disruption of TV will follow a similar path: a different
category will provide better live sports, better story-telling, or better
escapism. Said category will steal attention, and when TV no longer commands
enough attention of enough people, the entire edifice will collapse. Suddenly.
I’d bet on escapism being the next job we give to something
else, for a few reasons:
• The
economics of live sports are completely intertwined with the pay-TV model; this
will be the last pillar to crumble
• Networks
still play a crucial role in providing “venture-funding” for great
story-telling. Netflix is the great hope here
• Escapism
is in some sense indiscriminate; it doesn’t matter how our mind escapes, as
long as it does. Yet it’s also highly personal; the more tailored the escape,
the more fulfilling. This is why there are hundreds of TV channels. However,
there will never be as many TV channels as there are apps.
I was right about escapism being on the verge of collapse,
but the mechanism wasn’t so much apps as it was one app: Facebook.
FACEBOOK, SNAPCHAT, AND ESCAPISM
I wrote in The Facebook Epoch:
The use of mobile devices occupies all of the available time
around intent. It is only when we’re doing something specific that we aren’t
using our phones, and the empty spaces of our lives are far greater than anyone
imagined. Into this void — this massive market, both in terms of numbers and
available time — came the perfect product: a means of following, communicating,
and interacting with our friends and family. And, while we use a PC with
intent, what we humans most want to do with our free time is connect with other
humans: as Aristotle long ago observed, “Man is by nature a social animal.” It
turned out Facebook was most people’s natural habitat, and by most people I
mean those billions using mobile.
Snapchat is certainly challenging Facebook in this regard,
and one of the most interesting questions to watch in 2017 is if this is the
year both companies finally start to steal away not just TV’s attention but
also TV’s advertising.
Facebook is laying the groundwork to do just that; the
company has been pushing video for a long time now, and recently added a
dedicated video tab to its app. What has been missing, though, is an
advertising unit that can actually compete with TV for brand advertising
dollars; Facebook’s current advertising options are, both in terms of format
but also in their focus on fine-toothed targeting, predominantly designed for
direct marketing. Direct marketing has always been well-suited for digital
advertising; the point of the ad is to drive conversion, and digital is very
good, not only at measuring if said conversion occurred, but also at targeting
customers most likely to convert in the first place.
Brand advertising is different; whereas direct marketing is
focused at the bottom of the marketing funnel, brand advertising is about
making end users aware of your product in the first place, or just building
affinity for your brand as an investment in some future payoff. The mistake
Facebook made for a long time was in trying to win brand marketing dollars by
delivering direct marketing results: the company invested tons of time and
money in trying to detect and track the connection between a brand-focused
advertisement and eventual purchase, which is not only technically difficult —
what if the purchase takes place months in the future, or offline? — but also
completely misunderstood what mattered to brand advertisers.
I noted above that brand advertisers find TV to deliver a
superior return-on-investment; with its focus on tracking Facebook was too
concerned with the “return” at the expense of the “investment”. Specifically,
taking advantage of Facebook’s targeting and tracking capabilities requires the
continual time and attention of marketers; it was far more efficient to simply
create a television commercial that reached a bunch of people at once and then
track lift after the fact. This is why Procter & Gamble, the biggest TV
advertiser in the world, scaled back its targeting efforts on Facebook.
Facebook is doing two things to change its value proposition
for brand advertisers:
• First,
the company is reportedly on the verge of rolling out a new video advertising
unit that will play in the middle of videos — kind of like a TV commercial.
• Second,
Facebook is focusing much more on being an advertising platform with massive
scale than can also target — kind of like cable TV, but better — as opposed to
a measurement machine that targets individuals and tracks them to the grocery
store register.
That last point may not seem like much but it’s a noticeable
shift: on last quarter’s earnings call COO Sheryl Sandberg focused on the fact
Facebook made it possible for brand advertisers to do “big brand buys on our
platform like they would do on TV, but make them much more targeted.”; exactly
one year earlier the pitch was “personalized marketing at scale” and “measuring
ROI”.
I think this is the right shift for Facebook, but it also
highlights why Snapchat is very much its rival: thanks to Facebook’s ownership
of identity the latter is unlikely to mount a serious challenge for direct
marketing dollars (although it is — mistakenly in my opinion — building an
app-install product); however, if identity is less important for brand
advertising than simply scale, then Snapchat’s push for attention, particularly
amongst young people, is very much a threat to Facebook.
Not that that is much comfort to TV: Facebook and Snapchat
have peeled off the “escapism” job in terms of attention; doing the same in
terms of advertising is a question of when, not if.
NETFLIX AND STORY-TELLING
Meanwhile, Netflix is proving to be far more than a “hope”;
as I described last year in Netflix and the Conservation of Attractive Profits,
the company leveraged the commoditization of time enabled by streaming to own
end users, creating the conditions to modularize suppliers — and that’s exactly
what is happening.
What is interesting is that scripted TV is turning out very
differently than music: instead of leveraging their back catalogs to maintain
exclusivity on new releases, most networks sold the former to Netflix, giving
the upstart the runway to compete and increasingly dominate the market for new
shows. The motivation is obvious: networks have been far more concerned with
protecting their lucrative paid-TV revenue than with propping up their
streaming initiatives; the big difference in music is that the labels’ old
album-based business model had already been ruined. It’s a lot easier to move
into the future when there is nothing to lose.
THE GREAT UNBUNDLING
The shift of both escapism and story-telling away from
traditional TV are noteworthy in their own rights; equally important, though,
is that they are happening at the same time. Here is what the landscape looks
like once TV is broken up into the different “jobs” it has traditionally done
for viewers:
(pic.)
First, the new winners have models that look a lot like the
one that destroyed the publishing industry: by owning end users these companies
either capture revenue directly (Netflix) or have compelling platforms for
advertisers; content producers, meanwhile, are commoditized.
Secondly, all four jobs were unbundled by different
services, which is another way of saying there is no more bundle. That, by
extension, means that one of the most important forces holding the TV ecosystem
together is being sapped of its power. Bundling only makes sense if end users
can get their second and third-order preferences for less; what happens,
though, if there are no more second and third-order preferences to be had?
To put this concept in concrete terms, the vast majority of
discussion about paid TV has centered around ESPN specifically and sports
generally; the Disney money-maker traded away its traditional 90% penetration
guarantee for a higher carriage fee, and has subsequently seen its subscriber
base dwindle faster than that of paid-TV as a whole, leading many to question
its long-term prospects.
The truth, though, is that in the long run ESPN remains the
most stable part of the cable bundle: it is the only TV “job” that, thanks to
its investment in long-term rights deals, is not going anywhere. Indeed, what
may ultimately happen is not that ESPN leaves the bundle to go over-the-top,
but that a cable subscription becomes a de facto sports subscription, with ESPN
at the center garnering massive carriage fees from a significantly reduced
cable base. And, frankly, that may not be too bad of an outcome.
________________________________________
To be sure, it will take time for a lot of this analysis to
play out; indeed, I’ve long criticized cable-cutting apostles for making the
same prediction for going on 20 years. It’s a lot easier to predict unbundling
than to say when it will happen — or how.
To that end, this is my best guess at the latter; as for when,
the amount of change that has happened in just the last three years (since I
wrote The Jobs TV Does) is substantial — and most of that change was simply
laying the groundwork for actual shifts in behavior. Once those shifts start to
happen in earnest there will be feedback loops in everything from advertising
to content production to consumption that will only accelerate the changes,
resulting in a transformed media landscape that will impact all parts of
society. I’m starting to agree that the end is nearer than many think.
