Netflix’s Looming Merger
Photo by Dawid Labno on Unsplash

Disclaimer: I’m not a prognosticator and I’m certainly not an entertainment industry expert. As a result, this article is more like a working paper rather than a final, absolute argument. The main objective is to illustrate a line of reasoning heavily inspired by current events and this week’s study of the brilliant book Blue Ocean Strategy.

Netflix and Fragility

A few weeks ago, I wrote about Netflix and its fragility problem. To put it simply, Netflix has always been a distributor of sorts, a centralized hub for entertainment. Just like Blockbuster. The two companies weren’t rivals (at first) because they operated on completely different service models. But they provided the same service.

And as history showed rather quickly, Blockbuster’s original model was quickly made inferior. Netflix’s quick success was anchored on the innovation of its DVD-by-mail system which offered greater value than Blockbuster (more selection, convenient browsing online) at lower prices. Blockbuster eventually tried to mimic this service but the effort (Blockbuster Direct) was short-lived, inferior, and came too late (HT to Adam Gonnerman).

To put it in Blue Ocean terms, Netflix’s model perfected the value innovation of home media distribution. With lower costs and greater value never-before-offered, they set themselves on a course for success. To their immense credit, they continued to chase that value innovation to the next evolution.

After seeing the potential of online streaming, Netflix ventured into its next Blue Ocean as a pioneer in the Streaming Video On Demand (SVOD) industry. Few were equipped to enter this space and being the first real distributor gave Netflix a chance to retain all the value they originally held and simply offer it in a new, more-frictionless channel. It would be akin to Amazon somehow creating the Star Trek replicator so that every product was available instantly on demand, eliminating all the wait times that goes into the shipping and delivery component of their service.

Which is to say that Netflix’s streaming was something of a miracle. No more worries about DVDs, preordering, or being locked to a single device (dvd players). Customers flocked to it.

We came for the novelty and convenience but we stayed for the value. That value was built on the content selection. By virtue of being so early to the game, Netflix offered content providers the only real channel to share their entertainment. As popular television shows and movies came to the service, customers found just about everything they had wanted from the mail-order service and thus shifted to streaming-only. New subscribers came aboard, too, and the business just grew by leaps and bounds.

This showed Netflix’s great strength. And its vulnerability. Because what draws subscribers to join is different from what compels them to stay. The convenience is an easy attraction but the content is what keeps us.

So what happens when the actual content providers decide to take their ball (i.e., content) and go home?

The Reddening Ocean

We’re about to find out. The shift is happening. Netflix is losing some of its most popular content as AT&T’s WarnerMedia launches its own ship into the reddening waters of the SVOD ocean. Disney is doing the same. And NBCUniversal. And Apple. And existing competitors like Amazon are strengthening their offerings with live sports and even beating Netflix at the distribution game with new partnerships that once went to Netflix when it was the only real game in town. Meanwhile, separate content providers, like CW, are now exiting any exclusive deal with Netflix so that they can draw new bidding wars in this expanded ocean.

I should mention, too, that Disney isn’t just offering their own service for their own content. They’re also taking over Hulu to broaden their SVOD value, expanding just as aggressively as Amazon.

This will only continue. Because we’re still in the early dawning stages of the SVOD industry. And the action already casts an ominous shadow on Netflix. Despite all appearances, I honestly think they are in desperation mode.

Losing Grip On Value Innovation

To understand why, consider the following two bits of information:

First, as reported by the Wall Street Journal, non-original programming constitutes 72% of the viewing time spent on Netflix. In a simplistic view, this means that 72% of the value Netflix offers to customers is severely threatened as competitors regain their content.

Meanwhile, Netflix’s subscription fees have increased into HBO territory.

Value is decreasing rapidly from this one-two punch. Netflix is essentially being pushed to the ropes. They are losing what customers want and raising prices at the same time.

Hulu has already attacked this weakened position by lowering their subscription fees. Disney and others will also undercut once their services launch. And given that Netflix’s borrowing and spending has skyrocketed, the company can’t afford the pending price war.

Why has this happened? Because Netflix started and succeeded as a distributor. They provided content to people in convenient ways. Remove that content and you’re only left with convenience. This is the fragility.

If that sounds strange, think of it this way: imagine if Amazon could no longer sell major brands. Would you still keep a prime membership? The mass-market value of Amazon is built squarely on its convenient selection of major brands that consumers trust.

Similarly, the mass-market of Netflix is built squarely on the convenient selection of major entertainment that consumers trust. We are loyal to Friends, Frasier, The Office, Parks and Rec, and whatever else. We are not loyal to Netflix.

The only way for Netflix to guard against the fragility is to find new content that serves people just as well and build loyalty around it.

This, of course, is why Netflix exploded with a content-creation frenzy that dumped 1,500 hours of new entertainment onto the service in 2018. It’s almost obscene. And I think it reeks of desperation. Netflix saw this day coming and decided to go on a spending spree, borrowing and burning as fast as it could, to throw all the content it could onto the service and see what sticks.

Has it worked? I don’t know. I doubt it. And Netflix won’t give any straight answers.

The approach reminds me of Atari’s strategy in its heyday. Deliberately flooding the market with more content just cheapened the overall experience. Will bad Netflix shows become this industry’s version of Atari’s E.T. the Extra-Terrestrial?

I can’t help but think the company is losing its grip on the value innovation.

To refresh that idea, let’s return to Blue Ocean Strategy. The integral part of value innovation is to find ways to break the value-cost trade-off. As the authors write,

Value innovation requires companies to orient the whole system toward achieving a leap in value for both buyers and themselves.

That’s not happening anymore. When Netflix was a distributor of all the in-demand content, it had a perfect alignment of a convenient service at a low cost that continued to develop robust offerings, thus add more customers, thus add more content, in a virtuous cycle. Again, as a distributor, it worked great.

But with the non-original programming disappearing, Netflix is no longer a distributor. It’s an ersatz version of HBO. It’s another Disney. Another NBCUniversal. Its primary offering will be original content.

And given the quality of that content, it’s actually not a Disney or HBO. Instead, it’s more like Starz. Only more expensive.

That expense would not be an issue, per se, if there was a commensurate level of quality. Netflix is trying to provide that quality. But I don’t think it’s succeeding. The value innovation is disappearing.

Drinking Milkshakes

I’m reminded of the powerful ending scene in the movie There Will Be Blood. Without spoiling it, the film ends with the revelation of how the lead character used his wiles and the laws of gravity (i.e., drainage) to steal value (i.e., oil) from a competitor.

Netflix was the pioneer. It developed the model for true value innovation in the SVOD industry. In many ways, it created the technology. And while the company still has the advantage as the single best streaming experience, that convenience can (and will) be easily copied. It’s already happening. That milkshake has many straws.

It reminds me of a very important observation from the authors of Blue Ocean Strategy,

Value innovation occurs only when companies align innovation with utility, price, and cost positions. If they fail to anchor innovation with value in this way, technology innovators and market pioneers often lay the eggs that other companies hatch.

It brings new meaning to the idea that Netflix is walking on eggshells.

As those proverbial eggs hatch, Disney and NBCUniversal and others will draw us to their services with lower prices (free with ads!), better content, and longer trials. Existing players like Amazon and HBO might even get aggressive with lower prices for a period.

Meanwhile, certain components of Netflix’s value — like it’s kid-friendly experience — will be gobbled up by Disney or others who have strong position in those areas.

Netflix will also try to diversify. They’ve already ventured into interactive content and they’ll try gaming, too. But there are others already occupying that world and others moving in.

There’s no easy place to turn to hold onto value innovation.

Unless they merge.

The Consolidation

It won’t happen tomorrow but the entry of these new competitors offering trusted content at lower prices will create big shifts over time. Consumers will get frustrated by all the different services. The glory days will be behind us. Many will weigh the options between five or six competing services (to say nothing of regular cable television and the world’s greatest public access channel, YouTube) and start to trim their budgets.

Where do they go? History and current behavior shows they will not go with what is cheapest but rather with what has the most value. The value is in familiar, loyalty programming. Which Netflix will soon lack.

Nonetheless, there will be a price war to hasten this shift and, once it kicks into high gear, we’ll see the consolidation. As seen in countless industries before. Including cable TV.

Netflix will merge with someone who wants the remaining subscriber base, technology, and any of the valuable content that remains in-demand. Will it be Apple? Many hope for that. I see how they could combine to create something unique and valuable.

All the same, we’re headed to the next stage of the SVOD industry. Netflix created it. Others now enter. The battle begins. And like Thunderdome, fewer will leave this arena than entered it.

For reasons described above, I don’t think Netflix makes it out alone. Blue Ocean Strategy helps me understand this. Along with Taleb’s Antifragile (review here) and the nature of an entity’s response to stress and pressure.

So it goes. Meet the new TV. Same as the old TV. A blue ocean turns red. Some ships sink. Some combine. The waters grow calm. Balance returns as the many are winnowed down to a few and an industry matures into something familiar.
['Norm Wright']
['Entertainment', 'Netflix', 'Business', 'Technology', 'Strategy']