Supported by Greenhaven Road Capital, finding value off the beaten path.
Michael Smith and Rahul Telang of Carnegie Melon University wrote an interesting book, Streaming, Sharing, Stealing: Big Data and the Future of Entertainment.
Smith and Telang wrote this book because of a “perfect storm” in the economic entertainment ecosystem. Traditionally a few firms dominated because the best business model for the last hundred years was a return to scale. The value was in finding/attracting talent, creating a market, and distributing the product.
This model worked. This model was logical. This model was successful.
Before 1995, the search for talent “was unscientific at best” and size helped to seek talent, sell it, and ship it. The Firms did this well and movies are one example. ‘Windowing’ is the process of a theatrical release followed by DVD sales followed by digital sales followed by subscription streaming followed by cable and broadcast rights.
Each stage of price discrimination maximizes revenue. People who value movies highly see them early, people who value movies less seem them later. Streaming, Sharing, Stealing is a book now because technology has evolved and the old windows are closing.
Blockbuster was founded in 1985 and The Little Mermaid began the ‘second golden age of animation’ in 1989. Shawn Fanning created Napster in 1999. Each of these was a locally logical decision at the time. It made sense to start Blockbuster, it made sense to make The Little Mermaid, it made sense to start Napster. Each is like a mile marker on the highway of entertainment history.
Smith and Telang note that the Netflix/HBO/Amazon/Spotify/etc. state of today was a sort of perfect storm. We should be wary of simple stories like Napster ruined everything, and be more like Sanjay Bakshi and approach things with a ‘part of the reason is this’ mentality. Smith and Telang propose three things.
First is broadband internet, “It became harder to delay a product in one channel versus another channel because people found it easier to infringe.” Gatekeepers Firms had to control distribution so they could control the windowing of theater to dvd to rental and so on.
Second is digitization. “Now you had technology change happening that eroded the role of a gatekeeper at these firms.” Casey Neistat is the vlogging example. E.L. James is the writing example. The digitiziation pendulum might have swung too far:
Our third change is the rise of platforms, because, “they didn’t have limited shelf space.” Frank Underwood kills a dog yet Netflix lives on because there’s always something else on.
At this point we should pause for a moment and recall something Andrew Ng said. Ng told the story about the early days of the internet and what it meant to be an internet business. It’s the difference between being a tourist and being a resident. “What defines an Internet company is whether or not you have an architect at your organization to leverage internet capabilities to do the things that the internet does really well.”
What things does an internet company do? Internet companies, Ng said, AB test, push decisions up (not down), and have short product cycles. We’ll see a Spotify example shortly.
Michael Smith is emphatic about this because it’s a perpetual point in his presentations. The genius for House of Cards was not knowing that Kevin Spacey, David Fincher, and Robin Wright were good at their jobs.
“The advantage Netflix got was from using its data was to do something that no traditional broadcast network could replicate. Netflix’s advantage didn’t come from knowing how many fans of Kevin Spacey were in the audience. Netflix’s advantage came from knowing exactly who they were as individuals and promote content to them directly based on their individual preferences.”
That’s what it means to be a digital entertainment company.
Netflix made nine trailers for House of Cards; some for Fincher fans, some for (former?) Kevin Spacey fans, some for fans of shows with strong female leads. None were for dog fans, dog fans won’t like House of Cards.
Smith recalled, “Michael Eisner said that if he had tried to include a similarly violent scene in an episode of broadcast television he’d be out in ten minutes.”
Why could Netflix show House of Cards but ABC could not? Unlimited shelf space. ABC has a shelf space of one. This point is made by Ben Thompson at Stratechery too, pointing out the Netflix advantage when they signed a deal with Starz. Primetime evidence exists too, as we see shows about doctors, law enforcement, families, and more doctors, more lawyers, and more families.
Netflix serves niches.
Music is both like movies and not like movies. Hal Varian noted that “music is something you want to hear over and over again. Movies you want to see on an occasional basis with one exception, kids movies.”
They’re also different in consumer preferences. For music, live is the premium experience. For film, premium means polished. No one pays to see Daniel Craig run across a stage but many love to attend Phish shows just to be surprised.
Knowing that music and movies are different and knowing that Gatekeeper Firms and technology companies are different we’ll look at Spotify’s “discover weekly (Twitter)”.
Former Spotify engineer Chris Johnson said, “Discover Weekly wasn’t handed down from the top. There are news articles about how this is the Apple Music killer and we’ve been planning it for months. No. This is purely an organic bottom-up feature that a small team of four engineers worked on.”
In his talk, Johnson explains the iteration and small steps and, in hindsight, the obviousness of it. Their ‘that’s interesting’ moment was when “We noticed users spending more time on editorial playlists than they were on their personalized discover playlists. What’s going on here?” Didn’t people leave the radio DJ for Spotify?
It was 2014 and Spotify created the first personalized playlist. “It turned out that a month later millions of users are still listening to their personalized Play it Forward playlist. We’re like, ‘Holy crap, what’s going on here?’ We did not expect that.”
That’s when Johnson and his team realized, “The same content as the Discover Page but…a playlist.” People wanted, expected, used playlists more than pages. They tested and tweaked. They released internal versions. They changed the cover art of the playlist.
Then Apple pushed the U2 album onto iPhones. Uh oh. That’s kinda what Spotify was doing, pushing playlists onto the app. Johnson included a survey to Google Docs asking for feedback. Only three people out of a thousand brought it up so they kept building. “Users know best. AB test everything.”
Another part-of-the-reason Discover Weekly works is that it’s human curated. Not one person editorially but a person sporadically. “All the models we’re building are built using human data, on what users are streaming or curating. We’re just mining through the human element.”
In another talk, Mathew Ogle said “Every song on Discover Weekly is there because at least one other person on Spotify added it to their playlist. It’s not there because a machine thought it sounded good.”
Using Ng’s definition, Spotify is definitely a digital music company. Like Netflix, they’ve made it easy to pay for and listen to music and have provided added value using data and AB testing to the users.
But Spotify has other problems – “For Spotify the royalty payments also crush its gross margins.” – that Netflix does not. Marc Andreessen asked Ted Sarandos about sports and Ted said, “It’s okay for us not to be doing everything…The reason I don’t get tempted by major league sports is that the pricing power all belongs to the leagues.”
Netflix and Spotify exist because consumer preferences changed. In How Music Got Free we see part of the story about how this happened. For example, CD’s were over-engineered. “Where the (CD) sales literature promised ‘Perfect Sound Forever,’ (Dieter) Seitzer saw a maximalist repository of irrelevant information, most of which was ignored by the human ear. He knew that most of the data from a compact disc could be discarded—the human auditory system was already doing it.”
And the industry dominated distribution. “Consolidation in the radio industry also helped, creating a homogenous nationwide listening environment that could propel an album to a Platinum status almost instantly on the basis of a single hit. Controlling the airwaves was critical—if Limp Bizkit could go forty times platinum, then literally anyone could.”
In 1996 the compact disc retailed for $17, cost $1 to manufacture, and had approximately 1.8 good songs. Music was ripe for Christensen’s disruption. It was true that CD’s were easier to buy, sounded better, and had more ways to listen. But the MP3 was better in certain ways and the shortfalls could be improved.
It was technological advances that led to 1,000 songs in your pocket.
It was analytical advances that led to Discover Weekly.
It feels like circa 2019 there’s more room to improve analytically than technologically. Netflix uses analytics for strategy but not scripts. Ted Sarandos, “We’re way better off taking someone’s creative vision and putting it through the service than us trying to go in and retool it. At the end of the day if the creator says, ‘That’s my show.’ we put it up.”
Smith quotes Frank Underwood in House of Cards, “Power is a lot like real estate. The closer you are to the source, the higher your property value.” Netflix is darn close to the data source.
This approach is appropriate because Netflix has unlimited shelf space. Smith notes that they can invest in properties with niche audiences like those for Woody Allen, Adam Sandler, and Arrested Development. Netflix wants to offer one thing you love at any given moment. ABC wants to offer something most like at one particular time. “Netflix didn’t face the same scarcity that traditional broadcast networks do. In a traditional broadcast network, you can only deliver one show at a time so that show has to appeal to as many viewers as possible. But a Netflix subscriber who was offended by Kevin Spacey’s actions could choose from thousands of other shows on Netflix.”
“Netflix doesn’t have to find more viewers to watch the individual programs. Netflix has to find more programs that appeal to individual viewers.”
The stakeholders matter too. “Netflix wasn’t pursuing an advertising-supported business model so it didn’t have to worry about offending advertisers by including a potentially controversial scene.”
This trio of broad band, digitization, and platforms is the media subset of what Michael Munger writes about in Tomorrow 3.0. In the book, Munger explains the three T’s of transaction costs that prevent economic exchange; triangulation, transfer, and trust.
In other words, I’ve got to find what I want, I’ve got to get what I want (and pay the person for it), and I’ve got to trust the other person. That’s what the digital behemoths have done. Netflix make it easier to find what we want – even though we didn’t know we wanted it – because they make nine different trailers for a tv show Netflix is able to get us what we want legally by offering an automatic payment system. Netflix creates trust that they’ll provide something because they have so much.
Teaching this is fun, says Michael Smith. Students are digital natives and they get this.
“With higher education for example, we have nothing to worry about when it comes to technology changing our business and our power. The students do exactly what you all just did, they nod their heads then go ‘Wait a second!’.”
How so? “There’s a lot of parallels between what happened in the entertainment industry and what might happen in higher education.”
A transition from gatekeepers who succeeded thanks to the collection of talent, the creation of markets, and the distribution of content to digital companies with platforms and unlimited shelf space. Austen Allred has one theory of education. Our XMBA post is a looser approach.
Digitization changed some parts of the economy more than others. Information goods like newspapers, movies, and music all became non-rival as copies were cheap to make and share. Thanks also to network effects, ideas went viral and sharing was easy.
Ben Carlson observed this:
“Why 45 million ppl watched Bird Box on Netflix: holidays & ppl need entertainment, slow TV season before new episodes/shows come out in Jan, no good new movies released. So ppl basically had no other choice but to watch this I Am Legend/World War Z/Quiet Place reboot.”
Entertainment (and the economy) isn’t better or worse, only different. It’s like a hike where the terrain has changed but the direction towards good enough has not.
Sources: Smith and Telang gave a very nice talk at Google (https://youtu.be/ozdfYIALhnY), the book goes into more detail (https://amzn.to/2B8RV5O) and this lecture at UC Irvine about teaching this ideas also has some nuggets (https://youtu.be/u7f1RYXdUZI).
For Spotify, Mathew Ogle spoke in 2015 about music discovery (https://youtu.be/81OlAEnyTKE). Chris Johnson gave a talk in 2016 in Austin about Spotify’s Discovery Weekly history that was insightful (https://youtu.be/HWFYA6N9uA0).
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