Speaking of companies going to Hollywood with a checkbook, Netflix has been near the head of that line (along with Amazon Prime Video/TV) for several years now.  So their business must be modeled on that of the Hollywood movie studios, right?  No:  Wrong.

For enviable clarity on Netflix’s actual business model, I direct your attention to an HBR article published a few weeks ago, “Netflix and the economics of bundling.

It starts by noting that Netflix had “a breakout year” at the Oscars last month, winning 14 nominations (exceeding all its prior years combined) and winning four, tying it for first with Disney, Fox, and Universal.  The conclusion?

In just over a month, Netflix solidified its position as an insider in the theatrical business in every way.

Well, in every way but one: Netflix still doesn’t “release” its movies in theaters.

So Netflix has been enormously successful while rejecting the cornerstone (the HBR article calls it “the most important part” of the studios’ traditional business: The limited distribution release in theaters.  You know the drill: First in fancy houses in NY and LA, then high-end houses nationwide, then downmarket into saturation coverage, and maybe 90-180-365 days later onto DVD’s or pay-per-view and ultimately free on basic cable through TMT or any number of other equivalent channels.

Economically, the studios’ model is impeccable: it’s classic, and durable, price discrimination.  Customers who value your product/service most highly pay more while others who value it less still can purchase it but at a lesser, digestible and relatively attractive, price.  Price discrimination is the venerable term of art in economics, so cleanse your mind of any negative semantic associations and focus on its power: You collect the most each group of buyers/clients is willing to pay while still offering an equivalently attractive deal to others less highly propensed towards your offering.

The trick is almost always how to effectively segregate the groups based on their willingness to pay (“price elasticity of demand”) while  effectively excluding hose willing to pay more from “cheating” and getting everything they want at a lower price.

One final note of clarification on price discrimination and then back to Netflix.  Charging two or more different prices for different offerings is not what we’re talking about.  Business and economy class are two fundamentally different products; but economy class purchased three to six months in advance and that purchased 48 hours before the flight are the same product, where price discrimination comes into play.

Back to Netflix, shall we?

Hollywood depends on price discrimination because it’s selling individual movies to many different customers.  Netflix doesn’t have to because it’s selling a bundle of many different movies to individual customers.

Now, shall we join up AT&T’s latest move and Netflix?

The problem is that it’s hard to understand Netflix’s strategy from the perspective of the established business model. In November 2018, John Fithian, President of the National Association of Theaters Owners criticized the streamer, asking, “Wouldn’t Netflix make more money and establish a much deeper cultural conversation by offering a true and robust theatrical run first, and offering exclusive streaming to its subscribers later?”

With all due respect, we believe Mr. Fithian has it backwards. Couldn’t the studios make more money by adopting the model that Netflix is using?

Actually, that’s exactly what they are doing. The horizontal merger of Disney and Fox and the vertical merger of Warner Brothers and AT&T are both designed to exploit Netflix’s bundled strategy of selling movies. As more studios embrace this new business model, we believe they will see how bundling benefits both the bottom line and their audience.

“With all due respect, we believe” the HBR article author is way getting ahead of the story.  Yes, Netflix is absolutely positively bundling movies, a/k/a content.  Their business model is crystal clear, if crazily contrarian when they launched it.

But is that what AT&T is doing–“bundling content?”  I’m not privy to anything at AT&T outside our company’s monthly wireless bill, but if that is truly their business model what are they doing running a wireless cellular network?

Two further points:

  • “It’s hard to understand Netflix’s strategy from the perspective of the established business model.”  Indeed, isn’t that the point of what Netflix did when it opted to bypass theatrical distribution?  It’s hard for incumbents, following a business model that has served them very well for 100 years, to envision ripping out their distribution platform root and branch.  I would daresay it’s impossible.
  • As for AT&T: we haven’t yet mentioned the price it paid for TIme Warner: About 40% of its entire market cap at the time.  This goes a bit beyond preserving optionality; AT&T is making a big bet on a future not indisputably essential to being a wireless carrier.

Finally, according to a fascinating cover story/feature in the latest Bloomberg Businessweek magazine, AT&T has some internal housekeeping issues ahead of it:

Later this year, AT&T executives will introduce a streaming video service featuring WarnerMedia content, which includes brands such as TBS, TNT, and the Warner Bros. studio. HBO will play a crucial, if still uncertain, role as one of AT&T’s keys for unlocking digital fortunes.

But interviews with more than a dozen former Time Warner and HBO employees, many of whom declined to be named discussing a former employer, suggest that maximizing HBO on the internet has long enchanted and frustrated the scores of executives who’ve tried. “HBO has been the ultimate Gordian knot,” says Jamyn Edis, a former vice president of HBO’s consumer technology group who’s now an adjunct professor at New York University’s Stern School of Business. “It’s been a seemingly intractable set of problems: long-term contracts written before the dawn of digital, 30-year-career executives with no incentive to hurt the Time Warner cash cow, an institutional distaste for technology—‘we’re in the content business’—and the internecine tribal warfare typical of any organization.” […]

From the outside, people think of HBO for its innovative programming—The Sopranos, Sex and the City, The Wire, and, of course, Game of Thrones. But people who’ve worked there describe a hidebound institution. Decisions are made slowly and by consensus; longtime employees guard the network’s lucrative, award-winning status quo. From the start, HBO’s internet team was met with occasional outbursts of resistance.

But this isn’t an essay about AT&T’s or HBO’s internal quotients of seamless collaboration or paralytic dysfunction; it’s about business models.

  • What is your firm’s?
  • Does everyone know that?
  • Does everyone agree with that?
  • Can you specify in 25 words or less where you’re going to play…?
  • ….And how you’re going to win?

And is it generic or distinctive to you?

In plain English, just because everybody else is doing it is the last thing to be proud of.   A.G. Lafley, who oversaw a highly successful run as CEO of Procter & Gamble, put it this way:

“The more your choices look like those of your competitors, the less likely you are to win.”

You may, in other words,  have to be crazily contrarian.



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