Hollywood: The Known Unknowns

7 key variables to define the future of SVOD

You may have read Jason Kilar recently in WSJ predicting that subscription video on demand (SVOD) would consolidate around ~5 scale players (three plus Amazon and Apple), which means a few would have to merge (presumably Peacock, Paramount and anyone smaller than that). 

That’s the consensus expectation, well explained. 

What are some of the key variables that could lead to permutations in the outcome or unexpected outcomes? What factors could create interesting second act plot twists in Hollywood’s agon, struggling with technology and interlopers? I’ll try to include fundamental, plate tectonic issues and a couple of wildcards.

FIRST, DO THESE INCUMBENTS HAVE IMPORTANT MOATS?

Perhaps this is not a “variable,” but it is an important premise that must color every long term industry analysis.

Nothing lasts forever, certainly no company. It is worth observing that the only really defensible element of any of these businesses are brand (customer loyalty) and scale. The problem with customer loyalty is that, as a very insightful person once said to me, “customers are 100% loyal until your competitor offers a product for less.” 

So, scale. Scale works best in the physical world or with network effects. Amazon has a real moat — just try to build a new one! Walmart has a real moat.

In the long term, there are few defensible product characteristics in entertainment unless your product is widely considered to be unique. Disney is sort of unique; however, it should be noted that the power of Disney animation and even Marvel is either in a slump or is in decline. And every studio that is not Disney speaks more or less with the same voice (small brands like Hallmark and Lifetime excepted). So do they have a moat? 

Not really. 

Let’s face it. If they had a moat, Netflix and Amazon wouldn’t be two of the biggest players in entertainment.

What does that mean? It means that over the long-term their return on invested capital for a pure play entertainment company/SVOD should be competed down to their cost of capital. That means that it would not be value creating to invest further in the business. 

Upshot: In the future, unless big brands can cultivate a unique voice, creating unique and broadly desirable content differentiation, it may become essential to have a profitable side business. Amazon is here to stay. Apple is here to stay. Disney is here to stay (assuming they can pull their voice together). Do not count out YouTube or Walmart. For that matter, don’t count out Twitter as a FAST platform. But, in general, will diversified businesses grind down pure plays on price? 

VALUE CHAIN SHIFT

The lack of profitability at every SVOD network except Netflix (and even NFLX has extreme negative cash flow over the past five years), could indeed illustrate that there is a fixed cost to running an SVOD network and most networks haven’t yet scaled revenue up to the fixed cost threshold.

But given the significant scale of some of these networks have achieved (DIS+ = 146MM subs), it could simultaneously suggest that, currently, the SVOD segment of the value chain is bearing too much of the economic load for the industry. 

That is, maybe too much stuff is being crammed down this one pipe. This made sense when interest rates were zero and the only thing that anyone cared about was sub growth. Now, the risk free rate of interest is higher, people care about cash flow, and things are different. Customers may be over-served with excessively long windows and too vast a selection of library at too low a price in the SVOD window. This is why we see things like Westworld coming off HBO MAX. There is no need to have all assets amortizing against that one window and driving losses; selection will be surgically limited to titles driving sub growth or retention.

The lack of profitability may also imply that SVOD networks are taking too many rights in their first run deals with talent and studios to begin with, unnecessarily maximizing the cost of content to themselves. What they really need is first run, but they’re buying all runs plus all derivative rights. Cutting back on this rights grab could probably save 20% or more on first run costs when licensing from studios.

If this is all basically true, then 2021-2022 could turn out to be peak SVOD in terms of its share of total entertainment consumption and economics. The growth of SVOD expenses should moderate or go negative and the economic model for the industry as a whole should diversify with ad-supported (FAST) and ownership taking a larger share over time. We have already started to see this — FAST was the fastest growing format of 2022, reaching $4B in revenue in the U.S. (It might also imply that if you have counted YouTube out of the future of Hollywood content, you may have done so prematurely.) 

This would tend to make the SVOD networks still powerful but less dominant and might create a more viable second window for shows.  

Can ownership come back, like DVDs, or download to own? Well, it would really help! There is a lot to debate here in terms of reinvigorating the appeal of this category. PVOD is another transactional category with potential. 

Upshot: Ad-supported (and maybe ownership) will grow in importance and will shift business dynamics somewhat back in favor of talent, reinvigorating backend and residuals.

CULTURE SHIFT

I don’t think there will be a civil war in the United States, but I do think there could be something like a cultural secession. An unspoken assumption of most articles about Hollywood is that everything is fine with the content itself. It’s fine. People are fine with the voice of incumbent Hollywood and that voice will continue to dominate. The key taste makers we have in Hollywood are all there for excellent reasons.

I’m not sure that’s true. The numbers — myriad major movies bombing and a paucity of new hits (except Wednesday!) — do not indicate that it is true. I’m sure you are familiar with all of the recent bombs. 

In the late 70s, disco completely dominated the charts. Some rock n roll people didn’t like this. WLUP Chicago organized Disco Demolition Night at Comiskey Park on July 12, 1979. That night did not go well for disco. It was actually the end of disco. Things change. 

Let’s be honest. There is a cultural divide in America now, perhaps with more division than we have had since the Civil War. 

• About 49% of HHs voted for Trump

• 44% of households have a gun in the house

• 6 in 10 Americans have a family member who served in the military

• 40% of Americans consider themselves to be “very religious.”

• 85% of America hated Chad despite 85% of critics loving it. 

What network is speaking to these people? Which networks are alienating these people? 

There are so many shows Hollywood can’t do today. The Office. South Park if it wasn’t grandfathered in. The Hangover. Tropic Thunder. Top Gun if Tom Cruise wasn’t in it and it wasn’t a sequel. The Sopranos. The Shield. 

What can you do today? True crime. We have a lot of true crime. Also confessional. You can do Harry and Meghan.

Would a brand for this audience be political or “right wing?” I don’t think so. It would suffice to not be political. Ideology has been prioritized over creativity and often over connectivity with the audience. I’ll let Tarantino say it:

TV shows have demonstrably gotten worse in the eyes of viewers:

The chart indicates that there are more than 30 8+ shows that should have been expected (based on prior results) that we never got to see.

So, if every restaurant in town goes vegan, what happens if you open a steakhouse? 

Will woke be our disco?

Upshot: In a porous market, the culture wars would appear to create an opportunity for a big new brand or for the pivot of an existing brand, which could shake up the standings amongst SVOD networks. There is an underserved market out there and they don’t seem all that happy.  

A UNIVERSAL GRID MAY HELP SMALLER PLAYERS 

Currently Roku and Chromecast are portals to a series of walled gardens. The default behavior is just to click on your favorite walled garden and see what’s on. 

This is bad for smaller players because you only go to the smaller walled garden when you need a specific thing, which is rare. It is probably even bad for Disney in terms of their visits per month. 

But what if set top box manufacturers leaned into a UI that was more title-focused and less distributor-focused, using universal search and/or universal recommendations and a grid? That could look more like this, combining titles and networks (but with more grid on top): 

Many players in the content business would benefit from the content itself getting top level direct exposure to customers, placing more emphasis on the content and less on the network brand. AMC comes to mind but I could argue that Showtime and Paramount and definitely Peacock, Shudder, Criterion, and Mubi are in this category as well. Everyone except the top few players would be better off this way. 

Amazon offers third party subscriptions and a consolidated environment within Prime Video so it could wind up being the uniting platform for smaller players. But one can also imagine a new platform that hosts individual shows and third party subscriptions. Or Roku. Here we see content marketed to customers where the channel source is noted:

Upshot: Most SVOD is watched at home on TV. The more the industry leans into a universal search mode or all inclusive content grid, the easier it will be for medium size and smaller players to survive and thrive in SVOD. Netflix will resist this. But if customers start to make the universal grid their first stop and “home page,” everyone has to get on board. 

GLOBAL LOCAL CONTENT REBELLION

I have mentioned this so I won’t go on but there are a number of SVOD services around the world who serve up primo local content and have loyal audiences. They don’t have the scale to produce first run originals for their services but their local content is so strong that while they are indeed losing ground to Netflix and Amazon, they are still hanging in there. But they know they have to become international to have a chance at growth. I’m thinking of Hulu Japan, Voot, Sony Liv, Abema, Waave, et al. 

The obvious opportunity here is for these entities to merge and upgrade their originals (and possibly to merge with a U.S. studio to secure that flow as well). This is kind of a no brainer. With a larger footprint, they can produce at larger budgets and the only reason Japanese, Korean or Indian live action series don’t travel that well is that they are made for much, much lower budgets. As

The Ankler.

noted just this morning, 60% of Netflix’s global subs have watched Korean content in 2022.

Upshot: Merge. Scale up. Upgrade originals. Integrate a source of US supply. You just created billions in value. They won’t push Netflix into the sea but the combined entity would be formidable and long lasting. There is no clear winner yet in Asia so anything can happen. This would put a big dent into Netflix’s “next 100MM customers.” 

DECENTRALIZATION, CROWDFUNDING AND THE PERMISSIONLESS, OPEN FUTURE

Let’s crank this up. 

Ultimately what is happening in this industry is that there are 100,000 creators, 7,000,000,000 fans and a few institutions standing in between them doing traffic control and picking winners. 

You think that’s the long, long term? Now that we are all digital, do the physics of the industry actually require that or is that just legacy baggage? What’s essential here is the connection between the creatives and the fans, right? 

If the major players do not have insurmountable moats, one could imagine a decentralized marketplace — sort of like eBay or a juiced up Kickstarter that includes both NFTs and securities — that gives creators the ability to get their projects funded while retaining more ownership and control than they retain today. 

One could then imagine a decentralized global streaming service where any creator or studio could add their content and a smart contract would divide the revenues according to transparent on chain books and a public formula. This would be decentralized and open source, and people could build proprietary clients on top of it. Imagine BitTorrent except BitTorrent pays you as a creator. 

Why would major creators embrace such a system? 

More control. More ownership. No censorship. You don’t have a boss. Why not? Nicole LaPorte has done some good reporting recently about the frustrations of the Hollywood community. And I recently discussed Who Is Not Making Money in Hollywood?

Who in Hollywood is moving to Montecito today (except Shonda Rhimes and Ryan Murphy)? No one. Because no one is getting a big share of the upside. The only people who are becoming billionaires are the people who are creating direct relationships with the audience, like the Kardashians. 

Why would this grow and succeed? Because ultimately the best talent will be attracted to the autonomy and upside that such a platform would offer. And if you have the best talent, you win in the end. 

The fan relationship with shows and creators would in this world be different. Fans would not just be fans but would also be in the discord and would have a (perhaps small perhaps not) financial interest in the show. It would have evolved to the next step. But that’s not far fetched. It’s already evolving. Ironically, most of Hollywood is reticent about interacting with fans and cultivating their public profile. But Hollywood has to get on board with the mega trend. Celebrities launch companies and become titans of industry. The direct connection between creators and consumers is the mega trend. This is the new world and the future belongs to those who will turn it to their favor. 

In the future, the hottest filmmaker won’t be funded by a studio, he or she will be a studio funded by millions of people around the world. That filmmaker would not want to give up a ton of rights to put their movie on a streaming service. The prospect of a decentralized service more like bit torrent where they can permissionlessly add content and get their appropriate compensation in a timely manner, completely certain that they are getting the correct amount, would be quite appealing. In the future this will be normal. (And do not be concerned – – yes, there will still be an important role for agents in this world.)

Just imagine if Taylor Swift sold 30MM shares in her upcoming movie for $1 each. Or 300 million shares to create her studio. She’d be funded tomorrow, almost certainly on better terms than she received from Fox. She would be funded by a mix of fans, accredited individual investors, funds, and AIs trained on the content investment market and running AI funds.

The next Lee Wasserman will be an AI running off some server, backed up on 400 other servers across the world that allocates capital to TikTok videos, movies, batches of movies, television shows and 1:1 influencer social e-commerce ventures on decentralized marketplaces where media projects are funded. This future wins because it has the talent and the most liquid supply of capital. 

In this act three, power shifts from a coterie of executives and tastemakers to artists, fans and investors. 

As I have said, “The new ‘martinis at the Grill’ will be a wallet ping silently recorded on some validator node running ubuntu 18 after a light speed drift over the trans-pacific cable, flipping some bits before packaging them into the next block.” 

Upshot: talent is the studio. The key relationship is between talent and fans and investors. Investors will be agglomerations of anonymous people LARPing as frogs on the internet ad providing a ZK Snark as a proof of humanity. Or they could just be an AI. The financing process and the streaming platform are probably going to wind up decentralized.

GAMIFICATION WILL MAKE BIG WINNERS BIGGER

There is real upside which may or may not benefit SVOD networks to creating a game environment around your universe.

People commonly play 3,000 hours in a game on Steam. That’s 150 movies. People still love movies but there is something they are getting from that personal engagement that they aren’t getting from movies. Does this benefit the studios because they will be able to create world engines? Probably not. World engines are deeply developed already and it is most likely that an IP holder would be able to make a deal with one of a number of service providers. Again, this will shift everything in favor of creators. 

Upshot: This magnifies the importance of hits and makes “middle class” shows or shows that don’t create “universes” less valuable.

CONCLUSION

The path forward always seems predictable but reality does it ever really work out that way? Let’s find out.

Talk soon!