TV and the aggregation theory

When content differentiation comes into play

*This post is a sum of TV related articles written by Ben Thompson from Stratechery. Please check and subscribe to his blog.*

French version here.

TV is a great medium. Its content is compelling enough that Americans watch it 5.5 hours, in various form, everyday.

It is also great for advertisers reaching relaxed viewers through an immersive experience.

But the TV share of time spent consuming media is falling. From 41% in 2011 it was 35% in 2015, while digital went up from 32% in 2011 to 47% in 2015.

The decline though is not evenly distributed. And the younger the audience the more pronounced the drop.

This is bad news for the traditional TV industry.

Brands want to target young audiences since the younger you are the less likely you are to have developed brand affinity. And the more time the brand will have to earn back the money spent building this affinity.

Even as networks revenue has seen a significant shift over the last several years from advertising to affiliate revenue in particular (a little bit of money from every cable company is much more profitable, predictable, and sustainable than attempting to wrangle a massive audience to sell to advertisers) their business model still rely in large part on selling ads.

This shift also changed the type of TV that mattered: instead of the lowest common denominator that characterized the first several decades of TV, it is now far more important to differentiate and to have “must-see” shows and events.

Advertising

There is no wonder why brands have jump on the digital train: this is where millennials spend their time.

But then, why has TV ad spending been on the rise recently? As Variety reports:

After several years of moving money out of TV ad budgets to experiment with new digital outlets and social media, several big advertisers are spending more on the boob tube — and the result, according to ad buyers and other executives familiar with the pace of this year’s “upfront” negotiations, are a series of rate increases that TV has not won since the end of the last U.S. recession.

To understand what’s happening let’s look at the advertising industry:

  1. Advertising’s share of GDP has remained consistent for 100 years.
  2. TV’s share of advertising, after growing for 40 years, has remained consistent at just over 40% for the last 20 years.

During those 20 years we have seen the rise of digital advertising and particularly mobile advertising in the last five years. This emergence is probably the cause of the halting growth of the TV advertising business but the real victims were radios and newspaper whose share of advertising fell from 40% to 10%.

Still the share of digital advertising doesn’t reflect the amount of time spent.

So why the uptick in TV ad spending and not continued growth on digital advertising?

The CPG industry

Television is intertwined with the kinds of advertisers that use it the most, the products they sell, and the way they are bought-and-sold. Here are the top 25 advertisers in the U.S:

  • 4 telecom companies (AT&T, Comcast, Verizon, Softbank/Sprint)
  • 4 cars companies (General Motors, Ford, Fiat Chrysler, Toyota)
  • 4 credit card companies (America Express, JPMorgan Chase, Bank of America, Capital One)
  • 3 consumer packaged goods (CPG) companies (Procter & Gamble, L’Oréal, Johnson & Johnson)
  • 3 entertainment companies (Disney, Time Warner, 21st Century Fox)
  • 3 big box retailers (Walmart, Target, Macy’s)
  • 1 from electronics (Samsung), pharmaceuticals (Pfizer), and beer (Anheuser-Busch InBev)

Those are massive companies that compete on scale and distribution. They build a “house of brands” and target different demographic groups even as they leverage scale to invest in R&D, bring down the cost of products and dominate the distribution channel (retail shelf space).

All are looking to reach as many consumers as possible with blunt targeting at best, all benefit from scale, and all are looking to earn significant lifetime value from consumers. And all can afford the expense of TV (the top 200 advertisers account for 80% of the total TV advertising spendings).

What should be worrying TV executives is that all of those pieces that make TV advertising the gold mine that it has been are under the exact same threat that TV watching itself is: the Internet.

  • e-commerce combined with highly-targeted and highly-measurable Facebook advertising have given rise to an increasing number of small CPG brands that deliver superior products to very targeted groups. e-commerce also diminishes the shelf-space advantage they enjoyed.
  • Big box retailers that offer few advantages beyond availability and low prices are being outdone by Amazon on both. It is hard to see why they will continue to exist.
  • Cars companies, meanwhile, are facing three challenges: electrification, transportation-as-a-service, and self-driving cars. Those point to a world where cars are pure commodities bought by fleets, rendering advertising unnecessary.

Other companies on the list face less of a long-term threat, some because they are already commoditized — telecoms, credit cards, electronics — and others because they will probably grow: big movies are getting bigger (entertainment), and the population is getting older (pharmaceuticals).

TV advertisers are 20th century companies: built for mass markets, not niches, for brick-and-mortar retailers, not e-commerce. They were built on TV, and TV was built on their advertisements. They still keep each other afloat for now but the decline of one will hasten the decline of the other.

Uptick

The nature of the biggest TV advertisers explains the TV’s advertising uptick: brands uniquely suited to TV are by definition less suited to digital advertising. People don’t click on a link in their feed to buy a car or laundry detergent, and big box retailers don’t want to encourage shopping to someone already online. After a bit of experimentation, they’re back with TV.

As every new tech does digital brand advertising is following the hype cycle:

The hype cycle

Now turn the graph upside down to see what happens to other advertising areas. What represent the trough of disillusionment for digital advertising is what TV advertising sees as an uptick.

Still, Facebook and Snapchat in particular will figure brand advertising out. Both have incredibly immersive advertising formats, and both are investing in ways to bring direct response-style tracking to brand advertising, including tracking visits to brick-and-mortar retailers.

Were I a TV exec I wouldn’t get too excited from this small uptick.

Aggregators

Google, Facebook, Amazon, Airbnb, Uber all modularized suppliers and integrated consumers and distribution through a superior user experience.

The aggregation theory

Netflix, the wannabe aggregator

Back in 2008 Netflix was primarily a DVD-by-mail operation with a brand new streaming service that let you watch C-list movies on your computer (only). But it had a pre-existing user base built over the years. That was step 1.

Starz, a premium television channel, saw this young and limited streaming service as an easy way to make a few extra bucks on their vast library of movie rights, including the Disney and Sony catalogs, and signed a distribution deal with Netflix.

Concurrently with this deal the launch of the first Roku and the Apple TV2, both with Netflix apps, gave Netflix access to the big screen.

Netflix existing user base quickly adopted the superior user experience of thousands of great titles available at will. While Starz effective catalog size was one, the one content actually on the air, Netflix’s effective catalog size was 10.000. Its existing users started bringing their friends and Netflix generated a lot more subscriptions, revenue and momentum. That was step 2.

Internet information for Google (huge quantity) as well as cars for Uber, flats for Airbnb and retail goods for Amazon are pure commodities, they allow the discovery issues solved by aggregation to outweigh the value of one unit of good.

TV is different. There isn’t a lot of good content available. Differentiation is key.

So when the Starz deal ended Netflix used its increasing revenues and paid a lot to keep access to good content and keep growing its user base through its user experience.

With an increasingly high-profile brand, large user base, and ever deeper pockets, Netflix moved into original programming in a way that was disrupting traditional programming buyers: creators had full control and a guarantee that they could create entire seasons at a time. It brought onboard great creators who made quality contents. That is step 3.

There is no prime time on Netflix and Sunday at 9pm is no different than Tuesday at 11am or Friday at 6pm. Netflix commoditized the user time, like it did content suppliers, and created a marketplace of some sort.

Doing that, Netflix has the potential to become a true aggregator, the only TV you need, but it will need a lot of financial power to do so. That’s why its stock is so volatile.

On 3 out of the last 4 quarters it missed its user growth target. Alternatively blaming the change to chip-based credit card in the US or a slightly higher than anticipated churn rate. Each time the stock tanked. That’s the curse of recurring revenue and subscription models. One small change in the assumption set have huge repercussions on the forecast of future revenues.

A quick recap of Netflix pricing scheme history below:

  • In May 2014 Netflix raised prices for HD streaming from $7.99 to $8.99 for new members; old members could keep their old price for two years (i.e. they were grandfathered).
  • In October 2015 Netflix again raised prices for HD streaming from $8.99 to $9.99 for new members; customers at the $8.99 price point could stay there for a year.
  • In April 2016 Netflix announced that it would gradually raise prices on members on the $7.99 price plan instead of hitting everyone in May as originally expected.

Each time Netflix took a step towards the end of their “grandfathered” strategy it generated news about a “Netflix price increase”, user worried (see graph below) and churn rose.

Google Trend for “Netflix price increase”

To achieve the financial firepower required to pull their aggregator strategy off, they will need either a dramatically larger user base or significantly higher ARPU (average revenue per user).

Both prospects, though, look to be harder to achieve than anticipated. International growth continues to disappoint, while the U.S. looks more price sensitive than previously thought. Of course Netflix is not doomed: the company has many loyal customers, is profitable in many of its markets, and is still growing. However, the realistic upside of the company may be considerably less than the theoretical one, and that impact the stock price.

Disney and the differentiation opportunity

Bog Iger is considered one of the top CEOs in the world, and for good reason: Disney has enjoyed unprecedented success under his leadership. His first major decision was to acquire Pixar, followed up with Marvel and LucasFilm. The goal of these acquisitions was to establish must-see movies that made money not only for the company’s studio division but also powered merchandise sales, theme park attractions, video games, TV spinoffs...

The entire premise of the strategy is highly differentiated content.

Over the last few years ESPN, owned by Disney, has adopted a similar approach. The network had long carried popular sports, which made ESPN the profitable centerpiece of the US pay TV bundle. Recently, though, ESPN’s appetite for exclusive rights to the most popular leagues and events has increased tremendously while Disney acquired 33% of MLBAM, widely consider the best streaming technology after Netflix’s. (with an option for 33% more).

Alan Kay’s famous quote: “People who are really serious about software should make their own hardware.” can be translated to the media world: “People who are really serious about differentiated content should own their own distribution platform.”.

This investment, along with their great content, gives them significantly more control over their destiny regarding the decision to offer straight-up subscriptions instead of staying only bundled.

Thanks for reading, don’t forget to go check and subscribe to Stratechery.