In my spare time (laughs hysterically), I've been working on a book about the current state of television and the streaming industry. It's a series of essays that focuses on various hot topics, with some of them being extended versions of pieces I've written in my newsletter over the past three years as well as opinion pieces I've written for my web site.
One goal has been to try and frame an argument that cleanly explains the business model of Netflix. The company itself does a terrible job explaining the core aspects of its business, from content valuation to subscriber retention and its corporate stance against full theatrical releases for its originals.
Back in July, I had the opportunity to sit down for some off-the-record interviews with a handful of Netflix executives and we discussed a wide range of issues, including strategy. I might not agreed with some of the framing, but I walked away feeling as if I better understood the approach of the company. And it made me wish the streamer's executives were more willing to publicly pushback on critics instead of stubbornly remaining silent.
And that silence only makes the critics more likely to jump in with half-baked theories based on the traditional Hollywood model they know.
As I have worked through the various ways that I could frame this discussion, it occurred to me that the cleanest way to think about the business model of Netflix is to see them as the streaming industry's Costco. It's a membership (or in the case of Netflix, subscription) based business model and as a result, every decision they make is in the service of that goal. Which is diametrically opposed to how a traditional studio (or store chain) does business.
Traditionally, studios focused their efforts on making sure each individual movie or TV series was a success. They set the budget, spent money advertising and marketing it and worked to maximize the revenue in each window. And at the end of the day, the financial success or failure of that project was fairly easy to determine. And except in very rare cases, the efforts put towards each individual title don't bleed over into other projects. No one is out there making sure they see every film made by Universal or Paramount. Any more than breakfast lovers are out there sampling every cereal made by General Mills. For traditional media, the projects are the product.
But a pure-play subscription-based business such as Netflix more closely resembles Costco. Each decision it makes is based on increasing revenue from subscribers, lowering new customer acquisition costs, preventing subscriber churn and building the overall brand. Costco cares less about the profitability of individual products. It's more than willing to lose money on $4.99 Rotisserie Chickens and cheap gasoline if the money is lost in the service of maximizing membership revenue. Sure, Costco could make more money on chicken if it raised the price. But the company's calculation is that it helps drive membership satisfaction and that lost money can be retrieved by selling higher-margin products once customers are in the door.
And in a similar way, Netflix's often inexplicable decisions and priorities make perfect sense if you see the company's strategy framed through the lens of Costco. Netflix executives look at current subscriber numbers and set upcoming targets. They're tracking where growth might come from and what things increase subscriber engagement. The decision about what Netflix orders, cancels and renews is almost always driven by that subscriber based-calculation.
Netflix sets an overall content spend budget each year and that is what they are going to spend. So a new $150 million live sports deal means that $150 million less is being spent on original content. It's a Moneyball-driven zero-sum game in which executives try and find the best mix they can of originals and licensed programs that will help them achieve subscriber goals. A TV show might have a rabid fan base. But if that base isn't big enough or if the fans live in a territory that Netflix's isn't currently emphasizing, then the show has less value than one whose viewers better fit corporate strategy.
That is why Netflix executives continue to resist full theatrical releases for its originals films. Could those releases bring in extra money to the streamer? Maybe. But the theatrical business is notoriously difficult to predict and either Netflix would have to build a theatrical release division or contract with someone else. And either option brings additional costs with the potential for increasing the financial downside.
And streaming-only releases fit into Netflix's corporate mandate to maximize subscriber growth and engagement. Could Netflix make some money releasing some movies into movie theaters first? Yes, in the same way that Costco could make more money by raising the price of its Rotisserie Chickens. But neither move serves the core corporate goals of the respective companies. So it's unlikely that we'll see $6.99 Costco Rotisserie Chickens or Netflix theatrical films anytime soon.
This Netflix is Costco framing also helps explain why the streamer makes some of the decisions it does when it comes to original TV shows.
Take, for instance, the streaming standard of much more compressed season orders than you'll typically see on linear television. It's a topic that brings out strong emotions from Hollywood's creatives, in large part because there is a formidable pay difference between a 23-episode season and one that runs 6-8 episodes. But you'll also hear from writers that those longer seasons allowed shows to focus on more nuanced story arcs and secondary characters.
But the reasons why Netflix produces shorter episode seasons is a combination of financial and strategic factors, and both components are driven by its subscriber-centric revenue model.
From a revenue standpoint, producing longer seasons of a show adds a lot of expenses without a clear way for Netflix to recoup the spending. In traditional broadcast television, the networks would pay the producing studio a fixed production fee per episode. That episodic fee generally didn't come close to covering the actual cost of the episodes. But if the show stayed on the air long enough to reach around 100 episodes, the studio could take the reruns into syndication and essentially print money. So there were a lot of financial incentives to crank out a bunch of episodes per season in case the series did well with audiences. And the broadcast networks were able to get additional episodes of a successful show while still paying a fee priced below the costs of production.
But the cost structure of streaming is very different. There is a definite downside to producing long seasons of a show. There is no direct way to recoup the costs of the longer episode order, due to the ways in which Netflix values television shows internally. And based on what I've been told, longer seasons don't boost engagement for Netflix very much. What does boost engagement (and indirectly all of the subscriber-drive metrics) is a steady stream of new titles. Which means that generally speaking, three 8-episode TV shows provide more value than one 24-episode season.
There is also the strategic component of this approach. When you look at the results of user studies - both internal to Netflix and from external analytics companies - one of the factors subscribers value highest when asked about Netflix is the sense that there is always something new to watch. It might not always be what the subscriber is looking for. But I think every Netflix user has experienced the moment when you find that you've just watched three or four episodes of a show you were pretty sure that you wouldn't enjoy before you watched it. Netflix's breadth of content and variety of genres helps make it sticky and that directly impacts metrics such as subscriber churn.
That engagement question is also one of the primary factors behind Netflix's belief in binge-dropping most full seasons of television. Yes, there are exceptions to that rule and the reasons range from delayed productions due to the dual Hollywood strikes to release dates for licensed shows that are the result of broadcast schedules on the originating network (think The Great British Baking Show).
But most original series continue to receive binge releases because Netflix believes - and there is evidentially a lot of data to support this - that stretching most shows out to a weekly release approach when Netflix is releasing multiple new shows each week would lead to a near impossible mess where new weekly episodes of several dozen shows would be premiering each week. It would be confusing, frustrating and guaranteed to lead to a lot of unhappy subscribers.
That's not to say that Netflix can't tweak that policy when the viewing data suggests a better approach. I've been told that early on Netflix was releasing full seasons of some of its unscripted dating and relationship shows, believing viewers would prefer that familiar approach. What executives learned was that few subscribers were binge-watching full seasons. A typical viewer would watch a handful of episodes at one time, then often not return to the show for days. After some experimentation, Netflix discovered that breaking up the season of the shows into small groups of episodes matched what viewers of those shows tended to do unconsciously. And data showed that as long as the gaps in release dates weren't too prolonged, most subscribers who enjoyed the shows would make sure to tune in again.
These are just a few examples of how Netflix sees its business model. And if you are going to judge whether or not a pure streaming company is making the best decisions, you first have to understand the rules of the game. Entirely too many Hollywood creatives and industry journalists are still judging streaming by the familiar set of rules that have guided Hollywood for generations. It might not be an approach you're familiar with or even believe is correct. But there is no accurate way to judge the streaming business without understanding the underlying business practices that define it.
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