The Entertainment Loop: Problem for Netflix, Disney+ & Co.

Streaming services offered by companies like Netflix, Disney, Amazon and Co are getting more and more popular. Millions of subscribers stream countless hours of movies and tv series every month. Subscriber get access to a large media library for a monthly fee (subscription).


tl;dr

Netflix and similar streaming services can only earn money as long as they can deliver new content.


Netflix is the king of streaming. The company perfects the streaming business with nearly 193 million paying subscribers at the end of Q2 2020.

The share price of Netflix reflect its success:

Netflix share price. Screenshot taken at Jul 21, 2020. Source.

Even during one of the worst modern pandemic, the 2020 coronavirus pandemic, Netflix' share price just knows one direction: Upwards. Streaming is undoubtedly the future of entertainment.

But there is one problem — the problem I refer to as The Entertainment Loop. To understand the problem, we have to understand how Netflix (and similar services) make money. It's actually fairly simple.

How Making Money Works in the 21st Century

In just one single word: Subscription. For a small monthly fee you, as a company, provide a good service to your customer. This has two main advantages over the old school "pay once and get something" sales tactic:

  1. Due to the relatively small fee you are able to reach a large customer audience in comparison to a high (one-time)-fee.
  2. If you, as a company, are able to successfully bind the paying customer to your service, the monthly compounding fee outgrows the large "one-time-fee" that you could've charged instead.

It is important to understand these two advantages and why companies decide for a monthly subscription business instead of a one-time-fee business. There are additional advantages in the subscription-based model, but we'll keep it simple for now.

These two advantages are the key to Netflix success. That's the good (probably awesome) part of the story. But here comes the story: These two advantages will cause damage to your company in the future.

To understand why, we'll have to understand, how Netflix makes money.

How Netflix Makes Money

Netflix makes money by selling monthly subscriptions in exchange for unlimited movies and tv  on their platform. That's it. It's that simple.

Let's think about the service in exchange for the monthly fee, to understand the problem: Unlimited streaming of movies and tv series.

Netflix main goal is to make the user stay and keep paying. For reach that ultimate goal, Netflix has to deliver value to the user. Every month — or he will leave and stop paying the monthly fee. That's why Netflix has to keep pushing new content for every users' own (movie-)taste. Once the user doesn't receive any new value from Netflix, he will stop paying for the service. And Netflix only way to provide value is to deliver movies and tv-series.

I'm pretty sure that you understood this, but let me try to clarify (and simplify) it with a flow chart:

Broken down to one line: Netflix will not earn any money, if they don't add new content.

How Netflix can solve this problem and why it isn't easy

Netflix can solve this problem by adding new content (surprise!). But they will encounter a second problem, if they keep adding content: Costs.

Let's think it through. The loop goes like this:

  1. Netflix adds content
  2. Costs increase
  3. New (paying) subscribers join because of the new content
  4. Existing subscribers are happy and keep paying
  5. Newly added content gets old and boring
  6. Less new (paying) subscribers
  7. Existing subscribers get bored and start leaving
  8. Netflix has to add new content
  9. Go to #1

That is the Entertainment Loop. And it is nearly impossible to break out of it.

And this is just the start of the problem. The key here is, that Netflix has to add more and more new content to make existing customers happy. But they not only need the existing customers, they will need new customers to cover the increasing costs. And the costs will increase because, you might already guess it, Netflix has to deliver value (content) to the existing customers to make them stay (and keep them happy).

But the number of new (paying) subscribers isn't increasing from month to month. It will flatten in decline. Reason for that is, that the number of potential new customers is finite. There are not (!) unlimited new possible subscriber.

The real trouble starts once Netflix approaches the limit of adding new subscribers. New and fresh money stops floating in like the year before, but the expectations for new value (new content) of the existing customers is not declining — it is staying at least the same or the expectation will even increase.

So Netflix will have to deliver even more new value in form of content like movies and tv series. And that increases the costs — again. And now Netflix is in a situation, where the costs keep increasing (or staying the same) but the money they earn from paying subscribers will not increase that much. And that is the Entertainment Loop.

First counterargument against this

Actually, do the costs keep increasing? You might deny this question. Each month, Netflix need more or less the same amount of new movies and tv series to keep the subscribers happy and paying. So the costs stay more or less the same, don't they? The answer is yes... but actually, no.

The costs keep increasing. And that's why:

First of, the expectations for new content keeps increasing. That makes the production more expensive.

Second, Netflix' new subscribes are not mainstream subscribers. The "normal" subscriber who likes mainstream movies and tv series has already subscribed to Netflix. Netflix gains more and more subscribers who want to the non-mainstream content. That keeps increasing the costs as Netflix has to produce more and more of the non-mainstream content.

That keeps the costs increasing.

Of course, if a new subscriber joins, he'll be happy for some time, because he can watch all the content that Netflix added over the time when he wasn't a subscriber. But at some point, he'll run out of existing content to consume. Then Netflix has to deliver new content, to keep him happy and subscribing.

Second counterargument against this

Netflix could just increase its prices for a subscription step by step. Increasing the costs, by, let's say 10%, would increase Netflix revenue immediately. And a 10% price increase wouldn't hurt the user.

Problem with that is, that Netflix cannot create a monopoly. Unlike famous companies like Apple, anyone could build a streaming business. The technology is fairly simple (I mean, it is very complicated, but if you hire a lot of good software engineers and product managers, it would be possible to create a streaming service like Netflix has). And it is very hard to bind users to the value Netflix delivers: Movies and tv series. Of course, there will be some people who want to see the next season of a Netflix Original. But different producers could also create a tv series which binds users to it. In addition, it isn't very profitable for a company to produce a large number of seasons for a tv series.

That's because every additional season of a tv series costs more money to a company than the previous one. Why? Because who wants to see the following season? Only the people who also watch the previous one. Or did you ever said "damn, I really want to see season 5 of the show x", without having watched season 1 to 4 of show x? Producing a new season of a tv series will not make a company more money than the previous one. That's why it is incredible hard to bind users to a movie/tv-series business. Creating good content is interchangeable.

Disclaimer

This entertainment loop happens to every movie subscription company. I referred to Netflix as a practical example, because this company is the current #1 in the streaming-universe.

I have no business relation to Netflix or any of their competitors besides being invested in their stocks via global index funds (ETF).

And yes — I'm a happy customer of Netflix. As long as they deliver new content.

Thanks for reading.

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