What I’m Hearing: A Netflix “Orgasm of Schadenfreude”

Happy Thursday, a little later than usual thanks to all the calls I’ve been getting about Netflix…

Before we begin: a moment of silence, please, for Bill Ackman, whose Pershing Square hedge fund bought $1.1 billion of Netflix stock as a show of confidence in January. He sold the shares yesterday, losing about $430 million…

Thursday Thoughts…

• Disney C.E.O. Bob Chapek has been quietly sitting down with trade editors and reporters who cover Disney, hoping to influence his coverage. Good luck. The Florida situation has gone from bad to worse. I keep thinking back to the root cause here, the original email from Chapek to employees explaining his inaction on Don’t Say Gay, and arguing that corporate statements “do very little to change outcomes or minds.” Predictably, employees freaked, and he was forced to recant and go hard against the bill, which then poked Ron DeSantis and Florida Republicans, who have absolutely run roughshod over Chapek, including today’s vote to strip Disney of special tax status. It’s a communications cautionary tale, and we can trace it all back to the email.

• There isn’t a middle finger long enough to express how David Zaslav feels about Jason Kilar rushing to launch CNN+ before Discovery’s WarnerMedia acquisition closed. Killing the service so fast might seem hasty, but my read is that this is Zaslav cleaning the slate before new CNN chief Chris Licht officially starts next month.

• We’re making $70 million Viking movies now? The Northman has Last Duel vibes, so good luck this weekend to Focus Features, which split the cost with Arnon Milchan’s New Regency Pictures.

And it’s not just the headline news—that Netflix’s first subscriber loss in a decade, and its projection to lose another 2 million subscribers in the next quarter, gruesomely deflated its share price—that is prompting that revelry. Nor is it the fact that Netflix’s market cap has shrunk from $300 billion in November to less than $97 billion. To many, this day was a long time coming.

Because Netflix had swagger. It had sneaked from Los Gatos to Hollywood inside a Trojan horse made of red envelopes and straight-to-series orders, then won 220 million paying acolytes. Hastings, co-C.E.O. Ted Sarandos, and the algorithm behind the curtain declared they knew better than everyone else. Netflix, and only Netflix, could successfully go direct-to-consumer, overpaying the best artists to work at the company, all while eliminating the backends that made them truly rich. Netflix, and only Netflix, could use data, not silly executive taste, to select the right projects, even though nobody remembers most of them 10 minutes after watching. Netflix, and only Netflix, could delight the customer by dropping all episodes at once, rather than stringing them along (and, incidentally, keeping them subscribed) week-to-week. Netflix, and only Netflix, could avoid accountability by refusing to disclose meaningful consumption data, then convincing the media to cover self-serving “reveals” as news. And, of course, Netflix, and only Netflix, could scale the business globally by running up huge debts, and make traditional Hollywood (with its theatrical windows and syndication sales and profit margins) seem downright analog in the process.

That turned out to not be true, of course, which is why this feels so cathartic for so many people. For every executive who has lost a bidding war because Netflix paid a stupid price and promised a creator stupid freedom, even when that creator—be it Ryan Murphy, or Judd Apatow, or Kenya Barris, or whoever—pretty clearly needed creative supervision. For every showrunner whose series was canceled after a season or two because it’s not “efficient.” For all the studios that lost great people when Netflix offered to double salaries. Or for all the good employees who were shown the door because their boss was forced to apply a ridiculously subjective “keeper test.” And don’t forget the marketers who tried to rent L.A. billboards, only to find that Netflix hadn’t just reserved the good ones, it bought the entire billboard company.

Yeah, that’s why people are celebrating. But here’s the truth: none of that stuff is Netflix’s fault. The $17 billion in annual content spend, the firehose creative strategy, the soul-crushing culture, the entire philosophy of business—Wall Street made that happen. Wall Street identified Netflix as the key disruptor, the first major mover in subscription streaming. And Wall Street lavished on Netflix a rocketing share price that enabled it to load up on debt and spend without consequence. That allowed Hastings and Sarandos not just to shoot for total domination, but also to dictate strategy to the entire industry, to change decades-old business practices, to muscle Netflix into the M.P.A., to collect huge personal salaries and write the management-advice book and go ahead and buy the Montecito property.

Netflix is only crashing now because it never should have been run up in the first place. Everyone in Hollywood (even Reed and Ted, I’m pretty sure) always knew that. It was the investors who didn’t seem to realize that the legacy shops would soon get their acts together, and that the economics of streaming would not match cable television, at least not for a long time. It was the analysts who probably knew better, but cheerleaded them anyway (and who now, hilariously, are pivoting from “Are you all in on streaming?” to “Are you fully diversified?”). And it was the rest of the industry that happily took the checks and ingested the red-N Kool Aid.

The public markets have always been an insidious force in the creative industries, the cause of so many short-term decisions and long-term problems: AOL-Time Warner, Universal-Vivendi, Viacom under the corporate looter Philippe Dauman, even what’s going on right now between Twitter and Elon Musk. Yes, Netflix encouraged the narrative that scale in streaming would lead to a Shangri-La of 1 billion people all paying $15 a month to watch The Rock plug his tequila in Red Notice. But only Wall Street made that narrative real. And then everyone else chased it.

Until then, Netflix has officially pressed the panic button. In its Tuesday investor call, Hastings deployed ads and a password crackdown, while declaring to the talent community that, essentially, the party’s over. (It’s actually been over for a while now. Talent deals got markedly worse last year, according to dealmakers I talk to, and now Netflix is moving to flat fees for producers, rather than percentages of budgets, per the Journal.) Inside Netflix, the mood is pretty grim, according to people I’ve talked to. So many employees now have upside-down options.

But is it actually time to panic? Probably not. Don’t get me wrong, it’s pretty clear now that Netflix made some strategic errors:

-Yes, it was a mistake to let password-sharing run rampant. I never understood why a business built exclusively on subscription would encourage free riders. Now, though, those freeloaders have been trained. It’s like when news publishers decided in the late ‘90s that journalism should be free online; the industry still hasn’t recovered. Now, if 100 million households are indeed getting Netflix for free, transitioning even a quarter of them to paid subs (while not alienating existing members) will help reverse the slide, but that is no small feat.

-Yes, Netflix should have used its inflated stock price to buy a traditional studio. It could have had MGM, and its library and franchises, for the $8.5 billion that Amazon paid, which is a fraction of that peak market cap. Lionsgate, Sony Pictures—both would have significantly boosted the content offering that Hastings complained about in his shareholder letter. Now that’s not really an option.

-No, the “binge” model is not ideal for retaining subscribers. Netflix still insists the all-at-once strategy doesn’t impact subscriber churn. But who believes that? As HBO’s Casey Bloys noted a few months ago, “You leave a lot on the table when you release all the episodes at once.”

-Yes, Netflix should be syndicating its library shows to generate extra cash, just like traditional networks and studios do. Netflix has dabbled here, but it’s a big revenue pot that hasn’t been exploited because the service has been so adamant about exclusivity. One dealmaker says Netflix is indeed now asking for more platform freedom in deals, meaning the shows can be licensed elsewhere. (This freedom would also help Netflix if the company is sold, which is also intriguing…)

-No, the movies aren’t good enough, given how much they spend. Film chief Scott Stuber basically acknowledged that months ago, saying he wants to make fewer, better films. That line has become a punchline around town.

-No, the television strategy isn’t perfect. TV chief Bela Bajaria had a huge, industry-changing hit in Squid Game. But she’s pretty open about wanting to make populist, “lean-back” shows for a global audience. The problem is, Netflix is making lean-back shows for a streaming product that is priced as a “lean-in” experience—meaning it’s expensive. Premium pricing for non-premium programming doesn’t lead to satisfied customers.

What wasn’t revealed, and what I don’t think Netflix has figured out: How the heck is this going to work? Ad businesses are really difficult to launch, especially at companies that have shown no interest or expertise in them. And we know Hastings didn’t really want to do this because he told us dozens of times. He always considered it an unnecessary distraction from his simple mission: pleasing customers. Netflix insiders say the shift is a sign of his pragmatism, that the climate has changed and the company needs to be responsive to what consumers want (a lower-cost alternative), especially in developing markets. Okay… But the reality is that Hastings is essentially holding his nose and jumping into a freezing lake because his peers are all doing it.

The new thinking—the thinking that has completely changed the calculus in executive suites— is that nobody is reaching subscriber Shangri-La without either an ad-supported tier or a free, ad-supported service like Tubi, Pluto TV, or Amazon’s unfortunately named Freevee. But I’d offer another way to get there: Consolidation, of course. Some of these services need to go away or merge, reducing competition. Or bundles. Whoever cracks the code of offering 4 or 5 top-tier streaming services, including all the sports, for $80 to $100—about what the average American currently pays for video—will win this game.

Netflix will certainly be in the mix of those top-tier streamers. With 220 million customers and an innovative management team, how could it not? But whether Netflix will be the dominant player is now anyone’s guess. And that changes everything.

The Netflix advertising pivot seems so thrown-together. I can’t find anyone who knows how it’s going to work. Given that the company is being dragged into this business and has shown little interest or expertise there, is it the right move?

Nathanson: It does seem very ill-planned and haphazard. Will they hire a direct sales force? Will ad sales be programmatic? Will they partner with Google or The Trade Desk? We thought that they would move to an ad product outside the U.S. and Canada, in markets that are under-penetrated and have a lower willingness or ability to spend. We wonder how they will even set the ad-supported price in the U.S., given the healthy $15 monthly revenue per user.

Do you think Netflix will build out the infrastructure for ads, or will they buy it somewhere? Or, like you said, maybe partner with a Google or—gasp—Facebook to sell their ads?

Truth is, we don’t know. I think having your own ad sales force is an imperative and an asset. Even in digital media, publishers don’t farm out that responsibility or relationship.

What percentage of these 100 million password-sharers do you think Netflix can convert into paying customers? And how many will they lose who are pissed about the inability to share for free?

Ah, the unknowable. In the U.S. and Canada, there should be a high degree of conversion, given the health of this market. But will that be met by a decision to spin down to a lower pricing tier by households those who thought that 4 streams allowed them to share with family members? We simply don’t know yet, but it will likely be an incremental revenue gain. In the 70 million other households, where are they based? In Latin America, piracy is much worse than in the U.S., but there are also lower per capita incomes and lower credit card usage, so it might not be as easy. Some may be offended that Netflix is looking for even more money at a nearly $20 per month price point. The content has to get so much better, and competition has to lessen, for this to be easy to achieve.

Given Hastings specifically called out the need for more compelling content, do you think the top content executives could be replaced? Is Ted Sarandos even potentially vulnerable?

Running a studio is like managing a baseball team. Eventually, when the team starts to lose, it is easier to fire the manager than replace the team. I don’t want to predict any one individual job cut, but it did seem like the shareholder letter was squarely blaming the content side for some of these issues.

In your opinion, what is the actual “total addressable market” (TAM) for subscription video services worldwide?

We think that there are two TAMs: 400 million or so for the high-priced broadband offering that exists today, with the bulk of that growth from Japan, South Korea, France and Germany. And a 700 million mobile-first or low-price TAM in the developing world. At 320 million households now, we are close to 80 percent of the penetration in the first TAM.

DOUBLE BONUS: On my podcast, I interviewed analyst Rich Greenfield about the Netflix-pocalypse and his past all-in recommendations on streaming. Listen here.

See you Sunday,
Matt

Got a question, comment, complaint, or a hotter Netflix take? Email me at Matt@puck.news or call/text me at 310-804-3198.