Is Streaming a Good Business?

For most of the media companies, 20% margins are out of reach— and it’s not just about content costs

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Source: vegefox.com, via Adobe

In the wake of the recent slowdown in streaming subscriber additions, media investors have turned their focus from streaming subscriber growth to streaming business profitability.

About two years ago, I posted an essay called One Clear Casualty of the Streaming Wars: Profit. In a nutshell, it argued that the profit pool for streaming TV will be structurally smaller than the profit pool for traditional pay TV networks due to pressure on both the top and bottom lines: consumers will spend less when empowered to create their own virtual bundles and a large proportion of viewing will be ad-free; at the same time, margins will be lower due to deep-pocketed entrants with different profit motives, high operating costs to run a D2C business and lower consumer switching costs (and therefore higher churn). And, as a result, the shift of consumer time and attention from traditional linear networks to streaming is a net negative for the big media companies.

At the time, the profitability of streaming didn’t matter much. Mirroring sentiment in the broader market, what mattered was growth. NFLX was trading at over $500 — over 40x forward consensus EBITDA estimates — and the Street was encouraging the media conglomerates to chase Netflix’s sub count and multiple regardless of the collateral damage to their legacy businesses. Plus, industry-wide, streaming subs were growing rapidly. Being on the vertical part of the S-curve tends to render everything else moot. Whether streaming is a good business wasn’t an important question then. But now it has taken center stage.

So, is streaming a good business?

In this essay, I revisit the question, first by defining what a “good business” means in this context and then digging into Netflix’s unit economics to try to answer it.

Tl;dr:

• If a “good business” is defined as at least~20% margins, then streaming isn’t a good business for most of the media companies.
• Contrary to perception, content costs are only part of the reason.
• Now that Netflix has stopped growing in North America, it’s easier to figure out its unit economics. They provide an important reference point for the potential profitability of the media companies’ streaming businesses.
• Netflix spends an estimated $10-11 per subscriber monthly in North America on content, marketing and other operating costs, comprising ~$5-6 in (book amortization of) content, $1 on maintenance marketing and ~$4 on other opex.
• Whether Netflix’s content spend is a good benchmark for the media companies is an open question: it has a far larger sub base over which to amortize spend, but it also lacks large libraries of mostly-amortized content. Let’s call it a wash and put the question aside.
• Although it gets much less attention, churn is costly. Most of the media companies reportedly have churn rates that are double or triple Netflix’s. Even if their marketing is as efficient as Netflix’s (which it probably isn’t), that means their maintenance marketing costs — i.e., the monthly amortization of SAC over the life of their subs — is at least double or triple too.
• It is also hard to see how the media companies can possibly manage their other operating costs better than Netflix can. Running a direct-to-consumer business simply requires activities that operating linear networks do not.
• Adding it up, the media companies likely will incur marketing and other operating costs of $6–8 per subscriber monthly —before dollar one of content spend. For many of them, that is close or equivalent to ARPU.
• This analysis shows that even if there is a tacit collective agreement to rationalize content spending, other costs will stay stubbornly high. And, if lower content spend increases churn, maintenance marketing costs may actually increase. To a degree, cutting production spend may be pushing on a string.
• After making massive bets on streaming, the key question for the media companies is: what now?

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