On Friday night, Chris Dixon (@cdixon), Jonathan Glick (@jonathanglick), Peter Kafka (@pkafka), Todd Sawicki (@sawickipedia) and I had a conversation on Twitter about media concentration and where the power lies these days. It was inspired by an Erin Griffith (@eringriffith) post called “Spotify’s Best Chance at Beating the Digital Streaming “Suicide Pact” Is With Ads.” Chris assigned me the homework of blogging about it, so here goes.
Typically, as a distributor gains scale with lots of customers, we expect market power to accrue to them and provide them negotiating power over rights and rates of content from the content owners. As we will see below, this is true in some forms of media, but not in others. What types of media are more prone to distributor power? Jonathan offers us a framework:
- Content tends to be more fungible and less likely to benefit from concentration when it takes less time/cost to create a hit, the value of a hit is in decline, many substitutional offerings exist, aggregators have existing strong market power, and/or a strong motivation exists for self-publishing.
- Content tends to be less fungible and offers concentrators great benefit when it takes significant time/cost to create a hit, the value of a hit is increasing or sustained, there are few substitutions available (by regulation, uniqueness or otherwise), aggregators have low value, and/or content creators have strong and sustaining brands.
- A shift seems to occur allowing distributors to amass power when a disruption materializes in the format/form of the media object itself (usually the new object has higher volume, velocity, virality). Some recent examples, perhaps, are YouTube clips, Tweets and Kindle singles.
- Any media that’s worth owning is worth concentrating and there will always be capital available to do so. Only limit is regulators, until a format disruption occurs.
Let’s examine the state of many top media categories.
Music
One assumption many people have made about Spotify is that, while their current economics as provided to them by label licensing rates are essentially unsustainable, once they reach scale, they will have leverage over record labels and will be able to reduce their on-demand royalty rates. The reason this won’t happen is because of extreme continued concentration of supply. In 1999, when Napster was the harbinger of the demise of the recorded music business, there were six major labels who controlled about seventy-five per cent of the commercial recorded music market. With the EU’s recent approval of UMG’s purchase of EMI, there are now only three major labels. They control about seventy per cent of the world’s music catalogs. Indies have made a good run, and have grown in importance, but the world’s superstars are, for the most part, on major labels. And you just can’t operate a digital music retailer at scale without hit music content. I tried, when I ran eMusic for five years. We were the largest online retailer of indie music, but only reached about a half a million subs at our peak and came to believe that we could never be significantly larger than that without major label content.
So, suppose Spotify reaches 50M listeners and 10M paid subs? Or even 50M paid subs? Will they be able to demand better rates? No. Because they don’t have a service without the full catalogs from those three majors. If even one of them pulled their catalog, at least twenty per cent of all Spotify’s content would disappear. All the playlists on the service would break. And a third of the hits would be gone. Paying consumers would never stand for it and the service would crumble. The labels know this. They know they have fully concentrated power. In fact, I would bet that if Spotify ever reaches that scale, the majors will demand even higher rates, and they may be able to get them. Highly concentrated popular content allows owners to extract unprofitable rights deals. Even though Spotify is building listener scale, the absolute dollars they pay to labels still small, given that streaming rates are very low per play.
Does this mean Spotify has no future? That’s a different discussion, and my view is they do, if they diversify into other content types. But the music business for them will be, at best, a twenty per cent gross margin business (it was two per cent last year), and that is tough. (Remember, even Apple, the world’s largest music retailer did not have leverage to hold rates steady and gave in to rate increases imposed by the majors.)
So, in music, the power is in the hands of the content owners, not the distributors. Will this change? Will there be fragmentation among ownership? I hope so, and it is conceivable, but the amount of time it will take for a highly fragmented market to occur could be 10 – 50 years. At this rate, we will likely have two major labels within the next three years.
TV
I blogged about Hunter Walk’s view that TV content sits in three main buckets, No Substitute, Nice to see, and Filler. If you want to be an MVPD, you must have the No Substitute and the Nice to see content. Sure, you could try to operate a service without the Filler, but that is not how programming is sold. It’s sold by the channel, and each channel has its mix of each of the three tiers above. (Actually, it is sold as a package of channels, to be more precise. If you want MTV, you must also take Logo, etc.) Whenever an MVPD gets in a rate dispute with a programmer and the channels get pulled, the customers go crazy, put huge pressure on the MVPD, and start switching services. The MVPD generally gets beat. This is why Comcast bought NBC…to finally have some hedge protection against the power continuing to concentrate in the hands of the programmers. So, in traditionally delivered TV, the power is in the hands of programmers. I am told the NFL Sunday Ticket deal leaves DirecTV with essentially no margin in ways similar to online music rights deals.
How might this change? Well, one scenario is that the rise of IP-delivered TV programming (Netflix, Amazon, Apple TV, YouTube, etc.) breaks the channel model back into shows, since that is all we care about as consumers. In that case, the supply is quite fragmented. You can operate an IP-delivered video service without all the content (in fact, all of them do today, since none of them offer a package as complete as an MVPD). The challenge here is that the programmers are pricing their hit content in such a way as to make it economically challenging for you to assemble all of your shows on-demand, and/or they are withholding key programming from IP delivery unless you authenticate as a paying MVPD subscriber. Note that YouTube is attacking this market differently, and is going after the time we spend watching Filler programming. I think they will succeed.
News
In this category, supply is highly diversified. Content is highly substitutional. While important brands exist here, and we show a preference for many of them, the power exists in the hands of the distributor. Audience size brings increased revenue (whether ad-supported or consumer paid). This content category is highly fungible. A storm-is-a-brewing because of social media, however. Many prominent writers (and ones less so) are building enormous social media brands sometimes bigger and more loyal than the audience size of the news distributors themselves.
Books/eBooks
As Benedict Evans (@benedictevans) points out, there is considerable diversity on the supply side here, with many book publishers and one dominant eBook distributor today in Amazon. In traditional book retailing, there is less of an all-or-nothing phenomenon It is possible to create retailers without complete book catalogs. Nevertheless, a hit dynamic happens here too, and it’s hard to be a leading seller of books/eBooks if you don’t carry Harry Potter or whatever 4-5 titles dominate the bestseller lists. Today, in eBooks, Amazon has the balance of power and is certainly exercising it on pricing. Publishers hope Apple and B&N pose some competition here.
Generally, we expect the distributor to have power when supply is highly fragmented, and most media follow that axiom. While the internet has allowed a massive diversity of publishers and contributors to enter the market, big media ownership of “hit” content has been consolidating to extend their grip on pricing in the short-term. It’s reasonable to expect, however, that more and more “hits” will come from outside the consolidated super-structure. In TV, one could argue that nothing stops Netflix from buying high-end video programming direct from content creators, for example. But in the last few years, the networks (who often own/fund production companies) have worked hard to prevent this from happening and try to extract full value from their content before it gets into Netflix’s hands. In written media, super-blogs employ well-established mainstream writers. And in music, Adele is signed to an indie. But where hit media remains consolidated, media giants will exercise leverage.
Thanks for the great post. Here are a few additional thoughts.
Another factor that informs the balance of power between distributor and content provider is ownership of the customer relationship. Music, book, and movie producers don’t sell direct, while newspaper and magazine publishers do, other than newsstand sales. The shift from print to tablet threatens the newspaper/magazine publisher-reader relationship. Apple owns the iOS app customer relationship, but magazine and newspaper publishers are exploring alternatives. Next Issue Media aims to preserve the direct customer relationship for magazine publishers. And HTML5 gives publishers, like the FT, access to the tablet channel, while preserving the customer relationship. This dynamic may signal the future of television and, with it, the balance of power between content provider and distributor. Today’s cable channels could become Web apps in an over-the-top ecosystem, circumventing the MVPD’s direct customer relationship.
HTML5 apps for mobile and tablet platforms are also another example of the the shift in power you describe that results from a format disruption. The FT offers a Web app for iOS devices and not a native one. The NYT introduced an HTML5 app this week. The analogy here is to the control AOL exerted over Internet content fifteen years ago before consumers and content providers migrated to the Web.
When talking about news, I think it’s helpful to distinguish between national and local news markets. Some national news providers have been able to differentiate their products by politicizing coverage (Fox, MSNBC) or providing in-depth analysis (WSJ, NYT). It’s harder, on the other hand, for local news providers to differentiate their products. As a result, national news providers can establish meaningful brands and therefore gain more leverage in discussions with distributors than local news providers.
This is interesting, but I think you are failing to take into account one of the fundamental paradigm shifts (particularly with respect to TV) and that is the cost of creating the content and who can now make it.
Concurrent with the explosion in potential platforms wrought by the ‘digital revolution’ is a concurrent collapse in both the cost and complexity of creating content for ‘TV’. Where once a broadcast quality camera cost $40,000 and a professional edit suite cost $1m, you can now shoot a broadcast quality TV show on your iPhone and edit it on your iPad. In fact, FCPX is far more powerful than so-called professional CMX edit suites at CBS or NBC, and any 9-year old can operate them.
This new technology opens the door of for the democratization of content creation, but it also removes the barriers as to who can make content. (The video version of JK Rowling with a pen and paper). It also means that the break-even point for video content is a lot lower, allowing distribution that obviates the old gate keepers.
Michael, thanks for your comments. I fully agree with this, and I address this point in my other post about who else can make a run at content. The place where technology costs are not really mattering is at the high-end of TV production where the talent costs (actors, writers, directors) are responsible for the overwhelming costs of the show. I do believe the creative side of TV is heading for a massive day of reckoning on this score, but for now, the top 10% of shows created are getting very high talent fees disproportionate to the risk the distributors take.
This is really great stuff – and an area I’ve thought an immense amount about. Tren Griffin at Microsoft ‘schooled’ me on “transfer pricing pressure” and why Apple’s model of making their money on the hardware was the only way to really make money selling music online. You give a lot of additional reasons, and show how other markets with transfer pricing pressure are similarly problematic. Hulu’s difficulties with their JV relationships clearly is a great example – even though the company is jointly owned by the networks, the networks are beginning to apply transfer pricing pressure to Hulu. Crazy times.
I created a bunch of slides on media fragmentation and how power has consolidated on the buy side of the advertising marketplace over the last 20 years. They’re part of the first ‘meme’ of the five I cover in this deck:
5 important memes for the digital advertising industry from Eric Picard
I’m not sure how or why you’re differentiating the non-pay-per-view IPTV options (Netflix, Amazon Prime, Hulu, etc.) from traditional TV. Availability is exactly the same model – networks sell big buckets of channel programming, of which viewers generally view a small portion.
If you’re only talking about linear, non-DVR viewing vs IPTV viewing, I guess you have a point, but anyone who watches IPTV is likely to time shift, anyway.
Well, for a bunch of reasons, actually. The IPTV options are a different biz model (only pay-for-subscription, no advertising), they are sold direct-to-consumer, rather than sold to an MVPD for carriage fees/equity so have vastly different P&Ls for marketing, etc., and receive their content in a different rights window than traditional TV. They don’t look a thing like traditional TV businesses to me. Why do you think they are so similar?
Nice post, David.
Labels would tell you a large distributor such as iTunes or Walmart has all the power. That’s what they told Congress at the UMG-EMI hearings. I’m sure that’s what they told the European Commission.
iTunes keeps only 30% of revenue, but it exerts its influence in many other ways. Labels are deathly afraid of Apple. Now that’s power.
But let’s remember that digital music is not really a good business for standalone companies. Like you said, Spotify is looking at being a 20% gross margin business. I think it can do better over the long run, but I’m not going to nitpick over a few points. Subscription services will probably be far more successful in negotiating new product features than negotiating lower rates. New features could help revenues but not so much margins.
Bottom line: I think it’s a sustainable model. It’s not a making-money-hand-over-fist model, but it’s a sustainable model.
Spotify needs to diversify or find a suitor. In both digital and physical music, the economics of selling music all but demand that it be sold along with other products or services.
iTunes wouldn’t work if it weren’t part of the world’s most valuable company. Similarly, Amazon’s MP3 store wouldn’t work outside of the Amazon ecosystem. Walmart and Target sell music only because they sell many other products. eMusic and Beatport are aberrations, and I’m not sure they would be possible in the subscription world.
I agree, Glenn, that iTunes and Amazon don’t make any profit (or at least anything meaningful) from the sale of digital music. And we know Spotify is currently operating at 2% gross margins, which will not work. We know the labels cry about the power of the retailers, but truthfully, this is all due to their own making. The labels had all the cards, and over-reached in their licensing deals with startups, offering anemic margins to anyone who wanted to sell their music, dooming literally hundreds of businesses. As a result, the only companies capable of selling music are the ones comfortable losing money by doing so.