It’s finally happening. The Internet is taking over TV. It’s just happening differently than many of us imagined. There are two major transformations underway.
The Rise of The Internet Distributors. Led by Netflix, the group of new distributors includes Amazon and Microsoft now, but maybe Apple and Google later. They are largely distributing traditional TV shows in a non-traditional way. All the content is delivered over IP and usually as part of a paid subscription or per-episode EST (electronic sell-through). Important to note that all of this content contains no advertising and is available entirely on-demand. This content falls into the “non-substitutional” cotent bucket. To watch it, you don’t need to be a cable TV subscriber.
The Rise of Alternative Content Producers. Thanks to YouTube’s Channel strategy and investment in hundreds of content providers, new producers of content are emerging and offering non-traditional programming, usually in shorter form. This content is marked by dramatically different production economics than traditional TV content, taking advantage of an expanded labor pool and low-cost cameras and computer editing. This alternative content is chipping away at long- and mid-tail viewership on traditional networks (the “filler” and “nice-to-see” buckets.)
Both of these transformations are successful to date and will only become more-so. Rich Greenfield has a nice summary of why the TV industry suddenly loves Netflix. (Disclosure: I am long NFLX and have been a stockholder for some time.) The first transformation takes advantage of the massive pressure MVPDs place on traditional cable nets to not offer their programming direct-to-consumer. In this case, the HBO’s and AMC’s requirement that you authenticate your existing cable subscription in order to watch their programming over IP successfully persuades the cord-nevers to just avoid the programming on those networks until the hit shows are offered through Netflix or EST. Netflix, once again, looks like the hero. Those empty threats by Jeff Bewkes that he will never work with Netflix turned out to be, well, empty. The second transformation will take longer to fully prove out, but I believe it will happen. As more of our viewership takes place over IP, we lose our allegiance to networks as the point of distribution and allow new distributors to guide us towards content choice.
There is a third budding area of transformation, but I don’t yet see evidence that a business exists: trying to re-package cable TV bundles and sell them over IP. Companies like Aereo and Nimble.TV offer versions of this. I believe we live in a show-based world. Consumers aren’t looking for networks (with the exception of ESPN and regional sports nets) so much as they are looking for shows. Shows delivered over IP allow for the slow unbundling of television. One of the many challenges about this model for traditional broadcasters is that there is no advertising in this world. The traditional cable net business model enjoys two great revenue streams: affiliate fees and ad dollars. In IP-delivered shows, there are no ads.
Who are the winners and losers in this model? Well, show creators continue to flourish. The new distributors enjoy great success. Of course, ISPs, who are often the same companies as the MVPDs, do fine in the ISP business, but I believe the decline in total cable subs will continue. In a world where shows do not contain advertising, why do we need Nielsen? They have been a measurement standard for decades largely because advertisers needed a third-party validator of viewership. You can see why they have a vested interest in insisting TV ad viewership is not on the decline (despite everyone’s experience to the contrary.) I don’t think cable nets are in immediate trouble. They enjoy a great business model now, and also get to reap EST or licensing benefits after the shows air. But the Netflix House of Cards effort shows that consumers will now expect to be able to watch shows whenever they want and not be bothered by inconvenient broadcast schedules. The day is coming when the cable nets will have to respond.
For startups, one of the wide open spaces seems to be in cross-provider discovery. Now that my shows are spread among Netflix, Amazon, YouTube and on my DVR, I would prefer one interface to reach them all. Companies like Dijit’s NextGuide, Peel, Squrl, and Telly are taking cracks at this important space.
It was an honor to be asked to address the 2007 Penn Engineering class as their commencement speaker. The video has been posted on YouTube for years, but I was recently asked to post the text. While it is several years old, I don’t believe the message is out of date.
Good afternoon. I know exactly what you are thinking; what is a guy that you have never heard of doing up here delivering your commencement address? Well, truth be told, I am wondering the very same thing. In fact, when Dean Glandt asked me to be here with you, my fist reaction was, “No. I have not accomplished enough to stand in front of such a distinguished crowd. What wisdom do I have to empart to them?” Well, I will do my best today to share something meaningful with you. Let me assure you though, this is not where I expected to be when I was sitting in your seat 16 years ago, thinking, “now what?”
When you got into Penn Engineering, your parents, like mine, probably breathed a sigh of relief. “At least he’ll have valuable skills and a career – and not just some vague liberal arts degree.” Well, I have some bad news for your parents. Engineering is the new liberal arts. It is the lingua franca of the next generation. Technology has become so pervasive, particularly in western cultures, that we engineers are no longer the geeks in the corner – we are now responsible for nothing less than the economic, media, and communication underpinnings of society. But the good news is, if you speak this new universal language – and all of you do – then your opportunities to contribute – not just to your own success but to society at large – are limited only by your drive, your desire, and your ideas.
When I sat in your seat 16 years ago, I of course knew exactly where I was headed. Had it all mapped out. I wanted to be a rock star – a drummer in a rock and roll band. Granted, that is not the most expedient path to becoming a CEO of a digital music company. But please don’t be misled by my title. Yes, I realize being a CEO opens some doors. It gives me the platform to accomplish things that I might never otherwise do. But CEO is the least important aspect of my career trajectory. It is representative of the fact that I have merged my two passions into my career. And that’s what I’d like you to think about today.
What are your passions and how can you incorporate them into your career? How can you utilize these newfound skills? How can today become a jumping off point for tackling the things you deeply care about?
When I graduated from Penn Engineering, I had two passions: I was really into computers and I was really into music. Like many of you, I was tuned in constantly. I played in bands around campus and here in the greater Philadelphia area. I left the engineering lab as often as I could to practice and play gigs. Yes, I was a musician. But I was also an early adopter of technology. Penn helped open my eyes to that. It was clear where the music was headed – computers – to compose and mix, electronic drums, all the new tools of the trade. But I think I knew then that making a career out of my rock and roll aspirations was a long shot.
I came away with a couple of takeaways from this experience. For one thing, I learned that I had somewhat radical intentions from a very early age. The straight and narrow probably was not going to work for me. But the biggest lesson – and the most empowering one of all – was that it is possible to do what you want to do. Maybe not play Madison Square Garden to 20,000 fans. But I was hopeful that I could combine my passion for music with my keen interest in technology.
So I took the same degree that you are receiving today and I went to work at Apple in California. At that time, Apple was still a huge underdog and its future was by no means certain. I fit in with the culture perfectly. Apple embodied the rebel mentality. It was, pardon the expression, marching to the beat of a different drummer. Working for an underdog and innovator like Apple was a great influence. I learned to “think different.” I learned that consumers will reward you for innovation. And most importantly, I learned that technology could be terribly disruptive to incumbent industries.
Remember the phrase “desktop publishing?” Because of the Macintosh and laser printers, an entire business was upended. Apple (and eventually Microsoft) reaped the benefit. It turned the print industry on its head. I saw a chance to take that very same disruptive psychology and apply it the music industry.
When I was a student here, Penn was an early contributor to the development of the Internet. It was clear that as information and entertainment became digitized, the businesses of distribution and retail of entertainment would be transformed. I already knew that music was my true north. So I devoted my career toward working to accelerate, and hopefully reap the benefits of this transformation in the music business.
After joining the first digital music company and then founding another, and trying multiple times to build a business which would be pivotal in the transition of the music industry, eventually, with some partners, we bought eMusic, an abandoned dot-com company in disarray. Long story short? We turned it around to become the number two digital music service in the world. Second only to my old company, Apple. It’s success is due to the fact that consumers, not the music industry itself, forced a format transition from physical goods to digital goods. All enabled by technology. While the incumbent music industry feared, and even ran from this inevitability, I welcomed the disruptive nature of technology and knew it would fundamentally alter the entertainment industry,
However, I don’t want to set up false expectations that if you stick with the drums, you’ll end up CEO of a music company. Dean Glandt did not ask me here today to talk to you about playing in a rock and roll band. So I asked myself, what can I possibly share with a group as educated and informed as you that would be original and have any possible value whatsoever? I labored over this and as I did, it struck me. It’s not about technology or engineering. It’s about the disruptive nature of it.
You see, you all are sitting in the catbird seat for the next industrial revolution. You can join existing industries and work to build them bigger – or you can be the disrupters. The shapers. The policymakers. Every last one of you can land a job in any technology role. At the biggest and most successful companies! You already speak the language. But is that enough? Do you want to get out of bed every day just to log on? Or do you take this incredible genius you possess – this mastery of bits and bytes – and use it for something that matters to you? Something transformative?
There is an ambassador who comes to mind who also got his start like I did, in music. His name is Bono. You’re probably sick of hearing about him. Why does a scruffy singer from a small country in the North Sea have so much clout on the global stage? Because he took a common language, mastered it, and made it his platform for change. It begs the simple question. What is your platform for change going to be? How will you disrupt?
I understand – you might be scratching your head and saying, “C’mon, it’s happened already. The billions have been made – with Microsoft, Google, Yahoo!, MySpace, YouTube. All the big bets have been placed. Everything has already been disrupted.” But in fact I don’t think that’s true. Those companies are just the building blocks for the next wave. These companies, these web players did not exist 30 years ago. No one knew where it was going back then and honestly, we don’t know, today. That’s where you come in.
How do you take these Goliathan companies and their all-encompassing technologies and turn them on their head? How do you wrap your arms around this knowledge and do something that no one has thought of yet? How do you take this “language” Penn Engineering has taught you and make it stand for something you care about?
My understanding of the digitization of music gave me an inkling that someday the songs I grew up with would be available in formats we could not imagine as kids. The model was changing and I saw that and embraced it and tweaked it and now I get to wake up every morning and spend my days guaranteeing that people can buy it. Any kind of music on any kind of player. Period. That’s what I believe in. That’s where I staked my tent.
Although I’m a computer scientist by degree, I am no quantum physicist or nanotech engineer. I didn’t invent something that is going to save the world. I foresaw a market trend in a field I was passionate about and was fortunate enough to get on board at the cusp of the transition. Sniffing out market trends? This is a very good skill to hone. And you’re not going to find it in any book. Turn to your instincts on this one.
Here are some more examples: Sergey Brin and Larry Page – the guys who figured out how to do “search” better? They got it. Andreas Pavel? How many of you know THAT name. He and his girlfriend tested a new musical device he’d invented, on a snowy day in the Swiss Alps, listening to a Herbie Mann/Duane Allman composition – outdoors! – while they walked! The Walkman was born. Transformational! The way we listen to music has never been the same. And Steve Jobs can’t take all the credit on this one.
Nick Negroponte from MIT media Lab? One laptop Per Child! He is going to change the way children learn and he aims to do so one laptop at a time.
And it won’t just change the way children learn and think. It will change the way countries pull themselves out of poverty. The way emerging markets become self-sustaining. One man’s vision – and the language of technology – is going to change the lives of kids who never dreamt of having a chance – from Angola to Myanmar to Kazakhstan. These people are all using technology to disrupt the natural order, and making something better for consumers – for people – at the same time
Does this mean you have to invent the next big idea? if you have it, fantastic! But I think your mission is greater. You see, as I said at the outset, you are the new liberal arts generation. Technology is now omnipresent in society and you speak the common language. However, there are a lot of you speaking that language and believe me, the pack is closing in. You’re going to need more. You’re going to have to be aggressive, disruptive, and visionary.
I know many of you are thinking about the jobs you will start tomorrow. If I could spark one thought in you today, it would be to look five years out. Ten years out. Ask yourself, what are your kids are going to be listening to? What are they going to read, and watch? What’s their world going to look like? And how are you going to shape it? What industries are going to be completely disrupted by the inventions of today, and how can you, and society, benefit?
So I offer you a challenge. Look at yourself today, and ask what’s going to matter to you tomorrow. Which one of you is going to use your remarkable talent to feed Africa? Who’s going to tackle global warming? Does any one of you really believe, 20 years from now, that we’re going to still be running our cars on thick black crude pumped 2 miles out of the ground from a desert?
You are the 2007 graduating class of Penn Engineering. But engineering is merely the platform for the future. You will be more than engineers. You can engineer the shape of our society and shape the destiny of our lives. You will be inventors. Designers. Architects. Engineers. But through your ideas and design and architecture, you will become the de facto policymakers of the 21st century. You will define our society, all because you understand technology better than everyone else.
Call it a grave responsibility, or the greatest road trip you’ll ever undertake. Either way, you are empowered. There is no turning back. You are truly on the launching pad.
In closing, I offer these words. Follow your passion. Question the status quo. Bang a few drums. Don’t be afraid to make some noise. Take this awesome new language you speak and use it. Put it to work. We truly are on the cusp of a revolution. Get out there and be disruptive. Be responsible and give a damn. And lead. Show us where we’re headed next. It really does matter.
With my mind fully stretched in various different directions, a bunch of thoughts are coalescing, coming out of another fantastic TED. Three main points are loosely stitched together in my mind and they point to a bunch of future opportunity.
First, we heard convincingly from economists like Robert Gordon, Erik Brynjolfsson and Andrew McAfee that America’s manufacturing jobs which, for so long, powered our healthy middle class, are not coming back in any big numbers. Many of us scratch our heads to understand how to fill this enormous hole. At Venrock, largely informed by a similar Hunter Walk observation, we believe this dirth of fruitful middle class employment is leading to so much of the activity in the shared resources sector (AirBNB, etc.), in the peer to peer marketplace sector (PoshMark, etc.) and in the digital labor market sector (Uber, TaskRabbit, etc.) as income supplementation. This will help and is a highly investible opportunity. But still, is this enough?
Second, we marveled at Elon Musk and his unrivaled appetite to tackle the planet’s largest problems through commercial endeavors filled with enormous risk (SpaceX, Solar City, Tesla). He is an international treasure and it simply begs the question…why aren’t there more of him? Of course, there are many fantastically successful entrepreneurs and we celebrate them all. But how many Elon Musks are there on the planet? One hundred? One thousand? Ten thousand? Why aren’t there ten million? What are the specific experiences, personality traits, education paths, parenting, and DNA necessary to produce the planet’s super humans driven to defy the odds on such interplanetary scale? It is clear the planet needs more of them, and so why aren’t we unlocking the answer to the question of how to make more? A speaker reminded us of the Chinese proverb…
If you want one year of prosperity, grow wheat. If you want ten years of prosperity, grow trees. If you want one hundred years of prosperity, grow people.
We need to grow more Elons (and Steves and Bills, etc.)
Finally, Sugata Mitra delivered a compelling argument that our schools are simply obsolete for the task of turning out the kind of people we now need in our modern society. He argues for far more self-organized small learning groups of kids with cloud-based tools and light direction from a teacher. That may be part of the solution, but it is likely only a part of it. If our future doesn’t need line workers but needs more inventors, creators, risk-takers, builders, and makers, where will they all come from? Surely there is no natural limit on the number of people with these strengths in our species, right? Surely we can teach and encourage more people to excel in these areas, right? In order to do that, just how much of our society needs to change? Isn’t it more than just our schools? Isn’t it the goals we set for our kids as parents? Is the over-whelming emphasis on organized team sports in our suburban communities part of the problem? When we reward kids at spelling bees, perhaps the ultimate test of rote memorization, are we not helping? Shouldn’t every kid on the planet be playing Minecraft? How deep must we dig to get at the real root here?
I suspect this is perhaps the greatest issue we face as a society. How do we produce more entrepreneurs?
I was invited to testify in front of the IP/Competition/Internet Subcommittee of the House Judiciary Committee on the state of internet music licensing. I presented the following testimony today:
Testimony of David B. Pakman
U.S. House of Representatives Committee on the Judiciary
Subcommittee on Intellectual Property, Competition and the Internet
Hearing on “Music Licensing Part One: Legislation in the 112th Congress”
November 28, 2012
Chairman Goodlatte, Congressman Watt, and Members of the Subcommittee:
Thank you for inviting me to testify today regarding the state of internet music radio licensing. I am a venture capitalist with the firm Venrock. We invest in early stage internet, healthcare and energy companies and work to build them into successful, stand-alone, high-growth businesses. We look to invest in outstanding entrepreneurs intending to bring exciting new products to very large and vibrant markets. Our firm has invested more than $2.6 billion in more than 450 companies over the past 40 years. These investments include Apple, Athenahealth, Check Point Software, Intel and DoubleClick.
Although I was previously a multi-time entrepreneur in the digital music business, we are not currently investors in any digital music or internet radio companies.
As venture capitalists, we evaluate new companies largely based on three criteria: the abilities of the team, the size and conditions of the market the company aims to enter, and the quality of the product. Although we have met many great entrepreneurs with great product ideas, we have resisted investing in digital music largely for one reason — the complications and conditions of the state of music licensing. The digital music business is one of the most perilous of all internet businesses. We are skeptical, under the current licensing regime, that profitable stand-alone digital music companies can be built. In fact, hundreds of millions of dollars of venture capital have been lost in failed attempts to launch sustainable companies in this market. While our industry is used to failure, the failure rate of digital music companies is among the highest of any industry we have evaluated. This is solely due to the over-burdensome royalty requirements imposed upon digital music licensees by record companies under both voluntary and compulsory rate structures. The compulsory royalty rates imposed upon internet radio companies render them non-investible businesses from the perspective of many VCs.
The internet has delivered unprecedented innovation to the music community and allowed more and more artists to be heard unfiltered by the incumbent major record labels and terrestrial radio stations. I believe more people listen to a more diverse set of music today than ever before in our time. However the companies trying to deliver these innovative services are unsustainable under the current rates and frequently shut down once their investors grow tired of subsidizing these high rates and elusive profits fail to arrive at any scale. Pandora is a company that has done an amazing job of trying to make their business work at the incredibly high rates under which it currently operates — but their quarterly earnings reports make abundantly clear why they are virtually alone in this category. Regretfully, I cannot point to a single stand-alone business that operates profitably in internet radio. In fact, in all of digital music, only very large companies who subsidize their music efforts with profits from elsewhere in their business currently survive as distributors or retailers of music.
There was a time when the record companies were part of conglomerate media companies which also distributed and licensed the music they controlled. These joint “owners” and “users” of music appreciated the need for healthy economics on both sides of a license. Once the internet emerged, new distributors or “users” of music grew outside of major label ownership. Perhaps in response to their failure to prosper as internet distributors of music, the major labels took a short-term approach and refused to license their music on terms that would allow the “music users” to enjoy healthy businesses. To this day, more than 15 years since I first entered the digital music business, I remain baffled by this practice. In my opinion, it is in the long-term best interest of music rights holders to encourage a healthy, profitable digital music business that attracts investment capital, encourages innovation, and indeed celebrates the successes of the licensees of its music. A healthy future for the recorded music business demands an ecosystem of hundreds or even thousands of successful music licensees, prospering by delivering innovative music services to the global internet. Yet the actions of the RIAA seem counter to this very goal. They have appeared on the opposite side of every issue facing digital music innovators, opposed to sensible licensing rates meant to achieve a healthy market. Regretfully, and perhaps most upsetting to all of us, the artists are the ones who suffer most. They depend on the actions of their labels to encourage a healthy market to grow and have little influence on the decisions of the RIAA.
I am a believer in the value of open and unfettered markets and generally prefer market-based solutions. Unfortunately, the music industry is controlled by a mere three major labels, two of them controlling about two-thirds of all record sales. That amount of concentrated monopoly power has prevented a free market from operating and letting a healthy group of music licensees thrive. That said, I do believe there has been great value in compulsory licensing regimes such as the one governing internet radio. This structure has allowed internet radio companies to license the catalogs of all record labels and tens of thousands of independent artists, not just the dominant majors, bringing unprecedented exposure and revenue to the vibrant long tail of indie music — often where music innovation itself gestates.
The problem is simply that the rates available to internet radio companies under this compulsory license are too high. They frighten off investment capital, prevent great entrepreneurs from innovating, and kill off exciting attempts to bring great new music services to consumers. American entrepreneurship and innovation require vibrant markets unburdened by artificially high rate structures. I am hopeful you will see through the rhetoric often employed in this debate and make sensible policy based on sound economics. I would like nothing more than to invest in the many entrepreneurs we have met who have great ideas about the future of music. With a sensible rate structure in place, our focus on this market could return.
Please note: the views expressed herein are my own and are not necessarily those held by Venrock or other individual partners at the firm.
Today we announced our investment in Dollar Shave Club, a consumer subscription service focused on men’s grooming. I am honored to be joining the board of the company Michael Dubin has so successfully introduced to the world.
eCommerce companies can be challenging for venture investors. They tend to require lots of capital and usually have low multiples. There are a few cases where outliers can emerge. In subscription commerce, a few rules have to be met for large companies to be created. First, the market must be enormously large. Subscription, by its very nature, usually appeals to a subset of any market it aims to serve. Consumers must intend to make a long-term commitment to a brand in order to subscribe and must not tire of of the service. My experience running eMusic taught me the key metrics to look for in subscription models in order for large companies to be built. Churn rates must be very low. If your average customer leaves after, say, nine months, a large company cannot be built. Your average customer must stay in the service for many years. Think cable, satellite radio, and Netflix. These companies have average monthly churn rates of less than 3%. In the razor market, brand loyalty is measured on the order of twenty-five years. You generally can acquire a customer for a lifetime. And that is exactly what Dollar Shave Club aims to do.
Even more exciting, however, is how Michael sets out to build the brand. He believes that brands are now publishers and must market themselves largely through content. His overwhelmingly successful launch video, viewed more than seven million times, instantly went viral and jointly conveyed the brand personality and the benefits of the service deftly. In this age where social media dominates our collective conversations, we believe very large brands can be built without the widespread use of paid traditional media. It will take several years for the incumbent CPG companies to master these new marketing arts. In the meantime, companies like DSC emerge and get very large despite the massive spend of the traditional guys. We refer to this as asymmetric marketing — no matter how much money spent by the incumbent, the new brand can still become very large for tiny fractions of that spend.
Michael and his fine team have exciting plans. They look to build an enormously successful men’s lifestyle brand. I hope you’ll give Dollar Shave Club a try. I loved the product so much, I invested in the company.
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.
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.
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.
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.
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.
To build the online media giants of tomorrow, companies need models where the costs of both content and distribution are near zero. Google, Facebook, Twitter, Instagram, Pinterest and countless others employ this model. These models allow scale to emerge at very low-cost. And in these particular examples, the scale achieved is astronomical — on the order of hundreds of millions or billions of users. In thinking through how to build businesses around this scale, a lens emerges: what kind of traffic produces that scale? In the case of social media companies like Facebook, Twitter, Instagram, Pinterest and Tumblr, the root activity on the site is the sharing of content. But the content shared on those sites differs widely, particularly around which content attracts the most engagement. Broadly, Facebook attracts photo sharing and light-hearted personal content. Twitter responds far better to true news and topical information sharing. Tumblr seems to resonate around entertainment and creative media. And Pinterest lights up around home design, apparel, food and other commercial items. (I am taking some liberties by generalizing, but you get the point.) At the scale of Facebook, you could have your users share almost anything and still be able to build a large business, purely by loading the site up with lots of advertising that is (at very least) rudimentary targeted. At that scale, you can reach billions of dollars in revenue. And I believe, even at their scale, their ad load will need to further increase (along with their targeting abilities) in order to signficantly grow the business. (They also must move advertising off-site, as they are now doing, which I detail in this post.) But if your service attracts particular verticals of content engagement, not all content is created equal, and some is much more valuable than others. I divide traffic/content engagement into three buckets: topical, informational and transactional.
Topical content engagement is what is mostly taking place on Facebook, Tumblr and Twitter. It is comprised of posts generally linking to news, information, family, entertainment, photos, etc. The signal in this stream is the lowest of the three in terms of monetizeable traffic.
Informational content, often found on sites like SlideShare, Zillow and automotive blogs is the sharing of information that is near the top of the funnel for demand creation. Things like business white-papers or product reviews are perfect examples of informational traffic. This traffic has significantly more value than topical traffic, and excels at attracting endemic advertisers in the key verticals of travel, auto, tech, financial services, real estate and pharma, to name a few. Intent is well understood in this traffic and the signal is strong.
Transactional content is traffic that is essentially one click away from a purchase. Obviously, traffic found on ecommerce sites is the prime example of this and search traffic is a close second, but increasingly Pinterest is proving itself to be a massive source of high-converting traffic. Here, intent is clear and the signal is strongest.
I believe, with the Facebook share price correction, we are entering a period where sites based on topical content traffic are going to struggle in generating value for themselves. Much of the valuations around the consumer web are rationalizing, and because of that, investors are once again focused on understanding business models. Social media properties building traffic around informational or transactional content will be significantly more valuable than topical ones in this forthcoming period. This general notion that every social property with scale will be able to create their own custom “social ad” units and monetize themselves consistent with their earlier valuations, I think, is flawed, unless those properties are in the two higher tiers of content.
A traditional and effective way to launch software platform companies is to recruit early developers and host hackathons. Singly, the social data platform company did just that on June 3rd in San Francisco. Singly offered a grand prize of $10,000 to whomever created the most creative and interesting app based on the Singly API. The response was fantastic. They had more than 200 developers attend the 48 hour hackathon in person and more than 20 apps submitted at the end of the weekend. Somewhat surprising to many of us, a bunch of teams were working on apps during the weekend but were not physically in attendance. They showed up at the Sunday 5pm deadline with completed apps, working with our dev teams in the IRC chat rooms.
As important as it is to attract developers to a platform, demonstrating responsiveness to their needs is key. During the 48 hour hackathon, the Singly team re-deployed the API more than 25 times based on bug fixes and feature requests. This was truly development in real-time.
At the end of the 48 hours, 6 judges (including yours truly) evaluated the apps and picked a bunch of exciting winners. It was amazing to see so many apps born in such a short time. Congrats to Yard Rush and all the winners!
Lots of recent discussion on TV and Hollywood. Ari Emmanuel accuses Google (again) of aiding and abetting pirates. Henry Blodget writes a nice piece on the changing TV viewing habits of consumers. Dan Frommer says those changing habits won’t really affect the MSOs and Networks anytime soon. And Jeremie Allaire seems to claim that Apple’s next move in TV will be to emulate TiVo’s (largely failed) box/cable-card strategy (but correctly points out the disruptive power of AirPlay). Oh, and Sean Parker launched version one of AirTime.
I wanted to add a few points to the discussion about the pressures on the TV industry. First, some basic observations:
TV programming is not homogenous
The uber-bright Hunter Walk provided me with a fascinating view into his opinion of the real tiers of TV programming. Out of the 4-5 hours of TV the average household watches each day, there are essentially three tiers:
Hour 1 (No Substitute) – This is the never-miss-an-episode, live-sports, must-see-TV that exists across many networks. The Sopranos, Mad Men, Yankees/Red Sox, French Open, Homeland, etc. When we watch TV, this is the first hour we watch. We watch this stuff live or DVR it and try never to miss it. We will pay for it any way we can and even endure roadblocks to watch it (like when networks won’t make it available on our preferred viewing device, or expire old episodes, etc.) While the networks believe 80% of their content fits this description, it is probably more like 20% of all shows currently on the air, at most.
Hours 2-3 (Nice to see) – This is stuff that we have an allegiance to, but are comfortable missing an episode and won’t really endure friction to see it. Many comedies fit this category, from 30 Rock to The Simpsons, as well as the countless procedural crime dramas like CSI, etc. The networks think all of this content is in the category above, but it really isn’t. And probably another 30% of all shows on the air fit this category.
Hours 4-5 (Filler) – This is the low-budget, mostly reality show programming that networks use to fill the time between their one or two hit shows. Think Kate Plus 8 or Let’s Make a Deal re-runs. The only time you watch this stuff is when you are couch-surfing. This is probably 50% of all programming on air.
When Ari insists that Facebook, Google, Twitter and everyone else in tech will have to “pay for Aaron Sorkin”, he is really talking about the “Hour 1″ category of programming. That stuff is really high-value and is not in a lot of danger of being disrupted any time soon (although the rising production costs and off-the-charts no-risk fees paid to talent are surely to be reconsidered in the future.) But as for the other two categories…
Our attention is shifting away from TV
All media operates in an attention economy. They compete for our attention against the backdrop of thousands of choices as to how we spend our time: email, video games, Facebook, Twitter, Flipboard, Instagram, etc. The latest numbers show those choices are finally catching up with TV; we are watching less of it, whether DVR’d or not. We aren’t watching less of that incredible No Substitute programming, but we are watching less of the 80% of the other stuff. And by the way, those big “hit” shows that Ari talks about have relatively small audiences. Only about 3 million people “tune in” for an episode of “Game of Thrones” and over the course of a week about 9 million people have seen it through various means. Same for Mad Men (3 million), Desperate Housewives (9 million) and The Good Wife (9 million). That’s a pretty small audience compared to, say, the 450 million on Facebook every day, the 800 million who watch YouTube videos every month, or the more than 100M people who watched the final episode of M*A*S*H. As TV and other entertainment choices proliferate, “hit” audience sizes have decreased. So, one of the immediate threats to network/cable television is that we are likely to watch less and less of the “Hours 2-5″ programming that fills so much of their programming grids. (The smart production companies know this and are already producing much lower-cost, quality programming for YouTube and other online-only outlets.) And where will that lead us?
The pressure will first come from the advertisers
If Nielsen didn’t lie and try to convince TV advertisers that the 50% of people with DVRs still watch commercials (hint: that is utterly ridiculous. We don’t watch any commercials anymore unless we watch a live sports event), I believe advertisers would appreciate that we aren’t seeing their commercials anymore. While the PC and mobile web still don’t offer nearly the great story-telling opportunities for advertisers as TV commercials do, it just doesn’t make sense to continue to buy very expensive TV media when no one sees your commercials. Certainly live sports TV CPMs will go up, but the rest has to fall as advertisers figure this out. And reports detailing that we are watching less TV has to start to sink in. Advertisers would love to try to buy only the hit stuff, but networks are good at bundling to force them to buy the filler programming too. But the whole bundle will start to feel more and more pressure.
The dual revenue stream model of the cable networks provides lots of air cover against decreased ad revenue. The affiliate fees they get for carriage will sustain them for a while. Brand advertisers are looking elsewhere to find places to tell their stories and to reach their audience. And online, we can target viewers and assemble audiences with drastically better efficiency (and reliability) than on TV. Online video is becoming so performance-based, that advertisers now can pay only when someone has actually watched the commercial and not pressed the “skip this ad” button. If you really care about making sure someone sees your commercial, online is the only place to show it. And more and more, we just aren’t seeing the ad on TV anymore.
What’s This Mean?
Advertisers will begin to spend less on TV and that will be the canary in the coal mine that big changes are afoot
We will continue our shift away from viewing traditional TV and towards IP-delivered unbundled shows, some which will have migrated from traditional TV, but many that will be organic and native to internet programming (the made for YouTube stuff is a prime example here.)
Ari will continue to demand high prices for the “Hour 1″ shows created by his elite clients, but the audiences for those shows will grow smaller and smaller.
As a result, networks will begin to feel the pinch of decreased advertiser spending, and they will try to raise carriage prices to the MSOs more aggressively
MSOs will keep trying to push our bundled TV prices up higher as a result of this, pushing more and more of us away and into other IP-delivered options
Finally, I believe the as more of us watch IP-delivered programming, the lure of certainty that the audience you really care about is seeing your ads will prove appealing to more and more advertisers, and online video ad revenues will continue a dramatic ascent
And so the cycle will go
(Update: this report from Pivotal Research refutes all of Henry’s points…but bases all of its observations on data provided from a single and biased vendor: Nielsen – a panel-based research method that looks at activities of only 25,000 households – and has concluded, for one, that those of us with DVRs still watch ads. Go figure. Oh, they make their money from the TV industry.)
Last week’s announcement by the Justice Department that they are suing Apple and several of the world’s biggest book publishers for conspiring to keep eBook prices high generated plenty of media coverage. One challenge in wading through this coverage is that most of it tends to be written by…journalists. And some journalists are also authors. And authors seem to have a soft spot for publishers who fight for higher prices. So, we get lots of coverage sympathetic to the plight of the poor book publishers. Amazon is evil, you see.
Absent from most of this coverage are two main questions: a) what is the right price for eBooks and who gets to set it, and b) why are eBooks not interoperable on different devices? These questions, in my mind, are far more interesting than the ongoing struggle of publishers to adapt to Amazon’s dominance in book retailing. In fact, the answers can significantly help legacy publishers stay competitive for the future and avoid extinction.
First, a conversation about eBook pricing. Readers of this blog are familiar with my many discussions on digital good pricing and price elasticity. There’s “Weighing In On the Amazon/Macmillan Pricing Debate” where I detail that the market can tell you your optimal (i.e., highest profit producing) price for digital goods. Each incremental digital good has no additional cost. The marginal cost of distributing it is zero. So you really want to maximize total profit by finding the price that produces the most number of copies sold. In these markets, you make a mistake when you set your price by looking at your legacy costs (which were designed for a physical goods market in pre-digital times). Digital markets produce much lower profit per item, since digital markets tend to have lower prices for goods. (See “As Big Media Goes Digital, Markets Shrink“.) In all the discussions about why book publishers demand that eBooks should be $15 and not $10, they say it is because they cannot afford to sell books at $10. That is, they cannot cover their legacy cost models on that number. Right. Which is why you must rebuild your cost structure for a digital goods industry with far lower prices. You start by paying your top execs much less than millions of dollars a year. Then you move your offices out of fancy midtown office buildings. Why should eBooks cost $15? Amazon is far more of an expert on optimal book pricing. They have far more data than publishers, since they experiment with pricing hundreds of thousands of times a day across millions of titles. Amazon can tell you the exact price for a title that will produce the most number of copies sold. Amazon is pretty sure that number is closer to $10 than to $15. Yes, they want to sell more Kindles. And they believe that lower eBook prices mean more eBooks sold which means more demand for Kindle. The negative coverage of Amazon is centered on them selling eBooks below cost in order to reach the $10 price point. But that is a function of publishers setting the cost higher than $10. If the profit-maximizing price for an eBook is $10, then publishers must adapt to set a wholesale price lower than that, even if it means your legacy cost structure doesn’t allow it. And that’s the rub. [By the way, as publishers continue to resist this market force, new "publisher" models are appearing and will replace the traditional functions of publishers with more digital-friendly models.]
Openness and Interoperability
Now, how do legacy book publishers fight back? Well, to begin, their biggest mistake prior to over-reaching on pricing was to insist retailers DRM their eBook titles. Just like in online music, this insistence on anti-copying protection (albeit with limited usefulness) not only creates inconveniences for consumers, it allows for dominant proprietary ecosystems to form (like Apple did with iPod/iTunes, where tracks bought from iTunes only played on iPods, Kindle books can only be read on Kindles.) Instead, publishers should have demanded the opposite. All eBooks should be sold in open, interoperable formats, so an eBook sold at Amazon could be read on a Nook, etc. This would have separated the reader market from the retail market and lessened Amazon’s eBook dominance. It may be too late for this change to work, but it is worth exploring. Incidentally, I predicted this in 2009 with this piece, “The Book Industry Is In Trouble, But Piracy Is Just A Symptom.”
Here’s the essence of what I see — we have authors and publishers screaming that Amazon wants to sell their books at prices lower than the arbitrary costs the authors and publishers have set. But why must eBook prices be $15? What is so magical about that price? Will it maximize profit? I am skeptical that this price does optimize profit. I see how it attempts to protect a legacy cost structure that is out-of-whack with a digital goods market. Yes, Amazon is a relentless competitor. But they always seem to be on the side of lower prices. And as consumers, we love this about Amazon. But none of the articles I have read seem to mention that the winner in a lower-price eBook market is the person authors are all writing books for in the first place. The reader.
(Incidentally, I am completely unmoved by the argument that if Amazon forces traditional publishers to sell books at lower costs, then the publishers will go away and we won’t have books anymore. Hogwash. The publishers built for a printed books world may go away, but their digital native versions will replace them.)