Early Investing

An Investor’s Approach to Business Models

An Investor’s Approach to Business Models

I have Netflix on my mind. Yesterday, I wrote about how Netflix exploited market inefficiencies to build a dominant consumer brand for our Pre-IPO Profits members. (Editor’s note: It probably isn’t the market inefficiency you’re thinking of. Click here to sign up for Pre-IPO Profits if you want to read about it.) Then last night I started scrolling through my earnings report news feed and saw the Netflix reports.

On Monday, Netflix was trading at about $196. As of this writing, Netflix is trading around $210. I’d like to say a strong earnings report pushed Netflix’s stock forward. But that isn’t the case. Netflix jumped because its earnings report was less disastrous than expected.

Netflix lost about 1 million subscribers in the last quarter. That is objectively terrible news for the company. But Netflix was forecasting that it would lose 2 million subscribers. So it “beat” expectations. And Netflix stock started going up.

Netflix is also introducing a cheaper ad-supported tier next year (more on that later) and cracking down on password sharing.

But the Netflix headline that really caught my eye was this one: “Netflix’s CEO is ready for TV to die.”

Here’s how The Verge paraphrased Netflix CEO Reed Hastings’ thoughts from the Netflix investor call:

He reiterated his belief, confidently saying that Netflix was in a great place because linear TV would be dead in ‘5 to 10 years.’

Linear TV is the industry term for non-streaming television — so basically broadcast and cable TV. Hastings is predicting its demise. And the prediction — which reflects his bullishness on Netflix and streaming — is almost certainly premature. 

The business of TV is very different from the consumption of TV. In streaming’s infancy, most people couldn’t wait to cut the cord. They hated cable TV companies.

As far as most customers were concerned, they spent too much money on cable TV and received mostly channels that they didn’t want to watch. Plus, the cable TV viewing experience wasn’t very good. Video on demand was wonky and DVRs had too many hardware and software limitations. Plus, everyone hated commercials. Almost everyone said they would be willing to pay extra to have an ad-free experience.

What consumers said they wanted was to pay for just the channels they wanted. The working theory was that they would save money by not getting all of the channels they didn’t want. They wouldn’t have to watch ads. And the content could be streamed to them whenever — and wherever — they wanted.

What most people didn’t know is that on cable TV, the most popular channels are also the most expensive ones for the cable system to carry. And all of those channels that nobody really watches are just bundled in for free to convince the cable company to carry the more popular channels. So by moving to a full streaming world, customers were essentially going to have to pay for multiple streaming services to get all of the content they wanted (because it was owned by different channels/companies). And they were going to have to pay for internet access. So when it was all said and done, they would be paying about the same amount they paid to cable companies — if not more.

Cable executives actually made this argument to try and prevent streaming from taking off. But customers weren’t buying it. And the streaming revolution took off.

There’s no doubt that streaming has improved the viewing experience. People have enjoyed the on-demand nature of streaming along with the endless library of options and the ad-free experience. But the fragmentation of the market largely played out the way cable executives predicted it would. 

Here’s a small sample of your streaming options right now:

  • Netflix
  • Hulu
  • Amazon Prime
  • Peacock
  • Paramount+
  • HBO Max
  • Apple TV+
  • Disney+
  • ESPN+.

If you paid for each of those services, it would cost you about $85. And that’s before you add in internet access. I have several friends who are switching back to cable because they get everything they want to watch at a lower cost.

And customers — the same customers who said they would pay a premium to not watch ads — are clamoring for advertiser-supported versions of streaming services (Netflix is adding one next year) to save some money.

Streaming services are also quickly learning how expensive it is to acquire and produce programming. Jason Sudeikis, for example, is paid $1 million per episode to play Ted Lasso (on Apple TV+).

Meanwhile, broadcast networks have been doing this for decades. And they’re still free.

The lesson in all of this for investors is that business models matter. You can’t really understand how well a business is going to do in the long run until you understand how its business model works.

Whether it’s a public company or a startup, put in the time to learn how an industry works — and whether a company’s business model fits into that industry. It will save you — or make you — a lot of money in the long run.

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