Author
Joel Espelien
Date
May 30, 2017

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Last week, Netflix released its biggest budget original movie ever. War Machine, starring Brad Pitt as an American general sent to sort out the mess in Afghanistan, apparently cost $60 million. Hollywood reacted with both excitement and dismay at the SVOD giant’s latest attempt to disrupt the traditional video content ecosystem.

Why is this important and what does it mean for the future of TV? Two thoughts.

1. The Traditional Hollywood Windowing Model Continues To Unravel
Businesses are a sum of their market segments. If the segments are healthy, the business is healthy. If not, things go south in a hurry. In Hollywood, market segmentation resulted in the well-known (but not necessarily well-loved) windowing strategy, in which movies were released first to theatres, then to transactional media (physical and digital), then to premium movie channels like HBO, and ultimately to broadcasters. While this distribution hierarchy has held together for several decades, today (at least with respect to the US market) none of these segments are in very good shape.

First, traditional box office is down dramatically, primarily due to adults preferring to watch films at home versus going out to the movies (thanks, Netflix!). Sure, teens will still meet up for a summer blockbuster or two, but that sub-segment has its own issues. As TDG recently reported, today’s teens increasingly don’t work, don’t drive, don’t date, and are addicted to their smartphones. Other than that, the teen market for movies is great! One poor guy in Texas recently summed up the state of affairs by suing his date in small claims court for texting throughout the latest Guardians of the Galaxy movie.

Second, transactional media continues to suffer. Physical media is basically dead outside of Disney titles for kids. As we discussed in our newest report, Back to the Future: Revisiting and Renewing TDG’s Forecasts Since 2013, 4K Blu-ray missed its window and will be at best a niche technology with minimal impact on the overall market. Furthermore, digital transactional platforms for movies like Vudu, iTunes, and Google Play continue to lag due to the increasing availability of SVOD, TVE, and AVOD content on connected TV platforms. Pay-per-view just has a lot more mental friction associated with it than these models.

The bigger problem with transactional content is the move to individual viewing. As TDG has been arguing for years, video has moved from a social medium to an individual one (i.e., the proverbial ‘audience of one’). This disrupts the perceived economics of transactional video. In the old days, people went to Blockbuster on Friday night, stood in line, rented a movie, and drove home to watch it with family or friends. A movie rental was (and is) very cheap entertainment when shared among 3-4 people. By contrast, paying $5.99 to rent or $14.99 to buy a movie to watch by yourself is rather expensive, even more so if you’re watching on your phone.

That brings us to the premium channel and SVOD window, and hence the Netflix problem. Traditional Hollywood movies licensed in the SVOD window are 18-months old, nonexclusive, and have by and large already exhausted whatever marketing pizzazz they had when first released. Spending $60 million for War Machine, by contrast, is actually pretty cheap from Netflix’s perspective because it gets the exclusive rights to plaster first-run images of Brad Pitt in an army uniform on the sides of city buses from Los Angeles to Bogota. One can be sure that combination tested well in the data Netflix used to fund this picture in the first place, which brings us to our second point.

2. For Better Or For Worse, Netflix Is On Its Own With Respect To Content
The logic of Netflix’s inexorable move from licensing Hollywood content to producing its own movies is impeccable for the reasons alluded to above. Original content is what differentiates. Netflix needs to differentiate. Ergo, Netflix needs to spend its money producing original content. True as this may be, this strategy (like every strategy) has problems of its own, the first glimpses of which we can already see with War Machine.

First, with respect the US, Netflix is no longer in the “shift viewing to the Internet” business. That wave has already crested and is no longer a source of growth. (Internationally, of course, it’s a different story.) Today Netflix is engaged, for better or for worse, in the “make hit content” business. The early not-so-great reviews for War Machine illustrate just how difficult (and different) this challenge is. Netflix’s current stock price seems to imply that every new Netflix title is going to be the second coming of Citizen Kane. I seriously doubt it, and there is just no precedent yet for how either the market or subscribers will react when a big budget Netflix original inevitably bombs.

Second, there is a price to bypassing the traditional Hollywood windows and making movies like War Machine available exclusively to Netflix subscribers. Movies are pop culture, after all, as well as a dialectic between the artist and the audience. Star Wars did not become “Star Wars” just because of George Lucas. Star Wars’ fans created that phenomenon. When I carried my Empire Strikes Back lunchbox to elementary school in 1980, I was part of that phenomenon.

One of the reasons this dialectic works so well is the ability of a wide audience to experience and react to the art in a broad variety of contexts. Seeing Titanic in the theatre back in 1997 was a totally different experience than buying the soundtrack and hearing Celine Dion sing My Heart Will Go On. Both elements, however, were critical to that movie becoming a massive cultural phenomenon.

The Netflix straight-to-app distribution model short-circuits this process. Remember, more than half of US households do not subscribe to Netflix, meaning they are essentially shut out of the conversation about War Machine or any other future Netflix movie. Ergo, it is highly unlikely that such a movie could ever attain iconic status. More subtly, while straight-to-app movies may be viewed individually, they will never benefit from the communal audience response of watching a movie together in a theatre.

Conclusion
One rule of innovation never changes. Pioneers have to blaze their own trails. With original feature films like War Machine, Netflix is leaving behind over 100 years of Hollywood experience and trying to carve a new path into the future. The rest of the industry is watching to see how the story turns out.

Stick with TDG and stay ahead of the curve.

Joel Espelien is Senior Advisor for TDG and VP of Client Services for the Corum Group doing sell-side technology acquisitions. He lives near Seattle, WA.

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