The chattering and sniping touched off by NBCUniversal research head Alan Wurtzel’s release of purported ratings data for Netflix last week during the Television Critics Association winter meeting, taken from network-backed Symphony, is still going strong.
After blasting the numbers released by Wurtzel as “remarkably innaccurate,” Netflix piled it on in its Q4 letter to shareholders this week:
The growth of Netflix has created some anxiety among TV networks and calls to be fearful. Or, at the other extreme, an NBC executive recently said Internet TV is overblown and that linear TV is “TV like God intended” [sic]. Our investors are not as sure of God’s intentions for TV, and instead think that Internet TV is a fundamentally better entertainment experience that will gain share for many years. The challenge for traditional media companies, most of whom see the future pretty clearly, is to use the revenue from Netflix and other SVOD services to fund both great content and their own evolution into Internet TV networks. Seeso, BBC iPlayer, Hulu, CanalPlay, HBO Now, and CBS All Access are the beginnings of these efforts.
Our titles are watched on the go and at home on a wide range of devices, making measurement of the viewing of any given title difficult for third parties. We don’t release title‐level ratings as our business model is not dependent on advertising or affiliate fees. Instead, we release “ratings “ for Netflix as a whole every quarter with our membership growth report (75 million and counting!). It is member viewing and satisfaction that propels our growth.
It’s that bit about Netflix not being dependent “on advertising or affiliate fees” that is at the core of the controversy.
There’s an old adage that there are really only three fundamental business models in the world: I pay, you pay, or someone else pays. The TV business has long relied on the last one: someone else pays. Originally it was advertisers who paid the cost of the content; more recently, and increasingly, distributors have taken up more of the burden, in the form of carriage and retransmission fees.
That model, however, has always placed tight constraints on the type and variety of programming TV producers can create. Advertisers want the largest possible audience for their ads, which requires programs with the broadest possible appeal. The ratings that set the price for advertising, also largely determine the size of affiliate fees: networks with the largest or most passionate audiences generally command the highest carriage and retransmission fees, which again creates a bias toward a limited range of content with the broadest possible appeal.
Netflix, on the other hand, has hit upon an entirely different model for financing its original content: you pay, in the form of a monthly subscription. To keep a diverse — and now global — base of subscribers paying month after month, Netflix needs to create a diverse range of programming rather than programming with the broadest possible appeal.
That difference has attracted a growing roster of A-list talent to Netflix’s production shop. And as I and others have argued before, the biggest long-term threat to the traditional networks is not so much where viewers go but where the best talent decides to set up shop. So a certain amount of the networks’ complaint with Netflix is simple creative envy.
Another factor, though, has to do with P&L accounting. In a very revealing comment at the DLD Conference in Munich this week, Netflix CEO Reed Hastings noted a key difference between Netflix’s financial model and that of traditional media companies.
“The advantage of Netflix at this stage is that we get to make a number of bets in parallel and manage it like a portfolio,” he said. “Our content has proven to be very popular. It’s not all that people watch. But it’s enough content to get people excited about paying for the service each month.”
Traditional networks and TV studios don’t have “portfolios.” They have individual shows. And because those shows are each measured against the same hard, transparent standard — ratings — each is produced under its own P&L, which determines whether that show succeeds or fails as a financial matter, and whether, therefore, it stays on the air.
That financial accounting system, moreover, is by now cemented into the entire TV production economy, from guild contracts, to talent deals, to executive compensation. Getting rid of it in order to operate more like Netflix, with its diversified portfolio, would be exceedingly difficult for the networks, whether they go over-the-top or stick to traditional platforms. As a practical business matter, Netflix’s operating and program-financing model is out of reach to the traditional networks, even as Netflix continues to bleed away their audience.
What must truly gall, though, is that Netflix’s subscriber base did not start out large enough to support the portfolio model. It got that way largely on the strength of the network’s own content, created under the old financial model — the one the networks now seem incapable of escaping.