Actually, Netflix *is* a Technology Company

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October 30, 2018

A month or so I came across a very interesting blog post by the ever-savvy Benedict Evans of A16Z. Title: Netflix is not a Tech Company; that it is, in fact, a TV company, and that thinking of it as a tech company is to miss the business that it’s really in. 

Evans uses the launch of Sky satellite TV in 1992 as an example of how a company may use a new technology as an entertainment delivery mechanism, but that, at its core, the company is really providing entertainment to its customers. Sky launched a business based on satellite video streaming — in other words, it provided entertainment via a new technology. In that sense, one could think of Sky as a technology company. 

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However, Sky built the business by paying unheard-of sums to snap up Premier Football rights. Evans says 

Rupert Murdoch’s Sky realised that you could buy football rights for far more than anyone had ever thought of paying before, and you could make your money back by selling the games on subscription instead of pay-per-view or advertising…” 

Sky recognized that it could pay huge sums of money for sports rights and use those rights as the foundation of building a satellite video streaming business. In this analysis, satellite was merely an ancillary component of an entertainment strategy.

Using this example, Evans goes on to characterize Netflix’s pioneering use of Internet video streaming as analogous to Sky — while Internet entertainment delivery is interesting, Netflix is actually a TV company. Evans says:

“Like Sky, Netflix has used technology as a crowbar to build a new TV business. Everything about how it executed that technology has to be good. The apps are good, the streaming and compression are good, the UI is good, the recommendation engine is good, and the customer service and experience are good. Unlike American cable subscribers, Netflix subscribers are generally pretty happy with the tech. The tech has to be good – but, it’s still all about the TV. 

“Netflix realised that you could spend far more money on far more hours of scripted drama than anyone had ever spent before, and you could (hopefully) make your money back by selling it on subscription directly to consumers instead of going through aggregators.

He goes on to say “[b]ut again, executing this properly is not the same as defensibility.” In fact,the technology underlying Netflix’s business is actually a commodity; anyone else can replicate it, so it provides no moat for Netflix. As he notes, 

Hulu is smaller than Netflix because of TV questions, not tech questions – because of rights and channel conflict and its shareholders’ broader strategies for monetizing their assets.” 

Media companies — or technology companies?

Hulu is a Netflix competitor, and its technology is pretty good, too; however, it lags in the market due to quirky programming decisions driven by rights availability, which in turn are skewed by the ownership structure of Hulu’s parent companies.

To understand the business prospects of Netflix vs. Hulu, says Evans, the important question is not the underlying technology: 

“These are not Silicon Valley questions – they’re LA and New York questions. I don’t know the answers – indeed, I don’t even know the questions …The more that we see new companies using software to create new businesses in industries outside of technology, the more generally this applies.”

Of course, one cannot deny that Netflix is in the business of delivering video entertainment. And that getting the content of its strategy right is critical. One has only to look at the US telco industry’s Cargo Cult acquisition mentality to realize how robotically emphasizing the form of a trend rather than its content inevitably leads to disastrous outcomes:

  • Verizon shuttered its public cloud offering after belatedly understanding that just because data crosses wires, that doesn’t mean a wire provider has expertise in processing that data
  • Verizon wrote off Oath, after finally recognizing that just because text content crosses wires, that doesn’t mean a wire provider has expertise in content. Of course, Oath was merely the rebranded Yahoo and AOL, which unloaded themselves on Verizon once *they* recognized that their content-led offerings were relics of an earlier Internet age
  • Verizon closed down Go90, its streaming video service, once it recognized that just because video crosses wires, that doesn’t mean a wire provider has expertise in video. 

Lest one think this is just picking on Verizon, it’s pretty clear that AT&T is following the same foredoomed path with its failing DirectTV and troubled TimeWarner acquisitions (registration required). Of course, one person’s failure is another person’s fortune, as Automattic found when it achieved a 97% discount in its acquisition of Tumblr during the Oath writeoff.

In summary, Evans is absolutely correct that having the right strategy is critical when launching a new technology-based offering. One can predict that Netflix will continue to prosper because of its pioneering approach of blending on-demand streaming, lump sum development deals that avoid ongoing royalties, and analytics harvesting to determine what content to invest in

This latter, famously, is why Netflix signed a huge deal with Adam Sandler, who had become box office poison after an earlier big Hollywood career (read this Variety Sandler takedown, complete with five item listicle documenting why his career cratered). 

And it appears to be paying offbig time. I proffer my support of that initiative — I watched Sandler’s Murder Mystery, and despite some withering reviews, enjoyed it, and certainly found it at the same quality level as other spy spoofs I’ve paid money to watch in “real” movie theaters (e.g., The Spy Who Dumped Me, Spy, or Johnny English, all of  which pitched up at the same level of silliness and implausibility as Murder Mystery). 

Adam Sandler — Netflix’s Stroke of Genius

By contrast, and reinforcing Evans’ thesis, Hulu is likely to trail Netflix’s success due to its ownership structure and strategy hampered by an ongoing need to avoid impinging on existing financial and licensing arrangements.

I differ with Evans on the importance of technology, however. At the very beginning of his piece, a bullet point highlights its takeaways:

  • Like Sky before it, Netflix is a television company using tech as a crowbar for market entry.
  • The tech has to be good, but it’s still fundamentally a commodity, and all of the questions that matter are TV questions.
  • The same applies to Tesla, and indeed to many other companies using software to enter other industries, especially D2C – what are the questions that matter? Often, they’re not tech questions at all.

In this view, technology innovation is a fleeting differentiator — sufficient to pioneer a market, but one that rapidly loses its competitive edge. After that, technology is an undifferentiated commodity for which “good enough” is good enough. One could go so far as to say that the message of the piece takes us dangerously near Nick Carr territory.

While Evans looks to satellite as providing an antecedent example, I think a more instructive comparison for Netflix resides in the auto industry. When first introduced, Japanese cars were laughable compared to the offerings of the dominant US manufacturers. 

However, the Japanese companies began to focus on improving their cars’ quality, most famously via the Toyota Production System. They pioneered a market segment — economical, reliable compact cars. And their manufacturing productivity soon outstripped their US counterparts. Unlike the Satellite example, this manufacturing advantage was long-lasting — in 2008 Toyota still had around a 10% manufacturing time advantage, along with a factory utilization advantage of around 12%. Summed up, this gave Toyota a $606 manufacturing cost advantage — per car! — over domestic rivals. 

We’ve seen the end result of this advantage pressed over time. Recently both Ford and GM announced, essentially, that they are getting out of the car manufacturing business to concentrate on more popular SUVs and crossovers. To me, this looks like classic Clayton Christensen territory: threatened incumbents cede the low end of a market due to uncompetitiveness, retreat to the high end where margins are larger, and eventually find themselves stranded in a tiny, high-priced market segment too small to sustain the business. 

How does this relate to Netflix? In some sense, Evans is right. Both Hulu and Netflix provide acceptable user experience (I’m speculating, as I’ve never watch Hulu, being so tied up with Adam Sandler movies on Netflix, as I am). Both present a pleasant enough interface, offer searching, and reliably stream video at an acceptable resolution.

However, that end user experience perspective only addresses part of what technology delivers. While both Hulu (finally) and Netflix both use AWS for much of their infrastructure, Netflix is a pioneer in that choice. It is widely regarded as one of the most advanced, if not the most advanced, AWS users in the world. From my own experience, I can vouchsafe that Netflix implements highly sophisticated architectures, operational practices, and cost management second to none. And several of the articles linked to above describe Netflix’s sophisticated data mining used to increase user satisfaction as well as direct content investment (Adam Sandler FTW!).

So the question is, is Netflix’s technology like Sky — a fleeting advantage reduced by easy mimicry by others — or more like Toyota — a lengthy, ongoing advantage that pays long-lasting dividends and provides enormous competitive advantage over the long haul?

I lean toward the latter. Here’s the thing, though: even with a long-lasting competitive input advantage, one still has to marry that to a customer-facing offering that results in better customer satisfaction, higher margins, improved offerings, and, ultimately, greater business success. Put another way, the technology advantage has to be part of an overall offering, a flywheel that results in long-term competitive advantage.

I’ll have more to say on this topic in the near future. Let me provide a send-ahead. I believe that every company and every industry is facing its Netflix moment (many use the term Uber moment, but I believe Netflix is a better illustrative example) in which digital technology is used to rewrite the rules of an existing market. And I believe that cloud computing is the foundation of that transformation and a critical part of an overall digital strategy. 

As simply as I can say it: moving to a digital orientation is an existential imperative, and it can’t be done by bolting a pretty interface onto a creaky underpinning of legacy technology, outmoded business processes, and obsolete market channels. What makes Netflix brilliant is how it has married a digital entertainment delivery offering to a better way of understanding consumer desires and a more effective method of creating content delivered to its customers. Look for more on new models for running digital businesses in the upcoming weeks.

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