Fivehaus Two-Hour Pilot…”Ad-Supported,” Of Course

Ads?  Who wants to be bombarded with ads?  Especially true on mobile, they invade our precious screen space with products and services.  They pop up on the screen without our permission, forcing us to glance and then close.  Sometimes they even start playing a video when we never clicked a play button.  Never mind the annoying products that can be served our way:  carcinogenic detergents filled with surfactants and other planet-degrading ingredients; jewelry made with gems that have been sourced from areas where people die in order for the product to reach us; trucks that consume fossil fuels at absurd and unsustainable rates but are built as tough as mountain sheep; athletic-wear assembled in third-world countries where unrelenting production demands can drive workers to madness.  No, this is not an article about our environmentally and socially overtaxing and unsustainable lifestyles; feel free to consult the excellent writings of Wendell Berry, Edward Abbey, Janisse Ray and Henry David Thoreau among others on this subject.  This is a piece, though, about awareness.

Ads, as annoying as they are, allow for a model that is more socially favorable, less elitist, and more egalitarian.  Let’s digress for a moment.  When was the last time you paid Google to use  How about Facebook?  Snapchat?  Google and Facebook have emerged as the neo-media pipeline leaders, at least as far as attracting digital ad dollars go.  Shira Ovide writing for Bloomberg Gadfly reported on May 24, 2016 that “43 cents of each dollar spent on digital ads worldwide” go together to Google and Facebook. And this in light of the fact that “neither are major ad sellers in China, which is home to the most Internet users in the world.”  And as most know by now, since its big bang, technology, or more specifically the number of transistors per square inch of integrated circuit, has been expanding at a rate defined by Moore’s Law (“Moore’s Law”).  The amount of video content arising daily in the neo-media movement must, in our assessment, approximate Moore’s Law as well.

For decades there were few pipeline options, so the old media cable and satellite companies determined what content was worth.  Both content owners and consumers were at the mercy of the companies and the content they chose to distribute on their networks.  Of course the content owners wanted and needed their content and/or channels to be included as an option in each of the few precious bundles but limited portals for content gave content owners little negotiating leverage.  Additionally, the old media companies were able to charge ever-increasing, steep fees for each cable package, and most consumers paid for up to hundreds of channels just to watch four or five with regularity.  Finally, the price per thousand views that advertising companies paid to run ads on cable was quite lucrative, roughly one order of magnitude more than what mobile pays today.  High subscription fees and high per-unit ad revenue?  Times were definitely good for these old media companies!

Then times changed.  Google and Napster were born.  The value of print and music were challenged almost overnight.  Publishing houses and newspapers had a difficult time competing with cheap or even free content sites.  Many folded or had to significantly cut costs by either abandoning print for digital or adopting a hybrid print-digital model.  File-sharing brought the music labels to their knees and ultimately drove down the value of music.  Almost ten years ago the writing was on the wall for the cable industry as well:  The future will look nothing like the past.  YouTube and Netflix were certainly pioneers, each in their own right.  For the first time, you could watch free video content or see premium content for a much discounted price relative to cable, respectively.   This was the birth of the content explosion we are still witnessing today.  Moreover, it was also the birth of the commodification of video.  By Aaron Barlow’s definition of commodified content, YouTube’s lower-quality, non-premium content would indeed be a platform where “the process of research and writing has been superseded by ‘product’ with no necessary connection to that process.”  Much of YouTube’s incredibly large and rapidly-growing body of non-premium content is being commodified by Google and/or the individual posting the content, both of whom are often seeking profit from ads.  Netflix, arguably, has commodified more premium content through their cheap subscription model.  Either way, both models have set the precedent in motion and both are two of the larger engines helping along what many commonly refer to now as the race to the bottom.

Back in 2010, producer and writer Jeff Melvoin was quoted by Amy Chozick of the Wall Street Journal (WSJ) as saying that it was as if “broadcast,…the sun,” had “exploded and no one knows how many little solar systems will be formed.”  Content owners with digital streaming options then on the table began publically disputing contracts with cable companies in ways that the traditional media industry was not used to seeing.  Consumers, especially young, technically-savvy, twenty-somethings started cutting the cord (or never attaching it to begin with).  Early on there was a debate as to whether cord cutting was a phenomenon, as the onset was slow at first and certainly full of stoic denial in the camp of traditional media.  In the same year that Melvoin made his comment, the always honest, always independently-minded Holman Jenkins, Jr. stated in a 2010 WSJ article that “as far as we know, both [Time Warner and Comcast] are trim and have 20-20 vision, but their confidence that the industry will not be Napsterized still fills us with manly admiration…the cable kingdom is…wedded to a business model that just can’t be saved.”  As challenges continue to unfold for traditional media, it will only be a matter of time before we will find out if his words come true.

Not only is the universe of video content expanding, so are the number of sites where content can be discovered, and within each of these sites are countless URLs that contain content as well.  Just to name a few of today’s sites:  Buzzfeed, Fullscreen, Complex, Huffington Post, TechCrunch, FiveThirtyEight, MakerStudios, Vice Media, Tastemade, Vox Media, icanhascheezburger, YouTube, Vimeo, Netflix, Amazon, and Time Warner (HBO, the Turner Broadcasting suite, Warner Bros.).  According to Margaret Gould Stewart and Derek Thompson, YouTube uploads grew 1300% from 2010 to 2015 from 28,800 to 400,000 hours per day, amounting to close to 50 years worth of uploads each day in 2015…and that’s just uploads to YouTube.  Even valuable premium content is now spread across a dozen or so digital sources, making it harder and harder for consumers to find even top-rated content.

The importance of advertising could not be better exemplified than through Twitter’s recent performance.  Prior to this year, Twitter was poised, it seemed, along with Facebook, Snapchat and Google, to be one of the next major pipelines for video content (Bloomberg West “New Media”).  At the time of this writing, Twitter’s share price is about half of what it was at their 2013 IPO.  In the aforementioned Bloomberg article, Ms. Ovide points out that ad sales from the content on their owned and operated (O&O) properties, which includes Periscope and Vine, was up only 23% year-over-year (YOY) compared to 68% the previous year.  Shareholders are clearly listening, which is why analysts like Michael Nathanson from MoffettNathanson recommended on May 24th of this year that shareholders sell.  Ads and other sponsored content are and will be the life-blood for Twitter.

Let’s look at the other three aforementioned sites that are considered the next major pipelines according to Ben Lerer (Bloomberg West “New Media”) and possibly the next king- and queen-makers of online video. Google’s 2015 total revenues were $67.4B in 2015 (“Advertising revenue”) and assuming that their Q4 2015 results claiming that $19.1B out of $21.2B came from advertising, then around 90% of their revenue is from advertising (Peterson “Google’s”). Facebook is the same.  Adage expects Facebook to get 31% of the U.S. ad market in 2016 compared to 14% for Google.  Facebook’s fourth quarter 2015 revenue generated from ads was $5.64B, up 57% YOY compared to its overall Q4 2015 revenue of $5.84B, an increase of 52% YOY (Peterson “Facebook’s”).  Perhaps a slightly higher estimate, but based on Q4 2015 results, Facebook’s ad revenue makes up approximately 97% of its earnings.  Finally, let’s look at Snapchat.  While we expect an IPO sometime this year, we do know that as of May 26, 2015, Snapchat’s valuation is around $18B (Bloomberg West “Is Snapchat”).  As far as anyone knows, almost all of its revenue is generated from sponsored content such as their branded geofilters business, pushed short-form video content from major media outlets and even user-sponsored filters covering small geographic areas.  As they grow their business, they will most certainly have to find more ways to generate more revenue from other various and creative forms of advertising.  One way that seems to be in the works is a way for businesses to communicate directly with consumers through the chat function, something Facebook has done through WhatsApp and Facebook Messenger (“How does Snapchat”).  If one assumes a 10X valuation (though, the current multiple is likely much higher) and a conservative 90% of revenue generated from ads, then we can estimate that their ad revenue is around $2B annually.  Ad revenue will clearly continue to be a lynchpin in their growth model as well.  Therefore, sponsored content will be the a key part for any company’s monetization strategies…except Netflix’s?

Though ad-free platforms like Netflix argue against any future use of ads, as recently as June of 2015, Mike Snider of USA Today, among other sources, reported that Netflix was advertising its original programming to some users prior to and after Netflix shows. While they clearly weren’t third-party ads, it did move the social networks to wonder what could be next.  Reed Hastings, Netflix CEO, quickly rebuked on Facebook:  “No advertising coming onto Netflix.  Period.  Just adding relevant cool trailers for other Netflix content you are likely to love.”  A quick look at Netflix’s financial situation could lead one to believe that their model is working well and that as long as they maintain decent subscriber growth and numbers that their subscription-only revenue model will continue to work well for them.  On the other hand, one must look closer at their hefty and still-growing off-balance sheet debt that they have been incurring for original content production.  As of May 2015, Mingran Wang of Seeking Alpha reported that, in addition to their current balance sheet liabilities, Netflix’s 10-k revealed another $5.5B of off-balance sheet liabilities, previously unreported.  Todd Bishop and John Cook, co-hosts of the GeekWire podcast, reported that “Netflix said that they were going to spend $5B on content in 2016.”  Amazon also recently started offering a streaming service content service of its own, competing directly with Netflix.  By producing content of its own as well as paying top dollar for shows like Top Gear, Amazon has put itself in the ring to directly compete with Netflix and could effectively drive up the value of content as they both bid for content in the same competitive market.  All of this makes one question just how sustainable Netflix’s large off-balance sheet debt will prove to be.  “No advertising…Period”?

A younger generation is favoring free, ad-supported platforms, or at the very least a cheaper subscription model.  Thus it will be a challenge over time to upsell a generation that never got hooked on the cable subscription model and pricy bundled options to begin with.  And, while it is obvious, it does seem important to remember that there is a constant number of hours in one day (23 hours, 56 minutes, 4 seconds to be exact). In other words, there is only so much time in a day that one can spend looking at content.  And time is one of the limiting variables in the content revenue equation.  While there will continue to be new Internet users, driven in the near future by the anticipated steep growth in users in India, there will always be a battle for people’s limited daily time. Unless a business develops a model that is not time dependent, then the battle for viewers will be a chumming of the waters in the grandest sense: competitors will continually try to take business from one another.  Moreover, it will be the amateur TV producers, comprised primarily of friends, family and strangers, that will be the greatest competition to network TV and other premium content.  Consolidation may be the inevitable truth, but in the meantime this still leaves the consumer with an ever-increasing body of content to choose from, an ever-increasing number of platforms on which to find content and an unsatisfying number of effective search alternatives with which to discover known AND unknown content.

According to Jonathan Abrams, founder and CEO of Nuzzel, people are on Facebook almost an hour each day while they spend around six hours of each day on email (Bloomberg West “The Social Content”).  (As an aside, he also mentioned that Nuzzel plans to start running ads as part of their plan to become profitable.)  Six hours a day on email seems a little high.  Nonetheless, it is interesting to compare that to eMarketer’s data from 2015.  eMarketer claimed that adults over 18 consumed 5 hours and 38 minutes of digital content a day, including digital TV (“U.S. Adults”).  Therefore, if Mr. Abrams’ numbers are in the ballpark, then that leaves almost NO time for watching video on other platforms.  Regardless, it does seem to emphasize just how small the window is for which most content providers and creators are competing, and in turn highlights how challenging it will be to compete and to monetize video content moving forward.  To add insult to injury, if Facebook is indeed in a position to become the next “super king-maker” in the media industry and “looks like ten cable companies combined back in the day” (Bloomberg West “New Media”), then the available gap could close even faster as the Facebook behemoth expands its media empire.  Ouch and double ouch.

The dilemma can be summed as follows:  How does one get more eyes to one’s primary content and the ads and/or sponsored content running along that primary content?  And, furthermore, how does one remain relevant enough as a content distributor to be considered worthy by the advertising companies and their important ad dollars?  It’s all about platform build-out, according to Alex Moazed, Applico CEO and co-author of the new book Modern Monopolies. Mr. Moazed predicts the platform model to be the dominant business model moving into the 21st century.  Unlike linear models such as Standard Oil and Ma Bell who owned and controlled their own supply chain in order to assert monopolistic dominance, platform models utilize partnerships throughout the supply chain.  And instead of spending money on a supply chain network, these modern businesses commit resources to building a multi-faceted platform, with components such as apps, websites and virtual reality, that focuses on bringing value to the producers (e.g., Uber drivers or YouTube uploaders) in order to attract customers (e.g., Uber riders and YouTube viewers, respectively) and vice versa.  In many cases this involves subsidizing the market by incurring losses (e.g., Uber in China), taking on off-balance sheet debt (e.g., Netflix) and/or building a large cash trove, usually through private equity, in order to acquire value-added and disruptive businesses and to scale quickly. In his assessment, Mr. Moazed believes that in over a decade or so these large platforms could establish modern monopolies.  Websites, as Mr. Moazed stated – and as we strongly agree – are a key part of this model.  As in the above examples, it is our assessment that companies need to make a significant investment so that they can own, control and deploy the best collection of website domains that they can for each key area(s) of content and/or product(s).  Domains therefore can strengthen one’s platform and position oneself for long-term, sustained value-added exchange between business and customer.  A strong website position along with a strategically deployed system is an ideal disruptive, yet irreplaceable, one-of-a-kind, un-replicable tool that a company should consider adding to their array of tools that makes up their overall platform.

Rate of build seems critical to these platforms as one platform could lose subscriber momentum to newer competitors.  In other words, all of these platforms are subject to users and the users’ habits.  So while one may enjoy such a habitual monopoly for a time, it ultimately is subject to trends and users’ choices.  And younger users aren’t married to one platform if a newer, hipper platform comes along that all of their friends are using.  In order to help build out a more sustainable platform, businesses will need to find ways to make their platforms less sensitive to users’ habits.  This can be accomplished by including tools on the platform that are less user-dependent, such as strategically-deployed domain-based systems, that would provide a company with a stronger natural competitive advantage.  Indeed, a large, high-quality, domain-name set and associated system would allow a company to establish an unmatched natural advantage that competitors could not replicate.  That said, this would not be the sort of natural advantage one saw with the Standard Oils and Ma Bells of yesteryear, where the advantage translated to greater price control over the consumer.  The advantage we’re describing is similar in that it is one of the only ways that we can think of for a platform model to possess a facet that isn’t user-dependent and that provides a company with highly-valuable, highly-relevant, highly-customizable assets that can work both offensively and defensively with respect to branding, sales and content distribution.  The difference, however, lies in the fact that domain-based systems actually benefit the customer by encouraging better content organization, by making it easier to discover content and by being able to support ad-based models, which inherently are more egalitarian.  In fact, one could envision an ad-supported system for video content distribution that also includes content channels for children and teens that are ad-free.  Such a network would certainly win the hearts of millions of viewers, especially once the millennials start having children.

Ads.  A blessing and a curse?  Could ads and getting users to them be the key to the survival of the platform model, especially one distributing video?  Twitter, it seems, might certainly agree…


 Works Cited

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