Ten years ago there were two companies poised to be the de facto powers in online video. Netflix was the lone provider of piracy-free movies and television, cornering the market on mainstream entertainment online. YouTube had just rolled out its partner program for revenue sharing to lock in its biggest content creators, making it the most important and lucrative platform for independent creators and amateur video producers.
With the cost of storing and serving video content as high as they were (and still are) it seemed that both of these companies were destined to be natural monopolies. Now only one of those companies has locked in that position: YouTube. So why did YouTube succeed at becoming indispensable for independent creators while Netflix was unable to do the same for mainstream content? Ultimately, their divergent paths have to do with the relative strengths and weaknesses each had in their market segments and the strategies they employed to adapt to them.
Let’s start by looking at YouTube. YouTube was able to leverage a number of key advantages, gained through a mixture of early positioning and their acquisition by Google, to cement themselves as the only viable platform for new media and independent creators. The reasons for YouTube’s success with independent creators are many fold, some obvious and others less so.
Perhaps the most obvious is that YouTube benefited from an immensely strong negotiating position with its creative partners. YouTube was native to streaming and had grown the platform, creators, and community organically. They used profit-sharing through the partner program to keep their top talent from leaving, and then extended that down the proverbial tail even to fairly small and niche channels. Although the nature of the partner program is always in flux, and a recent change dropped monetization for many small channels, traditionally this has kept both creators and their audiences glued to the platform. The partner program “bought” talent to keep competitive sites from getting much traction. Now that YouTube is the behemoth it is, it almost feels too late for a competitor to come along and try to “buy” that talent away with better deals and fixes for the frustrations creators have experienced with YouTube’s policies and lack of clear communication.
Equally important, the creators themselves don’t have a lot of clout to leave the platform and make their own distribution channel work. Even if you are one of the incredibly small number of high earning creators on YouTube, reportedly making several million dollars a year, your income won’t come close to generating the capital needed to cover the engineering, design, and storage requirements to be a YouTube competitor. Even if several of the most popular channels banded together, there still probably wouldn’t be enough capital to get a stable site up and hire the kind of sales team needed to attract lucrative advertising deals. Plus, how many of those creators want to make the kind of lifestyle sacrifices they would need to make in order to pump their own money into what many analysts would advise is a longshot? Why is it a longshot? Can’t they simply move their viewers and sponsors to a new platform?
Historically, moving fanbase from one platform to another has been dangerous. Twitch, a soft competitor to YouTube that offers a live video experience rather than prerecorded, has been useful for some independent creators to build followings away from YouTube and for YouTube creators to find new audiences for a different kind of content, but data suggests that the actual crossover between the two isn’t very high. Anecdotally, there are broadcasters on Twitch whose content I will watch highlights of on YouTube but I have never watched their Twitch streams at all, and vice versa. So even if popular YouTube creators wanted to leave, and could finance the creation of a competitive alternative to YouTube, it is not clear that they could leverage their millions of views into a loyal following on the new site. In this sense, it feels like YouTube has their creators over a barrel, which is probably why every time a major shift to the site angers its creators, YouTube largely ignores the problems until the viewers begin to repeat those complaints as well.
Less obvious are the numerous network effects that YouTube provides. Audience discovery is one of the biggest and easiest to see. YouTube is massive, with hundreds of hours of footage uploaded around the world every day. To sort through all that YouTube uses algorithms to help their viewers find the content that is right for them. This process is, despite being worked on for years, still amazingly unrefined. Despite that, the related videos and recommended videos sections on the site, particularly for those with an account, really do help viewers find new videos, creators, and communities they will enjoy. Watch a video by Every Frame a Painting and soon you will discover a treasure-trove of interesting channels that also do video essays. Some are quality, many are not, but that is up to the end user to ultimately sort out. For this reason, anyone who wants their shorter form content, typically anything under 20 minutes, to be found by the largest possible audience knows that YouTube is the way to go.
It should be telling just how many mainstream companies maintain a presence on YouTube for this exact reason, old media and new media alike. Every “Late Night” show has a channel for highlights from their shows. CNN has a channel for (mostly) 8-12 minute clips from their news shows. Vox has a channel for video essays and Vice hosts mini-docs. Discovery Digital, of the Discovery Channel, bought SourceFed, and Disney bought Maker Studios. This ability to find new audiences is so strong that it has even brought in smaller independents who had large followings before YouTube took off. For example, video game humorists Penny Arcade and game strategist/instructor Day[9]TV both shifted all of their content from Blip.TV to YouTube several years ago to take advantage of YouTube’s larger potential audience and simplified revenue system. Rooster Teeth was able to expand their offerings well beyond Red vs. Blue once they began putting their content on YouTube as well. The more the platform hosts all these people, the more it becomes the first place to look for bite-sized video content. The more it solidifies itself as the place to find bite-sized content, the more it draws in new people looking to build or expand their audience.
Still, there is so much money at stake that it is surprising there has been so little competition with YouTube over the amateur video and independent creator markets. Some estimates put YouTube’s annual revenue in the ballpark of $4 billion. That’s a lot of money. You would think that with that kind of money on the table, one or more large companies with equally large war chests, like Amazon or Disney, would simply build their own version of YouTube and steal away as many creators, and their viewers, as they could. There are plenty of both who are deeply dissatisfied with the way YouTube chooses to do things. While independent creators might have trouble moving their views with them as a single channel, or collection of channels, a large company can spend tons on advertising to alert people to the change, in the same way a TV channel might advertise a change in time slot for a show. Even in the TV realm, this never happens without some loss of viewership, but advertising can help smooth the transition. Plus, as big as YouTube is, it isn’t actually bulletproof. Blip.TV was seen as the go-to for independent video hosting for a time, until it wasn’t. MySpace might have been the final word on social networking, until Facebook killed it. These things are never as locked in as they seem.
Except in this case, they might be. The problem with building a YouTube clone as a competitor isn’t just the lack of a viewer base, or creators, or the sense of community, or any of the other things that YouTube has that a big, rival company would have to build or “buy.” The problem is the ads. This is where the most subtle advantage YouTube has, its membership in the Google family, becomes important. YouTube gets two benefits from being under the Google umbrella. First, they get access to the Google Adsense system without the overhead. Second, they can work with their partners within the Google ecosystem to make money without directly placing ads on videos.
A competitor will need to place ads. This leaves them with one of two choices. They could pay a staff to help them make deals and sell advertising space to advertisers. Making these partnerships work isn’t easy and the people you hire to negotiate them aren’t cheap. This cuts into profits, makes less money available to the creators on the platform, stalls development that improves the website, and so on, all of which puts the site at a competitive disadvantage compared to YouTube. YouTube doesn’t have to hire these people. YouTube already has an easy way to sell ads through Google Adsense, a program Google would be running with or without YouTube. Google staffs the ad sales people and amortizes the costs over the entirety of Google’s products and companies, something a media only company would not be able to do.
The competitor could do something similar by syncing up with an ad service network. This is the second option. They work with an ad placement network, perhaps even Adsense itself, so that they don’t have to spend the money on sales staff. This still isn’t better than YouTube though. Working with an ad placement network requires giving some of your profits over to the network in exchange for help with the ads. While this is potentially cheaper than hiring an internal staff, as now the costs of ad placement are being amortized across the network’s multiple clients, it still probably won’t be good enough to compete.
Then there is the added wrinkle that any platform large enough to contest with YouTube would also have many of the same problems YouTube is having with keeping its content advertiser friendly. The site needs premium ad money to keep the lights on, but it is impossible to individually vet videos as they come in, when they come in at the rate and volume that YouTube routinely manages. If you write a learning algorithm to do it for you, then you get lots of false flagging and monetization loss and creator unrest, which is exactly what YouTube has dealt with in the last year.
If anything was going to make creators and viewers open to moving, it would be a platform that could effectively deal with these issues. Yet the presence of these issues is a natural result of the volume of video that YouTube, and any competitor, has to handle. As a result, YouTube is like a natural monopoly. A competitor can’t come along and offer an alternative because they would have to deal with the same challenges of policing piracy and vetting appropriate content over massive quantities of footage as YouTube, likely necessitating very similar solutions. Since those solutions are what often causes so much frustration with YouTube, and are therefore YouTube’s main weakness, the competitor would struggle to offer a platform that was sufficiently differentiated. With both YouTube and this theoretical competitor offering videos for “free,” viewers will just continue looking for new content on the site that is habitual, has the massive catalogue, and is likely still home to many of the familiar faces they know and love.
And all of that presumes that the competitor is getting any money at all. Ad blockers are a big problem that just keeps growing. Many creators have switched to a patronage model, such as monthly payments on Patreon or a tip jar system run through PayPal, because the monetized views on their content (i.e. the number of ads actually placed) is going down as ad blocker numbers are going up.
This is where YouTube’s ability to monetize beyond just simple video advertising comes in. Although I don’t think a YouTube rep has ever confirmed this, the scuttlebutt is that YouTube knows how to make money off of views even if they aren’t able to place an ad. Again, this comes back to their membership in the Google family. Both on an individual and a demographic level, data on what is being watched on YouTube can be utilized by Google to make money in other realms of the business. What you, a viewer, watch on YouTube shows something about who you are and what you are interested in. This can be factored into your Adsense profile and can be used to better target advertisements to you, the individual, as you move around the family of Google products, such as Gmail, Google Maps, or regular old Google search, as well as the larger web in general. Or, if YouTube/Google are like Facebook, the information about your viewing habits could be anonymized, packaged with others like you, and sold to organizations that make use of large-scale psychographic data, such as branding departments of large companies and political operatives of major political parties. In the case of individual targeted ads, YouTube being part of the Google family helps individual Adsense profiles become more robust, making ads better targeted, inflating the value of those ads. In the case of bundled psychographic data, being able to combine both the information gleaned from Google’s and YouTube’s data collection makes the whole data set richer and therefore more valuable to the organizations that want it. In both cases, it makes utilizing alternative revenue streams much easier for YouTube than it would be for a competitor.
Now let’s turn to Netflix. Where YouTube was successful, Netflix struggled. Unlike YouTube, their position was actually much shakier and rather than cementing themselves as the kings of mainstream entertainment online, they were forced to reconsider their strategy in order to keep their customers interested in the streaming subscriptions they offered. So how did this happen? Was this a failure by Netflix, or an ultimately unavoidable consequence of the market segment in which they found themselves doing business?
Ten years ago, Netflix’s streaming service had a lot going for it. It had dominance in adoption: it had the largest user base in the space by far. Like YouTube, it seemed to have the network effect advantage: when looking for something to watch, its subscribers always went there first. It had a sterling reputation for movies, which it had inherited from the DVD side of the business, and was quick to build out an excellent TV catalogue as well. It didn’t seem to have much in the way of competition in its niche. The first major competitor, Hulu, didn’t even really fill the same space. Initially, Hulu only offered TV and only carried the most recent episodes of a show’s current season, something Netflix almost never did. In contrast, Netflix acted more like a syndication network, maintaining a huge back catalogue of episodes from previous seasons or shows that were no longer on the air. Not everything was perfect, of course. Netflix used a rotating catalogue of films to make it seem like they were always adding new content and building their library, while secretly maintaining a smaller catalogue that cost them less in license fees. Still, Netflix remained an apparent juggernaut destined for a commanding position over the secondary market for movies and television. So what happened?
Netflix had several hidden problems. First was the issue of content ownership. Netflix had always had a strained relationship with Hollywood. Back when they were still just a DVD-by-mail company, they had a brief stint as an indie film distributor, through a subsidiary called Red Envelope Entertainment. After two years, and a handful of really interesting narrative and documentary film acquisitions, they closed the division over concerns that they were alienating their partners in the entertainment industry. This carried forward into their streaming business. They didn’t own any of what they were distributing, they were merely paying a license to exhibit it, to use the industry terminology.
Interestingly enough, this is how a lot of TV channels work some of the time. Obviously, when TBS broadcasts Die Hard with a Vengeance, they are paying the rightsholder, either 20th Century Fox or Buena Vista depending on the original production contract, to do so. Less obviously, when NBC was broadcasting Community, they were paying Sony Pictures, the studio that actually owned and produced the series, to do so. In this sense, Netflix didn’t seem like it was all that different from any other broadcaster.
In the end, though, Netflix isn’t like a TV channel. It exists on the web. Due to the limitations of broadcast TV and the costs of cable packages, television channels have traditionally had to worry about a scarce resource: broadcast minutes. It goes without saying, of course, that channels can only be broadcasting one thing at a time. This makes broadcasting minutes a premium commodity. In the pre-Internet world, the big broadcast channels were happy to sell their syndication rights to another channel. New content is more lucrative than old content, so new shows always get priority, especially during prime time. Old shows still have earnings potential, however, which is where syndication comes in. A smaller channel believes that they can make more money airing old, popular shows than they could trying to fund their own content, so they pay a license fee for the exhibition rights. Syndication offered something unique, unreplicatable, and valuable: more minutes of broadcast time.
None of this logic works on the Internet. There are no limited broadcast minutes because the platform isn’t restricted to one piece of content at a time. Anyone can broadcast anything to anywhere at any time. Netflix’s streaming service offered something anyone could make themselves: a place to house and profit from old content. As such, the financial incentives to use a third party for Internet syndication, over building a competitor, were very different than they were when dealing with other TV channels. This made Netflix’s position weak.
Things get even stickier when considering how Netflix’s presence threatens the purpose of a broadcast network. Let’s explore this idea using the NBC show Chuck. Warner Brothers Television owns Chuck and had a contract with College Hill Pictures, and later Fake Empire, to produce it. Warner Brothers had a deal with NBC/Universal to broadcast the show on NBC during prime time. Chuck is canceled after five seasons. NBC then strikes a deal with Netflix to exhibit the back catalog of Chuck now that it is off the air. What exact is NBC’s role in this process?
In the old days, they were the exhibitor. With Netflix in the picture, they are still the primary exhibitor, and potentially function as a middleman between Warner Brothers and Netflix. While there is money to be made as a primary exhibitor, there is less and less as viewership shifts away from appointment viewing and towards the web. Increasingly, this turns the primarily exhibitor role into that of a curator, not a broadcaster. In other words, the service being provided by NBC is akin to tastemaking: picking the pilots that make it to air, granting those productions a certain legitimacy. Not only is this change a hit to the pride of the channel that was home to Friends and Seinfeld, it is also a shaky business position as well. How important is their curation? If they are primarily a middleman, what stops Warner Brothers Television from making deals without NBC being involved? If online is replacing syndication, how will NBC make money on its old shows if production studios are able to negotiate with Netflix directly? This threat, combined with the ease with which networks could roll out their own sites, led to a sudden rise in online viewing options for TV shows, both old and new.
Almost all networks, both broadcast and cable, are owned by a large media parent company that has the financial capability to build out it’s own streaming platform for the content that it owns, without the need to work with Netflix at all. Since many saw Netflix and its ilk as a major threat to their business model, building their own platform did double duty: it increased the money they could make by eliminating the middleman (Netflix), while also removing valuable content from a perceived rival (also Netflix). This was a no brainer. Soon, basically every network had a website that included the ability to watch recent episodes. Hulu, which is owned by a handful of the old guard of network television, began adding full runs of current, and older, shows from their partner networks. Blood was in the water.
So instead of consolidating all of the best of mainstream movies and television on to a single platform, as some might have predicted would be the end game for Netflix, the entire media landscape on the web actually became more fractured. There aren’t enough incentives for the networks to want to play nice and offer convenience for their audience, so they don’t. Hulu, being owned by a number of the major networks, is relatively good at providing content from those owning partners: NBC, ABC, FOX, and TBS. Not surprisingly, networks who are not owners don’t love the idea of sharing a platform but not sharing the wealth, so CBS’s and The CW’s presence on Hulu has largely been dependent on how good a deal they can strike with Hulu’s management. The CW was on Hulu for many years but is now exclusively available on The CW’s website and apps, and CBS was off for many years but is now on, although much of their offerings are old shows no longer airing.
Facing this new reality, Netflix realized it needed to pivot. Once channels like ABC and Fox began pulling content from Netflix and putting it on Hulu or their own websites, and Hulu started adding the kinds of “syndicated” content that Netflix had been specializing in, Netflix realized that whatever attempts they had made to play nice with the entertainment industry, a carry over from the Red Envelope days, wasn’t buying them anything. To keep streaming alive on Netflix they would need to add exclusive content to their platform to keep people interested.
It began with House of Cards, which was a bit of a trial balloon. As the story goes, they used their massive data set on viewer habits, harvested originally to fuel their recommendation engine, to zero in on a TV series that would be almost formulaically successful. People who like movies about political intrigue also liked films that starred Kevin Spacey, and films directed by David Fincher, and so on. When that project was a big success, it opened the floodgates. While Red Envelope Entertainment remained dead, Netflix fired up both a production studio and a film distribution division to create exclusive movies and TV shows, and pick up hot projects from the indie film festival circuit, respectively. They also remained open to working with partners. For example, they took foreign TV shows and brought them to America under the label “Netflix Original” and would even keep shows going after they were canceled in their country of origin. For example, this kind of move saved Charlie Brooker’s brutally dystopian Black Mirror, as well as cheeky, fun, and terribly named Scrotal Recall (renamed Lovesick), both productions originally from the United Kingdom.
The push for exclusive content on the platform staved off what would likely have been a steady drumbeat of account cancellations. As many longtime Netflix users, such as myself, are quick to lament, the quality and quantity of Hollywood movies and television offered by Netflix streaming seems to be on a constant decline. Every time a big popular show, or one with a massive cult following, gets removed there is a minor furor online. It happened with It’s Always Sunny in Philadelphia, Futurama, 30 Rock, Doctor Who, and on and on. Without their own catalog of shows and movies, Netflix might be a dead company walking. With exciting, exclusive offerings, like Bojack Horseman, Narcos, The Crown, Stranger Things, and more, there is a more promising future. My bet: Netflix will survive, and thrive, for the foreseeable future. Their profits are massive and their product is still good. They will just never become the kind of all encompassing, convenient provider that many believed they would be.
While neither company failed, they ended up on different routes. YouTube was able to press its competitive advantages to create an ecosystem for independent video that is very, very difficult for even a well funded competitor to challenge. Netflix had to shift its focus once it realized that its initial strategy wasn’t going to work when its creative partners were no longer willing to cooperate. So what lessons can we learn from this as strategists? How can we take these case studies and apply it to our work and our clients?
The first lesson to learn is about understanding the advantages and disadvantages a business might possess. Both YouTube and Netflix had a platform that wasn’t all that difficult for a competitor to replicate, technologically. There are high costs, of course, associated with storing hours and hours of high definition video, even compressed, however those aren’t completely unattainable for new companies entering the market. But only Netflix felt pressure from alternatives entering its space.
It all came down to the fact that Netflix was simply weaker in their part of the market than YouTube was in theirs. Netflix had to contend with strong partners, ones who were happy to use Netflix to exhibit their content when it was convenient and happy to leave as soon as it wasn’t. Through Google, YouTube had access to an advertising network that gave them a massive advantage over any competitors. Netflix had a subscription base that offered admittedly high user numbers, growing from 22 million to 117 million over a ten year period, but not much else. YouTube and Netflix both had a system for recommending videos to help their audience in discovering new things to fall in love with, but only YouTube had partners that valued that feature highly. All of these little things built up to make a business environment where YouTube could stay the course and Netflix realized, correctly, that its platform alone wasn’t that special and needed exclusive content to remain relevant.
Not that YouTube has been perfect. They have done a lot of experimental, some would say questionable, things that weren’t (and still aren’t) totally on brand, like YouTube Red and movie rentals. They have made changes to their policies and their monetization deals that have angered large numbers of the people that are supposed to be the backbone of their website. They were able to weather these issues more easily than Netflix because their strong strategic advantages gave them that leeway.
But the comparison to YouTube does beg the question: could Netflix have done things differently? Possibly. We don’t know what kind of negotiations were going on behind closed doors, so we have to do a fair amount of guessing, but there are elements to Netflix’s streaming that should have been appealing to their partners long term. Perhaps Netflix could have made more of the fact that their platform had so many people already on it (and has done nothing but grow since) to emphasize how good Netflix is at helping people find shows and movies they had never heard of before. Like audience discovery on YouTube, this could have helped old content find new audiences. If new people are finding and watching the show, it incentivizes Netflix to keep renewing the licenses, making the rightsholders money. Some of those people will go on to buy the shows or movies on physical media, like DVD or Blu-ray, which feeds another revenue stream for the content. I know that Party Down became one of my favorite shows only after I was able to discover and watch it through Netflix. Netflix might also have tried warning its partners about the difficulties associated with ad blockers and piracy and convinced them that Netflix had already solved those problems to the best of anyone’s ability. In that case, Netflix would have sold itself as the hassle free way to get their partner’s content online and making money. Would either of those approaches have worked? Maybe, maybe not. Maybe Netflix tried them and the entertainment industry didn’t care. In the end, as an outsider, there is just no way to know.