Was Prime Video a Loss Leader or Loss Loser? – Most Important Story of the Week – 5 Feb 21

Jeff Bezos ending his run as CEO of Amazon is certainly neé clearly neé absolutely the biggest story in business this week. Is it also the biggest story in media, entertainment and communications broadly? Sure. 

Bezos is a man who built Amazon to be “the everything store”. That includes your video watching habits. As I’ll explain, if there is a way to deliver video, Jeff Bezos’ Amazon has launched a business unit for it. That makes this big announcement an easy winner of the “most important story of the week”.

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Most Important Story of the Week – Was Prime Video a Loss Leader or Loss Loser?

When I opine on Twitter about Amazon, usually critically, someone inevitably opines that Prime Video is a “loss leader”, as if I didn’t know that it was the purpose of Prime Video. But I’ve been around the entertainment-strategy-take game long enough to have read that rationale for Prime Video’s existence. Multiple times. 

The challenge, for me, is that “loss leader” is a vague term. Like it’s cousin “flywheel”–read my thoughts on that phrase here or here–my concern is that loss leader can be used to justify bad decisions. The logic goes: Amazon/Apple/Google/Facebook are big and successful, they invested in Product/Business/Vertical, then even if it doesn’t make money it must be worth it.

When I’m questioning Big Tech’s strategy in video, the words I’m focused on aren’t “loss leader”, but the words “investment” and “worth it”. That’s where we need to start to understand how all of Amazon’s entertainment/media enterprises will fare under Andrew Jassy.

Loss Leaders vs Loss Losers: Is the Investment Worth It?

A “loss leader” is a simple concept: a business sells a given product at a loss to sell more of a different product.

Take an example from the legal world that I just heard on All The Presidents’ Lawyers. Sometimes, a defense attorney will take a high profile case and waive the fees. They do this because the case is so notorious they will get lots of free publicity. The gain in additional paying clients offsets the initial lack of payment.

But consider a defense attorney who represented President Donald Trump in his election lawsuits. Normally, representing the President would be worth reduced fees, because the publicity would be huge. But Trump was so toxic that many firms risked losing paying clients because they were associated with frivolous election lawsuits that were destroying democracy. That’s not a “loss leader”, but the opposite.

For lack of a better term, I’d call bad loss leaders “loss losers”. How do we judge if a potential “loss leader” is good or bad? Well, if the extra sales exceed the costs. One could simplify that to:

A loss leader is worth it if the costs (the losses) are exceeded by the benefit (the sales elsewhere).

Take Roku. They sell their hardware at cost, meaning almost exactly what they pay for it. Devices are loss leaders. They make up the revenue by selling subscriptions and advertising. But if “loss leaders” are good, why not go further? Why doesn’t Roku lose money on each device? Don’t stop there. Could Roku pay every American $100 to take a device? Or higher? $1,000? 

Obviously not. Because at some point the losses don’t lead to enough additional sales. So the question isn’t “Is Amazon’s video investment a loss leader?”. Instead the question is, “Has this loss leader strategy worked?”

Beyond the Black Box: The Hazy Economics of Big Tech

So the obvious question becomes, “What has been Amazon’s return on investment in all of entertainment?”

And we have no idea.

I’m tempted to say we can’t know because Prime Video is a “black box”. Honestly, even calling it a “black box” would be wrong. A true black box is when you have known inputs, that go into an equation/algorithm/process, which spits out known outputs. The black box is the process. For Amazon, we don’t know the inputs (costs, mainly), the process (how Amazon accounts for success) or, most importantly, the outputs (performance, revenue, usage, etc). 

This applies to a range of Big Tech investments. Google, until very recently, reported no financials for Youtube in their earnings reports. Apple hasn’t told us any performance details of everything from Apple News to Apple Music to Apple Arcade to Apple TV+. Amazon has a range of smaller investments beyond Prime Video, all of which are bundled under three vague business lines in their earnings report. 

I’d call it an “invisible box”, where we don’t even know what is going in or out of the system. To compound it further, Amazon isn’t one invisible box, but a stack of several, sometimes competing, invisible boxes.

Amazon Prime/Video/Studios/Twitch/Channels/IMDb TV/Music: Amazon’s Voluminous Investment

Even defining “video” for Amazon is probably the most confusing of the Big Tech firms. Google is primarily focused on Youtube (though it also owns Google Play and Youtube TV), Netflix is only Netflix, Facebook has Facebook Watch (though it also owns Instagram videos), and Apple only has Apple TV, TV+…okay it’s confusing for all the tech companies except Netflix.

But Amazon makes an art of how many different investments in video they have: 

– Amazon makes its own content via Amazon Studios.
– It distributes this via Prime Video, while also licensing a huge content library content.
– Folks can upload their own videos to Prime Video using Prime Video Direct.
– Amazon also sells movies from all the studios to rent or buy. (This was actually Amazon’s first digital video business.)
– Further, Amazon also sells other streaming services via its Amazon Channels business.
– On top of it all, it sells devices that can be used to stream, the Fire TV and stick.
– Lastly, Amazon has other investments in video including Twitch, IMDb TV and Amazon Live. 

And honestly, if you told me there were five more businesses I missed I’d believe you. That list also leaves out music, podcasts, Alexa and video games. That’s a lot of stacked up invisible boxes.

If we can’t say if the investment was good or bad, what can we say? That there were good arguments on both sides.

So is All of Amazon’s Video Investment a Loss Leader or Loss Loser?

I don’t know. Without the inputs and outputs, it’s all guess work. But the alternatives–relying on the CEO interviews, stock price, vague assertions of flywheels and loss leaders –just aren’t very informative.

Instead of providing a definitive answer, I’ll provide both sides. Consider this both the prosecution and defense arguments around Amazon Video broadly, though I’ll center it around “Prime Video”, which is still probably the most well known investment. 

The Cases For Amazon’s Video Investment

The Customer Lifetime Value Math is Very Enticing. 

Given that Prime renews yearly, even a small increase in retention year-over-year can have huge impacts on the potential customer lifetime value of Prime. The best upside math for this comes from Scott Galloway. In his accounting, boosting Prime retention from 80% to 91%–based on some survey data–essentially results in $47 billion in market capitalization for Amazon…and that was pre-pandemic!

Galloway Flywheel

(Source: Scott Galloway Talk)

Now, I quibble with some of his math, but this is clearly the upside. If Prime Video–and the Channels ecosystem broadly–can lock folks in for a cost of a few billion per year, that’s worth it.

Prime Video enabled the Amazon Fire TV Ecosystem. 

Like flywheel, “ecosystem” is overused. But this is a true ecosystem! Amazon leveraged Amazon Video (selling movies/TV series) and Prime Video to launch the Fire TV system, which launched Amazon Channels. Now that they’ve built it, there is the question if it makes money on its own, since it is increasingly removed from additional retail sales, but they did build a valuable ecosystem.

Some analysts think the media/entertainment upside is even higher. 

For example, Laura Martin of Needham. Including advertising on Amazon–which I don’t count as entertainment, since it is the price of doing business on their retail platform–she puts it at $500 billion in value. In other words, Amazon likely spent a few billion dollars every year on content, but it built a $500 billion business, about 30% of their current value.

It seems like Amazon has been successful. 

If you care about awards, Amazon Studios has won with Manchester by the Sea, Transparent and The Marvelous Mrs. Maisel. And the trendline is good: The Boys is likely their biggest hit yet and Upload, Hanna and Hunters made the Nielsen top ten last year. Moreover, the Channels business may exceed them all as Amazon is likely the biggest seller of third party subscriptions, including Showtime, CBS-All Access and HBO/HBO-Max.

Moreover, Amazon hasn’t killed off its video investments yet.

Amazon isn’t innovative so much as adaptive. Or put uncharitably, they’re a copycat. Amazon doesn’t innovate, they let others do that, and then “fast follow” with a copycat product. Diapers dot com. Angie’s List dot com. Etsy dot com. Amazon has created clone businesses of them all. (Indeed, Prime Video is a Netflix clone, IMDb TV is a Pluto clone, and even Fire TV is a Roku/Chromecast clone.) Yet Amazon has axed many businesses if they don’t work. Video, though, has lasted. This would be circumstantial evidence that it must be doing well.

All of Big Tech is into video. 

More circumstantial evidence that video surely must be worth it. If it were a bad investment, why are Google, Facebook, Apple and Amazon all investing billions in it?

The upside in success is that Amazon would likely have built the oft searched for “moat” in digital video. 

Or “monopoly” in layman’s terms. With millions of devices and tens of millions of subscriptions sold, Amazon can demand better and better terms for supply of content, be it movies to rent, subscription to sell, or content to buy. In short, they used profits from AWS to acquire a dominant position in digital TV and now will be able to generate big returns (in pro-business terms) or extract rents (in pro-market terms). There is nothing more profitable than oligopoly, and if Prime Video paved the way for that for Amazon, then that justifies all the investment.

(Consider if Fire TV acts as one of say three distributors of streaming TV by the 2030s, presumably with Apple and Roku. Instead of collecting huge rents on a regional basis, as cable did in the 2000s in America, Fire TV could do that globally. That upside is huge!)

The Cases Against Amazon’s Video Investment

At this point, going all-in on video seems like the smartest decision made by an executive of all time. Not so fast…

The spending was likely out of control. 

Richard Rushfield called Netflix’s last half decade the “drunken sailor” era of spending. Was Amazon the “Not-drunk-but-can’t-drive-home sailor” era of spending then? Whenever you see estimates of spending, Prime Video is usually right behind Netflix in terms of spending on streaming at about $6-7 billion per year. Including traditional content producers, Amazon still spends more than everyone except Netflix, Comcast and Disney.

Screen Shot 2021-02-05 at 8.55.00 AM

(Source: Variety 2019 Dare to Stream Report)

And Amazon discounts other parts of video too. Fire TVs were often aggressively discounted to move units as well. Same for Amazon Channels, which often offered extremely low or subsidized rates to get users. In other words, Amazon sold Fire TVs at a loss, so they could sell more Prime Video at a loss, all to sell more socks. That’s a double loss leader. 

Usage is still low comparatively. 

Going strictly by Prime Video, has the investment been worth it? Prime Video is either second (using Comscore data), third (using Nielsen data) or fourth (using my estimates) place in the streaming wars. Moreover, the streaming wars are just getting started. Can Prime Video hold off Disney+ and HBO Max forever?

Comscore via Hedgeye by Type

(Source: Hedgeye Comm)

In other words, if Amazon’s content spend was about half of Netflix’s spend, but it got about 1/4th of the usage. That’s not great.

screen-shot-2020-09-02-at-9.20.15-am

chart-us-paid-streaming-subscribers

What would a third party pay for all of Amazon’s entertainment products? 

When in doubt, in other words, let the market be our guide. Far from Martin’s valuation, I think you would struggle to find a valuation for all of these businesses even approaching Netflix’s $250 billion valuation. And that’s because while everyone currently subscribed to Netflix is doing it (mostly) deliberately, the vast majority of Prime Video users consider it a luxury. If you sever that link, how many folks keep using Prime Video? I can’t begin to guess.

(Fine, I’ll try. If Roku’s market capitalization is $50 or so billion, say the Fire TV/Channels business gets 100% of that value. Then call it $25 billion (one tenth of Netflix) for video and $6 billion for Amazon Music (10% of Spotify) and say everything else is $2 billion. So is “Amazon Entertainment” worth $82 billion? That would be about 5% of Amazon’s current value.)

Did Amazon have to “build it”? 

Imagine instead of Prime Video and Music, Amazon had offered free Netflix and Spotify to every customer. What would be the better subscription, the current version or those? Most folks would prefer free Netflix and Spotify to free Prime Video and Amazon Music. In other words, Amazon could just do what Verizon does and partner with other streamers to give away better video products than Prime Video.

Presumably, licensing the rights temporarily is much cheaper than building an entire video ecosystem. This is why Verizon doesn’t build it’s own streamer, but simply gives away whatever the buzzy streamer of the moment is, from Netflix to Disney+ to Discovery+. If the return is the same in terms of customer retention, then the better ROI is in partnering, not building a new video subscription.

Most folks overvalue the “hidden business” model. 

In addition to CLV, folks love to repeat the Bezos quote that Amazon invested in Prime Video so customers would “buy more socks”. I call this a hidden business model because most folks stop there and don’t do the simple math to ask, “Well how many more socks?” (The previous king of the hidden business model was MoviePass. It would lose money on tickets to sell “data”. But data isn’t worth that much.)

I’ve done the math, and frankly because retail margins are so low, this is at best about $5.50 per month:

Amazon Retail Margins

(By the way, it’s tricky to nail down exactly what the lift is for new sales and what Amazon’s actual retail margins are. Some folks claim they are still really low (actually under 2-3%!), but then advertising is booming, which is really the price of doing business on Amazon. Play with the numbers to make your own estimate.)

Yes, it’s valuable to sell more socks. But that’s not an unlimited pot of gold. In fact, it’s an increasingly tapped out mine. (The highest net worth customers have already adopted Amazon, so Prime acquisitions will decrease in value.) So for Prime Video to act as a loss leader, its costs need to be under $5.50 per customer per month. And that’s for the folks who use Prime Video. In other words, you could imagine that the content budget definitely doesn’t make up for itself in extra socks sold. 

Big Tech loves video, everyone else can’t make the math work.

Interestingly, whenever conventional companies look into video, they tend not to have the stomach for it. Microsoft abandoned Microsoft Studios very early on. Verizon gave up on Go90. And most notably, Wal-Mart looked at video, even launched its own membership, and bought Vudu. Then they decided that video is not a good business. Clearly they weren’t going to sell more socks! And thus Walmart sold Vudu to Comcast. What does Wal-mart see that Amazon doesn’t? 

Big Tech may be into video because there is nowhere else to go. 

As Matt Stoller has written, as consolidation has risen across industries, firms and investors have few places to park their cash. And since firms can only do so many share buybacks–like Apple–video is the logical extension. Video is one of the more simple/obvious ways to use digital technology, so Big Tech is into video because they have so much cash from their monopolies/oligopolies (cloud/ecommerce, search, social or app store, depending) that they’re blowing it on video. This doesn’t really mean it’s a bad investment, but probably a sign something is wrong with our economy.

It is a loss loser, but Jeff Bezos didn’t care.

I said I’d use this quote quite a bit, and here’s my first chance. The question isn’t if Prime Video is a loss leader, but a loss leader for what?

Screen Shot 2021-02-05 at 9.03.56 AM

Results: Shrug emoji

Look at those lists and draw your own conclusion. Each pro has its similar con. All of Big Tech is into video, but Walmart/Verizon abandoned it. The CLV gains are huge, but the additional sales are likely overrated. Prime Video may be second place in usage, but hardly anyone would pay for it. Again, this is the shoulder shrug emoji of analysis.

So what’s my point? Simply that I’d like more skepticism about Amazon out there in the world.

In conventional wisdom, Prime Video and related investments have been considered tremendous successes. I don’t see the evidence or data to justify that. If you just glance a pinch more skeptically at Amazon next time someone touts their success, then I’ll consider my job done.

Bonus Most Important Thought: What Happens Next?

Probably nothing. Jeff Bezos has said as chairman of the board, he’ll likely have final say on any “one way” decisions. Selling or giving up on devices or video would be fairly final, and given Bezos’ clear backing of those investments, I can’t see him approving that. Moreover, as the con side laid out above, who would buy Prime Video and related businesses if most of their value is tied to the Prime ecosystem? $82 billion is likely the high watermark and I could see, under scrutiny, most potential buyers fleeing to the hills.

However, levels of investment can fluctuate, and that could impact Amazon’s multitude of entertainment investments. Amazon has famously often competed with itself, for example two different business units now produce original audio, Audible and Wondery. Maybe Jassy streamlines video/music and kills underperforming units. Or just drastically cuts back on “investment”, meaning content spend. 

Moreover, there is the antitrust wild card. One article mentioned that Jeff Bezos would likely break up his creation before letting regulators do itEven if Amazon did get ahead of the curve in breaking itself up before regulators can try, it’s hard to see video getting cleaved from retail. Even if Prime Video sells less socks than they claim, it’s value is still clearly as part of a Prime membership. And that serves as the basis for Fire TV devices, so it will likely stay bundled together. AWS could, though, be split off with fairly little disruption. Twitch is part of AWS, from what I understand, and I could see it going with either AWS or staying in the remaining retail/Prime Amazon.

I’d argue that even if Prime Video isn’t performing well enough to actually boost the CLV of Prime, simply the dream in Amazon’s head of selling more sock has/will keep Prime Video alive.

(How well does Amazon retail do without AWS covering any potential losses? The finances are so entangled it is impossible to say and makes the mind reel at the ramifications.)

  1. […] (Catch my most important story of the week–Jeff Bezos stepping down as CEO–here.) […]

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