(Welcome to my series on an “Intelligence Preparation of the “Streaming Wars” Battlefield”. Combining my experience as a former Army intelligence officer and streaming video strategy planner, I’m applying a military planning framework to the “streaming wars” to explain where entertainment is right now, and where I think it is going. Read the rest of the series through these links:
Part I – Define the Battlefield
Defining the Area of Operations, Interest and Influence in the Streaming Wars
Unrolling the Map – The Video Value Web…Explained
Aggreggedon: The Key Terrain of the Streaming Wars is Bundlin
The Flywheel Is a Lie! Distinguishing Between Ecosystems, Business Models, & Network Effects and How They All Impact the Streaming Wars
My wife and I have watched some of “The Imagineering Story” documentary and there was a tidbit in the first episode about Disneyland’s launch which has stuck with me:
Disneyland was profitable by the end of the first year.
To compare Disney to the company that led the introduction to last week’s article, if Amazon opens a “BezosLand” in Seattle, do you think it would make money in its first year?
It would probably never make money. It would be created as a unique bonus for Prime subscribers who could attend for free. We would never find out how much money they make and if there were rumors BezosLand was losing billions every year, they’d leak to a few favorite journalists that the “data” makes it all up for them in selling more socks.
It feels quaint what Walt Disney did in the 1960s: He saw a way to create value—have amusement parks that were clean and cutting edge that emphasized decades old beloved characters—and when he launched it, he was quickly proven right. This is capitalism at its finest: for his bet he earned lots and lots of money. Shareholders still are benefitting from his foresight.
Far from being quaint, Walt Disney was actually on to something. For most companies making money is key. This is true even in the streaming wars. But we’ve lost sight of that fact because so many companies entering the streaming wars with plans to lose oodles of money doing so.
This is part II of my three part exploration of “flywheels” in the streaming wars. Last time I defined my terms. Next time, I’ll use the principles of this article to look at a few other new streamers. Today, the lesson is all about why making money still matters, even in streaming. And Disney’s future is the case study.
– The best way to evaluate any business is still Net Present Value.
– Even in flywheels and deficit-financed business units, the goal is still the same: to invest money in net present value positive endeavors.
– The risk of a “flywheel” with a deficit-financed component is that you simply lose money, not start the flywheel spinning.
– Disney provides the case study in this: if streaming can’t/won’t make money, their flywheel of toys, parks and resorts won’t make up for it.
– Thesis: The best business model makes money at every point, not “flywheels” that lose money in one area to make money in others. This is actually the forgotten lesson of Walt Disney.
A Reminder about Net Present Value
Fortunately, the key to evaluating flywheels is the same as the key to evaluating all businesses:
Net Present Value
Or NPV. The short hand for calculating “net present value of the discounted future cash flows”. That’s a finance-y way of saying that a company should invest in businesses that promise to make money. Again, we’re talking Finance 101 here. But it’s worth repeating because I’ve seen many businesses or ventures praised in the streaming world who likely won’t make money, even on a net present value basis. (They use narratives, not numbers. And strategy is numbers.)
Read my explainer for this concept here. (And no website can do it justice, you really should read your finance textbook to understand the details.) But for a reminder, since I use it a lot, 90% of NPV decisions look like this:
– You invest a lot of money at the start. (Capital expenditure)
– You slowly start to make some money. (Revenue)
– You still have some ongoing costs. (Cost of goods sold.)
– You subtract the two, and keep the remaining. (Profit)
– You take those future sums and account for the time value of money. (Discounting)
Since we’re talking Disney, here’s a look at my big series on how much they made from Star Wars toys:
The problem I keep running into with streaming video is folks seem very willing to ignore these two core principles when evaluating the streaming wars. Most money losing/unknown streaming or digital video ventures are excused because frankly we don’t know. Since we don’t have the numbers—and it’s hard to calculate them—we use narratives instead.
If you take nothing away from this article, remember that even a flywheel can be evaluated on NPV terms. It’s components can, nee MUST!, be evaluated on NPV positive terms as well. Otherwise, companies run a huge risk.
“A License to Lose Money”: Explaining Deficit-Financed Business Units
– Prime Video (money made unknown) isn’t around to make money, but to sell more socks, thus spoke Jeff Bezos.
– Apple TV+ (will spend $6 billion on content) isn’t around to make money, but to sell Apple devices and Apple Channels.
– AT&T (will spend at least $3 billion on HBO Max) isn’t around to make money, but to sell more cellular subscriptions.
In these cases, the explanation is that video is a means to an end. At extremes, defenders of the “lose money in media to make money elsewhere” even call it a “marketing expense”.
It’s worth dwelling on the concept of “marketing expense” more. Because in the previous world—the old fashioned/traditional business world—it wasn’t like you could just label something as marketing and spend as much as you wanted on it. Indeed, marketing was always taken out of your operating profit. So the more you could trim marketing while keeping sales the same, the more you trimmed! That’s what advertising is the first thing to go in an economic downturn.
Despite the branding as marketing expenses, there is real money being spent on video. These are real products from real business units. Not simply “marketing”. We need a new name, which is why I’ve come up with:
Deficit-Financed Business Units.
DFBUs. Yes, I was in the Army so I acronymize everything. It’s worth unpacking the phrases to see why these definition makes so much sense.
First, a venture is “deficit-financed” if the plan is to never make money on it. Or to make money, but so far in the future that current financing is still net present value negative. Thinking about this abstractly explains why. Say I offered you a billion dollars a year starting in 2050. The key is you have to pay me $20 billion now. Should you do it? Heck no! You could just invest that $20 billion and probably double it multiple times before 2050, making more than enough to pay yourself $1 billion per year.
That same scenario is a microcosm of “net present value”. Should Apple invest $20 billion right now to make $1 billion a year in 2050? Heck no! Just keep it in cash or cash equivalents. No matter if it is marketing.
Second, I like business unit because it really distinguishes between streaming video companies and a marketing expense. Plopping down several million dollars for a Super Bowl ad could be a net present value negative decision. (And should be evaluated in those terms.) But we should distinguish from genuine efforts at marketing versus creating brand news businesses, that in most other contexts would need to make money.
The Riskiness of DFBUs: You Don’t Make Actually Make Money on the Flywheel
My worry for companies and investors is that they don’t insist on looking at these business ventures with an NPV lens. As a result, DFBUs become a license to lose money for big tech companies. They may even grab market share—that’s certainly the case with all of them—but that doesn’t mean they actually make money.
That license usually has a justifciation, though. If we lose money on this part of a flywheel, can it make more money elsewhere? In other words, the key question is:
Can Deficit-Financed Business Units Turn a Flywheel?
This is really the supposition that has fueled the rise of streaming video. If you have a true flywheel or ecosystem, getting more customers in will help cause it to spin. That’s expressly Jeff Bezos’ logic. Apple’s too. AT&T even.
The answer? Maybe. It depends on the flywheel.
My thesis is that they can, but they are risky and hence rare. Losing money is easy for a business to do. Allowing someone to lose money means they will. It makes their thinking sloppy. Moreover, it’s easy to get the tradeoffs slightly wrong, and you deficit-financed business unit just becomes a money losing hole.
And I think I can illustrate this with Disney. If you’ve been following me on social, you’ll know that my household has been into Disney’s Inside Out recently. Which is appropriate to call back to, for this scene:
That’s how I’d describe DFBUs, they’re shortcuts that should be labeled danger. The current danger-disguised-shortcut facing Disney is losing money on streaming (Disney+, ESPN+ and Hulu.) to make it on extra toy sales. The rationales I’ve seen justifying Disney’s move into streaming reinforce this money losing narrative. I’ve seen the same arguments used by the tech conglomerates trotted out for the House of Mouse. For example, I’ve seen Disney’s streaming efforts explained as…
– They’ll lose money on streaming to get folks into the “ecosystem” of theme parks and toys.
– Disney has a flywheel and streaming video will bring more subscribers into the flywheel.
– Disney should disrupt the theatrical business model to own the customer relationship in streaming.
So all the buzz words. Of course, since strategy is numbers, the question isn’t what narrative you employ to justify losing money, but whether or not the investment will make it up in the long run. So let’s quantify—for what I think is the first time on the internet—the actual numbers behind those narratives.
The Messy Financials of Disney
One of the first explanations for Disney’s push into streaming was so it could “sell more toys”, just like Jeff Bezos sells more socks. But take a gander at this Hollywood Reporter image I love trotting out:
Toys—from here on “consumer products”—is a small, small part of Disney’s overall operating margin, isn’t it?
Let’s dig deeper. I approach a company’s financials like a hostile witness on the stand. What are they trying to hide? What don’t they want me to know?
For Disney, I looked at their financials going back to 2009. And a huge red flag jumps out, which should be a clue for the quality of the toy business: