Value Chains…Explained!

2019 is off to a great start for “maps of the entertainment universe”. When I was writing on media consolidation, I wanted to make one of these to help explain this crazy industry in better detail. But I doubt it would have looked as good visualization as this Wall Street Journal visualization I saw on Twitter last week:

WSJ Map of Universe.png

Source: Wall Street Journal

What I love about that image is that it conveys multiple pieces of information in a 2D fashion. That’s really hard to do. That’s the gold standard of charts/tables/maps. This image conveys the names of companies, types of entertainment they offer, who competes in multiple areas and who doesn’t. Good job.

But while I love that lay out for what it does, it still has limitations. Mainly, you don’t know the directions of the various branches. Are they all separate types of services or are they interrelated? Are some companies distributing the other types of entertainment? How do they relate? How distinct are live TV, ad-supported and sports content anyways?

So while that visualization is good, it is still incomplete. (To be clear, I liked the image. A lot.) I want to build on that chart and others, but to do so, I need more tools. My goal is to explain the business of entertainment, and to do that requires first explaining some of the tools I plan to use. These tools explain not just what the companies are competing in, but how they compete and relate to each other.  Today, I’ll explain the “value chain; tomorrow, I’ll explain a different tool. Then we can build our own map of the entertainment universe. 

Note before I start: These two tools are both super complicated. My explainers do not do them justice. I mean chapters and chapters in strategy text books have been written on this. And I felt I needed to reread those chapters in my still saved text books as refreshers before writing today. So at some point I’ll make a reading list if you’re interested.

Value Chains

Let’s start a series of shapes. 

A shapeOkay, that didn’t help. Let’s add three words to make the simplest value chain imaginable:

Image 1 Simplest

The “chain” here is the journey of a product to a customer. Essentially, someone makes a good. They sell it to a store who sells it to a customer. If each step “adds value”, that’s your “value chain” in action. (What if someone doesn’t add value? Well, they’re still here in the value chain. That’s what we call it.) Here’s a pic from my strategy text book, just vertically rotated:

IMG_4437

Same really simple principle.

In my experience, good strategy starts with this core tool. Even if you think you know your industry top to bottom, back to front, you should still use this tool. First, it’s a good refresher to challenge how your industry has changed over time. Second, as new industries emerge, you can use this tool to understand their emerging value chains. In my previous role, when I dug into a new business opportunity, I would sketch out an initial value chain and use that to figure out how to research the new industry. It never failed to generate some insights.

(An aside, yes, I’m explaining a “strategy 101” concept here. The basics of industry analysis. Some super smart executives definitely don’t need me to teach this to them. If you’re one, skip ahead. That said, at three different companies, I never saw this tool used. Even as business models changed rapidly. It’s a basic yet powerful tool, like value creation. And I doubt business affairs, creative development or production executives have ever seen it.)

The value chain is a little tricky for digital goods. It started its life as a tool for manufactured goods. You know, the hey day of American might and exceptionalism in the 1960s. So I’m going to explain the tool with a manufactured good. Trust me, we’ll get to digital video.

Let’s use a delicious example, potato chips. This will pair nicely with my example for value creation, craft beer. Throw these two articles together and you got a party. The first step? The potatoes:

Potatoes

How do farmers add value? Well they grow a crop that wouldn’t exist if they didn’t. Harvesting the raw supplies. But now we need someone to come in and turn potatoes into something:

Potatoes and ManufacturersThe manufacturers add value in two ways. First, by turning potatoes into chips, they make a tasty treat. Then, they also pay for the marketing to make you want to eat that tasty treat. But potato chip companies like Frito-Lay don’t own all the stores. And often don’t have the distribution to sell everywhere. So they use:

Full Value ChainThe distributor has the logistic excellence the factory doesn’t to get the chips out there and the store has customer service and variety of products. (Again, in an ideal world.)

You can see that you start with potato farmers, who sell to potato chip manufacturers. They sell to distributors or wholesalers who sell to stores. At each level, they take their margin, so that a potato sold for say $0.25 becomes a $3.99 bag of chips at the store. In an ideal world, each level is “creating value” for the end consumer. The potato farmer creates a potato that wouldn’t exist otherwise, the potato chip manufacture transforms it to make it delicious using special techniques. We need one last piece though.

True Full Value ChainI like adding customers even though it is redundant in someways because it clarifies if the end of a value chain ends in customers or a business. And I always believe in reminders of the value of the customer. 

I’ll make one last point. I mentioned that the problem with the Wall Street Journal article was that it didn’t explain the relationship between the layers, and the value chain doesn’t either. What it does is explain what pieces feed into what to make a final product. So we need to start adding some numbers to get this thing rolling. And since I mentioned value, ideally we’d fill out a chart like this:

Value Creation Chart

Again, this is a vertical form of the horizontal value chain from above. (I’ll explain tomorrow why I left it horizontal.) But now if you can estimate the “willingness to pay” for customers, and you know the values of potato, then you can figure out all the prices and see who is capturing what value at what level. If I knew the actual numbers, I’d fill this out, but don’t want to lest I get something wrong. But you can see where you would put the numbers in. 

The next key insight, though, comes from using those numbers to see who captures the biggest share of the pie. (Technically, PIE, but do not have time to explain that in one article. That’s some math.) If one level captures an inordinate amount of the value, well, they are pretty powerful. 

Well, how do we explain that? With another tool for tomorrow.

Other Ideas/Notes

First, if you search “value chain”, or go to Wikipedia, you usually get this phrase tied to Michael Porter’s “value chain”, which is about a company internal value chain. That is specifically not how I am using it and again my professors teaching me were using value chains to discuss larger industry analysis. Which is how I use it. (And we’ll get to Porter tomorrow!)

That said, I do love always thinking about creating value and the similarities between a company and an industry. And this type of value chain analysis can be insightful. For entertainment, a development exec adds value by finding a great project, business affairs gets the talent signed for good prices, a production exec adds value by producing it on time and on budget, finance gets the money on time to pay for everything, and then marketing gets customers to pay for it. 

Second, value chains don’t always have one straight line. You can sell to multiple distributors, with their own value chains and outputs—say liquor stores or super markets or online—or have multiple suppliers—how many things go into a car, for example? But still, understanding them at a high level is usually useful. 

Why I’m Unveiling These Tools Now

I don’t like referring to strategic concepts that are even slightly advanced if I haven’t explained them. And on Thursday, I’m going to need to use the value chain to explain my next HUGE analysis article. (Analysis articles are where I use numbers to draw definitive conclusions. Like my series on Lucasfilm-Disney Acquisition, M&A in entertainment or the Pac-12. Just look to the column on the right for ideas.) I’m not telling what it is, but it involves dragons, orcs, talking lions, white walkers, rings and multiple media companies.

Also, the definition of digital video”, it seems to me, needs a better explanation. Understanding the value chain helps get there. The roll out of Apples Plus/TV product two weeks ago seems to necessitate better explanations of digital video’s value chain.

Oh, and last week, I mentioned value chains with agents! So if I see value chains all over the place, and they need explaining, well, I’ll help out.

Most Important Story of the Week and Other Good Reads – 5 April 2019: #WGAxit

I’ve been distracted from one part of the entertainment world (the filmed part) because of my deep dive into another (the sports part). But we had BIG news this week. Big enougth to deserve my use of the caps lock key. That’s right, the writers (specifically, the WGA, the Writer’s Guild of America) voted to end package fees. (Technically, to leave agents who accept package fees.)

This is so complicated that one column can’t cover it all, but let’s do what we can while the clock ticks. (The agreement expires on Sunday.)

Most Important Story – The WGA Votes to End Package Fees

Here’s a question that I’ll hopefully explain in detail next week:

How do agents fit in the “filmed entertainment value chain”?

I ask because it is tough. Talent makes shows, that are paid for by studios, who sell them to networks or streamers, who get customers to pay them. So maybe agents are talent? Or related to that? But they don’t actually provide any talent to the actual product, do they? More like they sit between talent and studios. And collect 10% of paychecks for that privilege.

So what is it that agent’s do?

Let’s try to explain it in two ways, charitably and uncharitably. When we’re done with that, we’ll probably have our answer. And I’m not going to focus on just package fees here, but the very idea of having an agent in the first place. (The best package fees explainer is this WGA–so admittedly self-interested–video.)

Charitable Explanation

An agent adds value by finding more work that pays more for the talent. First, they find additional projects for the writer to work on. This increases the number of projects the writer gets paid for. Once they are working, an agent negotiates the payment of the writer, and since they take 10% of the writer’s paycheck, they are incentivized to maximize the writer’s salary. Second, the agent maximizes the pay of a writer by negotiating for the highest possible amount on the projects they do get.

The problem with that explanation is a couple fold. First, do agents find more work for their clients? One of the big complaints with the bulk of the writer members of the WGA is that they tend to use personal networking to get future jobs. Moreover, writers really only work on one TV show at a time. So it is unclear if agents actually do increase the number of jobs. There are also plenty of horror stories from writers where  agents slow played projects that were less financially valuable for the agency as a whole. And do they really negotiate higher payments? Especially for junior writer getting paid guild minimum? The word “minimum” implies…no?

This leads us to the uncharitable explanation.

Uncharitable Explanation

In Hollywood, every writer has an agent. In fact, studios tend to only hire writers with agents. The agents have positioned themselves as gatekeepers to getting access to this extremely walled garden of movie and TV studios. By creating a role for themselves as gatekeepers, they can extract extremely high rents–so they are rentseekers–on people trying to work in Hollywood. (Their currency is top talent. If studios try to go around the agents, the agents will threaten to withhold top talent.)

Consolidation has only increased the size of the walls and the fees to get past the gatekeepers. The agencies have merged into a few super agencies, which work to block out other agencies trying to get into the space. Or they acquire those they can’t block. The biggest agencies have almost all the major talent, so the studios have to work with them.

Which is Right? Neither and Both.

Likely, neither the uncharitable or charitable view is completely true. Or they are both true simultaneously. Agents can help increase the value of certain writers–especially say the top 10% of writers, the showrunners–but are probably extracting value from the middle and lower level writers. Package fees make this whole situation worse, as agents become de facto producers.

(By the way, I’ve punted on the agency’s “costs” issue for today. I’d love to know how a job that can essentially be done from home demands high costs. But I’ll stipulate that for today.)

Unfortunately, US antitrust law is so weak from decades of being hollowed out that it can’t do anything about the fact that agencies are consolidating and/or gatekeeprs. Sure, agents may be rentseekers, but how does that hurt “consumers” in the “consumer welfare standard”? Since prices likely stay the same–writers are just poorer for it–the US Department of Justice spends its time fighting…AMPAS?

(Wait, that has to be a typo. Nope, it’s real. How could the DoJ go after an awards show? Sadly, this is our state of antitrust law.)

Does this situation make for good movies?

Let’s tie this back to my literal first article on this website: “Why does Hollywood Make Bad Movies?” (And maybe my theme of the week since I talked about “misaligned incentives” and the Pac 12 yesterday.)

If you talk to a fantastic chef, they’ll always tell you great food starts with great ingredients. So if development execs or producers are the chefs, well talent is their ingredients. But development executives don’t really pick ingredients anymore. Here’s the best quote from The Ankler two weeks ago:

In private, [writers have] put it to me that not only is this the way the system has evolved and become a fact on the ground but that it reflects what the agencies actually do at this point. As they put it, the studios have basically withdrawn from the work of developing a show, leaving it to the agencies to turn a concept into a more or less ready to go package, if you want to sell it and get it on the air, that is.

Sadly, this matches my experience. A lot of development teams have outsourced talent acquisition–in the writer, actor, director sense–to the agencies. Many development execs wouldn’t know what to do if agents didn’t send them lists of people to hire. The problem is the incentives of the studio–make great films–isn’t actually aligned with the agencies–maximize salaries for current talent. The agencies have some incentive to make great films–it leads to better paychecks–but only obliquely. Mostly they just want people to get hired and they’ll blame failure on the writers if they rep the actors, actors if they rep the writers, the director if they rep actors or writers or if all else fails, the marketing. If most studios wanted to improve the quality of their movies and TV shows, relying less on agents and finding innovative ways to do identify great talent–which will cost time and money, admittedly–would be my first recommendation.

Listen, I don’t mean to come down on the entire agent/manager system. (Managers are a part of this even if this issue doesn’t address them immediately.) And agents were an improvement over the old studio system, which treated talent incredibly poorly. But just because the current system is better than the old one doesn’t mean we can’t make it better.

Good Reads on WGAxit

Want more WGAxit explanations and thoughts? I have you covered.

The Ankler – Richard Rushfield from two weeks ago covers tons of ground. I’d point out two great ideas in particular. First, California and federal laws prohibit a lot of the current behavior by agents. But since agents donate tons of money to politicians, the regulators don’t do anything. Second, he paints a nightmare where only four entertainment buyers exist in the future. This is the worst case. If you want everyone to get paid better and prices to go down, encourage competition. If you back big business and consolidation, well expect worse shows for more costs as everyone gets paid less.

Variety – And once we’re through with this current fight, we’ll move to a renegotiation of the WGA with the major studios, which probably will include even more digital players. Good read by Cynthia Littleton on what that could look like.

Deadline – Has the best summary of the plans of the WGA going back to last year.

ICYMI – The Entertainment Strategy Guy is Everywhere!

Even as social traffic is increasingly important for traffic to websites, old fashioned “guest posts” have really helped my site this week. So I have been incredibly grateful to Decider and Athletic Director U for letting my write for their two websites under my pseudonym.

First, I had two articles up at Decider since I last shouted myself out.

Why Did Hulu Lower Their Price to $5.99?

Six Crazy Theories about Apple

Which features my favorite art of all time:

crazy-scale-1.png

Second, I dug into the Pac 12 for Athletics Director U. I think the Pac 12 is a delightful case study in how to optimize an asset, in this case media rights. The Pac 12 bet on themselves to launch their own network with no strategic partners. Well I dug into that decision, with numbers, and the time value of money, net present value, back of the envelope, top down, a director’s commentary and finally my opinion on it, which is the Chancellors and ADs need a second opinion.

Other Contenders for Most Important Story – The Record Industry is Back

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Opinion – Should the Pac 12 Sell a 10% Equity Stake? Why the Pac 12 CEOs Need a Second Opinion

(This article is Part 3 of my series on the Pac 12, including whether they should have brought on a strategic partner in 2012:

Did the Pac 12 Need a Strategic Partner in 2012? Part I at Athletic Director U
Did the Pac 12 Need a Strategic Partner in 2012? Part II at Athletic Director U
Did the Pac 12 Need a Strategic Partner – Director’s Commentary)

 

If you found out you had a serious medical issue, a life threatening condition, you would get a second opinion, wouldn’t you? I mean, this is your life we’re talking about.

However, say you have a toilet running in your house. You call a plumber and he says he can fix it. Do you call a second? It’s one toilet and the guy can fix it for probably a hundred bucks or so. No second opinion needed.

Really, it’s a cost-benefit analysis, even if we don’t think of things in these stark of terms. A life is valued—no really, governments around the world calculate this—between a few hundred thousand to millions. A toilet getting fixed costs a couple hundred dollars…maybe.

When Larry Scott proposes to the Pac 12 leadership that they sell 10% of their future media rights, are they contemplating a small repair or major surgery?

This is major surgery, and the Pac 12 patient needs a second opinion.

That’s the message I’m here to deliver today, along with how to do it right. Hopefully all my readers have read my two articles analyzing the Pac 12 decision not to use a strategic partner in 2012. (And my follow up yesterday.) If you have, you know the Pac 12 likely made a big strategic mistake in 2012, and this decision could exacerbate it further. But let’s focus on the “how” of making the right decisions, not the past, with some other thoughts for the Pac 12 CEOs.

Thought 1: Hire a Devil’s Advocate

I’m a big believer in using a “Devil’s Advocate” when making tough decisions. Essentially, you need to pick someone who will make the strongest case possible for the opposite case of what you are pursuing. (The key is—in a corporate environment—that you don’t judge them for zealously doing this, if they do it respectfully.) There is a reason why we have an adversarial justice system; having two dueling cases helps uncover more information and discourages confirmation bias.

Confirmation bias is really what the Pac 12’s strategy screams to me. You have a charismatic leader in Larry Scott who believes in his vision. Which is great. And you need that. But if he has made serious strategic missteps in the past, he could be making them again. By the time all these bills come due, it may be too late. 

Now is a crucial time in the life of the Pac 12. My read of the news coverage is that the Pac 12 is very serious about selling some portion of ownership of their media rights. Whether it gets $750 million for 10% remains to be seen, but it seems likely they will try. (My gut is that they get $750 million, but for a lower valuation. Say for 20-30%.) That decision absolutely needs someone to come in, look at it, and tell you if you’re making the right decision over the long term. Here’s why and how to do it:

Why to get a second opinion

Two reasons. First, despite what they may tell you, this decision is likely irreversible. If the Pac 12 appreciates in value, then the partners who bought in at $750 million may ask for $1 billion to get your equity back. Where are the universities ever going to find that type of cash? So basically, once this deal happens, you never get that equity (of your media rights) back. You’ve permanently sold your ownership.

Second, do you really think you are getting a great deal here? That’s a huge judgement call. Do the universities really think they can outsmart the investment bankers (or ex-investment bankers at giant tech companies)? They have teams working on this. They do it all the time. And they usually win. You hired an investment bank which may have compromised judgement. (I’ll explain that next.) So why not just keep your ownership unless the offer really is too big to pass up?

Why to hire an outside advocate: Combat personal economic self interest

One of my eventual themes will be “understand economic self-interest”. In short, a lot of behavior can be explained by profit maximization. I mean, that’s economics 101, isn’t it?

Unfortunately, in the business press, individual economic self-interest is usually ignored. Here’s an example of what I mean. Say a biz dev guy sees a huge potential deal with a partner, but his firm has no ability to deliver on it. Still, he pushes and pushes, gets the deal through, collects a big bonus. Six months later, he bounces to a new company. That’s a decision that was bad for the company—when they fail to deliver—but good for him personally because he got a big bonus and resume bullet. Individual and firm incentives are often not aligned.

The Pac 12 likely has quite a few potential “individual versus collective” conflicts in this deal. Start with your lead adviser in The Raine Group. They are an investment bank. They don’t collect pay checks on deals that aren’t done. So they have an incentive to find a deal and, more importantly, to sell it really hard. If you know that, you can see why you need devil’s advocate, or you’ll only hear the positive case from the bank. Again, it’s not their ownership, and they get paid more based on a successful deal. Do you see that conflict of interest? (And if they get paid either way? Well, I mean that’s money straight from the university’s pockets.)

Second, I think there is a good chance that Larry Scott has a bonus structure tied to the distributions to schools. If that is true—and I don’t know for sure—then if he sells an equity stake and gives that to the schools, and calls it an increased distribution, he could collect a bigger bonus. That’s surely a conflict of interest, isn’t it? We can’t want the head of the Pac 12 to have a financial incentive in selling a portion of the equity because he would personally benefit in the short term do we?

How to Do it Part 1: Insist on the skeptical approach

Insist that the consultant you hire gives you the bad news. The skeptical approach. The takedown of your current strategy. At best, you’ll decide not to pursue an unwise course of action. At worst, she’ll identify flaws in the plan that can be corrected in time. So the key is an approach that interrogates the numbers harshly. That identifies all weaknesses and flaws in reasoning up front.

This person will need all the Pac 12 financials, ideally. They need the Excels and data too, not just power point summaries. Then they can build alternative models.

How to do it Part 2: Don’t hire anyone else who can profit from the Pac 12

Category one of this group is the Wasserman Media Group or IMG or any other sports media related entities. The bummer is they have tons of great knowledge to apply to this problem. The reason I still recommend avoiding them, though, is because their advice will likely come back to, “You should hire us instead!”, which is still conflicted. So only consider hiring them as a consultant if they sign something like a no-work clause for 20 years. (Or let them do a free analysis, and still have another Devil’s advocate.)

Category two is non-sports consultants, who are better but not perfect. The challenge with every consultancy is they also just want more business. Most of the recommendations will conveniently include “hire us for more analysis”. So you have to be careful. They are also plenty expensive and the Pac 12 is already spending some unknown fortune on consultants.

The problem with this recommendation—no matter how important it is—is that I’ve sort of eliminated the entire universe of potential partners. So consider getting creative with it, Pac 12 leadership. You have how many business schools in the Pac 12? Everyone or nearly all? Why not hire one of them to do this analysis? UCLA’s business school handles consulting projects all the time and even has a Sports Management club. They’d leap overthemselves to answer this question. In a dream scenario, have each club come up to an undisclosed location for a week, and make it a case competition. (And you know what? I’d take that work over a lot of consultancies…)

(Oh, I’m available too. And I guarantee my day rate is much less than all the people the Pac 12 is currently paying. If you are an athletic director and reach out to me, I’ll answer your questions. Seriously, my email is on the contact me page.)

Thought 2: Don’t Pay Bonuses Tied to This Deal

The key to “creating value” is to increase the willingness to pay for customers (in this case, distributors) or lowering the costs of producing your product. This is how smart strategists think about their customers and how to deliver products to them.

Selling ownership is neither!

Really, I can’t emphasize this enough. If you sell a part of yourself, you aren’t generating revenue, you’re giving part of you away. I’ll try to explain this in two ways. First, the traditional finance explanation. When you sell equity as a publicly traded company, you don’t report that on the “income statement”, which is about revenues that flow down to profits or losses, but on the “statement of cash flows” under “cash flows from financing activities”. This is because it is about generating cash, but not from business activities.

Here’s the common sense case for that. Take your house. If you take out a home equity loan, did you “generate” additional revenue? No, you got cash in your bank account, but you have to pay it back. In an equity sale, you do that by paying out a proportion of future earnings. If a company sells more stock, they don’t say they boosted revenue.

If the Pac 12 increases its distributions to schools based off this equity sale, then claims that this increased distributions to schools and hence bonuses tied to distributions should be paid out, then yell, “STOP!”. That’s using an accounting gimmick to boost salary. That would be crazy. (And if it happened, the UC Board of Regents should investigate or consider litigating, if their own universities won’t.)

Thought 3: Demand Accountability in All Consulting Payments

Just casually looking at the books of the Pac 12—via the Form 990s and Jon Wilner’s reporting—a lot of people get paid millions from the Pac 12. This is one of those situations that has me scratching my head. You pay your CEO the most of any conference, he has more higher paid lieutenants than other conferences and yet he still pays millions to other people to advise him what to do. (Right now another consultancy is reviewing officiating, but I definitely agree with that hire.)

If the Pac 12 wants to increase distributions, insist that the Pac 12 find the cash savings in consulting fees. I bet the Pac 12 could find $1 million per year, easy. You could likely do this immediately. (And if he or his lieutenants won’t, find someone who will.) I’m also not the first to suggest this, as both Pac 12 Jon/John have suggested it. 

 

(But seriously, keep the independent review of officiating. That’s needed.)

Did the Pac 12 Need a Strategic Partner – Director’s Commentary

(This article is Part 3 of my series on the Pac 12, including whether they should have brought on a strategic partner in 2012:

Did the Pac 12 Need a Strategic Partner in 2012? Part I at Athletic Director U
Did the Pac 12 Need a Strategic Partner in 2012? Part II at Athletic Director U)

When Athletic Director U reached out a couple months back, I knew I wanted to collaborate with them on an article. Live sports will be a key component of future digital video bundles, and they currently prop up MVPD bundles. And I love UCLA and college basketball/football. So that’s a no brainer on my end.

I don’t know if Athletic Director U knew what they were in for. When I finally sent in my finished piece, it had exploded to 3,000 words. It’s like a New Yorker article, destined to sit in an unread pile for being too long. (So we split it into two.)

I went deep into the Pac 12’s finances so, of course, I had extra ideas. Those ideas would have interrupted the flow I had and since I was long already, many of those thoughts ended up on the cutting room floor. So here they are, including additional homework assignments for myself (and hopefully follow-ups to Athletic Director’s U). Today is thoughts about the model and what I learned; tomorrow is an opinion article with my advice for the Pac 12 CEO Board, from a business perspective.

The Missing Piece: Bottom’s Up Analysis

My initial “concept of the operation” to value the Pac 12 was to roll out a back of the envelope, top down and bottom’s up look. Like most plans, it didn’t survive first contact with the enemy, which in this case was a lack of data. Here’s my half-built bottom’s up model:

Table 1 - Bottoms Up Model

It was still useful to build, even without the data, because I got a great sense of the drivers of the Pac 12 Network, and what I did and didn’t know. Still, a model with that many guesses instead of estimates would have misled more than it educated. How much does it cost to run the Pac 12? In what areas? How much do they make on advertising? I just don’t know.

Though, if I can ever get my hands on Pac 12 financials…

New Scenarios

One of the great things about building a model is, if you do it right, it can be very easy to update the model with a few inputs or tweaks and you can get a new output. And a few jump out that I absolutely want to build:

The $750 Million Equity Sale for 10%

I conveniently used $750 million valuation as the middle case in 2025, because that’s the number currently being trial ballooned by the Pac 12. (And it’s about one-third higher than the amount initially expected.) The key difference is this $750 comes a few years earlier than the 2024 “all distribution deals expire” scenario. Being 5 to 6 years earlier means the Pac 12 gets to keep more of the cash in a “time value of money” sense. So an equity sale could change the model. 

But not quite so fast. As hinted in today’s column by Jon Wilner, an equity sale isn’t a long term solution. If you get money up front now, presumably your equity partners gets paid later. (Otherwise, how do the bankers make their money back?) This would mean estimating how much distribution the partner gets starting in 2025. It’s really a trade off of cash flows. It isn’t about generating more revenue or cutting costs, but timeshiftimg your flow of cash. (More on this tomorrow.)

The ESPN Extension

This is an intriguing deal too. As reported by the Sports Business Journal and confirmed by Jon Wilner, instead of getting $750 million in equity sales, the Pac 12 could have extended their deal with ESPN to 2030, and ESPN would have taken over distribution (with a split of revenue, presumably) of the Pac 12 Networks. The Pac 12 passed on this deal and my gut is that makes sense, but I could still run the numbers on it to prove it.

A Higher Cost of Capital

Sensitivity analysis is the name of the game here. Basically, you test your model on various inputs to see how much it changes. I sort of already did that with the low, medium and high revenue loss scenarios. But the other big input is the “cost of capital” which is how much the Pac 12 would lose or gain depending on how much return it expects on its capital. As you’ll recall, the current WACC is 9.4% for entertainment, but I used a lower 8%. That was generous to the Pac 12.

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Most Important Story of the Week and Other Good Reads – 29 March 2019: Apple Unveils…More

This was supposed to be “WGAxit Week”. (Has that been coined yet?) I didn’t realize that voting started on Wednesday of last week and went for five days, so passed the deadline for this weekly “most important column”. (It will be next week’s story. It look like it passed, with 95% yes.) So fine, the story of the week is…

Most Important Story of the Week – Apple Unveils…More

Last week, we were looking forward to Apple unveiling something this week. And something was unveiled. In the entertainment space, “Apple Channels”–which is like Amazon Channels, but Apple–and Amazon TV Plus–which is like Disney Plus, but from Apple. Listen, I don’t want to be snarky here, but we still don’t know how well the product will work, what the content looks like, or how much it will cost. Those are almost all my categories to judge a product. (My 5Ps of digital video are: product-content, product-UX, pricing, placement and promotion.) 

Still, I have to opine. Here’s the good news. I’ll have another article up tomorrow at Decider that somehow ties predictions about Apple with Batman. I don’t want to step on that article’s toes.

But Apple’s entry is so monumental that even those 1,500+ words don’t capture all my thoughts. I was actually surprised I didn’t see any  “Winners and Losers: Apple TV Plus Launch” since those seem like the article de jour for media. So you know what? Shamelessly “borrowed” from The Ringer or Vox here are my winners and losers from the launch.

Winner – HBO

HBO is the must have streaming service that isn’t Netflix. AT&T is building a strategy around it. Hulu and Amazon had to have it. And once Apple sent invites, it had to get HBO on the platform for launch. I think Apple bent over backwards on deal terms to get it done. Sure, there were a bunch of stars in attendance for Apple, but the biggest star may have been HBO’s dragons.

Loser – Value Creation

When something is priced below market price, that should be the red flag of red flags that a company is using its size to “capture” value instead of “create” it. (And some of this is based on the surplus of rumors that Apple will charge $10 for HBO and Showtime.)

Ask yourself, if we know HBO and Showtime cost $15 on every other platform on the planet, how is Apple lowering the cost? I mean, it isn’t like Apple owns a factory where Apple created some more innovative method to manufacture “HBOs” and while it costs $15 for everyone else to “manufacture HBOs”, there method is 2/3rds cheaper. No, in a licensed content reality, every company negotiates with HBO to get authorization to distribute it. And they split the price customers pay. In the olden days–on cable–this was closer to 50/50 ($7.50 to Comcast, say, and $7.50 to HBO). The terms are better in OTT for the channels, so I believe it is now 70%-30%, as referenced here by Variety. Do that math and that means $4.50 to the distributor (say Amazon) and $10.50 to HBO. (Though, feel free to correct me if someone has seen the specific contracts.)

If those latter numbers are true, then Apple is paying $10.50 to HBO, and losing $0.50, while customers pay $10. That isn’t value creation. It’s value capture. It’s great for customers in the short term, but it just isn’t sustainable. It is like that old saw about “we’re losing money on every unit, but we’ll make it up in volume. Worse, I have a feeling HBO demanded extra fees in order to allow Apple to undercut their prices elsewhere. Or huge marketing spend commitments. Either way, Apple is losing money, which for most businesses (fine, all businesses) is unsustainable in the long run.

Winner – M-FAANGs being big, consolidated and boring

I’m gonna bang this drum for a little while longer. Almost all the M-FAANGs are getting into video. Almost all the M-FAANGs have a music service. Almost all the M-FAANGs have devices. Almost All the M-FAANGs have a social platform. Almost all the M-FAANGs are even launching subscription video services.

They enter each of these new lines of business (usually) not by developing some innovative new product or better operations, but by using size. That’s what Apple and Facebook are doing in video, what Google and Amazon are doing in gaming, and what they are all doing in devices.

Really, the only outlier here is Netflix: it is still just a video service, and I have to give them credit for that. They aren’t making a Netflix stick or a music channel or even a “Netflix for games”. And in a world with strong antitrust enforcement, I’d respect this. But I don’t think we live in a non-vertically integrated world anymore. So I worry about Netflix. (More on that tomorrow.)

Winner – Bundlers (and Loser: Everyone else)

I’m working on getting “bundler” to be used instead of  “aggregators”. Alan Wolk used “aggregators” in a piece that beat me to the punch and obviously Stratechery uses it constantly. But whether it is bundler or aggregator, the point is the same: I can’t look at the state of the industry, and not see a group of people looking to bundle video, and hence offer a lower price to everyone as a result. Sort of like the old cable bundle, but digital.

Netflix stands in the way of this, but just barely.  The big debate was, “Was Apple’s new launch a Netflix killer?” In a bundled world, Netflix looks like just another streaming channel. I made this the centerpiece of my article at Decider, so you can go there to read those thoughts tomorrow.

(Also, the dreams of both Apple and Amazon to own the entire content journey–via discovery and engagement–which means ending the concept of “apps” seems pretty far away. Even Apple admitted that, despite the hype, other bundlers like Hulu, Playstation TV and DirecTV Now won’t play inside their app.)

Loser – Traditional Cable TV

Cause, obviously? The more better options for cord cutters, the more people will switch.

Other Contender for Most Important Story – AT&T and Viacom Carriage Wars

Man, these black out fights feel old school now, don’t they? With all the news about Apple, and an old-fashioned carriage dispute doesn’t get the coverage it used to.

The thing we’re all looking for is that final change. That time when the blackout starts and never ends. (I suppose there is Dish and HBO, but that’s a premium channel, so viewed slightly differently and Dish and Univision, which also ended recently.) Tara Lachappelle in Bloomberg had the best take, linking to her article on why blackouts will become more frequent. In the end, Viacom and DirecTV ended up agreeing on an extension. So we continue to wait for when the cable bundle finally breaks.

Context – Ignore the yield curve (sorry Cardiff Garcia), but watch for Brexit.

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Read My Latest at Decider! Why Did Hulu Lower Their Price to $5.99?

Last week, I was thrilled to announce that I had a guest article at TVRev, and I’ve followed it up with an article over at Decider. The folks over at Decider asked me about the Hulu price decrease a few weeks back—which as I mention, was really a promotional price continuation—and at first I didn’t have an “angle” on it. But as I thought about it—and really as offers of free Hulu kept coming (by my count Spotify, WaPo, Sprint, with probably more)—I realized I had my view: This is just their “hook” to bring in customers.

So check it out and hopefully I’ll be appearing over at Decider from time to time.

Other Lessons from MoviePass’s Demise

Often, when I write a long article, I have extra thoughts. MoviePass—and its demise—may be my “story of the decade”, when judging off the “hype-to-cash flow” metric. (Remember when I used it to explain subscriptions? Or logarithmic distribution of returns?) Recently, I wrote about the lessons of MoviePass’s demise at TVRev (here for Part I or here for Part II).

Today’s article is is basically the “director’s commentary” of that guest article. Whenever I write a long article, invariably I have a ton of extra ideas. For example, in my first draft, I tried to find historical examples of companies that made my same mistakes. (What is old is new again, or just digital now.) I found some, but couldn’t find others—and I was already long—so I cut that idea from the initial article.

So what to do with all those extra pieces? Well, put them on my website! Enjoy more thoughts on MoviePass. Today is all about “additional lessons” to be learned from the fall of the mighty ticketing giant. These lessons weren’t as great as the initial four in my TVRev piece, but I still wanted to make them. Especially the first problem, which I see happening a lot. 

Lesson 5: Beware of upper 10% companies pitching themselves to the masses.

This is one of the underrated stories in business right now. You know who the business press doesn’t talk to a lot? Poor people. Sure, the political press ventures to Middle America to find Trump voters, and can’t help but write stories about the Dollar Store, but overall, most technology writers talk to software engineers or product managers or venture capitalists or lawyers or biz dev folks who are really, really well off. They don’t do a lot of interviews with the contract workers who are cleaning offices or serving meals or working in retail. (Unless it is an expose. But they don’t usually ask about their thoughts on the newest VC round.) 

(Politicians don’t know much more either, since most Congresspersons are millionaires. Same with the interns, whose parents are millionaires.)

There is a gap in lifestyles between the top 10% and the bottom 80%, especially the bottom 50% and the top 5%. MoviePass started as a top 10% company. If you’re an intern at a TV publication and your parents pay your rent, then yeah adding a $10 MoviePass subscription is no big deal. That doesn’t apply to a family eking by to pay rent every month. So MoviePass felt like an upper 10% product to me.

Who else does this apply to?

Not to pick on scooters again—as I did in my TVRev article—but they are a classic top 10% company. A lot of the initial hype around scooters billed them as a way to radically transform urban transformation. And suburban too! This never quite made sense to me, from a mass transit standpoint. If you can barely afford a car to get to work, can you afford a scooter ride?

Let’s do that math. Say you add a scooter to your daily commute. And it is $3 round trip per day (Which may be low, depending on the commute. This also means you live very close to work or to a bus stop, which I didn’t add to the costs.). Well, at the end of two years—assuming you found a scooter every day and never crashed—you’d have paid $1,440 to Bird or Lime or Uber.

Of course, you could have bought a scooter online for…$300.

Scooter rides aren’t replacing commuting (and the math on Uber is the same). Instead, my theory is that ridesharing and scooters are additional expenses to people’s lives. The majority of users—in Los Angeles at least—ride in Ubers or Lyft for convenience: Uber replaces one person in a group staying sober enough to drive when going to a concert or dinner. Any of the stories of people who gave up commuting for Ubers are invariably about wealthy business folks (definitely in the upper 10%).

Why do we get this so wrong? Because the early adopters are rich. At least upper 10%, but in some cases upper one-percenters. Given that they have the extra cash to pay for the convenience, they do it. And they assume this applies to everyone, even those scraping along at the bottom for pennies. This seems to be a feature of 2010 tech companies: they pitch themselves as cost saving, but are usually about adding convenience.

Uber/Lyft – Pay to avoid having to drive home from bars.

GrubHub/UberEats – Pay to avoid driving to fast food.

Amazon Prime – Pay to avoid having to drive to store.

Scooters – Pay to avoid walking.

The Grub Hub rise is the most fascinating one to me too. I mean, delivery from Thai or Chinese or pizza restaurants used to be free! Now we’re paying 10% on top? (In fairness, this convenience, can be value creating, it if boosts willingness to pay.)

The new wave of “bring it to you” from massages to house cleaning to car washes are just variations on the above principle: you used to drive to get it, now it comes to you, for a fee. Which doesn’t mean the companies above are doomed, but if the growth rate for a company—and hence its valuation—is built on 100% market penetration, ask if that is even financially feasible for lower income Americans.

Lesson 6: Beware who you sell your company to.

If MoviePass had been acquired by Amazon, wouldn’t it still be in business? Amazon would hide its revenue losses in some anonymous sub-category of its earnings—or add it as a benefit to Prime—and we’d have no idea what is happening. ($240 million a quarter? Piece of cake for Amazon.) Of course, I don’t mean to imply that Amazon has lost lots of money on other businesses it has acquired or built. But we don’t know, do we?

You can’t explain the demise of MoviePass without acknowledging that it got bought by the wrong company. It was acquired by Helios Matheson, a data company that couldn’t handle exorbitant losses month and after month. It could lose some millions as long as it stayed buzzy and that floated the stock price. But a not-Fortune 500 data company can’t handle losing tens of millions every month like an Amazon or a Netflix. 

Lesson 7: Beware wildly fluctuating prices and/or UX.

Some companies just feel shady to me. Some hallmarks for me are… 

Hastily designed websites. Honestly, do you trust a company who looks like they are working on HTML 2.0?

Dozens of subscription options. Why so many? Where is the catch? 

Or promotional pricing. Is it really 40% off today only? What is in the fine print?

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