Member Mailing: Has Netflix Shifted the Goalposts of The Streaming Game for Apple, Disney & Warner Bros. Discovery?
The past few weeks of PARQOR mailings have had a general theme: how each of the leading streamers has been (re)positioning themselves for growth.
There is the popular path of pivoting into AVOD which market leaders Disney+ and HBO Max have opted to reach a larger total addressable market (TAM). Then there is Netflix zagging where the market is zigging, building out a longer-term pivot into mobile games.
WarnerMedia also seems to be making a more aggressive push into gaming, according to a recent interview with current CEO Jason Kilar. Although, that push seems to be focused more on "immersive persistent environments" and less on mobile gaming
It is early days for both pivots: there are no guarantees of success in either, and expectation-setting with investors generally has been conservative, under-promise and over-deliver messaging. That said, after the past two PARQOR mailings (Was Netflix's Gaming Strategy Revealed In Its Boss Fight Entertainment Press Release? and Is Netflix's Mobile Games Strategy or Epic Games Antitrust Strategy Better vs. Apple?) we have a market signal that Netflix's objective in gaming is targeting a weakness in Apple's dominance of mobile gaming.
If that is indeed its objective - and, for the record, I believe it is - we do not have much insight into how Disney or WarnerMedia/Warner Bros. Discovery and leadership may be thinking about Netflix's gaming zig to their AVOD zag. Nor do we have much insight into how might Apple management be looking at Netflix after a surprise Oscar win on Sunday night. But, we can infer those dynamics from recent data and headlines.
Key Takeaways
The looming question in streaming is whether Netflix is shifting the goalposts of the game towards mobile gaming
The move invites more skepticism as to whether Disney has the right streaming model and management team in place
The move also risks undermining the story Warner Bros. Discovery CEO David Zaslav has been selling investors
But, the big X factor for Netflix's move into mobile gaming here is Apple's leverage over Netflix as a competitor
Netflix's Platform Software
Netflix's Spencer Neumann recently told the Morgan Stanley Technology, Media & Telecom Conference last month:
"[Gaming] is something I hope is a big part of our business in a decade," he said. "It is not going to be a big part of our business in the next 12 months.... The first year was really about getting the plumbing right... Now we're leaning into learning which games our members enjoy".
The "plumbing" of Netflix's software is evolving away from streaming and towards gaming, which is currently accessed by 220MM subscribers worldwide. Moreover, that new "plumbing" does not include advertising, which Neumann said is not something in Netflix's plans "right now"
The question, then, is what market opportunity will this new "plumbing" of mobile gaming solve for?
As I argued both last Friday and Monday, I think the opportunity lies in a TAM in mobile gaming that is currently $100B and of which Apple owns $45B. If Netflix can leverage its "ubiquitous access" (its ability to make its content available one click away to its subscribers both on-platform and off-platform (online and offline)), and 220MM subscribers to peel off 1% of that market, that's 3.4% growth in gross revenues annually, at least (off of $29.6B in annual revenue in 2021).
Global mobile gaming revenues are expected to reach $116B by 2024, according to market intelligence firm Newzoo, at a Compound Annual Growth Rate of 11.2%. Assuming that growth rate holds, the market will be as large as $150B by 2027.
Netflix seems to have no plans to change its subscription model - so it is expanding its value proposition while also redefining the value of a subscription for a streaming platform. Moreover, it is redefining what the software of a direct-to-consumer (DTC) streaming business model can and/or should offer its subscribers.
So, how are each of Netflix's competitors positioned to react to this pivot?
Disney
Target Scale: 230MM to 260MM subscribers in 2024
Disney has been slower at rolling out its streaming software, to date: An A/B/C/D test of various bundles across different regions (Disney+, Hulu, ESPN+, Disney+ and Star, Disney+ and Star+ in Latin America, Disney+ Hotstar in India) is ongoing. It has also had ongoing struggles in integrating Hulu operationally.
Moreover, Disney licenses its game development to third parties. There has been no in-house solution since 2016.
The looming question for Disney management is whether Netflix is now shifting the goalposts of the streaming game: meaning, if Netflix's streaming-only model was the right objective in 2019, it may no longer be the right objective in 2022. This change would come at an inopportune moment for Disney management: New CEO Bob Chapek has been under fire from a variety of directions only three months after former CEO Bob Iger left the premises.
Chapek has bet Disney's growth story on reaching 260MM subscribers by 2024, and recently delivered a still-controversial reorganization to achieve that objective. Its soon-to-launch ad-supported version of Disney+ is crucial to that strategy. The Disney+ AVOD is a bet that lower prices can drive more consumer sign-up and lower churn (reported to be an issue are open to streaming movies and TV series with ads.
The dangerous question facing Disney management is whether Netflix has done its homework and decided that there is more growth in gaming than in advertising. Because if it has, that means Chapek's team faces more tough questions at a time it could use a more favorable spotlight:
Have they opted for the right streaming strategy?
Do they risk over-promising and under-delivering with the Disney+ ad-supported model?
If Netflix is right and they will need to pivot the Disney+ software into gaming for growth, is that something management is positioned to do sooner than later?
And, if the answer to both questions is no, what moves can Chapek make to soothe investors worried about growth?
Disney's short-term growth story will remain strong: it just announced launch dates and pricing for 42 new countries and 11 territories across Europe, West Asia and Africa. It also beat estimates for total subscribers in FY Q1 2022 by 4MM (129.8 million vs 125.75 million expected), and grew ARPU in the domestic U.S. to $6.68/month year-over-year from $5.80 last year.
The announcement of the Disney+ ad-supported streaming service acknowledged that it needs to reach more consumers to ensure it hits that target. So, the odds of reaching 260MM may be lower than investors assume.
Fairly or unfairly, Netflix's pivot into gaming only invites more skepticism as to whether Disney has the right business model and management team in place for its streaming future.
WarnerMedia/Warner Bros. Discovery
Target Scale: 120MM to 150MM (pre-merger) in 2025, 400MM subscribers (post-merger)
The challenge for WarnerMedia and Warner Bros. Discovery is both similar to and slightly different than Disney's. It faces similar questions to Disney as to whether its HBO Max AVOD model helps it to scale and compete with Netflix. So far, according to AT&T CEO John Stankey, it has a decent story of solid-but-not-Hulu-like ARPU:
“The subscription line will possibly dilute a bit, but the advertising line will increase. So when you look at the customer overall, they’re no less profitable, it just books to two different places on the P&L. And our goal—and in fact, what we are seeing today—we are indifferent as to what the customer chooses. Frankly, maybe in some cases, it’s a bit more accretive if they go the ad-supported route.”
It is more interesting to ask whether HBO Max could find growth from imitating Netflix's move into mobile gaming.
First, WarnerMedia management have effectively transformed HBO Max's software into a purely DTC service (in its previous iteration as HBO Go, it originally relied heavily on Amazon Channels). That is unlike Disney+, which relies on "hard bundles" in France (Canal+) and UK (Sky). Those are not direct-to-consumer relationships because they involve Sky and Canal+ in the billing and software relationships. Also, Disney relies on two different platforms in the U.S. (BAMTech for Disney+ and ESPN+, and Hulu).
So, purely in terms of its software, WarnerMedia is better positioned than Disney to mirror Netflix's moves. Also, unlike Disney, it has gaming capabilities in-house (Disney has licensed gaming to third parties since 2016).
That said, its gaming strategy under current CEO Jason Kilar has been more ambitious than mobile gaming, and is focused on the emerging Metaverse business logic of "immersive persistent environments where our beloved characters are in Warner Brothers games". That points to more "metaverse", Fortnite role-playing models, as Kilar told Recode's Peter Kafka recently:
...It turns out that a lot of people that [gaming is] their first go-to choice when it comes to entertainment and we happen to be as you also said uniquely positioned, we have thousands of world-class talented game developers, we have a sandbox of IP that people would kill for when it comes to creating incredible immersive worlds we’re doing really well with it and so I happen to be very bullish on it because the consumers are very bullish on it.
So, it is not clear whether it could make that pivot into mobile gaming, now, if needed. A larger looming question for that gaming strategy is what will happen after the Warner Bros. Discovery (WBD) merger has been completed (which I wrote about recently in WarnerMedia & Netflix's Narrow but Fascinating Challenges in AVOD & Gaming). Incoming CEO David Zaslav has yet to mention gaming in his discussion of WBD with investors. Also, like other legacy media companies, Discovery has been risk-averse in gaming. So, gaming may not be a priority for incoming management.
That said, the risk for Zaslav is - if Netflix is indeed now shifting the goalposts of the streaming game - growth-oriented investors shifting their spotlight away from streaming and onto those gaming capabilities. If that happens, the story Zaslav has been selling investors on the merger - lower churn and more global scale with the merged libraries of Discovery and WarnerMedia - risks losing its popular appeal, and odds of improving the stock's Price-to-Earnings ratio, despite the solid finances of the bet.
In particular, the challenge for WBD will be the story of TAM: global AVOD revenues are projected to reach $56B by 2024, according to Digital TV Research, but global mobile gaming revenues are expected to reach $116B by 2024, according to Newzoo (above). So, the TAM in mobile gaming is trending more than 2x greater than the TAM for AVOD: The pie for Netflix's new mobile gaming model always will be larger than the pie for its nearest competitors Disney+ and HBO Max.
It is also worth noting that whereas Netflix would be competing with Apple and Google within their own stores, ad-supported models have a wider set of competitors in SVOD and FAST (free ad-supported TV).
Will that challenge matter to Warner Bros. Discovery management? Their messaging, to date, has been focused more on a strong balance sheet and sound financial model for a business with its feet in both linear and streaming. So perhaps not.
The risks, instead, are the market dynamics Paramount Global has been navigating recently: investors who understand streaming and DTC growth may not reward a streaming growth story with a higher Price-to-Earnings ratio. A mobile gaming strategy from WBD may be rewarded with higher a "streaming multiple" because the TAM is clearer, and is defined less by aspiration and more by disruption. Those dynamics must be weighing on incoming WBD management.
Apple
Target Scale for TV+: N/A
The big X factor for Netflix's move into mobile gaming here is Apple. The obvious challenge is Apple controls the App Store, and therefore controls distribution to over 1.7B active devices worldwide (excluding over 100MM Apple Watches). Netflix distributes via the App Store, but since 2019 has not offered in-app subscriptions through the App Store (meaning, users cannot be billed by Apple).
But the other challenge, in a less riskier form, is Apple's success at the Oscars on Sunday. Apple TV+ became the first streaming service to win a Best Movie Oscar. It has less than 10% of the scale of Netflix globally (20MM paying subscribers and 40MM global accounts), but has accomplished Netflix's longtime, cherished objective with its first Oscar-nomination for Best Movie (Netflix has had seven Best Picture nominees). In this narrow sense of competition, Apple has dealt a painful blow to Netflix's reputation with talent.
Apple seems to be picking a tactical battle with Netflix in the Oscars, and Netflix seems to be picking a tactical battle with Apple around mobile gaming. Impressively, both have identified unhappy customers and/or key partners in the other's model, and both have built strategies that have early wins in addressing the pain points of those unhappy customers and/or key partners.
But, the upside to Netflix in disrupting Apple's $45B in annual mobile gaming revenues is significantly greater than anything Apple may pull off at the Oscars. On the flip side, the existential damage Apple can inflict upon Netflix for any misstep in the attempt to disrupt its hold over mobile gaming is far greater than anything Netflix can do to Apple in Hollywood.
This is a market asymmetry that Netflix must carefully navigate, even if there may be hundreds or thousands other developers who need an alternative to the economics of distribution on iOS and Android devices.
The "Vibe Shift"
As I wrote in The Information earlier this month, both Disney's and HBO Max's move into ad-supported models, and Netflix's move into mobile gaming reflect a "vibe shift" happening in streaming.
If we assume Netflix's Boss Fight Entertainment acquisition has provided the clearest signal of the TAM for Netflix's "vibe shift", the pieces align in the streaming marketplace very differently from how we have been assuming to date. I think there are two big questions that emerge from the above analysis about this "vibe shift".
1. What if the opportunity in AVOD is much smaller than Disney and WarnerMedia are assuming?
The TAM in AVOD is and will always be half of mobile gaming. There are also other factors to consider in AVOD, like advertisers not spending enough on reach in Connected TV (according to an Innovid/ANA survey from October ), or the murkiness of the Connected TV marketplace. It may be that a lower price will help Disney+ and HBO Max reach subscriber goals, but little more.
2. Will Apple allow itself to be disrupted in mobile gaming?
Epic Games tried to disrupt Apple's hold on the gaming marketplace via "Project Liberty" and its antitrust lawsuit. Despite some tactical victories in incremental changes to App Store policies (also Google lowering its fees), the strategy has failed (Epic is now appealing the ruling).
Netflix seems to have a more limited objective: after the Boss Fight Entertainment press release it now has bought three smaller developers, it can afford to buy more and it can partner with others should it choose to do so. The more smaller developers it can make happy within its ecosystem, the larger the sliver of a growing marketplace it can peel off.
But, those smaller developers will still be in Apple's ecosystem (and Google's, too), just via Netflix and with a different business model. The more developers Netflix brings into its ecosystem, the more disruptive Netflix becomes to Apple's mobile gaming business. Another way to say that is, the more unhappy smaller developers Netflix can partner with, the more disruptive Netflix becomes to Apple's mobile gaming business.
That means it is worth imagining why Apple might react to this move into mobile gaming from Netflix, and also why it might not react.
If games help to reduce churn of Netflix subscribers, Apple may be happy with lower churn from existing Netflix subscribers who still are billed through Apple and not directly by Netflix (meaning, Netflix ended billing via Apple in December 2019, so this would be all Netflix subscribers on Apple devices who have not churned out).
But Netflix is also betting on games to drive growth, and Apple will not see any of that new revenue. So, the loss of market share will be an actual loss of App Store revenues to Apple (an estimated gross of $70.58B to $85.71B in 2021).
It is not yet clear how much market share Netflix can capture, or what market share will trigger a defensive response from Apple. But, investors and Netflix executives betting on Netflix's growth through gaming will need to have a clear sense of what those outcomes will look like, as those may be do-or-die scenarios.
Conclusion
Netflix's shift to gaming is not a reflection of declining demand for streaming. Rather, it reflects higher churn - especially among Millenials and Gen Z, according to a recent Deloitte Digital Media Trends survey - and growing competition limiting the pool of remaining subscribers. In some ways, it may be harder to for streamers sell investors on the capture of a share of an estimated remaining pool of subscribers than for Netflix to sell the capture of a share of an existing mobile gaming marketplace.
That said, it may seem counterintuitive to conclude that Disney+ and HBO Max still may have more guaranteed paths to growth than Netflix. There is no existential risk to their streaming businesses from pursuing an AVOD like there is an existential risk for Netflix to pursue a mobile gaming business. There is no Apple-like figure in their paths who can turn off access to 1.7B active devices.
So, the more success Netflix has in this pivot in gaming, the more risk it will be taking on in its distribution relationships with Apple and Google. With more risk will come more fascinating marketplace tensions in this "vibe shift" market moment. Apple may be the most significant obstacle to Netflix's future success in gaming, and also in streaming.