In Q2 2023, PARQOR will be focusing on three trends. This essay covers all three trends.
To remind you, PARQOR identifies a few key trends each fiscal quarter that reveal the most important tensions and seismic shifts in the media marketplace. Must-read stories or market developments are not always obvious from press reports or research analysis, and often require a deeper dive. PARQOR’s analysis questions established ideas and common wisdom, reassesses the moving pieces, and reveals the potential in the media marketplace in 2023.
I love the Tom Hanks quote that I found in the book “Powerhouse: The Untold Story of Hollywood's Creative Artists Agency”, and recently used in my latest Medium Shift column:
“Every movie, every mom-and-pop chain rental store had to buy at least one copy—two or three if they wanted to make sure they could always have something for their customers. So that meant two or three copies times how many video stores were there across the country, half a million? Suddenly the VHS business was bringing in big money.”
It mirrors a quote I used in “The Linklater Problem” essay from Alan Payne’s book “Built to Fail”:
The video rental industry also launched and funded an unprecedented independent film movement. Films that previously would have never been made found an enthusiastic audience in the video store. As Quentin Tarantino put it: “From 1988 to 1992, people [movie producers] were all of a sudden getting $800,000 or $1 million or $1.2 million to make their little genre movie.”
Two of the biggest Hollywood creative talents of the past thirty years are saying that “free money’ from the VHS and DVD rental market has fueled the film industry’s growth. The decline of the DVD rental business suggests that “free money” from the rental business is approaching an end, and no alternatives have emerged.
Except that is not quite true: the past decade also has seen media companies and Netflix take on billions in debt fueled by zero interest rate policies (ZIRP) from central banks. In turn, that has enabled streaming services to spend billions of dollars annually to produce content. That was “free money”, too.
In other words, this moment in the media marketplace can be summed up as “It's about the free money... and it's about the free money.”
Key Takeaway
The first “It's about the free money” reflects how DVDs and VHS have subsidized the media industry, to date. The second reflects the two newer versions of “free money” to subsidize media companies during the streaming era. We are now witnessing the slow death of the first and weaknesses emerging in the second.
Total words: 1,900
Total time reading: 8 minutes
It’s about the free money…
This idea is inspired by another quote in “Powerhouse” from producer Joel Silver:
“There's an expression around Hollywood that I actually think was coined by Allen Grubman, a New York music business attorney, ‘It's not about the money ... it's about the money’. Money colors everything, and now it was about the money.”
I believe the expression Silver is referring to is from 20th century author H.L. Mencken: “When somebody says it’s not about the money, it’s about the money.” I think it means, for all the talk of the importance of creativity, show business is still a business.
So, the first “It's about the free money” reflects the distortive impact “free money” has had on the media industry. To date. I have written about two sources of “free money”:
The DVD and VHS rental market, above, and
Affiliate revenues from the linear TV business model.
I wrote about subsidies for the linear model recently in “Subsidies In a Streaming World”:
The bundle business model of cable networks aggregates multiple television channels and charges consumers a lump fee for a bundle of channels offered by AMC Networks, Paramount, NBCUniversal, Warner Bros. Discovery and others. As the retailer, they charge a fee for accessing their customer bases, often millions of households at scale. For example, Comcast currently has 15.5 million cable households and they generated $21.3B from those households, effectively $1.775 billion per month or $115 per household. That $115 “fee” is the aggregate of all fees Comcast is charging to networks to reach *all* households within a cable network.
Before cord-cutting trends accelerated, the model enabled the TV industry to build out more linear channels, which in turn subsidized both more scripted and unscripted productions.
In short, both the TV and movie industries — as we understand them today — are the product of “free money”. That source of capital is steadily disappearing as cord-cutting accelerates and movie distribution evolves towards streaming.
“…and it's about the free money.”
Nature abhors a vacuum, so what will replace “free money”?
Over the past decade, there have been two answers to that question. The first version is actual “free” money created by ZIRP from central banks, globally. Debt has been dirt-cheap, Wall Street encouraged media companies to take on debt to build out streaming businesses, and that dirt-cheap debt has funded content investments to the tune of hundreds of billions of dollars over the past decades.
Netflix appears to be the only business to have come out of the past decade with a profitable business model and not burdened by billions of dollars of debt. [1]
The second version is that the annual content spend from tech companies like Amazon ($16.6 billion in 2023) and Apple ($6.5 billion in 2022) also has been “free money”. I recently wrote about how Apple’s $6B seems like a protective subsidy for Hollywood as legacy media companies have started cutting content spend because it protects traditional, higher quality Hollywood content production (which Apple TV+ mostly produces and distributes). The same is true for Amazon, which has doled out over $1 billion towards its Lord of the Rings franchise, “The Rings of Power”.
These business models don’t rely on the first type of “free money” (DVD rentals) to succeed. In fact, it is not quite clear what the standards of success are and therefore even less clear how and why this “free money” business model works. This question was aptly summed up by IAC Chair Barry Diller in a 2019 interview with Kara Swisher that Amazon’s model “to people in the entertainment business, is like, ‘Oh my god, how did that happen?’”
WGA & “free money”
The Writer’s Guild of America (WGA) strike is asking the same question Diller had four years ago. Because the streaming production model pioneered by Netflix has done away with the residual model which came with the legacy broadcast, linear and movie businesses, and Amazon, Apple and others have followed in applying it. The impact seems to have been hardest on TV series writers, for whom half of their work comes from streaming.
Residuals are income from secondary distribution channels and so they have historically relied in part on the first type of“free money”, DVD and VHS rentals. Now, new media (basically, streaming) reuse of theatrical films is the largest residuals market for movies, having increased by 432.7% from 2016 to 2021. New media reuse of traditional media shows increased by 162.4% from 2016 to 2021, making it by far the largest TV residuals market. Those residuals generated $108.8 million in 2021. New media reuse of high-budget streaming shows increased 5855.6% over that same period, accounting for $26.8 million in 2021 and making it the third-largest TV residuals market.
Charles Slocum, assistant executive director at the WGA West, told Deadline that the problem was not in the size of the residuals, but in how they are allocated:
“In streaming, the companies have not agreed to pay residuals at the same level as broadcast, or the same reward-for-success as they have traditionally paid in broadcast. If you write for a streamer, you get two residuals payments – one for domestic streaming and one for foreign streaming. It’s a set amount of money. If it’s a big hit, you do not get paid more residuals in streaming, whereas in the broadcast model, you do because of its success. That’s the sense that residuals were slashed – they have not agreed to a success factor when a program is made for streaming.”
In other words, streaming indeed has generated a new pool of “free money”, but its impact on the Hollywood industry seems muted when compared to the precedent of the DVD and VHS era.
…and what about sports?
As I wrote in March, there has been no bigger beneficiary from the “free money” of linear subsidies than live sports:
The fundamental value proposition of RSNs [regional sports network] programming is live sports, replays, and nostalgia, the latter two of which I have labeled “filler content” in the past. That programming has provided MVPDS [multichannel video programming distributors] and advertisers with the valuable demographic of 18-34-year-old males with disposable income to watch sports. For these reasons and more, MVPDs have been willing to pay high carriage fees to carry these networks, sometimes over $6.00 per subscriber (ESPN charges MVPDs nearly $10 per subscriber.
Both the ongoing bankruptcy of Sinclair Broadcasting’s Diamond Sports Group and growing questions about ESPN’s post-linear future are also ultimately questions about “free money”. The Phoenix Suns and Phoenix Mercury recently announced a new distribution deal that puts all of their live games on over-the-air broadcast channels, and gives video streamer Kiswe the rights to deliver 100% of the games through its streaming platform. The deal would mean they leave Bally Sports Arizona, the regional sports network that currently distributes both and is owned by Diamond Sports Group.
That move makes a few bets. First, it assumes there will no longer be “free money” in sports distribution in a post-linear world. Second, it bets on the scale of over-the-air broadcasting which reaches 2.8 million households in Arizona, more than triple the current number of homes the Suns and Mercury distribute to. Almost two in ten (18%) TV content viewers report having a digital antenna, according to Horowitz Research. Last, a big part of both bets is the emergence of ATSC 3.0, a next-generation broadcast format that supports 4K, HDR, Dolby Atmos audio, and interactive apps over the air. It is free, and no cable or streaming subscription is required.
Meanwhile, ESPN Chairman Jimmy Pitaro told Bloomberg this week:
“We’re going to get to a point where we take our entire network, our flagship programming, and make it available direct to consumer,” Pitaro said. “That’s a ‘when,’ not an ‘if’….We’re only going to do it when it makes sense for our business and for our bottom line.”
In other words, unlike the Phoenix Suns and Mercury, Pitaro is saying that the best business model for sports distribution is to rely on “free money” from linear until or unless it faces no other choice.
Looking ahead
The move by the Phoenix Suns and the Mercury is a bit disingenuous in this light, and also in light of the expression “When somebody says it’s not about the money, it’s about the money.” Former Fox Sports head of research Pat Crakes tweeted after the announcement:
“Expect Suns to launch non-exclusive RSN that PayTV distributors can tier. Also, expect Paytv distributors to cooperate on DTC distribution & participate on upside. Finally, look for pay walled enabled game distribution on broadcast via ATSC 3.0 transmission format…”
In short, Crakes is arguing the sports distribution model still needs to be subsidized partially by “free money” even when it claims it doesn’t. Linear distribution may be declining but it is projected to stabilize at 50 million households. “Free money” will exist, though at a smaller scale, and the marketplace will find ways to replace it.
As for Hollywood, the residuals data emerging from the writer’s strike tells a good story for streaming, and perhaps better than the cynics had expected. But, as subscription streaming growth flatlines, streaming losses remain in the billions — Paramount global reported $511 million in streaming losses from the last quarter, alone. As consumers increasingly consume FASTS and other free services, the revenues available for media companies to pay residuals are going to decrease.
In “free money” terms, there is less and less old “free money” available to pay residuals or to subsidize sports teams with RSNs. The new “free money” is trending towards being insufficient for legacy media companies to continue to operate as is (as AMC Networks CEO James Dolan recently warned investors) and for sports teams to afford their team salaries (as I wrote in March). The model needs a new source of “free money” because nothing else seems to be delivering sufficient returns.
Again, Nature abhors a vacuum, but what is that alternative? Right now, no one has a good answer except for Amazon, Apple and Netflix.
Footnote
[1] It is worth noting that Netflix falls into a grey area here because it is both a technology company and a media company. Its content investment strategy has evolved quite a bit since it launched its originals with “House of Cards” and is currently in its “gourmet cheeseburger” phase, as Chief Content Officer Bela Bajara recently described it, offering TV shows that are both premium and commercial at the same time.
For those interested, I have written multiple essays on the topic of subsidies over the past two months:
I first wrote about subsidies last October in "Where Are The Profits To Drive The Flywheels (And Vice Versa)?"
Subscribers on the free trial tier may reach out to me for copies of any of these.