So long Netflix?

So long Netflix?
Photo by Thibault Penin / Unsplash

Due to their earnings report yesterday, there's a lot of doom and gloom coming Netflix's way. This is because whenever there's blood in the water – even from a paper cut – sharks circle about.

The typical talking heads have made their rounds. Elon Musk even chimed in. While I certainly don't think failure is a certainty – Netflix is still the market leader in streaming video – I largely agree that Netflix is in trouble, but not for the reasons many people think.

Yesterday, Mel Conway responded to my blog post about Palm, and sent me this paper he wrote. His general point is that almost every organization is prone to unfairness. This is especially true for commerce.

He speaks about unfairness in realms of inheritance, buyer communication, and then finally how large capital markets inevitably lead to oligarchy.

On that last point, he shared a chart about the threshold of profitability.

Graph showing threshold of profitability

Conway infers that, in almost all industries, few companies need to worry if they're #1 or #2 – but when they're #3, that's the point where life becomes hard.

This is generally true. When we look at mobile operating systems, there's Android and iOS, but what's #3? At one time, it may have been WebOS, Symbian, Windows Phone, and so on. Yet, all of them have been largely discontinued.

Or how about cola. There's Coca-Cola and Pepsi-Cola – but who's #3?

How to stay a market leader – cheaply

Being #1 or #2 is not necessarily good enough. That's because other companies may look at your profit margins and want a cut of it. So how to defend – especially when those other companies are #1 and #2 in different industries, and are sitting pretty with their cash cows?

Through acquisitions!

Graph showing market leader acquiring a loser

In Conway's words:

That’s Mega Global Enterprises there swallowing up a loser now. How
does MGE do it? With cheap stock.
By “cheap” I mean “cheap to existing shareholders but valuable to the
seller”. In other words, high-priced stock.
MGE must maintain its leadership so it doesn’t slide into the Long Tail. It
does this by growing. The cheapest way to grow is through acquisition.
MGE maintains its leadership by growing and using its growth to keep
its stock price up so it can grow through acquisition. Do you see the
circularity there?

Hence why there's a correlation with industrial and stock markets. In order to grow its business, corporations must increase the value of their stock. This is so they can acquire more companies that will grow their business, which will grow the value of their stock, so on and so forth.

The positive feedback loop of industrial and equities markets

The Problem of Valuation

But wait! What does this have to do with Netflix? As this next chart shows, it is true that Netflix is the market leader when it comes to streaming video.

However let's compare Netflix to its competition in terms of market cap.

  • Apple (owner of Apple TV+) - $2.23 trillion
  • Google (owner of YouTube) - $1.69 trillion
  • Amazon (owner of Prime Video) - $1.57 trillion
  • Disney (owner of Disney+, ESPN+, partial owner of Hulu)- $240 billion
  • Comcast (owner of Peacock, partial owner of Hulu) - $214 billion
  • Netflix - $100 billion

There we see the problem. Netflix might be #1 in streaming video, but it's #6 in terms of valuation. Why is this?

It's because Netflix's sole cash cow is streaming video whereas its competitors have diversified in other industries. What's more, over the past 10 years, Netflix has neither entered other lines of business, innovated brand new industries, now acquired competitors.

This is dangerous for Netflix. Its competitors may fail at video streaming, but they always have their cash cows to fall back on. Meanwhile, any hiccup from Netflix could spell doom.

What can save Netflix?

As I said, Netflix still has options. Here's three that come to mind:

  1. Acquire Paramount Global. This gives them another streaming service, a TV network, premium content from Showtime, Nickelodeon, and MTV, as well as franchises like Star Trek.
  2. Acquire Roku. This gives them a digital player option that competes with Apple, Google, and Amazon's offerings.
  3. Acquire Valve. This gives them a video game distribution service as well as cloud gaming technology that competes with Google Stadia, GeForce Now, and Playstation Now.

You might notice that all these options all point to the same thing: acquiring another company. This is because I don't believe Netflix currently has the option to innovate its way out of trouble. I see no evidence that Netflix has a bold blue ocean strategy.

The only thing Netflix can do is buy its way into innovation. This often works wonders for companies in trouble. Apple's turnaround started when they bought NeXT. The same thing happened when AMD bought ATI.

Personally, do I want this to happen? Not at all. Yet this is how capitalism works. The big fish eats the small fish – unless the small fish act as piranhas and chew the big fish to the bone.