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click to see where I found this image; come on, how could I *not* use it?GDP is “the size of our economy,” the sum total of goods and services produced by “our economy” consolidated into a single dollar figure. In case you didn’t already know this, how big it is, and how fast its growing, is considered by many observers to be important. When it doesn’t seem to be growing as fast as it was in the past, people write books.

It’s also probably not surprising to anyone who reads this blog (BREAKING: it still exists) that how we measure GDP is, when you dig into it, at least a little weird. For starters, the border between what is and isn’t “the economy” as opposed to “stuff people do with their time” is a little fuzzy. Plus, stuff that seems to definitely be party of “the economy” is occasionally hard to measure. This ends up with the rent that homeowners don’t actually pay themselves but are “imputed” to pay themselves to work out to be 5-10% of all of GDP!

When you think about it, that isn’t wrong—we obviously spend a lot of money building houses, buying new and used houses, fixing broken houses, and renting houses we don’t own, in a way that suggests a) houses are definitely part of the economy and b) if we don’t measure the benefits homeowners get from owning very larger economic objects then GDP will look weird as a result. The folks who do this for a living explain it better and more thoroughly than I can.

But when you think about it, it does suggest that the legal and economic structure of relationships between people and institutions can matter a lot in deciding what does and doesn’t go into GDP. To wit, let’s visit a parallel universe, one where America is just the same as it is today except for one big difference.

In this universe, there is a very popular thing called The Netflix Organization that millions of Americans use to stream content. Everything physically and institutionally about The Netflix Organization and how people use it is the same as Netflix in our universe, but legally it’s structured just a little differently:

  • The Netflix Organization is collectively owned by its members, not its shareholders.
  • Its shareholders are actually all creditors who just have a set of unusually-structured debt contracts with the Netflix Organization.
  • The monthly fees that owners pay to The Netflix Organization are actually collective contributions by the owners to
    • pay organization staff and other costs;
    • service debt payments (actual debt + dividends in our universe)
    • cover depreciation; and
    • engage in capital improvements (improving streaming performance and UIs, creating and buying rights to new content).

So here’s what would be weird about this universe—if you just left it here, GDP would be exactly the same as it is in our universe. But you wouldn’t just leave it here. Because the owners of Netflix don’t seem to be making any income! Yet they’re collectively paying billions every year to support this capital that they collectively own, which wouldn’t make any sense if it wasn’t producing economic value to its owners. So you need to impute the value of streaming Netflix content to users, and consider that economic output that would be added to GDP.

And depending on how you calculate it, that’s a lot of value. Netflix claims American users streamed 42.5 billion hours of content last year. How would you impute a dollar value onto that? Well, an average movie ticket last year cost $8.43. The average movie is around 2 hours; so you could impute a value of $4.215/hour streamed. But of course each hour streamed is probably viewed by more than one person; let’s just stipulate that the average works out to around two.

You would then impute a value of Netflix Organization income to its owners of $358 billion—which would add around 2% to 2015 GDP! And not only that—Netflix streaming is growing rapidly, from 29 billion hours in 2014. That figure would’ve only added 1.3-1.4% to 2014 GDP; put another way, the growth in Netflix streaming alone boosted nominal GDP growth by 0.6-0.7 percentage points last year.

Now, the assumptions I used to impute economic value to Netflix streaming are more than challengeable. But the point is that, in this parallel universe, you would very likely have to go through the exercise and impute something. We don’t do that in our universe because Netflix is considered to be selling a product to consumers, and therefore the product is automatically valued at the purchase price when it’s considered for addition to GDP. Which is fine! Fundamentally what I’ve done above is to rearrange a bunch of activity not considered economic in our current framework into something different purely on paper, with no real world change, and yet prompt a potential—and potentially large—reevaluation of our core economic metric.

The point of this exercise—and this post—isn’t that “GDP is bad” or “GDP isn’t accounting for disruptive tech, bro” or “the Lucas critique/Goodhart’s law/Cambell’s law,” although it necessarily includes a little of all those things. It’s mostly just that there’s an inherently arbitrary nature to measuring anything, and that if you want to measure something, you should probably measure it in a lot of different ways.

When I read Erik Kain’s post yesterday about how the Ouya has essentially failed, my immediate response was “well, of course, the video game industry is drawing dead.” Let me explain what I mean.

When technological innovation leads to a new product class that catches in, there is an initial phase called the adoption phase which is characterized by large and rapid growth, continued innovation, and something of a mania around the product and industry. We saw that with video games in the ’90s.

But when an industry becomes mature, sales plateau as the product becomes a more banal part of everyday life and the mania generally declines. This can sometimes be wrenching for an industry, especially since what worked before no longer works now. They may fail to realize that no amount of innovation can change the total magnitude of the industry relative to life in general, just compete within the bounds of that magnitude. Firms whose models were built implicitly around a continuation of the adoption phase will fail.

To give you a concrete example, here’s car sales per thousand souls in the US since Ted Turner bought the Braves:

fredgraph

Beyond the extreme sensistivity to business cycles, what you see is that, despite the fact that the quality improvements in American cars since the days of Nader’s Raiders has been extraordinary in safety, comfort, fuel efficiency, pollution mitigation, and other cool accessory features, it hasn’t convinced Americans to buy more car overall. This pattern is clearly taking hold in the video game industry:

Screen Shot 2014-03-08 at 8.00.29 AM

Now, let’s be a little clear here – mobile gaming has done a lot for the category of industry we’re calling “video games.” But that’s because it expanded the boundary of what video games were, not because it convinced people to spend more time playing what, up through 2007-08, we referred to as “video games.” My mother plays plenty of Candy Crush Amazing Epic Super Saga: Incredible Journey of Candy Gilgamesh or whatever but that hasn’t convinced her to take up Halo (though the image of my mother pwning and trash-talking on XBox Live is pretty hilarious). In a sense, this growth is illusory insofar as you are considering the growth of console and PC gaming. That’s really clear when you look at this:

Screen Shot 2014-03-08 at 8.00.56 AM

Video games, methinks, have entered the phase in their life where they are no longer stealing American hours from other activities; indeed, if anything, the rise of Netflix, board games, and some backlash against video games probably means equilibrium per-capita video game hours will end up settling at a lower number than they currently are. The Ouya was implicitly premised on the idea that it wasn’t competing with existing consoles; it wasn’t doing what they were doing better or differently, it was trying to convince people to do something new. But for most people, if they weren’t playing video games, they were just doing something else. The Ouya was drawing dead because video games are drawing dead. That doesn’t mean the industry is going to implode; it just means its moved on to fierce competition for limited market share rather than explosive overall growth.

so tell them haters cut it out like a coupon

Some businesses sell stuff a la carte; in fact, most do. You offer a number of thingamabobs for sale of varying quality and price, and hopefully enough people buy enough thingamabob that revenues exceed costs. There’s nothing wrong with this model, exactly; but if I were starting a business today, it wouldn’t be what I do.

I would try to turn customers into bonds.

Bonds, from an investor’s perspective, have key desirable properties – they offer regular, predictable, reliable payments. If you own a portfolio of solid bonds, barring a large and sweeping crisis, you can probably plan confidently for a large chunk of future.

For a company, then, if they can turn your unpredictable, lumpy purchases into a steady stream of predictable income, they also gain similarly. Many, if not most, of the businesses that have come to define the modern landscape do exactly this.

The obvious answer is Netflix, but in that realm there is also Hulu and Redbox; in music, Pandora, Spotify, and Grooveshark want you to subscribe. Amazon has Prime, and also individual product subscriptions, and also owns Audible, which wants you to subscribe to audiobooks. Dropbox is a must, and plenty of people subscribe to Evernote Premium as well. Feedly does it, as does Instapaper. LinkedIn does it. Zipcar and Car2Go want you to pay monthly for access. Apple, the king of a la carte selling, has iCloud. Shoot, even my local bikeshare system wants me to subscribe. And this says nothing about your friendly neighborhood broadband and cellular providers.

This isn’t earthshaking, exactly, but it’s worth examining why this model is taking off. It’s not new – it’s how newspapers and magazines, ironically, have stayed afloat for decades and now can’t seem to continue as free content floods the intertubes. But there are key reasons that now is the The Big Moment for subscriptions. Credit and debit cards are a big one – everybody has them, everybody uses them all the time. The internet is another, both from the consumer and producer standpoint. And these combine to produce interesting effects. Essentially, these services can give you the satisfying illusion of freeness – after the first instance, you never have to perform the act of payment again. Even if I only watch 3-4 Netflix movies a month, somehow it feels much more painful to individually rent those movies from Blockbuster, Vudu, iTunes, etc then it does to just watch them on Netflix. There are also concrete upsides, of course, like freeing oneself from the mental grip of the sunk cost fallacy – if you paid $5 to rent a movie that turns out to suck, you’re going to hold out a lot longer then if you just clicked it on Netflix.

The model also makes sense because so many of the firms I listed above have high fixed costs but low marginal costs, meaning that precisely metering access isn’t profit-maximizing. It’s also why many of them can so liberally give away sample service or even permanent not-quite-premium service to so many people.

There is also the bank-shot variation of this model, where you give it all away to  “customers” who then provide you with a steady, reliable stream of eyeballs, and then you sell those eyeballs to advertisers. I will not patronize you by listing the beneficiaries of this model.

These models have the downsides, compared to actual bonds, of being less reliable and predictable relative to actual bonds:

aol-netflix-march2013

Note both the brief stagnation and even decline of Netflix subscribers in the Qwikster-House of Cards interregnum; also note the large, secular decline of people paying monthly for crappy email and browser services.

But if you can make it work as a business, this model offers huge advantages over the boring old-school model of just selling unit-by-unit stuff; for the consumer, it remains to be seen. God knows I am paying a startling share of my income in monthly subscriptions, and certainly it feels more painless then it would to buy a lot of this stuff unit-by-unit; but is it actually saving me money, or just mental anguish? And is saving the latter worth spending the former?

Concluding note: I was surprised to learn yesterday that a business idea I pitched to Mrs. Rooted yesterday turned out to totally already exist and be called Tile; the one difference, of course, is that I pitched it as a subscription service whereas Tile is a la carte. Hmmm…

i'm from the government and i'm here to ZOMG RED POINTY DOT

Kevin Drum on Netflix:

What I wonder is what happens when Netflix eventually drops the disc-by-mail service that gave it its start. That’s inevitable, isn’t it? And when it happens, it will mean there’s really no place left to find a large selection of older movies to watch. The old brick-and-mortar stores will be gone, driven out of business by Netflix, and thanks to licensing wars, no streaming service will be available with a broad selection. People like me will actually be worse off than we were a decade ago.

First of all, I’m not certain this is true. Just because a movie’s not on Netflix doesn’t mean it’s not available for streaming. I challenge Kevin to find a movie that he could not instantly summon using canistream.it – which, BTW, may be the finest internet site of all time. He will find some, I’m sure. Just not many! And most of the ones he couldn’t find would be flicks he’d’ve been hard-pressed to find at any brick-and-mortar store ten years ago, that’s for sure.

Secondly, you could download things illegally. Just saying.

But lastly, for those of you who both want lots of movies digitally on-demand but don’t want to be lawless swashbuckling pirates, there is an obvious policy option – eminent domain! Just have the government take possession of every single American film made before, say, 1960, and then license them for a fee sufficient to fund their upkeep. It will be a one-time payment of a couple billion dollars, sure, but it will ensure that America’s cultural treasures are preserved and widely accessible. If you want to save the money you could even, say, revise America’s insane copyright laws.

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