Professor of Information Systems and Marketing at Carnegie Mellon University Michael D. Smith takes the questions that are bedeviling media executives and puts academic rigor into finding the answers. His research on how the transition into the digital age has affected the media industry formed the basis for his and Rahul Telang’s book Streaming, Sharing, Stealing, a must-read for anyone who wants to quantify the advantage that its unlimited selection Amazon gains over physical booksellers, how (and which) deterrents against piracy work, and why data is the singular key to winning the content wars in the digital media era.
We interviewed Michael to help guide us while we were putting together the 2018 Mixpanel Media & Entertainment Benchmarks Report. This is his take on the past, present and future of media.
On the internet, media inventory is unlimited. How has this changed business for media companies?
It has changed a lot. I co-authored a paper in 2003 called Consumer Surplus in the Digital Economy. The question was, when consumers can access every book in print online versus the limited selection in their local brick-and-mortar bookstore, how much will that added selection increase consumer surplus? Some folks thought it would create very little value for consumers, because most people were just interested in the most popular books, but my co-authors and I calculated that it resulted in a consumer surplus gain of about a billion dollars a year—ten times what consumers gained from lower prices on popular books sold online.
This means the main value from the internet comes from increased product variety. The unique characteristics of the internet allow companies to serve consumers with long tail products that only appeal to niche audiences.
For example, an Indian student in my class is really interested in Korean horror films. That is a niche market in the U.S., and in India. A movie rental business might not stock them in store but, online, they can. These products create a lot of value that you can’t access through traditional channels.
The only way to capture the long tail is to have a platform that can provide those products and track detailed consumer data that will match products and to the individual consumers interested in those products. For my student, you wouldn’t get her niche interests from her age, nationality, or gender—only from the content she views.
It’s the data-driven platforms such as Amazon, Netflix, and Google that dominate this space because they can access both long tail products and the detailed customer data that allows them to find a home for those products. This ability to provide both long tail and blockbuster products gives them an advantage over traditional media companies that only sell blockbusters.
What structural advantages to digital media companies have over traditional ones?
Traditional media channels are mostly broadcast-based, with one show delivered to many consumers at once. That means studios need to create blockbuster productions that appeal to a wide audience. Because of this, they have to be very careful about what gets made.
Today, Silicon Valley media firms have platforms that allow them to personalize content to the tastes of customers. This allows them to take more risks in what they make.
Netflix’s Chief Content Officer Ted Sarandos described the on-demand stream as allowing him to hit “singles and doubles” instead of always having to focus on hitting home runs.
So, it’s no accident that Netflix greenlit House of Cards when no one else did, or gave Beau Willimon and David Fincher so much creative freedom. That was a product of Netflix’s business model: House of Cards didn’t have to appeal to everyone. Unlike broadcast TV networks, Netflix is better served by producing lots of content that smaller numbers of people are intensely interested in rather than content with broader, but less passionate interest. So something like House of Cards could appeal to a specific slice of their customers while others could find something else to watch. That freedom allows these companies to manage the creative process differently, and allows Netflix to thrive with singles and doubles rather than always needing home runs.
How are media companies managing the shift from physical to digital?
The transformation can be incredibly difficult. Imagine you have a bunch of people in your organization with strong incentives to sell DVDs and suddenly you tell them that you are creating a new organization with incentives to sell products through a competing digital channel. That’s going to bother a lot of people—both internally and externally. For example, when Disney started selling movies on iTunes, Walmart and Target both protested by sending back crates of DVDs.
Today there’s another shift from digital sales to streaming. Early evidence shows that once again, the new product cannibalizes the old. Streaming hurts digital sales and digital sales teams are going to be impacted.
Streaming is also a big challenge because media companies are giving their content to streaming firms, but the streaming firms aren’t giving them back any information about the customer. It’s a two-sided risk: You’re hurting your existing sales and you are giving away access to customer data which, in the book, we argue is a key strategic asset going forward. For both these reasons, we think it’s crucial for the big media companies to create their own platforms.
Should media companies fight piracy by cracking down or by making their paid platforms better?
It’s a bit of both. First of all, nearly all the academic studies agree that piracy hurts sales. The second thing is that there is emerging evidence that piracy also hurts creativity. It’s not as conclusive, but it makes sense economically: If you make less money on content, you create less and invest less.
The question for media companies is what to do about piracy. Our research has shown both anti-piracy and pro-legal efforts can change consumer behavior. If you make pirated content even a little harder to consume, people switch to legal channels. And if you make legal content easier to consume and more convenient in digital channels, you see the same thing: consumers switch to legal channels. You’re never going to completely eliminate piracy, but you don’t have to. You just have to make it sufficiently difficult. It’s a mixture of enforcement and standard marketing to make your content more attractive.
You’re never going to completely eliminate piracy, but you don’t have to. You just have to make it sufficiently difficult.
The switch doesn’t happen instantly. Consumers tend to get set in their ways and consume through channels they’re comfortable with. This makes it all the more important for companies to entice consumers over to legal channels. When NBC took their content off iTunes in 2008, not only did many NBC customers switch to piracy, but the data appears to show that they also pirated more ABC, CBS, and Fox News content, and that it was very difficult to get those consumers back onto legal channels when NBC finally returned to iTunes.
How can established media companies become more competitive?
A lot of media companies are reorganizing so that data is centralized and used more efficiently. If you look at Disney, even a few years ago all their data was spread throughout the corporation in silos. The theatrical group, home entertainment group, and TV group each had their own data. But now they’ve made major strides to centralize that key strategic resource.
And it’s not just Disney. Time Warner gets this, NBCU gets this. They know they can’t rely on those they are in competition with such as Amazon, Netflix, and Google to share data. They have to go get their own.
They know they can’t rely on those they are in coopetition with such as Amazon, Netflix, and Google to share data. They have to go out and get their own.
What does this all mean for consumers?
With platforms, consumers have much more choice. But the paradox of choice is that if there are too many options, it can cause consumers to shut down. The challenge for entertainment companies and particularly distribution platforms is helping consumers make choices by understanding users’ unique preferences and targeting them with the exact information they want.
Companies can accomplish a lot with just the basics. YouTube, for instance, is very good at giving me 16 clips that I can lose about an hour exploring. This can be done with algorithmic targeting based on my past viewing behavior.
The problem is that if machine learning is going to play a big role in companies’ competitive success, we can probably expect a small number of firms to dominate in the future. Firms with the best recommendations will get the most customers and thus the most data. Once they have the most data, they can improve their recommendations. If that’s true, the big tech firms are just going to keep getting bigger.
How can media companies adapt their business models?
Consumers each value the product differently and the marginal cost of selling a digital media product is zero. So how do you sell your product—a movie, tv series, song, book or whatever else—for close to marginal cost to those who don’t value it highly and for a premium to those who do?
Economic theorists would tell you to segment the market based on quality, timeliness, and usability. Media companies have always done this through product differentiation and strategic delay. A movie studio will say, “I’m going to sell this in theatres where you can watch it once and pay me $9. If you’re willing to wait three months, you can buy it on DVD for $20 and watch it as many times as you want. If you’re willing to wait a year, you can watch it on HBO as part of your subscription. After that, you can find it on broadcast television for free and all you have to do is watch the ads.”
The problem today is if you can watch it on broadcast television the day after you watched it in theatres, a bunch of people who were willing to pay for the theatre will simply wait. Piracy and streaming and consumer expectations make business models like strategic delay difficult to execute.
One solution to this problem is bundling products, which is what Netflix does and, to a lesser degree, what Amazon and YouTube Red do too. The problem for studios is that today they don’t own the platforms to do that.
What media trends can we expect in the near future?
Movie studios in particular are doing a better job of giving customers more access. People are recognizing that the old business isn’t going to come back and they need to go after the new business. The AT&T-Time Warner merger is a great example of this, as is the jockeying for Fox between Disney and Comcast. In both cases, the legacy companies have realized that they need to create their own bundles and their own customer-centric platforms if they’re going to compete with Amazon, Netflix, and Google. More than anything, major entertainment firms need to get access to the customer through their own platforms. If they don’t, it’s going to be very tough for them going forward.