What Underpins Market Entry in the Video Streaming Industry?

Introduction

In 2007, Netflix – a company that was for all intents and purposes an online version of Blockbuster Video, sending DVDs via mail to its customers – launched an online platform where for the first time Internet users could stream entertainment directly onto their laptops. In the intervening years, streaming video on demand (SVOD) services have proliferated, with corporate entities ranging from legacy media to tech giants such as Apple and Amazon launching their own versions of the Netflix platform.

One of the mysteries of this recent SVOD boom is the heterogeneity of size across players in the space. It is not only large corporations who have launched services, but many tiny firms for whom it is their main product. Such smaller services in fact constitute the numerical majority of the approximately 200 different streamers in existence (even while their subscriber numbers pale in comparison to the larger streamers).

What has underpinned the recent explosion of these small streaming services? How do they compete with the much larger streamers, whose content libraries trounce these smaller streamers’ in size? In this paper, I will use an industrial organization framework to investigate the dynamics of entry into the SVOD industry for these small streamers, attempting to determine their approach to creating market power and, consequently, long run profitability for themselves.

Potential Barriers to Entry

The necessary condition for all of these small firms to enter the industry is a paradigm of low barriers to entry. Indeed, there are but three major costs associated with launching an SVOD service: streaming technology, sufficient server space, and content. Video streaming has become more or less commoditized, with many cloud service providers such as Amazon Web Services selling the technology to people building websites on their platform. Such technology is not sufficiently patent protected to create significant structural barriers to entry to the SVOD industry. Similarly, it is very straightforward for these small firms to purchase and maintain server space, either buying it themselves or paying a cloud service provider to host their website.

The only one of these three elements that could thus constitute a serious barrier to entry is the content that the service ultimately provides its customers. Every television series and film that the SVOD provider hosts on its platform must be licensed from the production companies whose intellectual property that entertainment constitutes. This could present a problem to nascent streaming services, especially considering the fact that many of the production companies have existing deals with other streamers, or themselves own a streaming service.

Evidently, the only way that such streamers can enter the market is to acquire content that has not been licensed by any of the existing streaming services, else they would have nothing to broadcast. There are two ways they can go about this.

First Approach: Direct Competition with Larger Counterparts

The first is to indiscriminately acquire rights to anything that has yet to be licensed. This approach would effectively put them in the market for entertainment writ large. The problem with this approach is that this is exactly the type of service Netflix already offers: providing a hodgepodge of content that appeals to just about anyone interested in entertainment. Such a streaming service would be eminently substitutable with Netflix, and indeed the product would be in all likelihood inferior, as the chance of acquiring a catalog as vast and varied as Netflix is essentially zero. Put differently, this approach would mean that the small firm is competing for the marginal consumer of film and television writ large, who has already effectively been captured by Netflix and is unlikely to substitute away from Netflix towards this inferior version of the same product.

The only technique that one could use to actually develop a clientele is to undercut Netflix on price. This could draw in customers whose willingness to pay is below the price charged by Netflix, along with those whose preferences are such that they do not value the broader breadth and depth of Netflix’s content offerings and are thus more sensitive to price than the typical Netflix consumer.

The sustainability of such an approach is immensely questionable. Long run profitability comes from market power, which is to say the ability to charge above marginal cost (in this case, the recurring cost of licensing content, distributed across subscribers). This approach does not develop any such market power, since the entire strategy is undercutting Netflix, which can simply reduce its spending on licensing to match the smaller firm’s variable costs, then possibly undercut the smaller firm and price them out of the market.

We thus see that entering this broad market for film and television entertainment writ large, with high availability of near-perfect, perhaps even superior substitutes and thus highly elastic demand, would imply that the long run profit margins of the firm, and the market power they would be able to accrue, would be severely hindered. Such an approach would put one in direct competition with Netflix, which for the aforementioned reasons is a losing proposition. This explains the dearth of smaller-scale streamers who offer the kind of cornucopia of content that Netflix does.

Second Approach: Capturing Niches via Market Segmentation

Instead of attempting to directly compete with Netflix, a more promising approach that these smaller firms could take is to cater not simply to the marginal consumer of film and television writ large, but rather to the marginal consumer in a different market altogether. In other words, these small streamers could differentiate their product by offering a highly particular subset of content to a market that is underserved by the wholesale, indiscriminate approach that Netflix takes.

Examples of this approach abound. Crunchyroll is a streaming service that possesses a near monopoly on subtitled anime television. Shudder focuses solely on horror cinema and television. The Criterion Channel finds old and under-seen movies, restores and digitizes them, then streams them to cinephiles looking to expand their knowledge of film history. In each of these cases, the approach is the same: these firms are not merely attempting to provide content to the marginal consumer of television and film writ large, but rather the marginal consumer of a highly specific niche within television and film entertainment.

By segmenting the market this way, these small streamers begin to face demand curves that are far steeper than in the previous case. Unlike before, the service they provide is far less substitutable with Netflix, tending to make demand more inelastic and providing these firms with greater pricing power than they would have if they were to more directly compete with their larger counterparts. Individuals who are horror fanatics will possibly run out of options on Netflix, while on Shudder their options will be endless. Serious anime lovers have no choice but to buy a Crunchyroll subscription to stay up to date on the latest episodes of their favorite shows.

Two immediate risks come to mind. The first is that Netflix attempts to outbid the firm when it comes to licensing the niche stream of content they wish to attain. In all likelihood, however, the small firm’s willingness to pay a premium for those licensing rights far outweighs Netflix’s. The larger firm will have far less ability to raise prices for their consumers to compensate for this high licensing fee than the smaller streamer, since the smaller streamer caters to customers with a high willingness to pay for that specific type of content, while Netflix caters to the marginal consumer who cares far less about that content. Ergo the risk of being pushed out of the market by a larger streamer is minimal, unlike in the previous approach.

The other risk is that another small firm attempts to target that same niche. However, if the streamer is able to capture a large enough share of the licensing for the particular type of content upon which it wishes to focus, the amount of additional content targeting that same market remaining for others is minimal. Moreover, after capturing this market, the streamer’s ability to pay a large premium to renew the licensing requirement is augmented, making it difficult for other nascent streamers to outbid them when it comes time to renew the licenses. The dynamics within this particular niche market then become akin to a monopoly, since the streamer is just about the only one with access to particular product they are providing, and can erect an effective barrier to entry in the sense of their initial greater willingness and eventual greater ability to pay a premium for the niche content. In this sense, the first-mover advantage in such niche markets is considerable, affording one effective monopoly rights in perpetuity.

Conclusion

In this paper, I have characterized the market entry dynamics that underpin the proliferation of small-scale streaming services, explaining using tenets of industrial organization how these firms exert market power. The optimal approach to market entry has been shown to be tailoring one’s product to appeal to a specific niche within the larger market, rather than attempting to offer a cornucopia of content to consumers. Note that I have simplified the approach by ignoring the possibility of these streamers becoming producers of content themselves. The decision about whether or not to enter the production business is a topic worthy of additional investigation, as it amounts to entering a different market altogether to complement one’s SVOD product.