Wired Magazine was founded in 1993 and focuses on the relationship between technology and culture. Chris Anderson became the magazine’s editor-in-chief in 2001.
Anderson proposed the Long Tail to indicate the value of less popular products. He argues that this value will become more important as the Internet and other digital technologies make a wider array of products accessible and as filtering software allows consumers to locate the products that match their individual tastes.
According to Anderson, the Long Tail model is most apparent in the realm of media and entertainment. He refers to Amazon, Netflix, and Rhapsody, as primary examples of the phenomenon.
Though the video rental industry had an innate affinity for the Long Tail, the rise of chains such as Blockbuster shifted the focus to new releases and other popular hits. As a result, Blockbuster ended up generating about 80% of its revenues from 20% of its inventory.
With DEJ Productions, Blockbuster moved into acquisition and financing. The subsidiary was particularly interested in independent films, niche genres, and straight-to-video releases. DEJ acquired the home video rights to Boondock Saints after its negligible theatrical release. The film later developed a cult following and was one of DEJ’s most successful releases.
Netflix launched Red Envelope in 2006. It participated in financing, producing, and distributing films in exchange for exclusive DVD rights or other considerations. Red Envelope focused on specialty content such as independent films (e.g. The Puffy Chair and 2 Days in Paris) and documentaries (e.g. The Comedians of Comedy, Born into Brothels, and An Unreasonable Man).
The major Hollywood studios were excited by the apparent cost benefits of video-on-demand. Several of the majors launched separate services in order to pursue this new delivery method. Disney backed Moviebeam. Fox supported CinemaNow. MGM, Paramount, Sony, Warner Brothers, and Universal embarked in joint venture with Movielink.
To compete with established premium channels like HBO and Showtime, the newcomer Starz overpaid for the rights to broadcast premium content from Sony and Disney. In an effort to maximize the value of this content, Starz developed a VOD service dubbed Vongo as part of its overarching subscription plan. When the service failed to gain traction, it was terminated and Starz sold the broadcast rights to Netflix.
At the time Netflix launched Red Envelope in 2006, it had approximately three million subscribers. These numbers represented a significant growth rate and were considered particularly impressive in the eyes of Wall Street analysts. However, in terms of the overall home entertainment market, the company’s subscriber base represented only a tiny fraction. It was precisely because Netflix was such a specialized service that it made sense to boast about the discerning tastes of its clientele and the extensive catalogue that it offered. Two and a half years later, Netflix ended 2008 with nearly ten million subscribers and was maintaining its projection to double in size again over the next three to four years. [open endnotes in new page] As the company began to change in overall size and customer profile, it recognized that it was no longer feasible to rely entirely on its affinity for specialty content or niche audiences. This meant not only appealing to more mainstream tastes but also maintaining access to the premium content controlled by the major Hollywood studios. The importance of this relation was evident as early as 2000, when Netflix agreed to the same revenue sharing deals with studios that had been a standard at Blockbuster. According to one report, Netflix in fact shut down Red Envelope because it did not want to compete with the studios or jeopardize these types of partnerships. In 2009, Netflix again capitulated to the studios’ more explicit and much publicized demands for a twenty-eight day waiting period between the release of DVDs and their availability for rental. The mounting tension evident in such disputes was tied not only to the steady decline of home video sales but also to the general instability triggered by economic recession and ongoing technological innovation. As the major studios looked to better secure their own Long Tail interests, they wanted exclusive control in dictating the terms of subsequent exhibition windows, and were willing to cut out, or at least pressure, unnecessary middlemen in order to do so.
The threat by major studios to withhold access to premium content seemed to reveal a decisive vulnerability in the rental business. This in turn called into question the entire Long Tail premise and, more specifically, its role in the future of Netflix. Maximizing long-term value and exploiting new methods of efficiency were increasingly important principles, but media and entertainment in particular involved a complicated array of stakeholders many of whom had the power to limit or undermine the interests of unnecessary intermediaries like Netflix. With Red Envelope, Netflix had an opportunity to pursue its own form of vertical integration. However, the plan was not viable because the content it was best suited to produce did not match its increasingly mainstream subscriber base. Additionally, the Long Tail benefits of this material did not justify the risk of losing access to premium content from other major stakeholders. As eager as the Hollywood studios were to embrace the Long Tail for their own purposes, they also found the approach flawed. The studios were ultimately reluctant to entirely abandon the additional revenues generated by the rental market yet still had no proven business model for delivering their premium content to consumers in a more direct or efficient manner.
At this juncture Netflix again demonstrated its propensity for fortuitous timing. In 2008, Netflix was not only adopting a more mainstream sensibility but also sought to introduce a new form of digital delivery. After several studios had failed in their efforts to launch various video-on-demand platforms, Netflix turned its attention to ‘streaming’—a system whereby data is made available as it is delivered. In another instance of improbable serendipity, Netflix announced in October 2008 that it had reached a deal with the premium cable channel Starz for the rights to stream about a thousand movies. The deal served as a major catalyst in propelling subscribers to try Netflix’s new streaming service and, in the process, significantly transform both the company and the future of home entertainment. Though Netflix had once again struck it rich with content that others had been unable or unwilling to optimize, its days as an improbable, and somewhat overlooked, intermediary were in short supply. In pursuing this new direction, Netflix was unlikely to simply settle for the short end of the Long Tail. But it was also not clear what exactly this new direction would entail.
Precursor or postscript?
As Netflix released its 2010 fourth quarter report, it seemed that the rental service had secured a place within the media and entertainment industry. It had established an impressive record by Wall Street’s standards—raising its stock from just under $10 per share in 2002 to a peak of nearly $300 in 2011—and it had distinguished itself as a market leader by successfully integrating new Internet technologies into the video rental business. At the same time, Netflix now would face its most difficult and tumultuous period, with some of the adversity arising specifically because of its remarkable ascent. First, Netflix built its initial business model by improving what had been an exclusively brick-and-mortar retail enterprise. It enjoyed early success because of its rapid growth and because the various metrics used by financial analysts tended to favor it over existing rental retailers. Unlike its predecessor Reel.com, Netflix could actually back up these favorable assessments and indeed offered a more convenient and efficient service to a growing number of subscribers. In this regard, Netflix’s success fundamentally transformed the entire rental industry.
In moving forward, however, the company’s initial business model was something of a drawback. For example, as Netflix looked to focus more on its new streaming service, its inventory of DVDs and distribution centers were suddenly a source of extraneous overhead. Even its sterling track record with Wall Street added the burden of exorbitant expectations and kneejerk reactions, at times instigating undue concerns and public relations gaffes. The success of the new streaming service, on the other hand, caused the value of digital rights to immediately skyrocket, in turn jeopardizing the company’s ability to secure additional content. Their success also created an uneasy dynamic with content providers leery of repeating Starz’s miscalculation but desperately needing additional revenues to make up for declining DVD sales.
Many of the underlining practical questions facing the video rental industry were further exacerbated as digital rights negotiations, contracting, overlapping exhibition windows, and changing consumer habits all became increasingly intertwined. As with traditional rental retailers before it, Netflix initially had been preoccupied with the dilemma between new release hits and specialty niche content. But as the new media landscape evolved, it quickly began to adjust its overall approach and discovered the advantages of embracing a more diverse mix of content. Also during this time television programming was one of the fastest growing areas within home entertainment. This programming was valuable for several reasons. There was a broader overall spectrum of content, including many shows that had never been released on VHS or DVD. There were also a wider variety of release strategies, ranging from packaging entire earlier seasons to making the most recent episodes available for limited periods of time. These attributes of television’s ‘afterlife,’ along with the serial nature of many programs seemed to be more conducive to emerging online viewing preferences. As Netflix began to increase its emphasis on television programming, the company began to be discussed less as a rental outlet and more as a particular type of media channel. Thus Netflix began to draw specific comparisons with HBO, the premium cable network that also started out with a distinctly hybrid business model and that had successfully navigated several significant transformations within the media industries.
Like Netflix, HBO’s launch was tied to a technological breakthrough in that it was the first to use satellite transmission for the purpose commercial broadcasting. Just as Netflix adopted DVD ahead of the curve, HBO carved out a dominant place within the fledgling secondary market of pay-TV. And like Netflix, HBO started as a subscription-based service that depended on its ability to access premium Hollywood content. The studios responded to the rise of HBO with a mixture of ambivalence and resistance. On the one hand, they welcomed the arrival of another secondary market and the possibility of generating additional downstream revenues. On the other hand, they were wary of another middleman, particularly one that had established a dominant position within this new market. As part of this escalating rivalry, several studios sought to introduce their own pay television channel, Premiere. The channel would not only allow the studios to showcase their films, but more importantly it would allow them to institute a nine-month window of exclusivity (not entirely unlike the twenty-eight day window currently imposed on Netflix). However, the endeavor was eventually struck down on legal grounds, and the studios remained handcuffed in their efforts to embrace new forms of distribution and exhibition. As Jennifer Holt has shown, the legal clashes between Hollywood studios and burgeoning cable interests nonetheless also marked the beginning of a gradual shift to a “more tolerant attitude” with regard to vertical and horizontal integration within the media industries. This shift was somewhat obscured in the sense that HBO rather than the studios was in the best position to take advantage of this change in attitude.
As HBO continued to expand its subscription base, enjoying tremendous growth between 1976 and 1983, the cable channel like its subsequent variants in the rental industry had both the necessary resources and incentive to move into financing and production. HBO pioneered the practice of financing theatrical films in exchange for guaranteed rights to the pay-TV window. Because these “pre-buy” arrangements shut the studios out of a critical secondary market, HBO’s financing tended to favor independent projects that the studios had rejected wholesale. While HBO maintained its affiliation with independent and specialty content (especially documentary), it began to shift its attention in the 1990s to high-profile original series such as Sex and the City and The Sopranos. These shows became incredibly lucrative in their own right as they generated additional revenues through DVD sales and syndication after their initial runs. Beyond that, the strategy demonstrated the strength of HBO’s vertically integrated position and, perhaps more importantly, how this position would be vital in distinguishing a clear brand identity.
By the time Netflix was giving up on its own short-lived flirtation with vertical integration, HBO’s strategy was becoming increasingly commonplace among cable networks. The specialty channel IFC, for example, moved into production and distribution in 1999 to ensure the flow of apt and economical content. At the other end of the spectrum, ESPN, one of the largest and most successful cable channels, began producing a series of documentaries precisely as a way to hedge against the skyrocketing costs of live sporting events. Interestingly, in almost all of these cases independent projects and specialty content have played an important role. Such projects, however, have had little to do with pursuing the promise of greater media diversity or consumer choice but have merely provided a cost-effective pretext for reaching desirable niche demographics and building brand value. More broadly, it has become clear that while cable channels have been in an ideal position to utilize vertical integration and build distinctive brand identities, their success simultaneously depends on the fact that they exist as part of much larger media conglomerates.
Despite the many parallels between the two, Netflix’s lack of a conglomerate affiliate marks a significant and telling difference. Following the early clashes between premium cable channels and traditional content producers, the two sides recognized the importance of negotiating a mutually beneficial coexistence. This understanding eventually culminated with the merger of Time Inc. (HBO’s parent company) and Warner Communications in 1989, one of the first major deals in a decade of epic restructuring. For HBO, the deal assured several key benefits. First, it guaranteed access to the premium content of at least one major Hollywood studio. Second, the new conglomerate included an expanded number of multi-system cable operators and thus ensured that HBO would maintain access to distribution and exhibition channels. In effect, the merger illustrates the importance of strategic alliances and interlocking interests within the media and entertainment industry. Individual channels like HBO can best utilize the advantages of vertical integration and develop content that enhances a distinct and highly marketable brand identity. However, they need the leverage, security, and access to infrastructure provided by an overarching conglomerate in order to remain viable. It is in this regard, as Janet Wasko notes, that even amidst dramatic changes throughout the entire industry,
Many commentators viewed Netflix’s lack of a conglomerate partner as a certain death knell. While the company has indeed encountered certain setbacks and some additional challenges because of its position, predictions that Netflix would be supplanted by HBO or other extensions of major media conglomerates have simply not been borne out. There are several possible reasons for the company’s ongoing resilience and perseverance. First, Netflix has the advantage of a substantial subscriber base. With over twenty million subscribers, it has secured a significant share of the overall market and, more important, has a steady source of income to support its operations. Even as acquiring the rights to premium content has become more expensive and in some cases openly vitriolic, Netflix’s cash flow provides it with the financial resources to continue doing so. As some competitors have refused to negotiate the rights to certain content, Netflix has also used its financial wherewithal to return to financing and producing original material. Its success with a number of originally produced serial dramas allowed the company to quickly rebound from several much-publicized setbacks and a precipitous stock downgrade in 2011. With the success of this programming, Netflix began to focus more deliberately on exclusive content as a key “differentiator.” However, the company also realized that even if select titles were necessary to drive interest, it was simultaneously important to balance premium content with a diverse range of specialty fare. By aggregating content in this way, Netflix can offer a distinct, yet relatively economical, service that individual studios cannot match.
The second reason for Netflix’s survival is that it has always been a technology-based company. It has more experience and expertise both in terms of software development and day-to-day logistics. Netflix, moreover, established industry standards with its user interface and its various “personalization” engines. This, again, sets the company apart from both individual studios and cable operators, which have been largely unable to replicate these services. As part of its success, Netflix has established one of the most popular destinations on the Internet. Their website ranks among the top twenty-five in the U.S. and likely constitutes an even larger web presence considering its overall usage. Though Netflix was the beneficiary of several fortuitous developments completely outside of its control, its longstanding commitment to technology cemented its reputation as a savvy trailblazer and the market leader in developing new forms of delivering digital entertainment. These associations were further fortified as the company appeared to single-handedly introduce streaming technologies into the mainstream and, then again, as Netflix programming was literally embedded within the next generation of consumer electronics.
In both regards, Netflix has maintained some of the flexibility and versatility that enabled it to outmaneuver an earlier era of competition. Despite the company’s remarkable navigation of one of the most turbulent periods in media and entertainment, it appears that Netflix will likely remain in a precarious position. Certainly both its move into production and its reliance on technology entail formidable risks. As many studios know all too well, a string of failures can quickly and irreparably undermine the success of an individual production. Meanwhile, technology is moving so quickly that it is highly unlikely Netflix will be able to sustain its ‘first mover’ advantage. Even more problematic is that Netflix’s basic operation relies on infrastructure it does not control. Just as its rent-by-mail service was inextricably tied to the U.S. Postal Service, its streaming service relies on Internet providers and cable operators, some of which are directly affiliated with various competitors. Whereas external circumstances worked to Netflix’s benefit throughout much of its first decade, it seems highly likely that at some point its luck will take a very different turn.
The rise of Netflix ultimately reveals the instability of the current situation and just how drastically home entertainment has changed in a matter of ten years. Its success involved an improbable combination of factors and demonstrates how in a period of radical transformation an unlikely intermediary can play a disproportionate role in reshaping a multi-billion dollar industry. What is also interesting about this period is that even if the major conglomerates are in a better position to eventually regain control of the home entertainment market, their efforts to institute new forms of exclusivity and to more carefully exploit premium content across multiple windows and formats have produced decidedly mixed results. In many ways, these efforts have done more to create confusion and instability than to generate additional revenues or points of strategic convergence. The zeal for secondary markets, and video-on-demand in particular, now appears somewhat misguided, as new technologies and changing consumer preferences have made for an increasingly fragmented and competitive market in which the demand for media artifacts appears to have disintegrated into the ether. The industry’s lack of a clear or unified long-term strategy essentially extended the life and value of a rental market that was supposedly doomed long ago, allowing the likes of Netflix to persevere in the process. It is for some of these same reasons that Hollywood’s digital dreams have not turned out the way many had hoped or expected. These dreams have not only failed to duplicate the material profits delivered by earlier home entertainment formats such as DVDs but have unexpectedly required an extensive material infrastructure of their own. Despite the tendency to overlook the realities of this new era, it seems likely that digital dreams will continue to harbor their fair share of disconcerting twists and occasionally nightmarish turns.