Part 2: What business are you in?

In 1960, Harvard Business School professor Theodore Levitt wrote a landmark article for the Harvard Business Review titled "Marketing Myopia." Levitt focused on industries that were struggling at the time--among those that he used as examples were railroads and motion pictures. Levitt wrote that in both these cases, management forgot what businesses they were really in. Railroads thought they were in the railroad business when they were actually in the transportation business. As a result, they allowed competitors (trucking firms, package delivery services and air cargo companies) to take away huge portions of their revenue and leave them with the niche of slowly delivering huge quantities of materials.

Movie studios thought they were in the movie business, not the entertainment business. As a result, their management first dismissed television, then denied its impact, and then refused to make their movies available for broadcasting. It was only after most of the movie studios came close to or entered bankruptcy that they realized that they had to do business with television networks and stations if they hoped to survive.

When you're in a business for several decades, it becomes natural to think "inside the box." The barriers to entry (cost, technology, experience, customer habits, etc.) are simply too great for new entrants to overcome. Rather than redefining your business, you focus on doing what you already do less expensively. Customers have purchased your goods or services for as long as you've been in business, so whatever you're doing is working, and you should keep doing the same things. That mindset makes legacy industries vulnerable to disruptive innovators: Trucks replaced railroads, and television replaced going to the movies.

The lessons from fifty years ago are still being learned today, and nowhere more than in the book industry. Book publishers aren’t in the business that most of them think they’re in. If you talk to publishers, or for that matter, booksellers, most of them will tell you that they’re in the business of selling stacks of nicely bound paper printed with well written and edited text, and their digital simulacra, eBooks. In reality, they’re in one of three businesses: Entertainment, information or education.

Once the focus changes from manufacturing and selling books to performing a job for your customers, the definition of what a publisher does changes radically:

1. Deliver entertainment, information and education
2. Quickly and cheaply
3. To PCs and mobile devices as well as to legacy media
4. Via the Internet and wireless broadband connections, as well as legacy channels of distribution

Advertising is dead. Deal with it.

Have you ever had the feeling that you were a fly buzzing against a window, not knowing that you could escape if you just moved a few inches to one side? That's how I've felt recently, thinking about how to build an advertising-supported Internet site. I've come to the conclusion that, for all but a handful of sites, it's impossible to build a successful business by depending on advertising.

The classical advertising model was based on an economy with few media outlets and many media consumers. In the U.S., for decades there were three broadcast television networks and three commercial television stations in most markets. In most cities, there were one, or at most two, newspapers. The scarcity of media outlets meant that each outlet had a large audience, and that audience attracted advertisers, who were willing to pay enough to turn the outlets into viable businesses.

The Internet turned the classical model on its head: Instead of having a small number of media outlets, each with large audiences, we have a huge number of outlets, each with small audiences. Only a handful of sites and services on the Internet have been able to attract the audiences necessary to make an advertising-based revenue model work. The cost of setting up an Internet site is tending toward zero, especially if you can convince people to create content for you for free. Operators of these kinds of sites can run them profitably, or at least not at a large loss, right up to the point where they have to pay people for their content and services. That's why The Huffington Post has pushed back so hard against bloggers who want to be paid for the content that they provide to the site. If the HuffPo had to pay for all its content at market rates, it would go bust.

The problem goes beyond the Internet--cable television networks, in the aggregate, have a bigger audience than the broadcast networks, but few cable networks attract a big enough audience on their own to be viable without fees paid by cable, satellite and IPTV services. That's why cable networks and service providers fight so hard against "a la carte" pricing that would allow subscribers to pick and choose channels.

So, what should you do? If you're thinking about starting a business, pick a business and a business model that allows you to charge users. If you're running a business that is advertising-supported, or that you hope to run on advertising revenues in the future, pivot to a business and business model that can be profitable on user fees. If you're an investor and someone comes to you with a business plan that depends on advertising revenues, walk away. In short, if you can't get your users to pay for your service, you're in the wrong business.

New Media Financing, Part 3: Controlling the Costs

More than a decade ago, I was working on a project that involved producing original 30-minute in-studio television programs. The cost of the shows had to be low enough to allow them to be bartered (given to stations free), or even aired through paying the stations for the time. I approached a number of producers in Los Angeles and said, "Here's an outline for the show, our budget is $300,000 per half hour, can you do it?" Not a single one would touch it for anywhere close to that budget, even though the series wasn't going to be technically difficult to produce and wouldn't require "name" talent.

It costs a lot of money to produce a network television show--according to The Hollywood Reporter, between $2.5 and $4 million per episode for an hour-long drama, while half-hour comedies are significantly less expensive at around $1 to $1.25 million per episode. For those costs, you get professional union talent both in front of and behind the camera, the best equipment, first-class music and sound, excellent post-production, and so on.

At the other end of the spectrum are user-generated videos like "Keyboard Cat" and the "Numa Numa" guy, shot and edited by a single person with a camcorder or webcam. The cost is virtually nothing, and sometimes, very rarely, a huge number of people watch them. But could you get a million or two people to watch the "Numa Numa" guy for 30 minutes a week, for 13 weeks?

Network television shows are very expensive to produce, but if they catch on, people will watch them over and over for years. They generate advertising revenues from day one. They can be sold to other countries and syndicated to local television stations, even while the original run of the series is still on the network. They can be packaged into DVD collections and resold. They can run on Internet sites like Hulu and generate more advertising revenue. The entire network series production system is based on creating these kinds of shows. The series that don't make it, that last a season or less, are a sunk cost, never to be heard from again. It's a little bit like the venture capital business, except that even a failed venture might have valuable intellectual property that can be licensed or sold, while a failed television series has virtually no residual value.

But what if the production model reflected reality? What if costs were based on the expectation that a show will fail? What if producers put real money into a show only once it was proven to be a hit? You'd see a very different model for funding series production, the model that I think needs to be applied to the Internet.

In the "Look out, she's about to blow!" model, everyone gets paid Union scale, not X times scale, until the show is a proven hit. DSLRs replace 35mm film; multicamera shooting techniques replace single-camera, decreasing the number of setups and saving both time and money. Teams are light and shoot fast. Sets go virtual; why make huge investments in practical sets when you can create them digitally and then build them once you know you've got a hit? Also, you don't have to tear down virtual sets. Editing and post-production are done on the desktop.

I can already hear a chorus of network executives and producers saying "That will never work! The production quality of our shows will be diminished, and we'll never get them to the point where they'll be hits. It'll be more expensive to upgrade production standards midstream than it would be to set high standards from day one."

But just because network executives and studios would find this an unacceptable way to approach production doesn't mean that it's unacceptable. For the Internet to take off as a platform that can generate its own hits, it has to be able to deliver compelling programming that will bring viewers back again and again. That requires more than a camcorder and an idiot jumping off a roof. It means operating as "close to the bone" as possible in order to keep costs in line with potential revenues, and to only ramp up costs once revenues can support them.

New Media Financing, Part 2: Who pays the bill?

At the dawn of the commercial radio era in the U.S., radio stations were established to sell radio receivers. Pittsburgh's KDKA, generally accepted to be the first commercial radio station in the U.S., was an experiment funded by Westinghouse in order to sell radios: People bought more radios if they had more things to listen to. NBC was established by RCA primarily in order to sell radios. The equipment sales-network relationship survived well into the television era; the reason that NBC's symbol is a peacock is that RCA used the network to sell its color television sets. People bought more color TVs if there were more shows to watch in color.

That concludes our history lesson for today, with the point being that business models evolve over time. Advertising wasn't the first, or the only, business model for broadcasters. The Internet is at a stage of commercial development similar to that of radio in the late 1920s and early 1930s, with a bunch of models but no clear path to profitability.

Companies and individuals are pursuing a variety of business models, alone or in a myriad of combinations:

• Subsidized: The content is provided by an Internet Service provider at no additional charge. Comcast's Fancast service is a good example of this model. Fancast is available only to Comcast subscribers, and is a part of the company's high-speed Internet service.
  
• Advertising: The content distributor sells advertising, and the content is usually (but not always) made available to consumers for free, in return for exposing them to the advertising. This is today's dominant business model.
  
• Subscription: Consumers pay a monthly or annual fee for access to content. The Wall Street Journal and Financial Times are examples of subscription-based content providers.
  
• Pay-per-View: Consumers pay a one-time fee to access content, usually for a single viewing or for a limited amount of time. This model is often used for high-value content such as movies, concerts and other special events.
  
• In-Game Transactions: Consumers get access to the basic game (or other content) for free, but to take full advantage, they have to buy virtual property and services within the game (everything from clothing and livestock to spacecraft and weapons.)
  
• Carriage Fees: I'm not aware of anyone using this on the Internet, but it's very common in cable television. Typically, well-established cable networks charge a per-subscriber fee to cable operators for the right to make their channels available to their subscribers. Those fees are then passed on as part of subscribers' monthly charges. There are also reverse carriage fees, which are paid by new cable networks in order to get carriage on cable operators' systems. As those networks grow and succeed, they can move from paying for to being paid for carriage.

There are other models, such as the "tip jar" approach where consumers pay whatever they want to a content producer, but these models are rarely sustainable.

The fact that none of these business models has clearly established itself (with the exception of search advertising, which is a special case) could indicate that we haven't yet found the right model, no such model exists, or we're following the right models but implementing them in the wrong ways.

New Media Financing, Part 1: The McDonalds Conundrum

The annual Cable Show ended last week in Los Angeles, and it's apparent that the status quo before the conference (the set-top box is the primary target device, and everything else gets TV Everywhere) is still the status quo. But why do a relative handful of companies have so much power over what people watch and how they watch it? The reason is what I call the "McDonalds Conundrum".

We all know that McDonalds' food is bad for you--it has too much salt, sugar and fat. Nevertheless, millions of people eat at McDonalds every day, because they like how the food tastes, and there's a McDonalds just about everywhere. Television today is much the same as McDonalds--there's tons of crap, but it's enjoyable and easy to find. Turn on your TV, and it's there. It's on your DVR. It's everywhere.

For all of YouTube's power, it never would have gotten off the ground if it didn't have a steady flow of content from television and cable. Hulu wouldn't exist if it didn't have NBC's and Fox's programs. People like to watch the television shows from the major networks and studios. They can find those shows incredibly easily. That gives the suppliers the power to limit access and to set terms for consumption.

There is nothing available on the Internet that has anywhere near the reach or ease of access of broadcast or cable television...unless it's broadcast or cable television shows that have found their way to the Internet. So, a critical step toward building a sustainable business model for Internet video programming is to make it incredibly easy to find and consume.

The media powers "have this Internet thing all figured out"

Earlier today, at the Cable Show in Los Angeles, former FCC Chairman Michael Powell chaired a panel of media bigwigs (plus Marc Andreessen) to discuss content on the Internet. The other panelists were Brian Roberts of Comcast, Tom Rothman of Fox, Les Moonves of CBS and Jeffrey Bewkes of Time Warner. The consensus of the media executives is that they've got this Internet thing all figured out. Their content will be on whatever devices consumers want to use, so long as they (the content providers and distributors) get paid for it. By and large, it sounded like a bunch of guys sitting around using buzzwords that they've heard but don't quite understand.

The executives clearly want to maintain the status quo, just on a larger variety of delivery platforms. They still want release windows so that they can maximize revenues from each platform. They see new technology simply as an extension of their old technology. For example, Brian Roberts demonstrated an application that turns a $600 iPad into a glorified remote control for your ten-year-old cable box. It can show program schedules, allow you to browse VOD content and even invite your friends to watch, but you watch the content on your TV screen through your set-top box, not on the iPad that you have in front of you.

What disappointed but didn't surprise me about the panel is that there was really no "outside the box" thinking from anyone, even Andreessen. He pitched integrating Facebook and Twitter with the services that the big media companies already have in place, and talked about Zygna's model of free games with in-game transactions, but didn't really explain how the media companies could take advantage of that model. Comcast's Roberts pitched using an iPad as a peripheral to its set-top boxes, not as a legitimate delivery platform. Thar was about as far as the envelope got stretched.

The incumbent content and service providers will never fundamentally change the economics of content production, distribution and purchase. It runs counter to their business interests. It's up to a new generation of content producers and distributors to convince a critical mass of consumer/producers to get on board.

The independent filmmaker's paradox

Several years ago, I ran a DVD distribution business. I didn't do a very good job, but sometimes you learn more from your failures than your successes. We were looking to license the home video distribution rights for a number of feature films, and worked with a company in Los Angeles that keeps track of all the independent films that are in production or completed and are looking for distribution. This was a few years ago, but there were more than 4,000 independent films produced each year without committed distribution deals. That's an enormous number by any measure. According to the Motion Picture Association of America, there were 610 movies released in the U.S in 2008. That's about the capacity of the U.S. theatrical exhibition system; they could of course show more films, but it probably wouldn't be profitable for either the exhibitors or the distributors.

Home video used to be a good outlet for a lot of titles that couldn't find theatrical distribution, but independent movie rental stores are all but dead, Blockbuster is "circling the drain", and the other leading rental chains are nearing, in or just existing bankruptcy. Home video is being driven by Netflix and Redbox; Netflix with a huge selection, and Redbox with a very small selection but low rental prices. DVD sales have dropped off due to the economy, and Blu-Ray is nowhere near picking up the slack. The big-box retailers like Wal-Mart and Best Buy no longer discount the new releases as heavily as they once did, slowing sales even further.

For an independent movie producer, the "conventional" outlets are becoming less and less viable. When shelf space is determined by how many discs can fit into a vending machine, the chances for small feature films to get distribution, let alone get noticed, drop to almost zero.

The Internet is seen by many as the savior of independent film, but that's where the filmmaker's paradox kicks in. You can produce and edit a movie today for less money than ever before. Distribution via the Internet is less expensive and more democratic than any method ever available to filmmakers. However, there's very little chance of making enough money from the Internet to cover the production costs of even a small independent film. So, even though it costs less to independently produce and distribute a movie than it ever did, it's no easier to turn a profit.

For decades, independent film financing has relied on an ever-changing assortment of starstruck investors, government agencies offering tax breaks and the families of filmmakers who want to help them make their dreams come true. Every year, there's a new set of players: One year there's money from South Korea, and the next year Germany becomes the big player. Canada and Louisiana compete to see which one can offer the most tax subsidies and the lowest overall production costs. Nothing, however, changes the fact that independent film funding is a sucker's game for the vast majority of investors. Subsidies allow you to save money, but you usually have to make some in order to get the benefits.

So what's the solution? It's attitudinal rather than structural. The Internet is not going to change into a profitable distribution channel any time soon. If you're making an independent film with the intention of making money, you're very likely to be disappointed. In you invest in an independent film with any expectation of making a return on your investment, you're also likely to be disappointed. The trick is to make and invest in independent films with no expectation of getting your money back. Make them because you want to tell a story, because you deeply believe in a subject, or you just want to pal around with actors and directors you admire. Take advantage of the lower costs of production and distribution to make films that otherwise would never have been made.

The Content Paradox

The "old media" Goliaths like News Corporation, Viacom, CBS, Disney, NBC Universal and Time Warner are often said to be doomed to extinction by the Internet, yet it's content produced and owned by those same companies that's the most popular on the Internet. Those of us in the U.S. may complain about Hulu's limited selection of and time limits on access to content, yet Hulu is envied by content consumers around the world. YouTube would never have gotten to where it is today without all the "old media" content that was (and still is) uploaded for free consumption. If YouTube had depended totally on user-generated content, it never would have reached critical mass.

We may not like the restrictions and limitations that the old media companies put on usage of their content, but they own it, and they have the right (subject to "first sale" rules and other restrictions in the U.S.) to control how it's sold and distributed.

No Internet "new media" companies have content that's in the same popularity class as the old media companies. Producer/Distributors such as Revision3 and TWiT have built very solid businesses. TWiT, Leo Laporte's company, is attracting bigger audiences than TechTV ever did, and judging from Laporte's own comments, it's making a nice profit. However, the audience for all of TWiT's programming is tiny compared to any of the old media sites. Thus the paradox: The Internet relies on old media to drive traffic to new media sites, but the vast majority of original new media properties can't find big enough audiences to sustain themselves financially.

The Internet has lowered the barriers to entry for content producers and distributors down to almost nothing, but making the content available and getting people to read or watch it are two very different things. Building a big enough audience that your content or site becomes attractive to advertisers is much more difficult, and getting people to pay to access the content is even yet more difficult. The old media companies have at least solved the problem of getting people to watch or read their content, but the new media companies all have to start from scratch to build an audience.

Old media isn't having that much easier a time of it on the Internet--just today, for example, Hulu announced that Viacom's Comedy Central is withdrawing its programming at midnight on March 10th, thus removing some of the most topical and popular content from the site. Hulu is widely believed to be unprofitable, and rumors have been flying for months that its parent companies (News Corporation, NBC Universal, Disney and Providence Equity Partners) have been pushing it to adopt a pay model in addition to its existing advertising-supported model. So, simply bringing old media content to the Internet isn't a formula for financial success.

This argument is going to continue until someone releases a breakout hit on the Internet, figures out how to make money with it and builds a profitable, growing media business. Until that happens, the Internet will remain primarily a distribution channel for old media, rather than a viable channel for launching new media.