Netflix Drop: The Downside of Platform Models -

Netflix Drop: The Downside of Platform Models

This week, Netflix shares plunged 35% in a single day after Tuesday’s report that the company lost subscribers for the first time since 2011. Overall, the stock price is down 40% this year. It’s an unexpected turn of events for the company formerly known as the “king of streaming” and a disruptive shock to the mystical platform economy that entrepreneurs and investors so often put on a pedestal.

Jonathan Knee, professor and investment banker, wrote one of my favorite books of 2021, The Platform Delusion: Who Wins and Who Loses in the Age of Tech Titans. In it, he explains the downsides of a platform model, why Netflix may not have had network effects after all, and what the company (and any platform business) needs to consider to turn things around.

The Platform Delusion

Knee defines a platform as a business whose core value proposition comes from the connections it creates or enhances. It’s not making a product; it’s connecting people.

Social networks are platforms because their value grows based on the users who join them. Airbnb is a platform because it connects guests and hosts. Arguably, Netflix was a platform when it started streaming, because it connected entertainment creators and users, before it began making its own original content.

According to Knee, however, the company today is not a true platform because it buys and produces content and then sells it through a subscription pricing model. Compare this to video platforms like YouTube or TikTok, in which the more users you have, the more content creators you have. Netflix enjoys no such network effect.

Knee’s “Platform Delusion” refers to two conflicting ideas that people tend to hold simultaneously:

  1. The idea that the world is dominated by a handful of mega-platforms that will inevitably push out smaller players and take over the world.
  2. That the platform business model is untouchable. If you have a platform business idea, it’s a “can’t lose” opportunity, and it can never be killed.

But, if the first idea says that these huge incumbent platforms will kill the smaller players, why would any entrepreneur want to enter into a platform market? Why would anyone invest in a new platform? The delusion is that people promote both of these ideas at the same time: that you should pursue a platform model because of its network effects and that network effects of existing platforms will limit the potential of any new entrant.

Network effects: the demand-side benefit of scale

In a platform model, the core advantage is scale. Knee explains that scale is a complicated concept. It’s not about size—if there are 20 massive businesses doing the same thing, scale doesn’t matter. Scale is only a benefit if you are larger than your competitors. Relative scale is what matters.

Before the digital age, scale meant lower fixed costs. If a product manufacturing company grew to twice the size of a competitor, it could likely produce goods at a fraction of the competitor’s cost. In a digital platform, the scale advantage comes from the number of connections the platform creates. The bigger the network becomes, the greater its value.

This powerful flywheel, referred to as “network effects,” is the demand-side benefit of scale. When a customer chooses between networks, the one with the most users, or the most content, becomes more attractive.

Netflix’s dilemma 

This week, Reed Hastings, co-CEO of Netflix, reported a drop in subscribers and said Netflix is exploring the idea of introducing advertising on lower-priced tiers. As many new streaming services have entered the market, the company partially blamed the drop on users sharing passwords and switching between streaming providers.

Knee’s theory of platforms supports Netflix’s 2022 decline. He says that in a world where there are 20 similar-sized networks, or streaming services, and they all break even, there is no customer captivity. Due to the ease and low cost of switching, the scale benefits can only be short-term. Even with network effects, a digital environment makes it hard to be sticky. In Knee’s book, written long before Netflix’s recent stumble, he expresses concern of the high rate of customer churn he estimates Netflix is enduring.

Solution: multiple sources of competitive advantage

In the beginning, Netflix benefited from being an early entrant “platform” service. It had a unique model that coordinated the uncoordinated by connecting users to entertainment options they could enjoy at home. Competitors eventually caught on, and in 2012, Netflix started producing its own original content. After a successful decade, the company looks to be on the verge of another strategic shift.

Knee’s solution for platforms to survive long-term is to look past the idea of a platform and focus on what makes any good business. Contrary to popular delusion, the platform model is not a cure-all. There are good and bad platforms just like there are good and bad businesses.

What allows a business to generate superior returns over time is its competitive advantage, and according to Knee, it’s actually about creating multiple, reinforcing sources of competitive advantage. If we consider the Netflix streaming service a platform, its core advantage is scale—number of users and availability of content—but today, Amazon, Hulu, HBO Max, etc., all have that, too.

So, what adjacent advantages can Netflix develop to protect its core? In a LinkedIn post, Robbie Kellman Baxter, subscription model expert and author of The Forever Transaction and The Membership Economy, offers three possibilities:

  1. A costly, ad-supported offering that distracts from the core
  2. A targeted ad strategy that leverages Netflix’s deep knowledge of consumer behaviors and preferences
  3. The first of several new revenue streams for Netflix including bundles, advertising models, and other options

Knee’s work and recommendation of multiple reinforcing sources of competitive advantage support the third option. Netflix will need more than an ad-supported tier to survive long-term.

Netflix is a good business—one with a strong culture and a solid offering, albeit in a saturated market. If the company can make use of its consumer data to create new bundles and offerings as Baxter suggests, there may be a brighter future ahead.

Listen to Jonathan Knee’s Podcast interview.

Photo by cottonbro from Pexels

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