Netflix and the Fall of Television | The Game Changer | 1

0:09It's fall 2016. Netflix chief content officer Ted Sarandos sits at a back table at Republique, a casual restaurant in the heart of Los Angeles Sarandos nods hello to producers, agents, and actors as they pass by The place is known as a hotspot for entertainment power brokers to make deals over avocado toasts and oat milk lattes Sarandos spies a reporter from an industry trade magazine sitting in the corner and kicks himself for not picking a more discreet place to go. If this meeting does go the way Sarandos hopes it will, he's going to poach one of the most successful television producers working today from the network she's called home for over a decade.

0:54But the producer still has over a year left on her current contract, and if word of this meeting leaks, well, it could scuttle the whole deal before Sarandos can even make an offer. The door swings open, and a short, elegantly dressed woman walks in, her eyes flitting around the room. Sarandos stands up and greets her. Shonda Rhimes, it's a pleasure. The pleasure is mine. Rhimes shakes Sarandos' hand and takes a seat. Rhimes rocketed to fame after creating the medical drama Grey's Anatomy in 2005. ABC has built its entire Thursday night lineup around her shows, which bring in an estimated$2 billion.

1:36And now, Sarandos wants her to jump ship from ABC, which is owned by Disney, one of the most storied entertainment companies in the world, to join a tech company that has a very short track record producing its own content. Although Netflix is credited with upending the movie rental business almost two decades ago, It has so far only made a handful of original shows. It's built its business on licensing content made by other studios. Sarandos was surprised when Rimes' reps requested a meeting. He's not sure entirely what to expect, but he's going to shoot his shot. A waiter approaches and Rimes orders a coffee before turning to Sarandos.

2:19She's not wasting any time with any small talk. One thing you need to know up front is that wherever I sign my next deal, I'm not making another Grey's Anatomy. I'm not making Grey's Anatomy in a cornfield. I'm not making Grey's Anatomy in an airport. I'm not making Grey's Anatomy on a baseball field. Good. Because I'm not interested in you making a second Grey's Anatomy. Rimes looks up at him in surprise, and Sarandos suppresses a grin. He's heard rumors that Rhymes is getting restless. Creative freedom is at the heart of his pitch to try to lure Rhymes to Netflix. Rhymes stirs some cream into her coffee.

3:00Okay. Well, two other things. One, I have every intention of keeping Grey's running as long as ABC wants it on the air. Understood. Two, you may think you know what a Shonda Rhimes show is, but you only know what a Shonda Rhimes show made for ABC is. And that's what's exciting to us. Look, we put a lot of thought into who we would want to dive into our first overall deal with and I strongly believe you're the perfect partner. You're prolific, you make shows that run for a long time and have global appeal. Sarandos leans forward. And quite frankly, in my opinion, You know how to craft stories and characters better than anyone else working right now.

3:48I want to see what you can do without the restrictions of network television. No rules on language, the ability to dive into more adult themes, flexible run times. You know what I mean? Rimes looks around. You're certainly saying all the right things. We're also prepared to offer you a lot of money. Rimes nods, impressed. I think this might be the start of a beautiful relationship. Sarandos grins. One year later, Netflix signs Rhymes to a multi-year overall deal where she will exclusively develop new shows for the streamer for a reported$150 million, plus bonuses. It's one of the largest overall deals in Hollywood history, and it sends shockwaves around the town, announcing Netflix as a major player looking to rival the legacy studios.

4:46The deal also kicks off the streaming wars, forever changing the entertainment industry.

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7:05From Wondery, I'm David Brown, and this is Business Wars.

7:33Now, you may remember from our very first series, Netflix vs. Blockbuster, that when Netflix was founded in 1997, it was a DVD by mail service. And while it disrupted the movie rental industry for sure, Hollywood at first saw the new company as an ally. It was another place to sell their content, right? Well, this attitude continued through 2007 when Netflix started streaming movies online, not just mailing DVDs. In fact, streaming turned Netflix into one of Hollywood's biggest customers. In 2010, Netflix paid the studios Paramount, MGM, and Lionsgate nearly$1 billion combined to stream their movies for five years.

8:17But Netflix co-founder Reed Hastings had bigger ambitions than just licensing other studios' content. For years, Netflix had been collecting massive amounts of data on viewer habits. The company knew which genres, stars, and directors kept audiences hooked to the screen. And in 2013, they used that data to produce their first in-house production that streamed exclusively on Netflix. You may remember the political drama House of Cards, starring Kevin Spacey as a murderous congressman. But even after House of Cards proved a hit, studios still saw Netflix as a minor player, not a major threat. Linear television and movie theaters remained their core business, with streaming as just another outlet.

9:04But by the time Shonda Rhimes signed her unprecedented deal in 2017, the studios realized that Netflix was a significant competitor, one that could use its deep pockets to upend the way the entertainment business had operated for decades. To stay relevant, the studios would have to change how they did business too. Within three years, the major studios had all launched their own apps. Well, in our new three-part series, we take a look at three of the biggest streaming services, Netflix, Disney, and HBO Max, and how they're battling to lure subscribers and turn a profit, and upending an entire industry, for better or worse.

9:49This is Episode 1, The Game Changer.

9:58It's April 2020 in Santa Cruz, California. Netflix CEO Reed Hastings logs into Zoom. A member of the company's communications staff is already logged in. It's the end of the first quarter of 2020, which means Hastings has to send a report on Netflix's earnings to shareholders. But this quarter, that's a taller order than usual. A little over a month ago, the spread of COVID-19 forced people around the world into lockdown. Millions of folks have been infected and nearly 200 ,000 people have died from the virus. People have lost their jobs and are isolated from friends and family. It's a scary and tragic time for the world.

10:39But amidst this chaos, Netflix has had a banner first quarter. As lockdowns rolled out around the world, people couldn't go into stores or eat in restaurants, attend concerts, sail on cruise ships. But they could watch TV and movies on their couches. Hours and hours of them. And Netflix, with its large library of content, is the perfect distraction. Shows like Tiger King and Love is Blind have gone viral, becoming global phenomenons. In the first three months of 2020, nearly 16 million people signed up for the service, a record number of new subscribers. With over 182 million subscribers overall, Netflix is now one of the biggest entertainment services in the world.

11:26Hastings discusses the tone he wants to hit with his letter. He wants to acknowledge the success the company has had, but not come across as a heartless monster gloating over profiting off a global crisis. Together, he and the staffer craft a statement that is both direct and empathetic. Hastings also makes clear that Netflix knows this growth is short-term, that it will slow down once the lockdowns ease. And it's not just lip service to uncertainty. Netflix does expect its subscriber growth to slow in the near future. But there's a different kind of trouble on the horizon for the streamer, and not just the inevitable end of lockdowns.

12:07For years, Netflix was the only major streaming service in town. But the legacy studios are entering the fray, drastically increasing competition. In late 2019, Disney launched Disney +, and WarnerMedia has announced that HBO Max will debut in May 2020, while Comcast's Peacock service is set to go live later in the summer. The problem is not just that there will be more services competing for eyeballs. Netflix will also be losing some of its most popular content to these competitors. Even though Netflix has aggressively moved into producing its own movies and TV shows over the past few years, its library is still predominantly made up of products the company has licensed from other studios.

12:51And what's more, the most popular content on the site tends to be shows that aired on traditional TV, including sitcoms like Friends and The Office. But now the studios that produce those shows want them for their own streaming services, and they're refusing to re-license the shows to Netflix. As a result, Netflix is facing an impending content cliff as these beloved shows leave their service. It's likely they'll lose even more subscribers as viewers cancel Netflix to watch their favorite shows on the new streaming services. The pandemic was a blessing for Netflix as much as they would never admit it.

13:30a way to stall or soften the impending crisis provoked by the slew of new streamers entering the competition. Meanwhile, the global lockdown creates a major crisis for traditional television stations. Both network TV and many cable stations rely heavily on live sports to drive viewership. Now, all of the major sports leagues have shut down, depriving networks of some of their most watched programming. But Netflix has never had live sports, so they're not so much affected by these shutdowns. And the Legacy Movie Studios? They have a business model that relies on releasing their major feature films into theaters before making them available to be viewed at home.

14:10And although Netflix has released some of its films into cinemas, most of their films are released straight onto the streaming platform. Theatrical ticket sales have never been significant to their bottom line. Furthermore, the company operates on a subscription model and doesn't have ads. So when companies slashed their advertising spending as the world shut down, eating into traditional TV revenue, Netflix was largely unaffected. In short, the pandemic didn't upend Netflix's core business model. It actually helped it. Netflix manages to keep its momentum going through 2021, continuing to add subscribers.

14:48It creates buzzy hits to draw in viewers like the Regency romance Bridgerton, the first scripted show created by Shonda Rhimes for the service, and the Korean nail-biter Squid Game. But as the vaccine rolls out and the world opens up, that growth starts to flatten. In the fourth quarter of 2021, the service adds 8.3 million new subscribers. That's slightly lower than their forecast. But more worryingly, they anticipate a dramatic drop-off in the first quarter of 2022. So, to compensate for that crash, Netflix announces that it's going to raise its prices in early 2022. Their most popular plan will jump from$13.99 a month to$15.49 a month.

15:36It's the first time Netflix has raised its prices since 2020. Netflix trusts that the service has become entrenched enough in people's lives that subscribers will stick by them. And Wall Street seems to agree. The company's stock price rises as analysts project increased revenue. But customers are less committed to Netflix than executives believed. And in April 2022, the unthinkable happens. Netflix reported losing subscribers for the first time in over a decade on Tuesday. Netflix blaming more competition, illegal password sharing and Russia's invasion of Ukraine. Streaming giant Netflix suffered its biggest stock loss in nearly two decades, losing more than$50 billion in market value.

16:23Suddenly, the streaming behemoth is looking vulnerable. And with rival streaming services circling, Netflix co-CEOs Reed Hastings and Ted Sarandos are forced to consider some drastic changes.

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19:31It's June 2022 in Cannes, France. Netflix co-CEO Ted Sarandos sits at a table at a restaurant overlooking the Riviera. His next meeting should be arriving in a few minutes, and his voice is raspy from taking meeting after meeting. Outside, celebrities bask in the sun and hit up night spots. But in this restaurant, Sarandos is the bell of the ball. After Netflix's poor first quarter, the company made a surprising announcement. They were going to start showing ads. For years, Netflix founder Reed Hastings insisted that commercials had no place on Netflix. But the general consensus is that to regain subscribers, Netflix has to lower the cost of membership.

20:16And the only way to make that work for the company is to use ads on a cheaper subscription plan to boost revenues. Now, there's a big lesson here, and not just for Netflix. If your business is established, the temptation is to panic. But actually, you have a choice. Lots of them. Think of this as an invitation to pivot. Notice here, in certain ways, Netflix isn't thinking about doubling down on what's worked in the past. They're doing things once considered forbidden. Adding advertising, cracking down on password sharing, eventually entering into live sports coverage. Sound like a streamer? Or more like, I don't know, a cable TV network?

21:03Hmm? As we've learned several times in previous Business Wars series, the companies that survive downturns are the ones already preparing for the next chapter, before the numbers dip. And if they do dip, don't panic. Pivot. Netflix wants to launch this new ad tier by late 2022 or early 2023, so they have to work fast. Hastings, Sarandos, and other executives have gone all in on this endeavor. They've been meeting with experts to get advice on how many ads should run per episode or movie and what those ads should look like. They've held meetings with engineers to make sure the technology's in place.

21:43and they're searching for the right executive to run this new ad division. But one thing that has become clear is that if Netflix wants to get this ad tier up and running in under a year, then they have to partner with a company that already has the technology and workforce to take over ad sales. And there are many companies who want Netflix's business. So while in con, Sarandos has been meeting with representatives working to hammer out a deal. The leading contenders right now are Google and Comcast. But he has one more meeting to go, with a representative from Microsoft. Sarandos checks his watch.

22:24Microsoft has a much smaller ad business than either Google or Comcast. As far as Sarandos is concerned, they're unlikely to land the deal. He's taking the meeting out of due diligence, but he hopes he can wrap it up quickly. A waiter escorts a middle-aged man with glasses to Sarandos' table. The man sticks out his hand and introduces himself as an executive from Microsoft. Thanks for taking the time to meet. Of course. Please have a seat. The executive sits and orders a coffee in perfect French, then turns back to Sarandos. Look, I just want to start by saying I know that the other companies you're talking to are bigger, and I know that you have ambitious plans for ad sales.

23:06Sarandos nods. Hastings has said that they eventually want to get to a place where Netflix can charge advertisers$80 per thousand views. This would be one of the most expensive rates in the business, on par with the most watched NFL games. So I know you're probably leaning more toward the big boys, but I would suggest that going with a smaller but no less competent company has distinct advantages. All right, lay them out for me. So the biggest thing is that unlike Google and Comcast, we don't have our own streaming service. Sarandos nods. It's a good point. Google owns YouTube and Comcast owns Peacock.

23:44So there's no conflict of interest in us helping you sell the most ads. I take that point. And it's not nothing. But as you noted, we have very ambitious goals. Totally, totally. But two things. We've been in the advertising business since 2009 when we launched the search browser Bing. so we're not newcomers to this. And recently we bought a major digital ad sales platform off of AT &T. In short, I'm telling you, we have the skills and the tools to take this on. Sarandos leans forward in his seat. This is all very interesting, but there's one thing that's been a stumbling block with some of the other companies, and that's that we want a sizable minimum guarantee.

24:24We want to know that we'll get a certain amount of ad revenue to offset the financial risks we're taking. That's something we're willing to discuss. Sarandos nods. Well, he has to give Microsoft credit. They may have just turned themselves into a dark horse in this race. Strategic partnerships aren't always about size. They're about alignment. Microsoft's lack of a competing service? That right there's a trust play. One month later, in July 2022, Netflix officially announces Microsoft as its ad sales partner. The new plan debuts in early November, costing consumers$6.99 per month. But it's not a home run.

25:09The number of sign-ups is sluggish. Reportedly, only 9 % of sign-ups in the U.S. are for the ad-supported tier that month. And what's more troubling for Netflix, estimates say that nearly half of the people who signed up for the ad tier were not new subscribers. They were current subscribers downgrading from pricier plans. One industry analyst declares the new ad tier a failure, saying it didn't move the needle in terms of boosting revenue for the streamer. But Netflix executives are a bit more sanguine. Sarandos assures investors that this is just the beginning. Netflix's plan with ads is first to crawl, then to walk, and then to run.

25:49And right now, they're crawling. But with a little patience, they'll be running soon enough. Now here's a hard truth. Cheaper doesn't always mean growth. A discount plan that cannibalizes existing revenue? That's not a win. It's a rebalancing act. Plus, Netflix has a plan to drive more sign-ups. For years, Netflix founder Reed Hastings encouraged Netflix subscribers to share their passwords with friends or family members, essentially giving them free memberships. In 2016, he even went as far as to say that he considered it a positive thing, arguing that many of the people who initially shared a password ultimately signed up for their own account.