Troubling Trend: Content Licensing Costs So High, OTT Services Struggling To Become Profitable

With all the non-stop mentions of how popular OTT services are, the one thing no one seems to be talking about is how any of these OTT providers are actually going to make money and become profitable. For years many said the key to the success of any OTT business was simply to get enough scale and subscribers to cover the costs of licensing and distributing content. But even as we have seen with Netflix, scale doesn’t get you to profitability when the cost to license/create content is so high and the price you can charge the consumer each month is so low.

Netflix’s subscription rates haven’t grown as fast as they need them to and the company can’t raise prices each year the way pay TV providers do. When content costs go up in the pay TV world, they pass those costs on to the consumer with higher rates. But when content costs go up for Netflix, Amazon, Hulu, Sling TV, PlayStation Vue etc. they end up eating those additional costs and rarely raise their monthly rates to consumers. Viewers have become accustomed to OTT packages in the $6-10 range for VOD and it’s a sweet spot as we have witnessed. Each time Netflix has raised rates, they have lost subs.

With more competition entering the market, content licensing costs have skyrocketed as more OTT platforms have been bidding up prices. As of last quarter, Netflix has streaming content obligations that total over $13B and their licensing costs have grown by more than 50% from 2010-2015 while their revenue has only grown 26% compounded annually. While breath and depth of catalog use to be how Netflix promoted their offering in the market, now they have so many competitors that original content is the only way to differentiate the service. Netflix is spending nearly $5B in content licensing/creation costs in 2016 alone and extrapolating out the numbers simply doesn’t work in Netflix’s favor. The company could literally run out of cash before the number of subscribers can support the business.

And it’s not just video. Spotify’s revenue grew 81% last year, but royalty fees jumped 85% to nearly $2B, taking up 84% of Spotify’s revenue. CBS said they lost money on their content licensing deal with the NFL last year for eight Thursday night games and that was for pay TV, not online. And internally, people at Twitter who don’t want to go on record confirm that they will lose money on their deal with the NFL as well. Content licensing costs aren’t just a Netflix problem, or one tied to VOD content, it’s a system wide problem across music, movies, broadcast TV, for VOD and live linear. That’s why no stand alone company can ever afford to offer a live linear services and has to be owned by an ISP, carrier, MSO or large company in the ecosystem like Google, Sony, Apple, Microsoft etc. Sling TV would not survive if it werent’ owned by Dish. And DirecTV Now is a service that could not afford to be in the market if AT&T didn’t own it. These OTT service are loss leaders for others products and services these companies are selling, or enable them to generate revenue from other services tied to it, like Amazon has with their Prime service. But even then, it’s no guarantee that OTT will make these companies more money in other ways. Hence why so few of them are willing to break out any actual numbers on their OTT ofering or the impact it has on their other lines of the business.

In 2015 Microsoft disclosed how they stopped all plans for live TV service to the Xbox as they said the content licensing costs were so high, they could never create a profitable business from it, at the price point consumers would pay. Hulu’s monthly fee of $12 a month with “almost” no commercials isn’t enough to offset the cost of licensing content, as the company isn’t profitable. Talking to those who saw the term sheet when Hulu was being shopped around last year they say Hulu has had over $1B of cumulative losses since 2008. And then we have guys like Yahoo who lost $42M in 2015 on licensing and original content creation and there are plenty of one-off examples like that to go around.

In any other segment of the industry, we typically judge the success or failure of a company based on their profit and loss statement. Yet when it comes to these OTT services, many want to judge their “success” based on the number of subs they have, without looking at profitability. Why are so many giving these OTT services a pass? And even if we do look at the number of subs, if we strip out Netflix and Hulu, none of the other major OTT services even have 2M subs, with many well under 1M. CBS All Access and Showtime each have 1M subs, as they reported in the summer. HBO Now had over 1M subs a couple of months back. Sling TV and PlayStation Vue won’t put out numbers, but are without a doubt have under 2M subs, with my bet being that both are under 1M. DirecTV Now is new in the market, but the company’s own internal projections are for 1-2M subs by the end of 2017. Hulu reported 12M subs, six months ago, which was up from 9M at the same time period, yet their growth slowed from 2014-2015 when it was growing 50% at the time.

The trickle down effect of what is happening, to everyone in the video food chain, is that Netflix and many of the other OTT service are bidding up prices for content that is so high, that even some cable channels and even studios think they won’t be able to compete. So while we have a lot of choices right now as consumers, the business of licensing content has to change if any of these companies want to make it long-term. The current way of licensing content and the costs that go with it don’t support a profitable business models. As a result, many of these OTT services are going to be impacted and will probably get re-packaged through an aggregator like Amazon, which we are already seeing take place. At some point, profit and loss of the OTT business will matter, for all of these companies.

  • This article touched a nerve earlier. I basically went on a Dennis Miller rant. Two tweets I posted are calm in comparison to comment drafts. The gall of studios never surprises me. License cost is a weapon of … I’ll go there another day. A timely and very good explanation of the issues; I didn’t know.

    The content distribution rights holder has the ability to hold OTT service hostage because deals with networks and transport infrastructure, cable and OTA, have leverage. One case that made me a bit hostile was around 2011 fall premiere of CBS show “Person of Interest”. If you didn’t watch live you missed it. Some Cable VOD choices within 7 day window did happen – No CBS online site full replay. This was distribution rights holder Warner Bros choice.

    Netflix was not in my budget in 2011 (very bad choices by management that year). Don’t recall how Amazon Video (Prime) handled that show (I speculate WB made no streaming deal). Note: I have all 4 seasons on DVD because I’m a fan & collector — I do not consider a file on remote server a collection, even though I paid to watch it whenever. Of course all the “other ways to watch” are suspect due to the origin of the stream, which leaves this consumer sad when held hostage by lack of approved distribution. That brings live stream sources question back.

    I will avoid comments on OTT live sports because I’m not a fan of any ball games except college basketball. College basketball live has the problem of not being tolerant of transport issues; cable, satellite, uplink/downlink. The stream to my device flatlines and its game over. Right now the game I could be listening to is missing from my XM device for no listed reason. Did the XM folks change rules overnight or did local FM “Flagship” station kick XM off? Answer to that is, “Maryland Sports Radio Network” stream on my mobile. I don’t see OTT getting treated very well by pro sports, luck with that.

    I may post crazy rant in my journal as a reminder that using a hammer to straighten curved glass is incorrect.