The Digital Media Layer Cake

Legacy content providers can still be in Fat City. But only if they overcome fear and greed.

I’ve recently come to think about digital media’s competitive environment as a layer cake with 7 distinct layers. These are, in ascending order:

Hardware
OS
Connectivity
Apps
Creators
Advertising (sometimes)
Content

Each layer requires those beneath it to reach the consumer, whose ultimate interest is primarily the content itself, but who also cares a great deal about the convenience and experience of discovering and accessing that content. For example, if I want to watch my favorite new show, Tim & Eric’s Bedtime Stories, my goal is to get the show exactly when I want in as few steps as possible. This can only be done by what is an astonishingly complicated hack: I must rely upon a deal that Tim and Eric have done with the Cartoon Network (creators), a licensing deal that Cartoon Network has done with Apple (content), Apple’s distribution through the iTunes Store (app), Time Warner Cable’s Road Runner service (connectivity), iOS (OS), and my iPad (Hardware). If I want to hear the two new Prince albums, by contrast, I might rely upon a different slice of the cake: a license that Prince has given Warner Music Group to distribute his albums (creators), a license that Warner has granted to Spotify (content), Spotify (app), Verizon Wireless (connectivity), Google’s Android (OS), and Samsung (hardware).

Each of these companies owns and operates assets on different layers of the cake, and relies upon other actors for the layers that it does not control. None of them is really a so-called “walled garden,” not even Apple, which gets a lot of heat for not playing well with others. Each exists in an uneasy equilibrium, knowing that its customer experiences — and ultimately, profitability — depend upon these other actors, the “frenemies” of the media layer cake.

Having frenemies is frustrating business for these players. For content creators and media rights companies (studios, record labels, etc), the anxiety arises from the need to go where the customer is going. Certain musicians dislike Spotify’s business model, for example, and although I’m biased (as Spotify’s Artist-In-Residence) to view this as a product of shallow thinking and misinformation, what it undoubtedly amounts to is discontent with a lack of control over the means of distribution.

In the past, when consumers had less power, they had to go where thegatekeepers wanted them to go. When I was 12, if The Smashing Pumpkins gave Target an exclusive on their album, I was going to Target even if my parents needed to drive me 20 miles to the nearest store! But multichannel systems and the Internet have created an entertainment abundance for consumers, and we’ve come to feel that our favorite stuff should always come to us. If it doesn’t, we now have access to so much good stuff that we’ll move on and listen to, read, or watch something else that does engage us on our terms. The result of this is that smart creators and rights-holders respect the customer much more than they did in the past, and must ensure that their content is wherever people want it. For the most part, they now license promiscuously, which is why the same songs are usually available on Spotify, iTunes, Google Play, and elsewhere.

Occasionally, an artist like Jack White creates such a differentiated experience around his content that he can still compel his fans to come to him, but this requires him to devote an incredible amount of energy to non-musical activities. His record store makes specialty vinyl records in limited editions, for example, and sells them in a highly stylized environment. Fans travel from other states and line up for hours to get his products. But White is rare, and he also entered the new media layer cake with an incumbent advantage: a large and energetic fan base that he grew for years in the old system with the benefit of a massive hit relatively early in his public career.

The rights companies, by comparison, rarely distinguish the experiences around their content because they are historically business-to-business enterprises. Their customers used to be the record stores, television networks, and movie theaters, but never really the customers themselves.

What seems in retrospect to have been a major missed opportunity was that these companies failed to create and own the means of distribution when the opportunity presented itself. For example, rather than recognizing that consumers liked Napster and attempting to create a competitive, legal environment under their own control, record labels tried to destroy it and sue the music fans who used it. How did that work out?

Their unenviable path has therefore been to “outsource” innovation to Internet companies like Apple and Netflix. And it’s these tech companies who now control access to the audiences for the rights holders’ products. Studios and labels have necessarily swapped their old analog retail partners for new digital ones, but these new partners are far more ambitious and directly competitive than their predecessors. The Sam Goodies and downtown movie palaces of the Old World contentedly occupied merely the app layer; companies like Amazon, Apple, and Google, by contrast, are attempting to consolidate power in as many layers as they can, building “vertically integrated” technology and media megaliths.

This Machiavellian strategy requires that each of these giants strives to weaken the power of its partners and competitors in the layers that it does not control. That’s the context for Amazon’s launch of the Fire phone (capturing hardware) and its just-announced acquisition of Twitch (buying into the app, content, and-probably — advertising, layers). It likewise substantiates the Facebook and Google forays into broadband (capturing the connectivity layer), as well as the Apple Google, Amazon, and Netflix activities around original content. Four of these companies now sell films directly to consumers. Three sell music. All but Netflix have primary businesses outside of these media offerings and can afford to think of art as a marketing expense in the context of far more profitable strategies.

All this acquisitive energy could come with a price, however. Perhaps the rich nerds running these companies are just trying to be cool by making movies and going to the Grammys. Bored rich people have always flocked to the entertainment industries for fun and status. And if these efforts fail to drive significant revenue and deepen competitive moats, then they’re a waste of time and shareholder money.

On the other hand, imagine that Google or Amazon can become the world’s first integrated film studio, record label, publishing house, advertising platform, advertising agency, digital retailer, physical retailer, telco, cable company, electronics hardware manufacturer, and digital services provider! It is hard to imagine a bigger hypothetical coup for shareholders, a rare, once-in-a-lifetime merging of industries.

That outcome may sound preposterous, but it is exactly the endgame that the chess pieces currently arrayed foretell.

The executives at these companies might deny that they envision such a future, but their activities indicate that this is exactly what they have in mind! And if they could capture the lion’s share of the advertising industry that is still devoted to billboards and television ads in the process, then they could deliver consumers innovative content experiences for far less than cable companies and other incumbent platforms currently charge. What’s more, they could use all of their data to program for consumers exactly what those consumers want, not what cigar-chomping media executivessubjectively think they want. To the technology folks, the content industries are backwards in their lack of empiricism and their reliance on highly-paid executive bet-makers.

The rebuttal from the content folks, of course, is that art is not a science. Making Game of Thrones isn’t easy, they’ll argue, and it’s certainly not best executed by deploying historical user engagement data and other esoteric analyses. The content executives believe that they alone still have the touch,the instinctive aptitude for making the things that people want to read, see, and hear.

This is mainly false. Sure, a few David Geffens, Ahmet Erteguns, and Walt Disneys grace the world, picking with hot hands the most brilliant geniuses of our times before they are apparent to the rest of us. But the content business is mostly an unstructured guessing-game filled with personal politics and capriciousness. I’ve seen it personally in the record business. All of the labels perennially get worked up about the next big thing, only to have it inexplicably fail, while the act they dropped three years ago shockingly tops the charts. Culture is largely unpredictable. Most things fail. A few succeed. Everyone believes that they know the future. Almost nobody does.

Picking winners before they are winners is hard in every industry where it’s required. Professional investors, with shocking consistency, fail to yield fee-adjusted returns on capital that exceed those of a thoughtless index fund. Unfortunately, with the erosion of revenues in media, picking winners today has become far less profitable than it used to be.

And it’s also become harder. In the old media businesses, you merely had to control gatekeeper channels to make something a moderate / break-even success (provided that it wasn’t terrible). But now you can’t make anything! Payola just isn’t what it used to be. The power resides with the audiences! If people don’t dig what you put out there, you’re unlikely to recoup the money you spent creating and promoting it in the first place.

If the content businesses want to remain relevant in this moment, then, they have only one option: create new, defensible strategies for identifying the most talented creators and the most remarkable content on the planet. This requires a shift in business strategy and culture, away from hierarchical oligopolies with bloated budgets and towards meritocratic, performance-driven, rational content investment methodologies. It means that they must blend more science into their art and ruthlessly shed their excesses. They must make themselves the most attractive homes to creative people, offering a refuge of funding and creative support. They need to ally themselves directly with creators and get past their historical unfriendly reputations. Whoever owns the output of the most talented creators in the world won’t struggle to make plenty of money over the next several decades, and no one is currently better positioned to do this than the incumbents.

If they can succeed at picking winners in a more consistent and proprietary way, rights businesses should also consider investing creatively in the historic brands that they own like Motown or Paramount. Even if they don’t control digital distribution, brands like these can still mean a great deal to consumers and deepen the competitive advantages and bargaining positions of the parent rights companies. Reanimating such brands with clear curatorial identities can also create direct marketing channels of considerable value. Let consumers know that a record with the Blue Note logo on it truly means something again!

For pure-play digital retailers like Netflix, the goal should be to become indispensable to consumers, which also means becoming indispensable to other players in the OS, hardware, and connectivity layers. They must ensure that distribution doesn’t become a commodity, in other words. Netflix must be better than the iTunes store. People must be unwilling to buy an iPad or a Samsung Galaxy if they can’t get Netflix on them. And how can this be accomplished? By becoming better at curation and recommendation than anyone else and, maybe, by developing a bit of original content that consumers covet. Each House of Cards is another good reason why the world (and especially Netflix’s frenemies) can’t live without Netflix.

Unfortunately, if we take this strategy to its conclusion, we could end up with a world in which content is fragmented between different players competing to differentiate themselves from each other. And if buying one type of hardware or using one media service over another means missing out on swaths of great content, creators and consumers will both lose.

A customer-centric future, by comparison, would allow consumers to get all of the content that they want through a multitude of legal environments as soon as it’s released. If the film moguls think I’ll like a movie more if I see it in a theatre, then they should work to reinvent the theatre experience so that I choose it over on-demand services on my iPad. They shouldn’t force release windows upon me for purely commercial reasons. New albums should be on iTunes and Spotify. Books should be on Amazon and Oyster. All networks should follow HBO’s lead and put their stuff everywhere! Let me fall in love with great work at a reasonable price and through whatever channels I prefer. Enable us to experience and share our favorite art with as little friction as possible. Allow common culture to flourish.

Realizing such a customer-centric economy could grow the pie (or cake!) for everyone. It could mean bigger hits for the content companies, greater engagement for digital distributors, and a richer media diet for consumers. It could mean windfall profits driving huge investments in new content and creators. It could mean a renaissance of great new art for all of us. Rejoice!

The question is: will Google, Apple and Amazon ever let that happen? It does seem possible that the game theoretical dynamics of this moment lead towards an arms race of exclusive content that might, ultimately, be suboptimal for all parties involved.

Ironically, the greatest leverage to prevent this techno-cultural catastrophe resides with the old guard: studios, labels and artists themselves. They alone have the final power to resist exclusivity regimes because without them, there’s no content. But this requires the patience and long-term orientation to turn down big, shiny checks in the short-term. If they exercise that self-control and wisdom, they can secure a pivotal role in the future.

But folks in the entertainment industry are not known for these qualities.