(This is a guest post by Applico Head of Platform and Modern Monopolies co-author Nicholas Johnson.)

Netflix came crashing back to earth last week.

While the company's share price had more than doubled since the start of the year, its quarterly earnings sent its share price into precipitous decline, dropping more than 10 percent overnight.

What caused the drop? Netflix fell short by more than a million subscribers of its growth estimates, delivering 5.15 million new members rather than the projected 6.2 million. Worryingly for Netflix, subscriber growth stalled both in international markets, where the company is investing heavily, as well as in the United States, where Netflix has a more established foothold.

The disappointing results come a week after news leaked that Netflix's spending on content this year could balloon to as much as $13 billion, up from an initially projected $8-9 billion. Netflix says it expects to burn as much as $4 billion in cash this year.

Early Warning Signs

Unfortunately, Netflix's recent struggles may be a sign of what's to come. 

Netflix's struggles with increasing competition extend beyond its slowing subscriber growth. Its marketing spend is also ballooning as well. The company disclosed that it has spent $1 billion marketing its shows and its services in the past six months, nearly double the $546 million it had spent on marketing in the same period last year.

For Netflix, the fall from grace was some time coming. To justify its peak valuation, Netflix's gross operating profits would eventually have to equal roughly half of all the profits made by the U.S. entertainment industry this year.

Is this scenario realistic? Not really.

Because Netflix is a tech company, many people mistakenly associate Netflix with the major platform companies like Facebook and Google. But Netflix's business model is very different from all of the big platform monopolies. Even though it is a tech company, Netflix is still a linear business that will never achieve the level of dominance of its platform competitors.

As we've written previously, the problem for Netflix is that its business model isn't very defensible. Most of its content depreciates in value within just a few years, and it lacks the defensible network effects of its platform competition. In order to get its users to keep paying, Netflix needs to churn out ever more and more content.

Until recently, Netflix was more or less the only game in town in OTT streaming services. HBO remains tied to its cable subscription model and Hulu is still comparatively hamstrung by its dependence on traditional broadcast networks. Netflix's situation today is comparable to the period in early broadcast television where there were only one or two big networks. But as happened with TV, this situation won't last for long. In fact, digital content has even lower barriers to entry than TV did.

Competition is quickly increasing, with Disney's streaming service to launch next year and major media companies like the now-combined AT&T Time Warner also growing their own digital offerings. In India and abroad, Netflix also faces increasing competition from Amazon, as well as newer competitors backed by the major Chinese platforms, like Tencent, Alibaba and Baidu.

A few years from now, Netflix will no longer be effectively the only game in town. And if Netflix can't make money now, how will it do so when its marketing and content spend continue to grow as it faces more and more competition?

Media Needs Business Model Innovation

Netflix's troubles are an even worse sign for traditional media companies, many of which appear to be all-in on trying to replicate the Netflix model. However, slapping digital distribution on top of what is essentially a traditional content company doesn't do much to change the economic fundamentals of the business model. As Netflix's growing cash burn suggests, creating content involves very high fixed costs. And as competition for content increases even more in the years ahead, those costs will only go up. 

Rather than falling into the Netflix trap, traditional media companies should be embracing true business model innovation and looking to open up new sources of content. Twitter's recent comeback provides a recipe for media companies to follow. Mixing user-generated content with premium, linear content is a winning recipe. It's one that all of the major content platforms are starting to embrace. But most traditional media companies have so far struggled with the idea of opening up to external content creators. Disrupting your own business model is never easy. However, Netflix's struggles show that the alternative may be even less attractive.

Published on: Jul 22, 2018