Almost all of us consume content in some form or the other on our smartphones, tablets or PCs. Be it for reading books, watching movies, listening to music and so on. It wouldn’t be inaccurate to say that the internet has destroyed value to some extent for a variety of content from news to music. A big reason for this value destruction is obviously piracy and the accompanying decline in digital revenues as the industry shifted from downloads to subscription based pricing. Lately, there has been a trend around treating content as a loss leader.
Content is being viewed as something that’s complementary by a lot of tech and telecom companies. These companies don’t want their product to be based on content but want it to act as something that would increase the value proposition of their main products. This bundling of content is happening by companies whose growth has either stalled or by companies that have a product/service that is witnessing tremendous amounts of growth.
Although bundling is done by these companies, they are doing so at a loss and this has been happening much more frequently in the industry lately. When it comes to saturation, I have two examples to provide – Apple and AT&T. The smartphone market globally is saturating, there’s no doubt in that. Apple, by virtue of being limited to the higher end smartphone market, is facing shipment declines for the iPhone Y-o-Y every passing quarter. In the case of AT&T, the US wireless market has already approached saturation and everyone who wants a phone connection has one. Apart from that, everyone who needs a smartphone has one. Just like Apple, even AT&T has been losing subscribers for the past few quarters to its rivals T-Mobile and Sprint.
In the case of Apple, the company decided to venture into Apple Music. It must be noted that Apple already had a very big presence in the music industry via iTunes, so venturing into Apple Music only made sense. Although Apple has received a little criticism for the UI and its messed up syncing process that made some people lose a few songs, there’s no doubt that Apple Music has been a success. The company now has 17 million paying subscribers for Apple Music while market leader Spotify has 40 million. The latter does have the larger number of subscribers but adoption in the case of Apple Music has been at a much faster rate as seen from the graph below.
Despite having the larger number of subscribers, Spotify still hasn’t been able to turn a profit. Even if we are to assume that Apple has negotiated better rates with the music labels, I’m sure Apple faces some loss. But for them, this loss in Apple Music doesn’t matter as long as it helps them sell more iPhones that carry some of the highest gross margins amongst consumer electronic devices. Apple has the balance sheet to continue Apple Music at a loss for years to come.
AT&T has introduced DirecTV Now which is an OTT service that provides close to one hundred channels. AT&T acquired DirecTV and is in the process of acquiring Time Warner in order to create content for its DirecTV Now OTT app. The acquisitions of DirecTV and Time Warner itself will come close to $100 billion for AT&T, which is a huge amount to recover considering that synergies are very limited. But forget about recovering the $100 billion spent on acquiring DirecTV and the impending Time Warner acquisition, AT&T is actually looking to price the DirecTV Now service at $35/month which in the eyes of many analysts is clearly loss making even at the gross margin level.
Again in the case of AT&T, just like Apple, the company has a wireless business as its core product. If zero rating DirecTV Now can help AT&T reduce its churn or help bring in more customers from other operators, then it’s a net win for AT&T. Also, the $35/month pricing of DirecTV Now can always be increased in the future and AT&T can stop zero rating it and charge customers for data incurred while using the service. While Youtube is limited to ads along with the newly introduced Youtube Red program for revenue generation and Netflix is mainly limited to subscriptions for revenue generation, AT&T has the ability to generate revenue by not only ads & subscription but the eventual data consumption as well.
When FCC hauled up AT&T saying that zero rating DirecTV Now was an anti-competitive move, AT&T replied by saying that DirecTV was paying AT&T for zero rating DirecTV Now and every other company could do that as well. So AT&T is already going to book revenues from the zero rating of DirecTV Now and probably pass on that money to customers in the form of increased subscription prices for the service in future in case it continues to zero-rate.
I’ve explained above how Apple and AT&T are making use of content as a loss leader to improve the value proposition of their core products namely iPhone and wireless data plans in a saturating market. There are companies however that are using the same strategy in order to boost the growth of their new product/service. Those two companies are Reliance Jio and Amazon.
Amazon has always been a low margin company that prefers to invest its profits into newer ventures rather than accumulate it. Amazon has a Prime service that bundles a lot of benefits such as free shipping, free music, free video etc for a monthly/yearly subscription free. It has used a combination of Prime and content recently to boost the growth of emerging products/markets. The very first place where this was visible was Echo. Most music streaming services cost around $10/month for individual plans and around $15/month for family plans, however, in the case of Amazon Echo/Dot, Amazon’s music streaming service is available for as low as $4/month per Echo/Dot.
Now, obviously, in an industry where players are not able to make money on a $10/month subscription, doing so at $4/month is almost impossible. But to Amazon’s benefit, Amazon Echo/Amazon Dot acts as the most frictionless medium to order goods from Amazon. If someone starts ordering a lot, thanks to the simplicity of Echo/Dot, then it makes a tremendous amount of sense for Amazon to throw in discounted music. There are certain second order effects at play as well. Let’s assume someone decides to buy an Amazon Echo because of the discounted music streaming service and starts ordering quite a lot of stuff from Amazon, then obviously the person would also be inclined to subscribe to Prime so that he can get free and fast shipping and a host of other benefits. Again, if a person subscribes to Prime, Amazon benefits at the end of the day.
Apart from music on Amazon Echo, Amazon is using its Prime video streaming subscription service as a loss leader as well. Having lost the battle in China to Alibaba, Amazon wants to win the Indian e-commerce market at any chance and is willing to do whatever it takes. Ever since Amazon set up shop in India, it has made great progress. It has already overtaken Snapdeal and is assumed to be a close second to Flipkart. Amazon has already launched its Prime service in India that provides free shipping and faster shipping times.
Amazon’s current aim in India is to gain market share as fast as possible. It’s already providing a lot of products on discount. To that extent, even Amazon Prime is quite aggressively priced. It costs just Rs 499/year ($7.3) for the first year and Rs 999/year ($14.6) then onwards. For a lot of people, free & fast shipping at Rs 499/year itself is a great proposition. If you add in a free video streaming service then it becomes a totally must have product. Also, Amazon is reportedly considering licensing Bollywood films and IPL for its streaming service in India.
After Amazon, there’s Jio. Jio has launched a pan-India 4G telecom network at an estimated cost of $22 billion and just like Amazon, even Jio wants to grab as much market share as soon as possible. To that extent, Jio has decided to give away subscription to Jio Mags/Jio Cinema/Jio TV etc for free. All the person needs to do is a data pack recharge and Jio’s entire suite of content apps would be made available for free at no extra charge till the end of 2017. It’s entirely possible for Jio to extend the free trial of Jio apps beyond 2017 as well in order to gain market share. Even if Jio makes subscription to its Jio suite of apps free, people still need to buy data packs from them to consume the free content.
With the help of AT&T, Apple, Amazon and Jio, I have detailed and explained how companies are using content as a loss leader to make their core offering more attractive or to boost their core business. The loss over here is that of companies that have content as their core offering. Apple is ready to take a loss on Apple Music as long as it helps them sell more iPhones just like Amazon is willing to take a loss on Amazon Prime Video and Amazon Music unlimited as long as it helps get them more Prime subscribers.
But what about companies like Spotify and Netflix then? Agreed that Spotify has a larger paying base than Apple but it isn’t profitable yet and doesn’t have a money printing smartphone business to subsidize its losses. If Spotify raises its prices, then Apple Music immediately becomes more attractive to Spotify’s subscribers considering it’s on Android as well. Netflix has a host of original content that it develops as a credible moat in markets such as America and Europe where it’s well established, but what about markets like India? Will anyone want to pay Netflix Rs 500-800/month when Amazon is willing to offer free shipping and video and probably even music for Rs 999/year?