Note: the following is an excerpt from my contribution to Finding Genius: Venture Capital and the Future it is Betting on, by Kunal Mehta, which features interviews and contributions from dozens of venture capitalists about the industries they invest in. It has been lightly edited for publication in OneZero.
Global media and entertainment is a $2 trillion industry consisting of filmed entertainment (movies, television, digitavideo), audio (music, radio, podcasts), publishing (newspapers, magazines, digital publishers), and video games (console, PC, mobile, eSports.) The United States represents a third of the global market — over $700 billion in annual revenue and has traditionally produced the most prolific media assets, which are subsequently distributed around the world. Media, perhaps more than any other industry, has been radically transformed since the advent and mass adoption of the internet. Prior to the internet, the vast majority of media and entertainment content was produced and distributed by a select few gatekeepers: movie and TV studios, record labels, book publishers, and newspapers. This control was necessary, as the costs to produce and distribute content was extremely high and out of reach of the everyday citizen. In the past 20 years, the democratization of distribution technology and falling costs of content production have opened the proverbial floodgates and allowed “new” media companies to emerge. However, industry incumbents have thus far survived and adapted, relying on their high-quality (and expensive) talent networks and capital advantages while ramping up investments in promising media startups.
Investing in media startups is a risky gamble, as content is highly subjective, and it’s difficult and expensive to produce quality at scale. In fact, entertainment is a hits-driven industry (much like venture capital), where investments in a few “home-run” projects yield outsized returns, covering losses on a majority of other investments. Some venture capital firms explicitly avoid media investments, and founders I’ve spoken with have expressed with frustration that “most VCs don’t understand media.” The truth is, the media industry is a complicated ecosystem, still dominated by a small number of corporate behemoths who are growing even larger with recent mergers and acquisitions. Today, the incumbents continue to have significant advantages over potential disruptors which can be simplified into two categories: talent and capital. The soul of the media and entertainment industry is the talent: Writers, journalists, developers, performers, and directors who conceive of new ideas for projects and execute the creation of them. This talent is traditionally supported and guided by highly paid professionals at studios, labels, and publishers whose jobs are to shepherd projects to commercial viability and maintain close relationships with talent. As demand and competition for quality content has increased in recent years due to the on-demand nature of the internet, prolific creators have commanded record financial incentives, making it even more capital-intensive to produce premium content — a significant barrier to entry for newcomers.
Technologies and innovations that have driven change in media in the 21st century have been streaming video infrastructure, smartphone, mobile video, cloud storage, direct-to-consumer subscriptions, content paywalls, and live streaming. These shifts have primarily affected the distribution and consumption of media, as consumers have a record number of content sources and platforms to choose from.
Ventures focused primarily on advertising-supported business models have not fared well compared to subscription businesses.
Recent, successful startups in media and entertainment
Interestingly, the most successful new media companies to emerge in the past 20 years all found ways to work directly with incumbents, often utilizing their premium content to build audiences and users, rather than creating original content from scratch at inception. This strategy of using proprietary new distribution channels to distribute third-party premium content rewarded Netflix (founded in 1997, IPO in 2002, $154 billion market cap), Spotify (founded in 2006, IPO in 2018, $22 billion market cap), Roku (founded in 2002, IPO in 2017, $10.2 billion market cap), and BAMTech (spun out of MLB Advanced Media in 2015, majority stake acquired by Disney in 2017 at a $3.75 billion valuation), which are some of the most valuable new media and entertainment companies over the past two decades.
Reed Hastings founded Netflix in 1997 with the vision of delivering movies over the internet, a product the company wouldn’t launch for another decade — over five years after its IPO in 2002. From the beginning, Hastings realized two things: First, it would require content from major studios to make a compelling consumer proposition; and second, this content would be relatively expensive (for a startup). So in the meantime, he built a massive DVD-rental-by-mail service, raising over $100 million in venture funding before the IPO in 2002. In his initial meeting with Ted Sarandos (now Chief Content Officer) in 1999, Hastings reportedly relayed his vision by explaining: “Postage rates are going to keep going up and the internet is going to get twice as fast at half the price every 18 months. At some point, those lines will cross, and it will become more cost-efficient to stream a movie rather than to mail a video. And that’s when we get in.” Hastings was then able to license streaming rights from major studios, who viewed the revenue as incremental to their bottom line and didn’t foresee the massive change in consumption that Netflix was heralding. Always one step ahead, Reed additionally foresaw that studios would eventually pull their content from the platform in order to offer competitive products, and began producing original content in 2013. In 2019, Netflix will spend $15 billion on content, reaching well over 700 original series and releasing 80+ original films in an attempt to remove their dependence on third-party content from Disney, WarnerMedia, and other suppliers. As of May of 2019, Netflix had a market cap of $154 billion.
Daniel Ek and Martin Lorentzon founded Spotify in Sweden in 2006. Ek, having experienced the ability to access the entire world’s music catalog through Napster, realized that “you can’t put the genie back in the bottle,” and believed that this on-demand access would eventually prevail in some form. At a time when music labels were combative with and threatened by any music download or streaming service, Ek found a way to mitigate the risk of their cooperation with Spotify: He guaranteed them the equivalent of one year’s worth of revenue to launch in the Swedish market and prove the model. Spotify launched successfully in Sweden in 2008, later gaining the attention of Sean Parker, the co-founder of Napster, who invested in the company through his role at Founders Fund in 2010. Parker joined Spotify’s board and personally negotiated with Warner and Universal Music Group on behalf of Spotify, which launched in the U.S. in 2011. After completing a direct listing on the New York Stock Exchange in April 2018, the company has a market cap of $22 billion as of May 2019.
BAMTech, the video streaming infrastructure platform originally pioneered by MLB’s Advanced Media Group to stream MLB baseball games went on to take on third-party clients beginning in 2005, including CBS’ March Madness, The WWE Network, HBO Now, Playstation Vue, PGA Tour Live, NHL Live, MLS Live, and Hulu Live TV. After officially spinning out of MLB Advanced Media in 2015, Disney acquired a controlling stake in the company in 2017 at a valuation of $3.75 billion. Today, Disney is utilizing BAMTech’s streaming infrastructure technology to launch Disney+, their forthcoming direct-to-consumer product set to launch in November 2019.
Other notable media technology companies pioneering distribution technology relied on someone other than incumbent media conglomerates to produce content: consumers themselves. YouTube, founded in 2005, enabled anyone to upload videos to its platform, and was quickly acquired by Google in 2006 for $1.65 billion. Twitch, spun-off from Justin.tv in 2011, enabled video gamers to live-stream their gameplay, and was acquired by Amazon in 2014 for $970 million.
21st century challenges and learnings
Companies relying on original content and third-party distribution channels have had a tougher time reaching and sustaining scale. Founded in 2007, Zynga, the social and mobile video game studio made famous by FarmVille’s viral success on Facebook saw explosive growth — raising over $866 million in venture funding in just over four years. After an IPO in December 2011 at a valuation of $7 billion, the company has shrunk to a market cap of $5.7 billion as of May 2019. Ventures focused primarily on advertising-supported business models have not fared well compared to subscription businesses. Native digital publishers have yet to exit with valuations over $1 billion, and the most successful exits occurred as acquisitions between 2010–2015. Business Insider (founded in 2007) was acquired by Axel Springer in 2015 for $442 million. The Huffington Post (founded in 2005) was acquired by AOL in 2011 for $315 million. The Bleacher Report (founded in 2007) was acquired by Turner Broadcasting in 2012 for $175 million. Digital publishers who weren’t acquired during the heyday of Facebook’s publisher-friendly algorithm have struggled in recent years. Mic Network (founded in 2012) was sold in a fire sale to Bustle for a reported $5 million in November 2018. Mic had previously raised over $60 million in venture capital, and was at one point valued over $100 million. Mashable (founded in 2005) was acquired by Ziff Davis in 2017 for under $50 million, after raising $46 million in venture funding and being valued at $250 million in an investment round led by Time Warner in 2016. Vox Media (founded in 2003 and last valued at $1 billion during a 2015 fundraising round) and Buzzfeed (founded in 2006 and last valued at $1.9 billion during a 2016 fundraising round) have both faced layoffs and significant revenue target misses since their last fundraising efforts.
The struggles of advertising-supported media companies over the past decade highlight the challenges facing newcomers in media and entertainment still today: FAANG. Facebook, Amazon, Apple, Netflix, and Google. Digital publishers who depended on ad-driven revenue models found that Google and Facebook sucked the proverbial air out of the room, amassing over 50% of the digital ad market. Amazon’s impressive entrance into ad-sales is also projected to skyrocket over the next few years. Further, the startups that depended on these platforms for distribution — Buzzfeed (Facebook), Zynga (Facebook), AwesomenessTV (YouTube/Google), and Maker Studios (YouTube/Google) — found that depending on third-party distribution channels could put their business at risk with the simple change of an algorithm; and they had no control over that. The two primary concerns of media companies — content and distribution — face tough competition by FAANG, which own the largest distribution networks in the world, and are now self-interested media companies, investing billions of dollars in original content annually.
Strategic partners and prolific venture investors in media and entertainment
Media startups face an interesting dynamic: Since the vast majority of premium content is still produced and distributed by a small number of legacy media conglomerates, there are few exit opportunities beyond scaling large enough to go public. Content isn’t a defensible moat, as media companies have superior talent networks and capital to invest in popular content trends. Incumbent media conglomerates also have active corporate development teams, and routinely invest in startups to either: Secure a stake in a high-growth media technology company, or learn from savvier technology challengers to innovate on their own strategy.
For more insights about how venture capitalists approach investing in media companies — as well as AI, Blockchain, Financial Technology, Future of Work, Education, and Healthcare — check out Finding Genius: Venture Capital and the Future it is Betting on.