Blockbusters: Hit-making, Risk-taking, and the Big Business of Entertainment

by Anita Elberse

  Facing mounting costs for its vast long tail, YouTube and Google’s executives have caught on to this reality. Remarkably, Eric Schmidt seems to have had a change of heart about the long tail. Just two years after championing the idea, he said: “I would like to tell you that the Internet has created such a level playing field that the long tail is absolutely the place to be—that there’s so much differentiation, there’s so much diversity, so many new voices. Unfortunately, that’s not the case.” Schmidt’s revised thinking is more nuanced. “While the tail is very interesting,” he said, “the truth is that the vast majority of revenue remains in the head. This is a lesson that businesses have to learn. While you can have a long tail strategy, you better have a head, because that’s where all the revenue is.” He described it as a “90/10 model,” stating, “We love the long tail, but we make most of our revenue in the head.” If Google does indeed make 90 percent of its revenues from the top 10 percent of its advertisers, the company is probably doing most of its business with many of the same large advertisers that were active in more traditional markets before Google pioneered online search advertising, and that still account for the biggest share of traditional-media advertising.

  Schmidt, once so enthusiastic about Anderson’s ideas, now argued for a winner-take-all effect, stating: “In fact, it’s probable that the Internet will lead to larger blockbusters and more concentration of brands.… [W]hen you get everybody together they still like to have one superstar. It’s no longer a US superstar, it’s a global superstar. So that means global brands, global businesses, global sports figures, global celebrities.”

  Insights such as these explain why analysts called for YouTube to find ways to make the tail pay for itself (by charging users to upload content, for instance), why YouTube experimented with video rentals—and even why Kyncl is pushing his “Original Channels” idea. The company’s latest strategic shift may have been framed as a desire to cater to niches, but the way YouTube’s executives decided to allocate their funds reveals that it is effectively a play for hits.

  When Kyncl and his team finished reviewing the flood of proposals he received after making the rounds with his idea, YouTube awarded advances to just over a hundred channels. Among those funded were channels proposed by Madonna and her manager, Guy Oseary, with a dance channel called Dance On; Shaquille O’Neal, with the Comedy Shaq Network; former Saturday Night Live comedian Amy Poehler, with Smart Girls at the Party; former professional skateboarder Tony Hawk, with skateboard channel RIDE; and Michael Hirschorn and Larry Aidem, former head of programming at music television network VH1 and former president of the Sundance Channel, respectively, with Life and Times, a channel focusing on Jay-Z’s cultural and artistic interests—some of the entertainment world’s biggest stars, in other words, and not a slew of unknowns and amateurs. Although the list of creators receiving advances does include less established names, YouTube’s bet on Original Channels is very much a gamble on the power of big media stars.

  Granted, the artists providing content for YouTube’s Original Channels may not be motivated primarily by fame and fortune. Creative freedom may be a key reason, just as it was for Tom Cruise in the United Artists deal. “TV producers are governed by a creative and greenlighting process with a lot of involvement from the network,” said Carloss. “There are notes and strict formats they have to follow, and a very narrow funnel into a piloting process. The whole process can take years. Even if their show goes on the air, it may be canceled two months later. That is very frustrating. The freedom and flexibility to go from idea to audience within a matter of days or weeks is very compelling to even the biggest content creators.” The ability to test new ideas could be another motivator. As Carloss put it: “They get to see how audiences respond, and boy, do they respond! These are highly engaged communities, who comment and like and share. That is very appealing. Content creators can use YouTube as a farm system to develop new formats or shows.”

  True to the principles of how blockbuster hits usually come about, the company also acknowledges that it has to heavily promote the efforts of those stars. “We are dedicating over $200 million to marketing our channels on YouTube,” said Carloss. “That is a big promotional commitment.” The marketing comes in the form of advertising—on, yes, YouTube. “When you have a platform the scale of YouTube’s, your smartest and most efficient venue is the one that is closest to where the content is viewed, just as television takes a percentage of its air time and devotes it to promoting its own shows,” Carloss explained. If YouTube is too focused on niche content, the site will find it difficult to recoup its sizable investment in content development and marketing. No surprise, then, that YouTube awarded so many of its advances to established audience magnets and proven characters.

  It is too early to tell how YouTube’s Original Channels will fare but so far the results do nothing to dispel the realities of competing in the new media environment. In late 2012, YouTube doubled down on its investment, providing a second round of funding to as many as sixty channel owners. At the same time, though, it pulled the plug on 60 percent of its programming deals. Shortly after YouTube launched its Original Channels, Carloss told me that “the channels are the network chiefs and I think that’s very appealing to them.” But by terminating so many of its initial deals, YouTube showed that in fact it is ruling the “airwaves” here. Meanwhile, among the ten most popular channels in early 2013 were those run by Jay-Z, auto magazine Motor Trend, humor site the Onion, Warner Music’s video channel The Warner Sound, and wrestling giant WWE (World Wrestling Entertainment)—all entrenched, popular brands that could presumably have achieved YouTube fame even without Google’s funds. Once again, blockbuster and superstar brands are carrying the day.

  Realizing that a few winners still go a long way—and probably farther than ever before—other online businesses are following suit. Netflix has entered the arms race for premium content by spending a rumored $100 million on its own television series House of Cards, starring Kevin Spacey. Judging by its pipeline, Netflix is acting more like an old-school television network than the long-tail company it once seemed intent on becoming: both the upcoming Eli Roth horror series Hemlock Grove and the Jenji Kohan comedic drama Orange Is the New Black are expected to cost up to $4 million an episode. “They’re huge budgets shows, they’re doing things in a huge way,” CAA agent Peter Micelli said about the series. Even Microsoft is joining the fray: the technology giant has hired television veteran Nancy Tellem, formerly in charge of programming at CBS, to produce high-end programming for its Xbox platform.

  The premium online video space is quickly becoming crowded. By upending their original models and placing bets on original, professionally produced content, YouTube, Netflix, and Microsoft are moving closer to a fierce competitor in that space—and, in an interesting twist, a site whose very launch was triggered by YouTube’s popularity.

  * * *

  Initially scorned as a futile attempt to compete with YouTube, Hulu had by 2009 made great strides toward its goal of, as its then chief executive officer Jason Kilar described it, “helping users find and enjoy the world’s premium, professionally produced content when, where and how they want it.” (“I’ll be the first to say that our mission is extremely ambitious,” Kilar admitted.) By 2009, in only its second year of operation, the site had become the premier online aggregator of high-end video content in the United States.

  Kilar and his colleagues had faced what many insiders considered an impossible task. In March 2007, Jeff Zucker, then president and chief executive officer of NBC Universal, and Peter Chernin, then president and chief operating officer of News Corp., had announced a deal to launch “the largest Internet video distribution network ever assembled with the most sought-after content from television and film.” The idea to join forces and form the venture “started out of frustration that other people were using our video online and creating a business,” said Zucker. “YouTube was really built on the back of one of our videos,
Lazy Sunday.… We want to make sure consumers know they don’t need to steal our content.” The two companies could bring a wide range of programming to the new venture: NBC Universal and News Corp. together had an extensive portfolio of television networks (including NBC, FOX, and several cable networks), television production companies, and motion picture studios.

  The announcement met with much skepticism. “Old media guys don’t ‘get’ the Internet,” was how one magazine put it. The company’s unimaginative temporary name, NewCo., prompted pundits to ridicule it as “NewTube,” “Old Co.,” or even “Clown Co.” Industry insiders openly questioned the idea, pointing to the failure-ridden track record of major media companies working together to battle piracy, such as BMG, EMI, and Sony’s MusicNet, which performed dismally. Capturing the prevailing sentiment about Hulu’s chances, influential technology blog TechCrunch proclaimed: “Name this thing fast, before ‘Clown Co.’ becomes more than just an inside joke.”

  In ten weeks, Kilar and a team of around twenty people raced to build a beta version of the service. “We used paper sheets to cover the windows and block the rest of the world out,” Kilar told me. “People were sleeping on air mattresses right here in the office.” In March 2008, Hulu opened to the public, offering free streams of television shows and movies. The site quickly caught on with users and critics alike: just after the public launch, show business magazine Entertainment Weekly called Hulu “the most promising new way for consumers to view television shows and movies online since the almighty iTunes.” One year after its beta launch, Hulu counted over forty million unique viewers, offered more than one thousand titles, delivered over one hundred million streams each month, and had served more than a hundred regular advertisers. The Associated Press named Hulu “Website of the Year.” Even TechCrunch ate its words; in an article entitled “Happy Birthday Hulu. I’m Glad You Guys Didn’t Suck,” one of its bloggers wrote: “I was wrong. Hulu rocks. Despite ridiculous odds, the company was able to pull off a joint venture between two humongous parent media companies and provide users with a compelling, sexy product.”

  The founding partners each had an equal minority stake in the company. In return for a 10 percent stake, Providence Equity Partners, a $21 billion private-equity fund, provided a $100 million equity investment. In April 2009, after what Kilar referred to as a “long courting process,” Disney joined NBC Universal and News Corp. as the third media conglomerate with an equity stake in Hulu, and agreed to provide Hulu with a set of shows from its popular broadcast network ABC and its cable networks.

  Despite the company’s early success, Kilar knew that the market for online video was only starting to take shape, and Hulu would have to evolve with it. One of the most pressing issues was the site’s business model. Like so many other Web sites, Hulu was completely free to users. But Kilar was convinced that, as he put it, “people want to consume content under reasonable business models,” so he and his team began debating whether to move away from that stance. “We could continue our hundred percent advertising-supported model,” Kilar explained. “Offering free, ad-supported content was a good first step toward achieving our goal.… We are playing in the single biggest pond out there—advertising-supported content is a sixty-billion-dollar industry in the US alone, and the model resonates with the largest group of users. But, we could also consider other revenue models, such as a subscription or pay-per-view model. When we developed our mission, we were very careful to make sure that it did not spell out our business model. Our mission at Hulu is to help users enjoy the world’s premium, professionally produced content. A service like HBO has wonderful original programming, and even though HBO’s Entourage or Flight of the Conchords is not explicitly included in that mission statement, we very much mean to include those shows as well.”

  * * *

  YouTube and Hulu are different beasts. Unlike YouTube, Hulu from its inception has focused on offering premium content. Driven by the strengths of its parent companies, Hulu emphasizes the head rather than the long tail. But like YouTube, Hulu has enjoyed rapid growth as a direct result of the advent of digital technology and the decreasing transaction and search costs that go along with it.

  Hulu deserves the accolades that have come its way. Kilar and his team beat the odds and created an attractive product for consumers seeking high-quality video online. “I needed something new and good in my life, and now I have Hulu,” is how one (obviously satisfied) user put it. The team also took the site’s popularity beyond anyone’s wildest imagination. But to fully appreciate Hulu’s business model, it’s important to take a step back and understand the pressures that digitization puts on traditional media companies—including Hulu’s parents. Two factors stand out.

  First, for even the most casual observers of entertainment businesses, the rise of digital distribution is synonymous with the growth of piracy—or, to be more precise, with the consumption of illegal copies of television programs, music, books, films, and other entertainment products undermining the sale of genuine items. Blockbuster bets may be especially vulnerable. “No one pirates copies of albums that nobody wants to hear,” A&M/Octone’s David Boxenbaum once said about the music industry. Like many other entertainment executives, Boxenbaum has good reason to worry about a downward trend in revenues: “Even when you are succeeding in the marketplace these days, you are still selling millions fewer albums than you used to with a hit record.” But while many executives are convinced that piracy is to blame for diminishing sales, academic researchers have not found it easy to prove a causal relationship. True, some studies have shown that illegal downloading erodes recorded-music revenues, albeit to a modest degree. Other researchers, however, have concluded that illegal file sharing has no discernible effect on sales. These studies examined a sector that, by all accounts, has been especially hard hit; evidence that piracy causes revenues to drop in other sectors is even spottier.

  The lack of convincing proof is less surprising than it may seem at first glance: after all, not every illegally downloaded file is a lost sale. Not every consumer of an unauthorized copy of a Lazy Sunday clip or a Saturday Night Live episode would have watched the program on regular television or bought a DVD later. Pirates may be so unwilling to pay that they simply are never going to be in the market for a paid-for version of an entertainment good. It is also possible that some of the most dedicated pirates are also heavy consumers of legal alternatives; they may use illegal downloads when deciding what to pay for later. Worrying about the size of the market for illegally downloaded products—a favorite pastime for industry associations such as the music industry’s Recording Industry Association of America (RIAA) and the film sector’s Motion Picture Association of America (MPAA)—may therefore be relatively unproductive. But to dismiss any possible negative effects of piracy would be wrong as well.

  Second, digitization is hurting the revenues of entertainment companies by making many people less willing to pay for their products—or, more generally, by changing consumers’ perceptions of what price is “fair.” This could be seen as an indirect effect of piracy: with illegal copies of books, music, films, and video games often only a Google search away, some people may feel that paying a full price for media products is somehow unfair, old-fashioned, or just plain stupid. But piracy is not the only culprit here: new—legal—digital business models may have a similar result. Through digital channels, consumers can access more content than ever before, often at lower prices. With YouTube now effectively serving as a giant jukebox that lets users play whatever song they want for free, and with Spotify, Pandora, and Netflix allowing music, film, and television lovers access to vast libraries of content in exchange for at most a modest subscription fee, consumers may lose interest in paying to own an entertainment product.

  Disney’s Alan Horn has talked about “new technologies decreasing the pie, at least in the short term” in the film industry; as just one example, new movie streaming and rental options may be crowding out more lucrati
ve DVD sales. That most consumers have a limited understanding of the peculiar cost structure of entertainment goods makes it harder to manage their perceptions of what prices are fair. In my experience, the public often overestimates how much it costs to manufacture, package, and ship hardcover books, CDs, DVDs, or other physical products, causing many people to expect greater savings on digital products (which eliminate many of those costs) than media businesses can realistically offer.

  The challenging combination of illegal downloads on the one hand and the pressure on consumers’ willingness to pay for content on the other hand means that producers who venture online may encounter unfavorable economics. Consider the perspective of free, over-the-air broadcast networks such as ABC, CBS, FOX, and NBC. They obtain programs from the television arms of their own parent companies, from competing media conglomerates, or from independent production companies, and generate revenues by selling advertising around those programs. Networks live and die by so-called CPM rates, which express the cost for advertisers to reach one thousand viewers. When Kilar and his team were rethinking Hulu’s business model in 2009, CPM rates for thirty-second advertisements during prime-time slots on the major broadcast networks varied between roughly $20 and $40. With at least sixteen minutes’ worth of such commercials in every hour of television, the networks made around $1,000 per thousand viewers per hour.

  Hulu’s CPM rates have been much higher from the start, in some instances more than twice the going rates on broadcast television. That’s because Hulu took “advantage of the unique attributes of online media that can make for a more targeted, interactive, and effective advertising experience,” as the company’s senior vice president of advertising, Jean-Paul Colaco, put it. Hulu gave advertisers new advertising formats and targeting capabilities. But it also showed far less advertising: relying on what Kilar described as a “less is more” approach, Hulu carried only a quarter of the advertising load of a broadcast network in 2009. As a result, even with its higher rates, advertising revenues per thousand viewers per hour of programming tended to be lower on Hulu than they were on broadcast television.