Eric Schmidt, Google's CEO once said:
Authors: Jason B Bazinet,Michael Rollins, CFA,Catherine T O’Neill,Thomas A Singlehurst, CFA,Mark May,
“The Internet is the first thing that humanity has built that humanity doesn’t understand… the largest experiment in anarchy that we have ever had.”
An ‘experiment in anarchy’... that’s an interesting phrase.
Merriam-Webster defines anarchy as “wild behavior in which the people in a group are not controlled by rules or laws.” ‘Not controlled by rules or laws’…another interesting phrase.
We could synthesize the two quotes this way: “The Internet allows rules to be broken.” And, virtually everything in the pre-Internet media ecosystem is governed by rules. The rules aren’t arbitrary. Rather, they’re dictated by the hard, profit-maximizing logic of microeconomics. Here are a few examples:
- In the past, if you wanted to sell video, you needed something scarce: Hundreds of billions in capital to pass every home with coaxial cable. Or, a fleet of geosynchronous satellites orbiting the earth. In the new, post-Internet world, to sell video you need…a web server.
- In the pre-Internet world, if you wanted to reach a large audience, only a handful of places would take your ad: the Olympics, the World Cup or the Super Bowl. Today, you use Facebook.
- In the pre-Internet world, to advertise to specific audiences, you used crude demographic measures: women over 50 years old, for example. With the Internet, you target a particular person.
- In the past, if you wanted to watch an entire season of a TV show, you needed a DVR. Or, you could buy an expensive DVD box-set. Today, you watch it on Netflix.
- In the past, if you wanted to watch a particular channel, your pay TV firm would force you to buy a bundle of 200 channels. But, increasingly, content can be acquired without a pay TV package via HBO Now, CBS All Access or Amazon Prime.
In simple terms, the Internet has done three things: 1) lowered the barriers to video entry, 2) offered advertisers a better value proposition and 3) given consumers more flexibility. For media incumbents, that’s a potent cocktail that can quickly lead to value destruction.
But, when investors try to navigate the complex media/telecom ecosystem, they usually run into two problems. First, Hollywood economics are, perhaps intentionally, opaque. Second, the telecom world is steeped in complex engineering. This makes it particularly difficult for investors to assess the risks and opportunities.
So, our aim in this note is to do something simple: explain how — and why — the media and telecom world will change as Internet video — and Internet ads — move to center stage.
Here’s the punchline: We expect value to migrate from content aggregators — like cable networks — to last-mile Internet access providers. Let’s see why…