Subscription Economies and the Rebundling of Consumer Demand

Today, we rarely buy individual movies, video games, and music albums.  Instead, we subscribe to digital services that let us access thousands of such units of entertainment for a monthly fee.  Popular video streaming services like Netflix, Hulu, Disney+, and others allow subscribers to choose from among hundreds of movies and television episodes.  Music streaming services like Pandora, Spotify, and Apple Music let users create playlists from thousands of songs.  Thanks to AI, these streaming services can now use algorithms to propose new shows, movies, and songs that subscribers are likely to enjoy.  So, why did entertainment go almost entirely subscription over the last two decades?

Economics of Subscription Models

Low Marginal Cost of Adding Additional Offerings

Digital platforms are great at lowering marginal costs for producers.  For almost the cost of hosting one movie or TV episode for streaming, you can host two…or three, or four, or more.  Thus, it only makes sense for website owners to expand their digital offerings in order to attract more customers.

Buying in Bulk Creates Economies of Scale

The ability to host a lot of content also provides an average cost advantage thanks to the principles of buying in bulk.  Website owners who host films, television episodes, and music for streaming can get more content per dollar by purchasing the rights to vast quantities of content at once.  This lets large streaming platforms enjoy economies of scale - they can buy lots of content from producers and enjoy per-unit discounts, which they can partially pass on to consumers.

Given consumers’ increased demand for digital entertainment, streaming platforms have to offer lots of content.  This means there is a minimum efficient scale necessary to remain competitive, and streamers that cannot host enough content will quickly lose consumer interest.  Essentially, offering only one download or stream at a time, as opposed to a subscription of mass offerings, is almost certain to fail.

Demand Enhancement Through Available Substitutes and Complements

Offering subscriptions to mass volumes of digital streaming entertainment helps capture consumer demand for more of what they want, especially if you have an algorithm that automatically suggests what to watch or listen to next.  If a platform owns lots of substitutes for a popular piece of digital entertainment, it can maintain customer demand by preventing them from straying to other platforms.  If a platform owns lots of complements for a piece of entertainment, it can increase demand by enticing customers to stream a new show, movie, or song made by the same artists as their previous faves.

Cross-Platform Complements of Bundling

Thanks to the Internet, electronic entertainment can be packaged and delivered in a myriad of ways.  This allows streaming platforms to work with each other, or with other web-savvy companies, to create subscription bundles.  Here, the concept of economies of scale goes even further: customers that purchase a bundle can get subscription access to multiple platforms for a combined monthly fee that is lower than if each platform was subscribed to individually.  Customers are frequently attracted by such deals.  An example of such a bundle would be getting a hypothetical Netflix + SiriusXM Radio package for a lower cost than purchasing both separately.

Revenue Predictability (Risk-Return Relationship)

Selling a subscription to a mass volume of content is similar to diversifying an investment portfolio.  As the portfolio grows and diversifies, you no longer see rapid increases in value (revenue), but you also no longer risk rapid decreases either.  While a streaming platform is unlikely to see a rush in additional subscriptions due to the release of a popular new movie, TV show, or album, it is also unlikely to see a mass exodus of subscribers due to a dud or two in the lineup.  Thus, revenue is more predictable: the vast majority of customers will continue paying the monthly subscription, usually with a small percentage growth of total customers over time.

Streaming platforms are behaving according to the risk-return relationship and accepting lower return [on investment] in exchange for lower risk.  Total fixed costs may be very high, especially to own a large body of intellectual property like popular movies and albums, resulting in relatively low profit margins.  However, customers tend to be satisfied with their subscription streaming services, providing stable revenue.

Dilemma: Rising Prices May Herald Return of Per-Unit Purchases

Unfortunately for customers, subscription prices for digital entertainment are frequently on the rise.  Simultaneously, several new streaming companies have entered the market, ending the “golden age” of cheap, high-quality content.  For example, many movie and television studios have created their own streaming platforms to host their own content, taking this property away from original firms like Netflix.  A decade ago, customers could get lots of prime-grade entertainment with a single subscription.  Today, they need several subscriptions.

To help attract and retain cost-sensitive customers, some streaming services offer ad-supported lower tiers, allowing subscribers to pay less per month if they’re subjected to commercials.  While this may be successful in the short run, it could drive some to simply revert to free network TV and radio (or free streaming platforms) once they become used to commercials.  This becomes even more likely as streaming platforms struggle to add popular new content.  If customers feel that they’re not getting anything new for their money, why not bite the bullet and cancel?

Popular Classics Versus Inferior Goods

An example can be found in holiday movies.  A decade ago, during the “golden age” of cheap streaming, original platforms like Netflix hosted lots of popular, Hollywood-produced Christmas movies.  Today, these platforms often only host their own self-produced movies, which some viewers may see as akin to inferior goods.  Nobody particularly wants to watch these platform-produced movies, but resort to them because they are included in the subscription fee.

To watch the classics, customers often have to pay for individual downloads, or even DVDs, today.  As streaming platforms continue to shuffle through a limited selection of popular, top-quality movies and TV shows, more customers may decide it’s actually cost-effective to purchase individual units of entertainment (a movie or season of a television show) that pay for multiple subscriptions and hope to catch desirable content as it cycles through.