Power of scale economies, creator economy myopia, velvet ropes and Clubhouse. A Lesson in Strategy

Transcript of the Episode

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The biggest moat for content companies over their competitors is scale economies

make large investment in production.

spread the investment over a large number of viewers.

get low per-unit costs.

pass on the low cost to customer as low prices.

Let's take Netflix. Netflix is able to invest Billions of dollars in original content as it can spread its cost over 208 million customers, keeping the per unit cost of original content very low. Let's unpack this further.

If $1 Billion is needed to create a kickass original, Netflix gets to spread it over 208 Million subscribers, significantly bringing down its per unit cost of production. While Hulu allocates same $ 1 Billion over 42 Million subscribers, which means 5 times the unit cost of production

Hulu with its lower subscriber base will always be at a unit cost disadvantage to Netflix making investment in originals very unattractive. But Hulu can also get more subscribers, you say?

How does Hulu gain subscribers? (a) By offering better content than Netflix (b) by offering better price than Netflix. Small subs base makes large investment in original content financially unattractive. So better content is out of play.

Hulu can drop its price below Netflix to attract subscribers. But as Netflix has a unit cost advantage over Hulu, it can match Hulu's lowered price. If Hulu drops its price further Netflix can again match leading to a price war

This can in theory continue to happen till Hulu's price drops to its marginal cost at which point it cannot drop price further without going bankrupt, giving Netflix the upperhand in the price war, all due to its larger subs base and the scale economy working to its advantage.

It is important to note here that I consider Netflix and Hulu as content companies and not as Tech companies. Benedict Evans wrote a stellar piece about how tech companies stop being tech companies and become movie, retail or 'sector' companies as tech is a commodity.

Now onto the creator economy and velvet ropes. Apps like clubhouse created quite a stir by being exclusively on iOS and using an invite-only launch strategy. This is dubbed 'velvet ropes' by james currier from NFX and li jin, like the velvet ropes at the entrance of clubs.

Many other apps have used this model to build hype early on in their journeys but where this model fails is it slows down reaching critical scale if followed for too long. This can allow competitors, in this case Twitter Spaces and Spotify Greenroom to catch-up.

Tech companies like Clubhouse think of themselves as social creator economy companies but fundamentally they are content companies and rules of content companies apply to them as well. I term this as 'creator economy myopia'

This brings us to the point of 'creator economy myopia'. Clubhouse believes that it is solving a creator economy problem (creators get a platform to connect with audience) but what they are really solving is a content problem (people need content to consume).

The use of word myopia in business literature can be traced back to the essay 'Marketing Myopia' by Dr Theodore Levitt who rightly mentioned that railroads companies are not in railroads business but in the business of transportation.

In case of apps like clubhouse, defining their market as social creator economy (and not content) can make their position highly uncompetitive especially when against Spotify and Twitter which are masters of the game of scale.

So if you are a startup where the unit of exchange is a piece of content (image, audio, video, text, whatever!), your first priority has to be to scale at all costs or else get consumed by lookalike apps.

Throw away the velvet ropes as soon as the initial marketing stir is done and get into onboarding users at high velocity to hit critical scale before anyone else does to get the moat of scale economies working for you.

I hope you liked reading this quick byte-sized take on clubhouse, myopia and scale economies. Subscribe to The Hypothesis at www.readthehypothesis.com to get more strategy goodness in your inbox.

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