Aug 26, 2016 · 8 minutes

Along with the reality that the $32 billion online display ad market is about 85% controlled by Google and Facebook, we have to face a few other realities intrinsic to the tech business.

We’ve written before about how it all but invalidates any IAB video advertising standard. And how it once again escalates the number of views you have to have to be considered a player in any remote way. And it’s been a shot in the arm to subscription-style businesses too, because the liklihood of anyone else building a scalable ad business is all in the hands of Google and Facebook's algorithms, distribution channels, and whims. 

But it has ramifications well beyond just media and news and ads.

That stranglehold over the global digital ad business means these two companies have unimaginable resources to wreak havoc with any other digitally tangential industry. I mean, even more so than Google already did off the back of the cash cow that was paid search, and even more so than Facebook leveraged its stock currency to do some $20 billion in acquisitions that would give it a dominant position in messaging.

What we’ve seen already is nothing.

One of the markets people like to talk about is ridesharing. As we saw from Bloomberg’s reporting on Uber’s multi-billion burn rate yesterday, thus far ridesharing has been a commodity business where the most cash wins. If that holds true in the self-driving car era, Uber is screwed next to Google. If hardware, maps, phones prove enough of an advantage that it’s not just a commodity business, well, Uber is doubly screwed.

But we’ve already written at length about that dynamic. One that bears more scrutiny is the entertainment industry. Not news, not user generated content. We are talking about nice splashy well made movies, television and music made by hard working professional artists.

This week, Spotify and Netflix were reported to be edging in on one another’s turf, with Spotify’s original video content “How EDM changed the world.” To put the reports in perspective: This was a two minute short. Still, Spotify is said to be getting into video, as is music generally.

Indeed, the two companies have been borrowing from one another’s playbooks. Netflix’s success gave the music industry hope that people would finally pay a monthly fee for an astounding collection of music at their fingertips everywhere they go. Both a bargain, but historically way higher than people have paid annually for music.

Then there are “exclusives”-- Netflix got out from under the thumb of its competitors by creating its own content. So, too, has Tidal hoped it can drive a wedge into the Spotify-Apple universe. (With less success.)

And Beyonce and Frank Ocean have blended the two markets even further with their “visual albums” or as we used to call them “music videos.”

Let’s get this straight: Spotify and Netflix are basically running the same playbook, only one has strengths the other doesn’t. Most notably, the entertainment world loves Netflix, it has built a better subscriber business, and has made exclusives work. Both have done a lot of work with discovery: Netflix through its recommendation algorithms and Spotify through its excellent curated playlists.

They have something else in common too. Long term both of these companies all face the same oligopoly of enemies:

Google. YouTube music can make money off ads, sure! That’s what Google tells the RIAA at least. But there’s no pressure to the way Spotify (and Pandora) will (and do) face that pressure as publicly traded companies.

Amazon. Amazon streaming is the only real competitor Netflix has for your monthly streaming budget. And while studies show “cord cutters” or cord thinners are happy to pay for multiple streaming services, the two certainly compete on content with one another. Witness the sky high prices coming out of Sundance this year. While Netflix is undoubtedly cooler and has had a better content track record, Amazon-- like the other majors-- has several other businesses to prop up its studios. Plus, Amazon Prime has a far better value proposition when you factor in everything else it gets you.

Apple. Apple Music hasn’t killed Spotify as some expected, but it’s also still early days. There are on again/ off again rumors that it may buy Tidal. Ultimately Apple has time on its side for the same reason Google and Amazon do: Their quarterly numbers don’t rely solely on music. Meantime, Apple still has greater designs on your TV. On the margins it competes with Netflix already.

Facebook. Who the fuck knows, but Facebook has said that video will be at the center of everything it does. Do we really think that’s only amateur or news related video? Perhaps with its $2 billion Oculus purchase it plans on simply leapfrogging TV, movies and music as we know it. Or perhaps not.

While articles like this one like to paint Netflix-- and even Uber-- as two of the five major horseman of the Internet, these companies are an order of magnitude smaller, and don't benefit by the modern day conglomerate structure that allows cash cow businesses to support moonshots and money losing experiments.

Compare the market caps of the traditional five:

Apple: $580 billion

Google: $528 billion

Amazon: $360 billion

Facebook: $355 billion

Netflix: $41 billion

And Netflix only has one central business, which isn’t nearly as global as the other companies. The Economist is one of several turning bearish:

There are reasons to worry. Netflix’s challenges are growing. After several years of rapid expansion, competition is looming larger, including from Amazon. It is having trouble finding a viable path into China, the world’s largest TV market, where it does not yet have a presence. The firm’s growth in subscribers has slowed of late, prompting concerns about whether it has taken on too ambitious a global mission, too quickly…

...The big, background question for Netflix is whether it can continue to make and acquire content that appeals to a sufficient number of its subscribers. That is an expensive proposition, and one that requires achieving great scale to earn big and recurring profits for the firm. Netflix will have negative cashflow this year of more than $1 billion, and it will increase its borrowings late this year or early next. The firm says it will be slightly in the black this year, and it expects profits to be significant next year. The variation between cashflow and profit is due to the fact that it spreads its heavy spending on content production over time. Yet there is no let-up in the vast quantities it plans to spend on programming. If the model works, Netflix’s appeal as a platform will grow, allowing it to afford more content that in turn will attract more subscribers, forming a virtuous cycle. But the circle could turn if a competitor lures away Netflix subscribers with superior content.

You’ve probably guessed what I’m driving at here: Should Netflix buy Spotify?

There’s no question this would be a good thing for Spotify. The company is valued by private investors at $8 billion, compared to Pandora’s sub-$4 billion market cap. It is going to have to go public. It may well do so successfully, although there are big questions about future rights pending. It may well face pressures to raise subscription rates ahead of an IPO-- not easy to swallow amid the competitive landscape. It’s hard for me to imagine that given the asset Spotify has and the conglomerate-style dividing up of the entertainment market that Spotify will be a stand alone, thriving public company in ten years.

But would it be good for Netflix?

As music and movies merge more, this would give Netflix a reason to charge subscribers more, and possibly an avenue to grow them. It’s possible that Spotify under Netflix gets more into the creation market. It’s already done custom concerts and tracks for its users. Both are technologically sophisticated companies that would no doubt continue to make strides in UI. And maybe-- who knows?-- even design or buy a sexy hardware product to show off its wares. (Sonos, anyone?)

You might argue if that’s the direction a merger would go in, Netflix should just by Tidal. But the hybrid entertainment/tech cultures of Netflix and Spotify are so much more aligned and Spotify is a way better headline for Netflix. It has enough of a center of gravity and would cost enough that it would have to get resources.

There’s another reason for Netflix to do this deal: To keep Spotify out of the hands of a rival.

If we go back to the ridesharing analogy, and Spotify is -- say-- the sexy, arguably overpriced Uber of the coming entertainment battle, Netflix is Tesla. Netflix and Tesla both have an equivalent market share, inspirational leadership, and cult followings. Both are sexy brands. Sexier brands certainly than Google or Amazon. Brands that-- like Apple-- get consumers and artists.

You can imagine Tesla and Uber combined would be a more formidable combination against Google. So too would Netflix and Spotify be a more formidable entertainment pure-play in the coming battle.

The problem is the same problem Spotify has already: Music is a shit business. Even though Spotify monetizes users far better than Pandora, Spotify pays out nearly $2 billion a year and has none of the industry good will that Apple or Tidal or even Netflix enjoys.

Would it be too much of a drag? Netflix it seems has two options: Go big in entertainment or diversify. And no one of its size an impact has the ability to do the former and dual-industry chops to do the former.