The Return Of The J Curve: A Lesson From Netflix


Nothing is free… or at least not free forever. The same goes for the lowest price. Eventually it goes away. Either a new, lower price is found, or the price rises. As the economy continues to rebound, free is no longer quite so free. We all know basic economics: when the economy improves more people pursue goods and therefore prices rise. There’s definitely some of that, but what is unique today is that the definition of free, or unlimited, or “eat all you want”… is changing. The recently announced price increase from Netflix represents more than just inflationary increases. The result is something called the “J Curve.” Imagine a that starts at some point, let’s say it’s the number eight. Then as we move forward in time, the number moves ever downward until we hit a point where it heads up again, and continues upward until it is higher than where it started. J Curves can lead to revolutionary changes when new cost structure, new populations, or new paradigms take hold and redefine how some element works.

Technology based services have for a very long time been getting cheaper and cheaper every year. When the Internet was new, users were mostly in universities that connected through very slow modems, where individuals paid nothing. Free is always a good price; then again the Internet didn’t offer much back then. As the Internet grew, so too did the fees. Hulu was started as a free distributer of TV programming and movies; today it offers Hulu Plus, where you pay for some services. This only makes sense, since you can now watch programming on your desktop, laptop, iPad and smart phone. As functionality increased, the owners of Hulu eventually said, “It’s now worth enough to start charging.”

Netflix has always charged for its services. However, every new rate card from Netflix has lowered its cost structure. They started with sending DVD’s, then they offered DVD’s and streaming content, which greatly lowered the cost per movie because it was cheaper to stream than to mail a movie. As more and more users downloaded movies, the cost per movie dropped and Netflix passed the savings on to their users. But this week that stopped. Why? One reason was that when mainstream America was not yet comfortable or capable of downloading movies, any revenue that a studio could get was found money. Now that Netflix and others download millions of movies every month, studios want much more money for their downloadable content. Another reason is that you can download movies on phones and computers, and increasingly on your brand-new  internet ready big-screen  TV. As long as no one wants what I’m selling, it’s cheap, but when everyone wants it… the price goes up.

Some of you may be thinking, “As always, Mr. Niccolls, you have enlighjened me with your  fascinating description of a macro-economic issue. But… uhhh… why should I care?” Well, you should care because the Internet isn’t just for entertainment. In previous blogs we have discussed outsourcing and Cloud services. Both  industries are heavily dependent on an inexpensive and unlimited use of long distance communications. In fact, the declining cost of technology has been the key driver for both industries. However, as we have all become Internet users we have also become big media users, dramatically increasing the bandwidth we consume. Consider the following:

  1. More files: Whatever service you are looking at, if you are looking at a Cloud
    service or outsourcing,  the number of files needed by that service are increasing. For example, in document review, the number of documents per review has risen a thousand fold in recent years because of the explosion in  the use of emailing and the number of backup files made by data centers. In the past you might have sent out a thousand paper copies of a memo, but few survive a few years later. Send out a thousand emails, and every copy is still on  the servers. And many more thousands of copies were sent around with minor comments, which all survive on some server… somewhere. All of these copies may need to be found and reviewed during a lawsuit. The same applies across your firm. Many more documents, databases and bits of information are used in a “product” today than just a few years ago.
  2. Bigger files: An even more profound change is that we are producing files that
    contain graphic and media elements that greatly expand the size of files. We store voice mail data, video training materials, graphic presentations and so forth. How much does this matter? Look at the home use of bandwidth. According to a recent article in “Wired,” a technology magazine, downloading a 3 minute CD-quality song consumes 0.03 GB of bandwidth. A 2 hour HD movie moves WAY up to 3.4 GB of bandwidth. If that movie is Blu-Ray, it consumes 30 GB. When that movie is in the next generation of Ultra HD video in 3D, Wired’s estimate rises to over 400 GB. As corporate work moves towards more graphics and more media (especially if you need Cloud services to modernize your technology) your data consumption can become astoundingly large.
  3. Continuous use: When a data vendor sells you a 3 MB line, they don’t assume that you will use 3 MB every second of every day. But we seem to be getting closer and closer to that behavior. Unlimited cell phone data plans now have… wait for it… limits on how much data you can use. This wasn’t a question when our media was smaller. Corporations tend to buy dedicated capacity and haven’t moved as
    intensively into video, but corporate data use is rising almost as quickly as home usage. The use of a Cloud service or outsourcing may have also been done to expand hours of operation, making more intensive use of the existing bandwidth, especially the late-night  hours. Today use is much lighter late at night, providing many Cloud and Internet services a time when they can perform maintenance. As usage at this time rises, maintenance options become more expensive.
  4. Changing pricing model: Consumers build the brand and volume for Cloud providers, but corporate users… who usually come later… are expected to be the big source of revenues. But once a service is mature enough to charge corporations, and become profitable, other groups that contributed to the product start to ask for their share. ISP’s are beginning to change how they charge for bandwidth. A lot of Cloud companies have benefited from free software, often Linux operating systems using “Open” software. These programmers generously provided their products for free, often for idealistic reasons; however, as the model changes and corporations rather than home users make use of their software this idealism is unlikely to last.
  5. Old guard resistance: When a major revenue shift happens in technology, providers with soon to be obsolete products pay attention to these changes. Not all the old guard will react effectively, but some top firms will invest in the new
    technology. Usually they want more than just short term profits; they want control of the new technology. Look at Thomson Research a decade ago. In the 90’s their revenues were primarily from print research. As the cost of on-line data fell and the products became more accessible, Thomson sold off paper assets and used the revenues to invest in or buy on-line services. Thomson invested in many
    potential competitors, buying them and integrating their products into their product suite when they matured. This provided Thomson clients with constantly
    improving products, and limited the number of competitors that could develop a dramatically lower pricing model. If this is the future of the Cloud, we can expect
    Microsoft, Cisco, Oracle and other major technology providers to push back on a
    dramatic fall in prices, even if it means buying out their competitors to slow pricing changes.

Will the cost of the Cloud and outsourcing services continue downward, or should we be ready for a new J curve? The improving economy is lessening the downward economic pressures of the last few years, the Cloud has real economic benefits but corporations may take much longer to benefit than assumed, growing bandwidth is offsetting financial benefits, and the current generation of technology providers will not sit by passively while revenues fall.  This mixed and difficult to interpret combination of forces seems to favor an upswing in cost. How much of a rise, and how fast is still a question, but that we are headed upwards seems much less of a question. Just ask Netflix. At least, that’s my Niccolls worth!

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3 Responses to The Return Of The J Curve: A Lesson From Netflix

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