Hollywood, What Are You So Afraid Of? | 2016: How the Giants Went Digital ⑤

As Hollywood's own creativity runs dry, digitalization has not solved its problems — it has become a heavy burden.

Traditional giants are still struggling to reach younger consumers, while digitalization is reshaping industry supply chains and the balance of power between companies. QDaily is running a year-end 2016 digitalization series: over one month, 10 articles examining what the big companies gained and lost as they went digital. This is the fifth.

Facing the internet's threat again, Time Warner made almost exactly the choice it had made 16 years earlier.

Just a month ago, the Hollywood giant announced a merger with the U.S. telecom carrier AT&T. The New York Times, reviewing the deal, wrote: "One of the pressing concerns for these media companies is finding new ways to deliver content to consumers."

That is not far from what was said in 2000, when Time Warner merged with the portal site AOL. Fortune China noted: "Time Warner had tried eagerly to build an internet business, but failed… Through AOL, Time Warner would gain 10 million new users."

Walking the same road it walked 16 years ago — the whole market is now waiting to see how it ends this time. But there is no dispute that the AOL merger ended in failure. To many people it was the worst merger the world had ever seen. After a long, painful series of clashes, Time Warner and AOL split in 2009 and became two separate companies again.

With that warning in front of it, why would Time Warner make the same choice? The answer may be that, facing this wave of digitalization, Hollywood could find no better plan than huddling together for warmth and winning on sheer scale.

Before digitalization arrived, Hollywood's business had barely changed in decades. Studios made films, distributors struck prints, and the prints were shipped to cinemas to screen. For a time Hollywood controlled every link in that chain — until 1948, when the system was ruled a monopoly and the exhibition end was broken off. That hardly mattered: what else would a cinema play but movies?

In the 1970s, the model met its first real challenge. Television — whether national networks like ABC or cable channels like ESPN — drew huge numbers of moviegoers away. In the end, with Wall Street's help, television and film merged, and Hollywood turned from a film business into an entertainment business.

Now it was digitalization's turn to attack. People who might once have gone to the cinema for Suicide Squad, or sat in front of the TV for The Big Bang Theory, were playing Overwatch instead, or watching PewDiePie's gaming videos on YouTube; and people who once watched The Walking Dead on television had moved to Netflix to catch it there.

Digitalization challenges Hollywood on two levels: Hollywood's products no longer pull in viewers; and viewers still like Hollywood's products, but no longer watch them on the platforms Hollywood controls — networks and cinemas.

Wall Street usually sees the second challenge as the graver one. Last August, Disney lowered its growth forecast for its cable television business, and its shares promptly dropped 9 percent. Comcast, Time Warner, 21st Century Fox, CBS, and AMC fell sharply too, and Discovery Communications dropped 12 percent.

To Wall Street, Netflix's 86 million paying subscribers worldwide and Amazon's video service with 54 million paying subscribers in the U.S. are playing a "zero-sum game" against Hollywood. The more people move to Netflix, the more stop watching traditional broadcast or cable television — and the networks' advertising and subscription revenue falls with them.

As things stand, Netflix and Hollywood depend on each other. According to a report by 7Park Data, of the 20 most popular series on Netflix, only one — Orange Is the New Black — is a Netflix original; the rest all come from traditional networks, including Friends, Prison Break, and The Walking Dead. The 20 most popular films on the platform likewise all come from traditional Hollywood studios.

But there is a point people often miss: Netflix is not just a channel. When users register their preferences on the platform, that data becomes the chip Netflix lays down against Hollywood — when it comes to reading the audience, Netflix has a better grasp of what is happening in the world and what is about to catch on.

This June, an article in the New York Times Magazine recorded what Vince Gilligan, the creator of Breaking Bad, had found: "Its ratings climbed sharply after the show went up on Netflix." In the words of the analyst Michael Nathanson, "Breaking Bad became ten times as popular once it started streaming on Netflix."

It recalls the famous line from Harvard Business School professor Richard Tedlow: "If Hollywood had defined itself as being in the entertainment business rather than the movie business, it would have embraced television."

The same applies today, only now the internet stands in for television.

With that, we can turn to the real challenge digitalization poses to Hollywood. New entertainment is being born inside the new digital media, taking away the viewers who once belonged to Hollywood, while Hollywood's own creativity is fading. As one side rises and the other falls, Hollywood's trouble has arrived.

Looking back over the whole of 2016 from the end of the year, only three things seem to have genuinely fired up a mass audience: Pokémon Go, Warcraft, and the DC Extended Universe.

Pokémon Go launched this July. It was not the world's first game to use augmented reality (AR), but with that hook and the Pokémon story world behind it, it pulled in more than 45 million daily active users within a month. Pokémon — first a video game, later adapted into anime and manga — became a household "blockbuster" all over again, carried by a new technology.

The film Warcraft opened a month before Pokémon Go. The movie that Blizzard, the maker of Warcraft, had licensed to Legendary Pictures back in 2006 finally bore fruit, taking $433 million at the global box office — short of pre-release hopes, perhaps, but still good enough for 13th on this year's worldwide box-office chart.

More important, Blizzard had also set up its own internal film and television division last November, with ambitious plans to develop a slate of game-to-film adaptations including Call of Duty. The gaming outlet VentureBeat commented: "This strategy signals that Activision Blizzard wants to become an entertainment giant, with rivals like Warner Bros. and Disney."

The DC Extended Universe formally launched with Batman v Superman: Dawn of Justice. Billed as the most expensive film ever made, with a reported budget of $410 million, it took $873 million worldwide and became the fifth-highest-grossing film of the year. But because it had to lay groundwork for later films, that burden boxed in the director and the film drew savage reviews.

By box office, critical reception, and revenue, Pokémon Go, Warcraft, and the DC Extended Universe were all less than ideal — but in their power to stir up an audience, they still point to future potential. In other words, if more films, series, games, or anime follow from these stories, the odds are high that consumers will buy in.

Of the three, only the DC Extended Universe belongs to Time Warner; Pokémon Go and Warcraft have slipped out of Hollywood's grip entirely. One comes from Nintendo, the other from Blizzard — companies that grew up out of digitalization, outside the Hollywood system, and that now show more creative force than Hollywood does.

Hollywood, by contrast, has not produced anything fresh in a long time. Of the ten highest-grossing films in North America in 2016, only two — Zootopia and The Secret Life of Pets — were original; the rest were adaptations or sequels.

And Hollywood has paid for it. The Legend of Tarzan took $356 million worldwide, Independence Day: Resurgence $389 million, Teenage Mutant Ninja Turtles: Out of the Shadows $245 million — none of them earned their costs back.

Then-Paramount vice chairman Robert Moore, admitting he had been through a hard summer, said: "In this market we always want to develop projects audiences already know, but we can't pin down exactly what audiences want to see. They are growing more and more picky about sequels and remakes."

In fact, Hollywood's creative exhaustion has been building for years. Over the past decade, Hollywood's fix for it was simple: buy. Between 2005 and 2012, Disney bought Pixar, Marvel, and Lucasfilm — the studio behind the Star Wars franchise — one after another. Today Disney has climbed out of the crisis of those years to become Hollywood's largest company.

As more and more such companies were bought up, the supply of good targets shrank. Naturally, Hollywood turned its gaze to the companies that had grown up alongside this wave of digitalization. They were rivals, but if they could be folded into Hollywood's own system, they might refill its creative reserves.

Over the past few years, Hollywood's pace of dealmaking could only be called frantic. On YouTube alone, four short-video companies were carved up among the studios. Disney bought Maker Studios; Warner Bros. invested in Machinima; DreamWorks took Awesomeness TV; Comcast invested in MovieClips. There were also many scattered bets on individual YouTubers — Lionsgate, for instance, signed the internet personality Flula Borg.

New-media sites became targets too. Disney invested $400 million in Vice across two rounds; NBCUniversal invested in BuzzFeed and Vox; 21st Century Fox and National Geographic set up a joint venture; Time Warner invested in Uninterrupted, a short-form sports video site founded by NBA star LeBron James.

Then there were games: Disney once pinned high hopes on its interactive division; Warner Bros. ran its own esports tournaments; Lionsgate, Universal Pictures, and MGM together invested in a Hong Kong gaming company.

But none of this had any real plan, and it sat oddly with Hollywood's own nature. Word came mid-year that Maker Studios, the company Disney had bought, was laying off staff en masse; it had not become the "next Marvel" Disney promised at the time of the deal, and the other YouTube short-video companies the studios bought returned little either. They look more like a "defensive strategy": no one knows what these companies will become, but write a check first, just in case.

Games turned into a disaster zone as well. This year Disney shut down the in-house development arm of its games business entirely and switched to a pure licensing model. That was something of a waste: beyond the once-strong Disney Infinity line of interactive toys, Where's My Water? had once shown the potential to become a TV cartoon, or even a film.

At a company like Warner Bros., the games business existed only to serve the existing creative properties — Batman, Superman, and the rest were turned into new games one after another. Inside that structure, Warner Bros.' games operation clearly could never become a major like Activision Blizzard, able to generate fresh ideas on its own.

It was the game companies, instead, that were ambitiously trying to break into Hollywood's turf. Beyond Blizzard building its own film and television division, Ubisoft set out to put Assassin's Creed on the big screen and added co-producing a TV series with Netflix to its agenda.

Netflix and Amazon, companies that began as video sites, also set their sights on making original content — and they believed they could use big data to win.

Put simply, from user behavior — saves, recommendations, replays, pauses, and search queries — Netflix predicted that a drama combining three elements, Kevin Spacey, David Fincher, and the cachet of "a BBC production," would be a hit; at the same time it caught audiences' weariness with weekly "appointment viewing" and changed the release model, dropping whole seasons at once.

"The worst thing you can do at Netflix is screen a film to 12 people in a small room and find out they like it," said Todd Yellin, Netflix's vice president of product innovation — and yet that is exactly how Hollywood studios test audience taste before a film opens.

Of course, how much this so-called big data actually helps Netflix make better entertainment is hard to measure, and plenty of people doubt it. But there is no denying that companies like Netflix and Amazon are more closely tied to their audiences. They may simply know better than Hollywood what today's viewers want to watch.

That is what leaves Hollywood so awkwardly placed against digitalization. With no successful integration to point to, Hollywood seems unable to do what it once did — use acquisitions to capture the creativity that digitalization is producing.

Once Hollywood and the internet move into open confrontation, a Hollywood drained of creativity will inevitably hand its audience to the internet. It does not know how to make good entertainment, nor how to sell what it does make. That is what Hollywood should truly fear in the digital age.

The deepest problem may be that Hollywood simply does not know how to use the internet — and those failed integrations and acquisitions are the plainest proof.

And speaking of failure brings us back to the story we began with. The 2000 merger of Time Warner and AOL may genuinely be the worst the world has ever seen — even though at the time it was hailed as the perfect match: Time Warner would get an internet channel, and AOL would get the best content.

The Wall Street Journal read the deal this way: "The combination of content and distribution makes sense, but cultural and organizational issues matter just as much." And a Bloomberg opinion piece by a former Time Warner employee argued: "The main lesson is that cheap distribution does not by itself create value for content producers."

Now those same questions sit in front of Time Warner and AT&T once more.