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Investing in Digital Content I: The Problem with the “Hits” Model

November 17, 2007


This is the first in a 4 part series on VC investing in digital content, prompted by the discussion at a NewTeeVee Live panel discussion on the topic with myself, Tim Haley of Redpoint, George Zachary of CRV and Dennis Miller of Spark.

George was right when he said at the panel that most content opportunities are plauged by a “hits” business model. Movies, TV shows, videogames all are great examples of hits based plays: you invest tens of millions of dollars up front, pray for a blockbuster hit that returns your money many times over, but truth be told really have very little ability to predict success. As one of my partners says, being able to create a hit entertainment property is like creating lightning in a bottle – it actually does happen sometimes, but you never know when.

Most agree this is a bad fit for the VC model. Although our business has lots of risk and (though we hate to own up to it) lots of failed investments,  over the years successful VCs have followed a formula which balances risk/reward along with amount of capital exposed. Time and again this formula has proven the one most likely consistently to generate good returns.

Here is what I mean by balancing both risk/reward and capital exposed:

Sometimes we see a very early stage project which we think has tremendous potential to be a big hit, but is so early or so risky that we know the odds of achieving the hit are not high. In those instances, if we love the entrepreneurs and think they have a real advantage, we sometimes will invest a small amount of capital to learn more. The calculated gamble is pretty straightforward: we know full well that we might lose every penny invested, but if the amount exposed is small enough, it is well worth that risk in order to see if the entrepreneur can make enough progress, and remove enough risk, that we are then willing to invest substantially more capital trying to go to market.

This is a classic profile for a “seed” investment. The key is that we limit how much capital is exposed in opportunities where the risk is exceptionally high. Over the course of a fund, we like to make a number such bets (and historically have had great returns with seed deals), balanced out by a larger number of less risky bets where neither the upside potential nor the risk is as extreme.

The problem with traditional “content deals” is that they invert the relationship between risk and capital requirements that makes the VC model work. While content deals are very risky and unpredictable, they require lots of capital up front. It feels like buying a $30MM lottery ticket. Only fun if you win.

So, while it is true that some folks with names like Malone and Diller have made a killing investing in content, it is a tough model. Rather than believing they have the midas touch of a Diller or Malone, VCs prefer the more proven model of only exposing a modest amount of capital when essentially taking a flyer. Which makes a heckuva lot of sense to me.


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  1. November 17, 2007

    There are two problems with betting on hits in the world we’re moving toward. Hits are driven by two things, scarcity and buzz. But increasinlgy it harder and hard to manufacture buzz a new tools and faster communication reduce the amount that paid media noise can impact sales. I call this the “Snakes on a Plane” phenomenon. There’s a film that had tremendous buzz. Huge buzz in fact. It was going to be a cult classic. But then something happened – it opened in theatres. And the same tools that generated all the pre- release buzz turn on the film. It turned out that SOAP (that’s the acronym for Snakes on A Plane) was B.A.D. And all the teens were off and texting each other saying – Don’t Bother. By the end of the first day – that film was dead. The authenticity of word of mouth marketing makes it hard to manufacture. Another good example is the Transformers movie this past summer. The fans rose up and demanded that the filmmakers engage them and not damage their beloved brand. You can say what you will about the final result, but fans did not go and blindly turn over their $9 to Michael Bay.

    The other thing i’d quibble with is that either Malone or Diller are ‘hits’ based investors. In fact, quite the opposite. Malone has a huge portfolio of companies that he owns pieces of, pieces he often was able to leverage because of his ownership of the distribution pipe (cable) back in the day. If you look at institutions like Discovery – they’re always putting bets on little ideas, hoping for one of them to pop. A show like Trading Spaces on TLC was a dog for a few years before it became a monster hit. The problem for these institutions is that the hits still work (Monster Garage) but all the singles and doubles are tanking – so folks are cherry-picking the shows they want to watch, and leaving all the other stuff with smaller and smaller audiences. It’s as if your LP’s could decide how to allocate their investment in your fun AFTER the IPO or successful exit. That’s just plain bad for business.

    And finally – there’s the question of wether ‘hits’ will exist at all in the future. The word ‘hit’ suggests a film, tv show, book, or piece of music that rises above the noise and becomes something of a pop culture phenomenon. But just look at the things that are cutting through the clutter these days. No one would argue that her pseudo-pornographic escapades are either good for the culture or – to use an internet word – monetizable.

    It may be that content becomes more like groceries. There are no hits in the canned vegetables section. I’m not suggesting that content becomes a commodity as much as that content becomes an eco-system of micro payments and micro-audiences. This could be a very good thing for creators and consumers, since it would be a much richer diet of choices, and the ability to vote with your check book and support creators that make things that are meaningful to you. Think of it like the ebay (or really more like the etsy) of content. Imagine a media diet that looks more like whole foods than McDonalds. There a pretty good arguement to be made that we’re heading there.

    In a world without hits – we might find our media diet is a whole lot more healthy.

  2. November 18, 2007

    Steve, thanks for the thoughtful comment. You make a number of really strong points. In fact I entirely agree with you that the one of the big opportunities presented by the emerging digital platform is for companies who’ve figured out how to predictably generate programs that, while not blockbuster hits, don’t cost a ton to produce and therefore can consistently be quite profitable. Stay tuned for the next installment of this series!

  3. November 26, 2007

    Being someone with a strong background in content creation and DVD distribution, I see much of what you’re saying all the time. That is, people want to spend too much money to produce a movie when the market won’t stand for it. The SNAKES ON A PLANE example above is a good case in point.

    SOAP should have been made without any stars – the concept is the star – and it should have had half its budget stripped away. Then it would have been a financially successful movie.

    They had it right on with trying to attract the genre movie fans right off the bat – especially through the cost effective venue of the web.

    The trick is to build a series of small movies and leverage the successful ones into franchises, but to ALWAYS adhere to a budget and marketing plan developed beforehand. “Hollywood” always spends way to much money on movies you KNOW will not be successful in theaters (which ultimately affects the all-important DVD sales)because the audience numbers aren’t there.

    Better to develop a series of different D2DVD movies (that all appeal to your target demographic niche), and build a consistent, sustainable brand identity for the same amount Hollywood spends on one film.

  4. frostmane #
    January 2, 2010

    Классные мультфильмы на Кинозоуне.

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