After weeks of reporting that Google would acquire game-streaming site Twitch to bolster its YouTube empire, it appears those talks have fallen through and Amazon will now acquire the site. The YouTube logic was so obvious that it didn’t even require explaining, but Amazon’s acquisition is a bit more of a head-scratcher. I thought I’d look at the context for Amazon’s acquisition to see why they might be doing this, and what it might mean. This analysis builds in part on several previous posts on Amazon, which you can see here. The first part of this post focuses on the context, which may be useful if you haven’t looked at Amazon’s media business in depth. If you just want to skip straight to the analysis of where Twitch might fit in, you can click here.
Media is the slowest-growing part of Amazon’s business
First, the obvious stuff. Amazon divides its business into three product segments for reporting purposes: Media, Electronics and other general merchandise, and Other. Other comprises mostly Amazon Web Services (AWS), advertising revenue and Amazon-branded credit cards, while Media includes both physical and digital media including books, music and video. The Electronics and other general merchandise category is basically the catchall for all other e-commerce revenue. When you look at year-on-year growth rates for these three segments, Media is clearly the slowest-growing of the bunch:
That’s not altogether surprising. Essentially all of Amazon’s business rests on the transfer of spending from legacy categories to categories it competes in, whether that’s e-commerce replacing bricks-and-mortar retail or digital content replacing physical content (or even cloud computing replacing premise-based computing). As such, Amazon’s addressable market is directly tied to three factors:
- the size of the legacy markets it’s seeking to disrupt
- the degree to which those markets are shifting into categories Amazon competes in
- the market share Amazon is able to capture.
If we look at these three factors for Amazon in the Media category, the picture isn’t that great:
- The overall size of the various Media markets (principally books, video and music) is small in comparison to the overall retail market (books is about $15 billion a year in the US, video is about $18 billion between sales and rentals, and music is about $7 billion per year, for a total of $40 billion, compared with total retail sales in the US of a trillion dollars per quarter, and e-commerce sales alone of $300 billion per year)
- The switch to digital and online sales is well underway, with 41% of video revenues in the US in the last four quarters going through digital channels, for example
- Amazon’s share in categories other than books is relatively low.
In addition, Media is the one category where Amazon enjoys a very significant share of the legacy as well as the new category, since it’s one of the biggest sellers of CDs, DVDs and physical books. As such, the ceiling is low, the transformation is well underway, and Amazon has such a large stake in the legacy business that even a rapid transition from physical to digital formats doesn’t benefit Amazon greatly (and may actually hurt it in categories where its digital share is lower than its physical share, including music and video).
Significant investments in digital media properties
In this context, then, it makes sense that Amazon would be looking to expand its already considerably digital media efforts still further. Just in the last few months, Amazon has announced a significant investment in original programming, new seasons for some of its existing original shows, and a deal with HBO for some of its older programming. It will invest $100 million in original content in Q3 alone. We can get a rough sense of the scale of its HBO commitment from Time Warner’s financials, since they specifically cited the Amazon deal as the major factor behind a $100 million year-on-year growth in content revenues. The Amazon deal kicked in halfway through the quarter, and some of that $100 million came from other sources, but it’s easily possible that Amazon is spending over $100 million each quarter now on HBO content.
Amazon is clearly taking digital media very seriously, and spending heavily to fund it. It’s very tough to break out the total costs of these efforts in detail because they’re buried in Amazon’s cost of sales line, and even financial analysts’ estimates vary widely. But it’s certainly on the order of hundreds of millions of dollars per quarter and is well over a billion dollars annually between original content, HBO and its various other content deals for video alone.
Amazon isn’t monetizing most of its content offerings
However, despite all these investments, Amazon is generating very little revenue from this digital content, for one big reason: it isn’t monetizing much of it directly. Ever since the launch of Amazon Prime, the company has been bundling more and more into the service as a way to convince customers to commit to the annual subscription fee, in the hope that it will drive greater e-commerce spending. As such, digital media has gone from a significant revenue driver in its own right to a bribe for other Amazon products and services.
The one exception to this is books, which of course was Amazon’s first product category, and the vast majority of which is still monetized through direct sales (though even here Amazon has now introduced a separate subscription service). But Prime Instant Video now includes access to many third party titles as well as to all of Amazon’s original programming. This isn’t entirely free to the user of course: it’s part of the $99 per year Prime subscription. But as I’ve written about before, given that Amazon actually loses money on shipping, and given how much Netflix spends on content, it’s very unlikely that Amazon is making money on the digital content that’s included in Prime, and in fact it’s likely that it’s losing a significant amount of money.
The question then arises, why spend another billion dollars on an acquisition in the digital media business, when Amazon’s recent strategy for digital media doesn’t seem to promise any sort of direct payback? Is this just another subsidy to drive e-commerce revenues, or could this be something different? I think there are several possible answers:
- Twitch will be more of the same, bundled into various subscription offerings and left largely un-monetized in its own right, in order to drive e-commerce revenues
- Twitch will allow Amazon to experiment with new business models for digital content and a shift away from simply bundling more and more digital content into Prime
- Twitch will support Amazon’s broader push into advertising as a source of revenue
- Twitch will enable Amazon to build other services on the back-end technology
- Twitch will bring a new audience to Amazon.
Let’s look at each of those briefly.
More of the same
This is the least likely outcome, for all the reasons I stated above. Although a certain amount of freebie content makes sense as a plug for Prime and therefore e-commerce sales, it’s not sustainable for Amazon to keep piling more content into this deal. The Twitch model also doesn’t make much sense in the context of Prime.
New business models and advertising
This almost certainly is part of the answer, especially as Twitch already has two business models which Amazon hasn’t been big in so far: subscription content as a standalone product, and advertising. But Twitch also represents a bigger shift into a new type of media product: non-traditional, non-professionally-produced content. YouTube is the world’s biggest exemplar of a video product built on user-generated content, and that’s why Twitch was such a great fit: it’s arguably the first site to rival YouTube in this category. But that’s also a category where Amazon hasn’t played so far, and the acquisition enables Amazon to participate. This is perhaps the first example of a media category where Amazon will actually benefit from entirely new revenues rather than just substitutional revenue as digital consumes physical formats.
Advertising is also becoming increasingly important as a revenue stream for Amazon, and it appears keen to extend it beyond its current scope. Just this past week there were the first signs that Amazon wants to build a display advertising network through its affiliates’ websites, and directly take on Google in this space. But its ad revenues have been growing rapidly, though quietly, through other products already, and Twitch could help it participate more directly in the video advertising market, which it has only dabbled in so far on its own properties.
Using the back-end technology to build more stuff
There’s a revealing sentence in the official press release from Amazon, which is a quote from Twitch’s CEO, Emmett Shear: “Amazon and Twitch optimize for our customers first and are both believers in the future of gaming”. Amazon has been investing in gaming, too, through the Kindle Fire TV and the Amazon App Store for Android. Twitch could be a very interesting addition to the Fire TV proposition, both from a broadcast and a viewing perspective, and Amazon could also build some of the same functionality into Kindle Fire tablets. Given Amazon’s investment in MayDay, which is also a one-way live video connection, there may be other things that could be built on the back of the infrastructure. Twitch is great advertising for the games its users stream themselves playing, and Amazon could leverage Twitch-like functionality to promote Fire TV and Kindle Fire gaming, among other things.
Bringing a new audience to Amazon
It’s a cliché, but Twitch appeals to a certain demographic which Amazon likely doesn’t reach very well today, and Twitch could help it reach that demographic more effectively and therefore cross-sell other Amazon products and services. I think this may be a bit of a stretch, in that there’s little inherent connection between the two and forcing one may break the experience on both sides, but there are at least obvious opportunities to sell games through Amazon to Twitch users, and the opportunity likely goes further too.
Amazon does as much for Twitch as Twitch does for Amazon
Of course, there’s a whole other side to this too, which is that Amazon benefits Twitch as much as Twitch benefits Amazon. Twitch will get to leverage Amazon’s infrastructure (if it isn’t already) and scale, along with its deep pockets. Shear mentions this in the press release explicitly, explaining that Amazon will allow Twitch to develop new services more quickly than it would have been able to do independently (and vice versa).
Ultimately, as with the Apple/Beats deal, we can have some inkling of what the two companies have in mind, but we really won’t know until new products, services and features start to roll out over the coming months. But one thing I’m fairly sure about is that this marks a change in direction for Amazon in the digital media space: it’s going back to making money.