Roku (NASDAQ:ROKU) is thinking about entering the increasingly crowded market for original video programming. The connected-TV company has reportedly talked to media and entertainment companies about producing original programming for its platform, according to Digiday.
Roku says it's not currently producing any original content, and it has no plans to do so. The talks are merely exploratory. Still, investors should consider what original programming would mean for Roku.
Big budgets for ad-supported streaming
If Roku were to try its hand at originals, they'd likely live in the ad-supported Roku Channel. The Roku Channel currently features a library of over 10,000 titles Roku device owners can stream for free along with dozens of live channels. Roku generates revenue from the service through advertisements, which account for the majority of its platform revenue.
Roku's management has repeatedly noted that ad-supported streaming hours are growing at a faster pace than streaming from subscription-only services. And several competitors with big budgets have piled into the space in an attempt to take advantage of that trend.
Amazon (NASDAQ:AMZN) launched IMDb TV early last year and has slowly expanded its efforts with the ad-supported service. It's also exploring the possibility of buying originals for the service to attract viewers and bolster its fast-growing advertising business. Amazon is willing to spend up to $500,000 per episode on IMDb originals.
Facebook's (NASDAQ:FB) Watch platform invested hundreds of millions in original series. It's found a few titles that resonate with its audience, but it's shifted its focus recently to original talk shows, licensed TV clips, and sporting events instead of scripted series. Its budget for 2020 is about $1.4 billion.
After trying to use originals to grow a YouTube subscription service, Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google started focusing on its strengths and shifted strategies to monetize through advertising. At the same time, though, it started pulling back on its investments, which were reportedly several hundred million per year.
Perhaps the biggest premium ad-supported streamer has yet to enter the market. Comcast's (NASDAQ:CMCSA) NBCUniversal will launch its Peacock service nationwide in July. The company will license existing titles from its television networks and produce several originals. In its first two years, the company expects to invest $2 billion, total, in the service.
Should Roku compete?
Investing in original content increases the risk-reward profile of the Roku Channel. Currently, Roku pays a relatively small licensing fee for most of the content in its library. That's rounded out by revenue-sharing contracts with other media companies, which carry practically no upfront risk. Roku merely shares a portion of the ad inventory or ad revenue with the content provider.
If Roku wants to compete in original content, it's going to require a sizable step up in investments in order to compete with all of the big-budget companies in the market. And it's hard to see where exactly that fits in Roku's budget. Roku's still cash-flow negative, and it holds around $500 million in cash on its balance sheet.
Even if Roku does raise the capital needed to invest in original series or films, it still needs to draw viewers to that content, the rest of the Roku Channel, and its products in general, in order to see a considerable return on investment. That's something even YouTube and Facebook struggled with, and they already have billions of users on their platforms.
Moreover, a push into originals seems unnecessary for Roku and actually goes against the business model that's brought it all of its success. Roku enables media companies to reach the broadest audience possible. Importantly, it's fairly agnostic when it comes to how it works with media companies. Even the Roku Channel is positioned as another distribution channel for content providers, as it provides incremental reach over stand-alone apps in the Roku Store.
Entering the original content arena could weaken Roku's position in negotiating revenue share and distribution agreements with other content providers. Roku could lose one of its key differentiators between itself and Amazon's Fire TV platform, which prominently features its own Prime Video and IMDb TV content above its competitors'.
Since Roku's main source of profit is its platform business (unlike Amazon, which has massive retail and cloud computing operations), it needs to focus on its advantages. Investing in originals may be too expensive and too risky for Roku.