Roku (ROKU +3.84%) isn't afraid of a little competition in the smart-TV space.
Roku ended 2022 with the most popular smart-TV operating system in each of the U.S., Canada, and Mexico, thanks to its manufacturing partners. This year, Roku's launching its own branded television sets, which sparked concerns that manufacturing partners may look elsewhere for a software partner.
"It's very difficult, I would say, impossible to build a new franchise in TV OS at this point," CEO Anthony Wood said during Roku's fourth-quarter earnings call. He contends Roku-branded TVs will only serve to grow the Roku TV ecosystem and increase innovation.
Do skeptical TV manufacturers have a leg to stand on, or are we living in a Roku world?
Roku's competitive advantages
If Roku wants to hold on to manufacturing partners, it needs to offer something its competitors can't. To that end, it has several competitive advantages that should ensure it staves off the competition.
First, there's the network advantage. As an early entry into connected TV, Roku has built up a substantial user base, now totaling 70 million accounts worldwide. But it's not just the user base. Since Roku is so broadly used, it has practically any streaming service you could imagine available on the platform. The only time users wouldn't have access to a streaming service is in the case of carriage disputes -- which have, unfortunately, become relatively common in the industry.
The two-sided network is a significant advantage, and only a couple of competitors can provide a similar level of users and content providers. Amazon (AMZN +0.26%) has at least 50 million users on the Fire TV platform and lots of content partners. Google said it has 150 million Google TV or Android TV devices in use.
Both Amazon and the Alphabet (GOOG +2.00%) (GOOGL +1.71%) company have mostly made their mark in standalone devices, though, and not through significant TV manufacturer partnerships. And that may be because of Roku's second advantage -- it built an operating system just for television sets.
While adapting Android for the TV screen, as Google TV and Fire TV do, might not seem like a big deal to consumers, it can be a big deal for manufacturers. Roku's operating system runs more efficiently, which means it can offer the same experience with less expensive parts. And in a business where the profit margins are already very thin, every little bit of savings on the manufacturing side counts. What's more, Roku offers reference designs to manufacturing partners, which helps them get the most out of their budget.
Finally, Roku has a brand advantage. As one of the earliest entrants in connected TV, Roku has a well-established brand. More importantly, it's winning favor with a very important demographic: Gen Z. Charlie Collier, the president of Roku Media, cited a recent survey from Morning Consult, which found Roku is the fastest-growing brand among Gen Z.
All of these advantages have led to a growing market share. Roku OS was on 38% of smart TVs sold in the U.S. during the fourth quarter, which management claims is greater than the next two closest competitors combined.
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What it means for Roku
It seems unlikely that we'll see a major shift in manufacturers partnering with other platforms, but that doesn't mean Roku's decision to push into building its own branded TVs isn't without risk.
Importantly, Roku's current deal to license its operating system generates zero revenue and zero profit (or losses). Meanwhile, its devices business has firmly moved into negative gross margin territory, as the platform business has become its primary source of revenue with significantly higher profit margins than the player business ever produced. As a small player in the smart-TV hardware business, Roku may face significant losses by selling its own TVs.
But Roku's player business is no longer a major source of new users. On the earnings call, management said its 9.9 million net new accounts in 2022 were driven primarily by the Roku TV service. Furthermore, it changed the reporting segment name from players to devices, signifying the shifting focus.
Owning the entire hardware and software stack could open new platform revenue opportunities for Roku. So the investments could pay off extremely well in the long run, especially if it results in continued user growth and strengthens its brand.
The competitive advantages Roku's management referred to during its earnings call and its confidence in the Roku TV program make it one of the best ways to invest in the growing connected-TV industry.
