This week’s edition of “Get Free Newsletters” is from the Business Breakdowns newsletter. Its tagline is “Like reading a 10-k, only infinitely better.” Check out this breakdown of the streaming company, Roku. If you’re interested in Business Breakdowns, read all the way through for a discount 😁.
Roku is an operating system for Smart TVs. The company now estimates it has 33% market share of all newly purchased televisions.
Roku is to the Smart TV as Microsoft is to the PC. Like all good operating systems, both companies have enabled hardware manufacturers to save time and efficiently sell their products.
Imagine you’re an executive at TCL or Hitachi (Smart TV manufacturers) and you can either create an operating system from scratch or just use Roku’s. Especially if software isn’t your core competence, the choice is rather simple.
Further, consumers are familiar with Roku and they know what to expect. If you created your own operating system, you run the risk of people not finding it intuitive. It all comes down to risk. Roku has become the risk-free option for Smart TV producers.
Now, since Roku has reached a critical mass with TV manufacturers and consumers, it has some leverage over content providers. Roku’s 32 million, highly-engaged, active accounts, provide a large installed base for content creators to sell into. To give some context, Comcast only has 21 million paying cable subscribers and that number is decreasing.
Here is how the value chain looks:
Roku has also leveraged this consumer demand by creating “The Roku Channel” which is why we included Roku as one of the content providers. Though it makes no original content, it is yet another way Roku can monetize its platform.
Speaking of monetization, let’s establish how the company makes money.
Roku has four main revenue streams:
Players (the little hardware remotes (+ a USB) that can turn nearly any TV into a Smart TV)
AVOD (advertising video on demand)
SVOD (subscription video on demand)
TVOD (transaction video on demand)
Revenue segments #2-4 are considered “Platform revenue” which now makes up 69% of total revenue. Look at how much the low-margin “Player revenue” has shrunk over the past four years:
Before moving on, let’s make the revenue segments come to life a little more, shall we?
Player revenue
You go to Best Buy and purchase a Roku stick + remote for $29.99 (there are different models these days, 4k streaming will cost you another $10).
AVOD
On Roku’s home screen, content providers can run sign-up promotions. Disney+ basically owned the home screen before the official release.
Roku also makes money through The Roku Channel where it runs short, targeted ads. This is the fastest-growing inventory for the company and should continue to be so. The delicate balance here is that Roku can’t afford The Roku Channel to become too popular since it might disincentivize content providers to continue as Roku partners.
Below is an excerpt from Roku’s Developer agreements. Basically, Roku makes money by forcing advertisers to give over 30% of their allocated advertising inventories.
SVOD
Roku has a revenue-sharing agreement with most of the content providers on its platform. For instance, if someone buys a Netflix subscription through Roku’s interface, Netflix has to share a little bit of that revenue. While it isn’t specified, since Netflix is the most-watched channel, I’d venture to say that Netflix has bargaining power and doesn’t pay the full 20% Roku take-rate.
Roku also makes some money through “Premium Subscriptions” on the The Roku Channel. This is a new offering but users can now buy subscriptions from HBO, STARZ, EPIC, and more through The Roku Channel. These content providers likely chose this route as Roku does a lot of the leg-work to help with sign-ups.
TVOD
When someone buys a movie for $3.99, Roku gets a piece of that transaction. The revenue-split is the same as the 20% SVOD take-rate.
Wow, that’s a lot to take in! But that’s kind of the point. Roku’s platform has quite a bit of optionality in terms of monetization. Since it sits at a crucial point between users, content providers, and TV manufacturers, it has the power to make money in creative ways. The Roku Channel is a prime example of this.
So the big misconception with Roku, that is now being understood, is that it’s not just a hardware company. Back in 2015, the argument could definitely be made since 86% of sales were from Players. But now, 69% of the business is the higher-margin, Platform revenue. Of the Platform revenue, about 2/3rds is ad-related with SVOD coming in behind it, followed by TVOD.
As AVOD grows quickly, Roku is capitalizing on a few big tailwinds:
Subscription fatigue
As the streaming wars heat up, flexible content providers like Hulu which offer paid and ad-supported options are seeing strong adoption. This plays in favor of ad-supported channels on Roku and The Roku Channel.
The decline in cable engagement (cord-cutting)
In the past four years, Roku’s ARPU has more than quadrupled and the company has added roughly 26 million active accounts. In the same period, all of the cable operators have lost video subscribers.
Budgets catching up to engagement
According to Magna Global, streaming accounts for 29% of U.S. TV viewing but only 3% of TV ad budgets. Anytime there is a wide discrepancy between engagement and budgets, money usually flows.
Roku is clearly not a hardware company anymore. Just look at how the Platform growth has changed the gross margin profile:
But the company isn’t without risks. One thing that I’d be wary of as an advertiser is that most of the engagement comes from YouTube and Netflix. This likely inflates Roku’s engagement metrics since these two services account for the majority of all hours streamed.
Further, the company has a lot of competition. Amazon’s FireTV is a worthy #2, just behind Roku in active accounts. However, I’m not as worried about this because of Amazon’s conflicts of interest. If you’re a content provider or a big CPG company like Walmart, you’re going to think twice about giving your data and content to the 800 pound gorilla which is Amazon. Roku sits as a neutral player which is a bigger advantage than most people realize.
And lastly, Roku has a delicate balance with The Roku Channel. Even though it seems like a great source of advertising inventory, it needs to be careful about its own conflicts of interest. Recently, in an interesting move, Roku acquired a demand-side advertising platform called dataxu. If Roku becomes a walled-garden similar to Facebook or Google, brands and ad agencies might be less likely to work with them as concerns over privacy and data security mount. While walled-gardens have historically been gold-mines, in today’s day and age, transparency seems to be of growing importance. It’s yet to be seen how Roku navigates this, but it is something to think about.
We’ll end with two fun facts:
Roku means “6” in Japanese and founder/CEO, Anthony Wood, named it that because it’s his sixth company. Talk about a serial entrepreneur!
Mr. Wood was working at Netflix where he led “Project Griffin.” Later, as the project gained some momentum, Netflix’s CEO, Reed Hastings, decided to spin it off. “Project Griffin” became Roku and the rest is history.