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Blockbuster’s lesson, revisited… when AI kneecaps a moat… two tests for every stock you own… Eric Fry’s “panic early” rule
As I write on Monday morning, the AI trade is trying to claw its way back after last week’s brutal selloff.
But whether this is a fool’s gold rally or the start of a real bull run into the end of the year, one thing is true: AI itself is quietly eroding the business models of some of the market’s best-known companies. It’s critical that you and I recognize how this is happening and prepare our portfolios – not just for a week of volatility but for permanent existential risk.
For an example that’s playing out right now, let’s rewind 26 years…
In September 2000, the founders of a money-losing DVD-by-mail startup flew to Dallas to pitch the CEO of the biggest name in home video on an acquisition.
The startup was Netflix (NFLX). The CEO was Blockbuster’s John Antioco. And the asking price was $50 million.
Netflix co-founder Marc Randolph, who showed up in shorts, a tie-dyed T-shirt and flip-flops, later described the moment the number landed. As he put it in his memoir, “John Antioco was struggling not to laugh.”
Blockbuster turned down the deal, and 10 years later, it filed for bankruptcy.
It’s become the business world’s favorite cautionary tale about a dominant company that didn’t see what was coming. But today, the story is worth retelling for an ironic reason…
Netflix may be staring down its own Blockbuster moment – though for a very different reason.
The streaming giant stumbles
Last Wednesday, Netflix management told employees it will lay off roughly 6% of its workforce, or about 1,000 people. The cuts land mostly on the product, tech, legal and HR teams.
A few weeks ago, co-CEO Ted Sarandos told a Bloomberg conference that the company was “not growing as fast as I want.” As one illustration of this, viewing time grew just 2% in the first half of the year.
Wall Street has noticed. In June 2025, NFLX stock hit a record high. But as I write on Monday, it trades at less than $70 – down nearly half since that high-water mark.
But this selloff is less about an upstart company challenging the industry king, and more about an upstart technology challenging the entire model.
Netflix sees AI coming. In fact, it’s embracing it. Last year, Netflix confirmed that its Argentine sci-fi series The Eternaut featured the first generative AI footage ever to appear in the final cut of a Netflix original.
The scene showed a building collapsing in Buenos Aires. Sarandos told analysts the sequence was finished 10 times faster than with traditional visual effects. He added that, without AI, the cost “would just not have been feasible for a show in that budget.”
But look at the flip side of that – the same tool that lets Netflix make an expensive scene cheaply lets everyone make it cheaply. And that dovetails into the problem…
For two decades, Netflix’s moat rested on a simple fact: great video is expensive and slow to make, and Netflix could outspend nearly everyone. Blockbuster’s downfall was a failure of vision. Netflix faces something more difficult: a technology that erodes its moat, no matter how clearly management sees the danger coming.
“Nothing is happening at all” –until it is
Tom Yeung, lead analyst for our global macro expert Eric Fry in Fry’s Investment Report, has been tracking this threat since March.
Back then, Netflix traded near $100, and investors weren’t worried about its long-term profits. After all, AI video was still mostly a punchline.
Here’s how Tom described AI video quality at the time:
A recently generated viral clip of Jackie Chan fighting Jet Li had more bugs than a picnic in July.
Anyone watching it carefully will notice the kung fu actors reaching straight through objects, growing phantom limbs, and magically teleporting between camera shots.
Then the situation changed, gradually at first and then all at once.
Back to Tom:
In short, people saw the technology the same way parents often view their kids – with progress so gradual that it’s tempting to conclude that nothing is happening at all.
But every once in a while, there comes an epiphany of how far things have come. For AI-generated video, that realization happened over the past six months after a stream of new developments began making headlines.
Two of those developments came from China. First, in April, regulators approved the world’s first theatrical release of a feature-length AI film by a major mainstream movie studio. That film, Sanxingdui: Future Memories, opens in Chinese theaters this Friday.
Then in August, a Chinese company began releasing episodes of an AI-generated TV show, The Sequel to Journey to the West. Tom notes that it racked up 280 million views across its first five episodes and ranked No. 1 among some provincial channels.
The economics behind all this are startling…
According to Chinese state broadcaster CCTV, the cost of producing one minute of an AI short drama fell from 5,000 yuan (about $700) to just a few hundred yuan in the first half of this year.
One Chinese director said a wedding scene that would have cost him about $9,000 to shoot cost about $210 with AI.
Circling back to Netflix, here’s Tom with the fallout:
Shares of Netflix have since fallen below $70, and one analyst even dared put a “Sell” rating on this formerly blue-chip stock – its first negative review since the start of the year.
After all, Netflix is now facing some real competition.
Credit to Tom – Wall Street’s first bearish call (last month) arrived after the stock had already fallen about 30% from Tom’s March warning.
In fairness to Netflix
Before we write Netflix’s obituary, a real bull case remains.
Netflix has more than 300 million subscribers, and its advertising revenue is on track to roughly double this year, to about $3 billion. Meanwhile, management has guided to $51 billion to $51.4 billion in 2026 revenue.
Plus, live sports and events, which AI can’t fake, are a growing part of the mix. And AI may cut Netflix’s own production costs as much as anyone’s.
These tailwinds mean investors trying to understand whether AI will hurt or help Netflix should ask two questions…
What is Netflix’s core asset as a company? And does AI make that asset more or less scarce?
If it’s the content, Netflix’s dominance looks shaky as a wave of cheap content is coming. But if it’s the subscriber relationship and global distribution network, the moat may hold.
Notably, CNBC reports that Netflix’s biggest threat has been YouTube, which is a distribution platform rather than a studio. YouTube doesn’t need to make the best shows. It wins by being the viewing channel people turn to by habit.
That’s a hint that in a world of abundant video, the scarce asset is the platform where viewers spend their time – and with more than 300 million subscribers, Netflix owns one of the biggest. The catch is that Netflix is competing with YouTube for those same hours – and YouTube is free to watch.
Now, beyond Netflix, the question of “what’s actually scarce?” is critical to ask as you evaluate your portfolio – after all, it’s how we spot small cracks in our own holdings before they turn into massive fissures.
Two ways AI breaks a moat
Netflix’s challenge – that something which once made it valuable is becoming abundant – isn’t unique. Plenty of good businesses will face it in the years ahead.
This points to two tests we can run on every stock we own…
The scarcity test.
Pricing power follows scarcity. When AI turns a scarce thing into an abundant thing, the pricing power leaks away, even from well-run companies.
The logic applies to any business whose core product is expensive, skilled human output. That includes tutoring and homework help, stock photography, call-center labor and ad production.
So, does AI make the products of the companies you own more or less scarce?
The friction test.
In our Sept. 29 Digest, we looked at how AI agents like Meta Platforms Inc.’s (META) Muse could commoditize businesses built on customer inertia. These include banks paying 0.1% on checking accounts, insurers counting on lazy renewals, and wireless carriers charging loyal customers more than new ones.
Scarcity and friction are two different mechanisms with one shared outcome: margins that looked permanent can turn out to be temporary.
So, does AI make it easier for customers to find better or cheaper alternatives to the products and services offered by the companies you own?
If the answer is “yes” to either of these two tests, be careful.
When to act: Eric Fry’s rule
The problem for investors is that by the time disruption is obvious, it’s usually priced in. Tom issued his warning in March. Wall Street’s first sell call arrived in September – 30% lower.
Eric – our macro investing expert – has a rule for exactly this kind of situation. Now, to be clear, he wasn’t writing about Netflix. He was writing about risk in the broader market. But the point remains:
Panic early. That’s the only near-certain defense against adversity in the financial markets, and in life generally…
Once you catch a whiff of smoke from a distant wildfire, you don’t hang around until embers are landing on your roof…
Successful panicking begins by saying “no” to obvious risks. Only then can you calmly examine and select opportunities that offer a more favorable route to wealth-building.
Panicking early doesn’t mean dumping every stock that AI touches. It does mean assessing the situation soberly, then making calm, deliberate choices.
For more on the stocks that Eric believes are worth holding today, click here to learn about joining him and Tom in Fry’s Investment Report.
Coming full circle
This brings us back to Netflix, which reports earnings tomorrow.
If you own the stock, this will be a live test of what Netflix’s core asset really is. Watch engagement trends, content spending, and anything management says about generative AI in production.
Strong engagement and a growing ad business would suggest the subscriber relationship is the scarce asset that holds. Another quarter of flat viewing would point the other way.
Either way, let’s not miss the wider point…
Netflix beat Blockbuster by making video easy to get. The next disruption is making video easy to make. Unlike Blockbuster, Netflix sees it coming. What’s still unclear is whether that’s enough.
Now, before we wrap up today, a quick related note…
Want to trade Netflix’s earnings tomorrow but aren’t sure about which way it will break?
If you’re tempted to trade Netflix’s earnings, you don’t necessarily have to correctly predict which way the stock will move to make money.
I learned that from veteran trader Jonathan Rose, editor of Advanced Notice. Sometimes, instead of betting on the direction a stock will move after an earnings report, Jonathan buys both calls and puts – positioning to profit from a big move, whichever way it goes.
Under the right circumstances, it can be very lucrative…
For example, this approach paid off for Jonathan’s subscribers last week with FMC Corp. (FMC). Shares plunged more than 36% after a dramatic guidance cut, and Jonathan’s subscribers took profits on the put side for what he called “more than 200% on our total position.”
For more on how Jonathan finds and structures trades like this – plus his entire trading approach to the markets – you can still catch a free replay of his $10K to $100K Challenge from last week. We’re taking the replay down later this week, so click here to watch it while you can.
We’ll keep tracking Netflix here in the Digest.
Have a good evening,
Jeff Remsburg
