Warren Buffett explained why Netflix's AI edge won't last -- 40 years ago

Streaming giant Netflix (NASDAQ: NFLX) failed to meet expectations with its second-quarter results and guidance last week, but the company did mark an important first. A sequence from Argentine science fiction series and Netflix original El Eternauta used generative AI for a building collapse scene. This is the debut of final footage created with generative AI tools appearing in a Netflix original film or series.

Netflix co-CEO Ted Sarandos noted in the earnings call that it would have taken ten times as long to create the sequence using traditional tools and workflows. He framed the AI tools as a way for creators to make better content for less money.

The prospect of dramatically shorter production times and lower costs for Netflix's originals sounds great on the surface, but an old Warren Buffett quote throws some cold water on the idea that this will give Netflix a durable cost advantage.

Standing on your tiptoes at a parade

In his 1985 letter to shareholders, Warren Buffett laid out the trap that companies can fall into in their quest to lower costs. Buffett was talking about textile mills, a commodity business that is very different from streaming. But the lesson still applies.

Buffett's Berkshire Hathaway tried for years to make its textile business work, turning to capital expenditures that promised to lower variable costs. Buffett noted that each investment made sense in a vacuum and was backed by sound logic, but that they delivered no benefits. What was the problem? Everyone else in the textile business followed suit. "Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industrywide," Buffett said.

Buffett likened the situation to everyone standing on their tiptoes at a parade. If everyone does it, no one sees any better, and everyone is a little more uncomfortable. Generative AI for content creation fits this mold. Netflix is seeing faster production times and lower costs, but so will all its competitors. No one will be willing to pay more for higher-quality content because the bar for quality will be raised. And, perhaps worse for Netflix, the barrier to entry into the content creation business will collapse.

Netflix has no choice but to use generative AI tools for its content. Unfortunately, there's no advantage to be had.

AI could still strengthen Netflix

While Netflix is unlikely to gain an edge in content creation, generative AI does have the potential to strengthen the advantages the streaming giant already has. Netflix's scale and its data are genuine competitive advantages, and AI can act as a multiplier. Personalization for recommending content and serving ads, fueled by a mountain of data on its subscribers, is a win that smaller competitors will have a tough time replicating.

Netflix's success in speeding up production times and lowering costs using generative AI offers a short-term cost benefit for the company, but it's unlikely to last. AI can still be a net positive, but Buffett's warning four decades ago is just as relevant today.

Timothy Green has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway and Netflix. The Motley Fool has a disclosure policy.