Legacy media has disrupted Netflix. The consequence may be mutually assured destruction

We must be living in the Upside Down. Legacy media has disrupted Netflix.

Netflix announced Tuesday it’s exploring adding a lower-priced, advertising-based tier to its service. The decision has put the world’s largest streaming video service in a peculiar place: following legacy media’s lead.

Comcast and Disney-owned Hulu is the founding father of advertising-supported streaming. In recent years, Warner Bros. Discovery‘s primary streaming services (HBO Max and Discovery+), NBCUniversal’s Peacock and Paramount Global‘s Paramount+ all launched with ad-based tiers for a lower price than their commercial-free products. Disney said last month Disney+ will offer an advertising-supported product.

The legacy media industry has spent the past four years overhauling their businesses to compete with Netflix. All of legacy media decided Netflix’s streaming-only model was the future of entertainment consumption. The companies saw Netflix trade at sky-high multiples, leading to a soaring stock price, no matter how much it spent on content.

The result was a pack of enormous companies shifting focus to compete directly against Netflix instead of protecting the pay TV bundle, long the jewel of the industry.

In the streaming world, Netflix looks like the incumbent — struggling with saturation and an aging core service. That may not be good news for the entertainment companies striving to gain market share.

The optimistic goal for legacy media companies has been to attain the same type of trading multiples as Netflix — an “everybody wins” scenario. But, at least for now, it appears entertainment rivals have pulled down Netflix, which acknowledged during its first-quarter earnings update that growing competition has led to its slowing growth.

Netflix shares fell more than 35% in morning trading on Wednesday, dragging its market capitalization below $100 billion for the first time since 2018.

When a company trades on subscriber gains, like Netflix, it’s inevitable the music will eventually stop. No company can sustain subscriber growth forever. Saturation kicks in.

That appears to have happened for Netflix, which lost subscribers for the time in more than 10 years during the first quarter and is projecting a further loss of 2 million subscribers during the second quarter.

The situation is so dire, on the surface, that Netflix CFO Spencer Neumann jumped in just before the end of the company’s earnings conference call Tuesday to reassure investors that Netflix will still be up in terms of subscribers for the full year — a telling consolation when you consider that most analysts expected Netflix to add nearly 20 million net subscribers in 2022.

“There will be paid net add growth,” Neumann said. “I just want to make sure that that’s understood.”

A shrinking Netflix isn’t good for Hollywood, which has benefited not just from the streamer’s willingness to spend but also the subsequent arms race from competitors.

A version of Netflix that needs to tamp down spending because it no longer has a ballooning market value forces the entire industry to figure out what’s next. If Netflix is embracing ads after years of resisting them, will the company next get into live sports?

Co-CEO Ted Sarandos said he didn’t see a profitable path into sports on Tuesday’s conference call, but Netflix seems to be getting into the habit of changing long-held beliefs. Netflix ignored password sharing for many years — and that’s changing now too.

If Netflix looks and acts like all other entertainment companies, it sets itself up to be disrupted too. It’s unclear video gaming, which the company has repeatedly touted as an area for innovation, will be enough to separate Netflix from the pack.

The industry now seems a lot more unsettled than it did a year ago, when “trading like Netflix” was actually a goal. There’s rampant speculation the streaming wars will lead to more consolidation, but it’s unclear regulators would allow those deals to take place.

Media companies could have rallied around protecting the pay-TV bundle, but they risked ceding the future to Netflix and other giant technology companies. Whether that decision was right or not, that ship has sailed.

And following Netflix into streaming hasn’t led to the multiple expansion the legacy companies were hoping for. As Netflix falls, its newly defined peers do too. Paramount Global dropped more than 7% Wednesday. Warner Bros. Discovery dropped more than 5%. Disney fell 4.5%.

Legacy media may have brought down Netflix to a degree. But in doing so, it created an existential crisis for the entire entertainment industry. What do we do now?

WATCH: Netflix has not monetized 500 million viewers, says Jim Cramer

Disclosure: Comcast is the owner of NBCUniversal, parent company of CNBC.