Netflix Needs Momentum for its Business Model

April 12, 2011

For a little while, it appeared that Netflix was on the ropes. First, there was the the loss of Showtime first-run series such as Dexter and Weeds. Then Starz announced they were adding a 90-day window to their shows after the first broadcast date. In addition, there was also speculation that Starz would renegotiate the agreement for some of the movies they supply. On top of this, the announcement of the new Amazon Instant streaming service posed a competitive threat. There is also the looming specter of Redbox getting into the streaming business as well. Many started to wonder if the studios saw a bullseye on Netflix’s back.

But then Netflix struck back with a plethora of content deals starting in February. A deal with CBS resulted in a number of off-air shows being added to the Netflix catalog, including Twin Peaks, Frasier and all of the Star Trek seriesThe original series House of Cards is going to be aired directly on Netflix first (it will be interesting if there are any UI updates to highlight Netflix original series). Next, an agreement was struck with Fox to stream popular shows such as Glee and Sons of Anarchy. The icing on the cake was securing the rights to Mad Men, especially since it’s on a one-year hiatus. The only thing missing was a significant movie deal.

While some folks were counting Netflix out, it appears the company had to act on these content deals. In short, Netflix stated recently that the amount and quality of content will be dependent on the revenue from subscribers. They will not sacrifice margin for better content. In another words, they will only add the content they can afford. In light of some of the negative press it received, Netflix realized it needed to score some significant content deals to maintain subscriber growth.

Netflix seems to executing a well-timed, let’s-put-most-of-our-chips-on-the-table strategy. While there are other competitors for all-you-can-watch streaming out there (Amazon, Hulu), none of them seems to be actively expanding their catalogs for the moment. As an example, Amazon has not significantly grown its free streaming library or HD titles since launch the launch of Amazon Instant. In some cases, its library has actually shrunk! Around launch, Amazon had 917 TV seasons and 408 movies available for purchase in HD. Now, the number of HD TV seasons is down to 751, with 401 movies in HD. (Alternatively, they may have changed how they count titles).

If the other players started building up their libraries, it would seriously hamper Netflix’s subscriber growth. An analysis from Seeking Alpha believes that Netflix’s growth is unsustainable based on their current cost structure. In particular, the cost of Netflix’s streaming library is rapidly increasing relative to its revenue. It’s also a concern that Netflix has only about $350 million cash on hand, which is small relative to the company’s expenses. Also, part of Netflix’s plan to maintain subscriber growth is to expand internationally, which will be capital intensive.

While not covered in this analysis, the other challenge for Netflix is that its subscribers are not locked in. They could cancel tomorrow and use another service if any of them gained a competitive content library. Many of the devices that folks use to access streaming services–including Roku, blu-ray players, Apple TV, PS3, and Xbox–all have access to at least one other streaming service.

Despite all this, the Hub is a little bit more optimistic about Netflix’s long-term chances. For one, Netflix has shown an ability to innovate, and it’s hard to measure what effect that will have. Perhaps they will become a home for first-run content. Furthermore, Netflix has built up a healthy amount of brand equity, which will help retain customers. While there’s concern the studios would hold back content from Netflix, the reality is that they can’t ignore the revenue. The CBS non-exclusive deal was estimated at $200 million dollars alone. CBS will still make money from selling DVDs even as it makes deals with other streaming providers. Given that DVD sales are slowing, on-line content is the future. Therefore, the studios need Netflix (and other streaming services) as much as Netflix and the other services need the studios.

It appears Netflix is also attempting to execute an iPad strategy with its content deals. Many acknowledge that the iPad is so far ahead of Android tablets that it will take Android years to catch up. Get so far ahead of your competitors and gain so many subscribers that content providers have to make a reasonable deal with you. This will control your costs and yield a healthy profit. It would also give Netflix an opportunity to beef up its stale movie catalog, which is its biggest weakness right now.

At the moment, Netflix is the leader with its twenty million subscribers. The company is walking the tightrope of balancing subscribers, content, and costs. The customers can leave the circus whenever they please. Netflix just has to be careful to keep its competitors far away from its big top or else the company will lose its balance.

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Tags: Amazon, Netflix, streaming

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