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Netflix Can’t Sustain Premium Content

by Jeff Steele

The Netflix pendulum-of-praise appears to have reached its zenith and is beginning to reverse its course.  It was a good month while it lasted.

The catalyst for this came from the announcement by Netflix CEO Reed Hastings that the company is willing to pay up to $100,000 per episode for “in season” series.  This caught the ire of Time Warner chief Jeff Bewkes, who immediately came out swinging in a patronizing public offensive — admonishing Netflix to go back to their snail mail sandbox and not bother competing with the big boys.  In addition, a slew of articles from this week cast a skeptical light on the company’s business model and future as a competitive streaming operation.  Two in particular are worth noting.

The first post came from Andrew Wallenstein at PaidContent, who started off by dismissing the New York Post report that gave too much credence to the announcement.  Andrew correctly points out that in the episodic business, Netflix will find it greatest success with serialized shows like Mad Men, which can’t be watched a la carte like Law & Order and therefore earn less money in the syndication market.

If Netflix scooped up serials, it could actually find itself in the position to be something of a saving grace to the TV industry that too often gets burned gambling on these shows only to make nothing on the back-end. Fortunately for Netflix, on-demand consumption actually lends itself to serialized episodes and the number of episodes is irrelevant.

The second article came from author Jay Epstein, TheHollywoodEconomist, whose article Is Netflix Streaming Towards Disaster rightfully questions the sanity of Netflix’s rapid transition from a DVD-by-mail company to a streaming-centric operation.

Jay raises the point that (in addition to their business method patents) Netflix’s secret sauce for dominating the DVD mail order business has centered around the “first sale doctrine”, which states that once a person buys a DVD, they can rent it out to others without the permission of the copyright holder.  Unfortunately, this doctrine does not apply to streaming, which means if Netfix wants the new releases that they’re accustomed to getting with DVDs, they’re going to have to pony up a lot more than the $150,000 they’re used to paying for 10,000 DVD.

In the case of new movies, studios license slates of 20 or so titles in so-called output deals for hundreds of millions of dollars. The average cost for a single title in such a deal is about $16 million for a two year license.

Netflix is obviously motivated to find a way to curtail their $450 million postage costs for the two million DVDs that are shipped each day from their 50 distribution centers.  And the educated press (and Mr. Bewkes) are justified in questioning the company’s ability to become a premiere streamer of premium in-season television programming and new studio releases, all for $9.99 per month.  That math doesn’t work, and Time Warner wants everybody to know it, and to keep it that way.  Netflix was undoubtedly aware of this prior to the announcement and didn’t need Bewkes to spell it out; perhaps they’re dangling a bright-shine-object for the media to focus on while they go about doing what they always do, which is innovating and getting the jump on everybody else.

I still stand behind my prediction from October, that Netflix will soon produce original content, or become an active (and much needed) domestic licensor of independently produced television series, like Stephen Segal’s Southern Justice (which Voltage Pictures financed almost entirely from foreign presales) and Dean Devlin’s Leverage (which is financed by a license from TNT and foreign presales, also sold by Voltage.)  Both series are successful, albeit at very different price points, and a library of similar series would extend Netflix’s library valuation well beyond its current three year life cycle.  I’m not going to bet against Netflix or Hastings, and look forward to seeing how this plays out.

7 Responses leave one →
  1. December 7, 2010

    Netflix spent a lot of time and effort to hone and tweak its prediction algorithm that helps it make a smart decision on what the acquisition price should be for a property. If they say its worth 100K and WB says otherwise….someone has to pay, and right now all eyes are on Netflix. They are the market maker…not WB.

    100% of 0 = 0

    In addition, 450M in postage buys a lot of licenses at the typical 300-700K level don’t you think?

    cheers

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  2. December 7, 2010

    I think Hulu will beat Netflix hands down on current TV content. Netflix streaming should be working towards its movie content being released faster and new movies converted to streaming quicker. Nobody wants to see Beastmaster 2 from the 80’s.

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    • Scott Hillman permalink
      December 7, 2010

      Thats where your wrong i think. Marc Singer as a mysitical barabian trapped in time in the late eighties? Whats to not like. There is a market that wants to see this kind of stuff. I know these people.

      Which is kind of where the problem where i think netflix is going to find itself as it expands expands. There are more movies and TVs shows out there you or i could could comftorably imagine or ever see. Its big idea is that for a small monthly fee you can see what ever movie you want-but with liscensing fees its going to be kidn of impossible to bring that all to the web.

      And keep in mind the vast percentage of there business is still renting recent studio movies as dvds. While this is almost certainly going to change i don’t think for the next 5-10 years there postage stamps are going to go bellow 100 million.

      Streaming movies is still a nascient industry, which netflix early adopter tastes are still influencing. I am not sure there is a tremendious overlapp between the audience who likes beastmaster 2 and little fockers. If you have to pay 16 million or even a million to netflix to show little fockers i am not sure netflix with its streaming business alone would make its money back.

      Bottom line Netflix wants to get ahead of the curve-which is admirable but if they go to ahead of the curve to far and make to many big deals they could have problems. Ask, Ask.com and myspace.

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      • Jeff Steele permalink
        December 7, 2010

        Hence, my recommendation that Netflix become a distributor of independently produced series, since they already have the channel/pipeline into millions of households.
        It’s (1) A new frontier (which Netflix can excel at), and (2) selling Pickaxes to Prospectors.

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        • December 10, 2010

          You’re exactly right, Jeff. They have 17 million households. That is too big to ignore. The parallels that have been drawn between Netflix and HBO are valid, and HBO differentiated itself with superior original programming. Netflix should do the same.

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  3. December 7, 2010

    Here’s a question that may get me flamed, but I hope it can be answered without drama.

    Is Netflix working under the parameters of the First Sale Doctrine?

    At various points, I picked up that Netflix entered into distribution agreements with the studios, agreements which would make the First Sale Doctrine mute since it’s no longer a retail sale. Further, I picked up somewhere that Netflix has special pressings and packaging for DVDs, again negating the “retail sale” that is the premise of the First Sale Doctrine.

    Jay alludes to some of these premises in his assessment, “Is Netflix Streaming Towards Disaster,” too.

    I wonder if the First Sale Doctrine is relatively insignificant to Netflix’s success.

    My opinion about their success is primarily twofold: 1) They recognized the DVD as ‘the next big thing’ before most other businesses did (I was in the thick of DVD back then; remember that big companies and individuals were still wondering why it would be successful). 2) They built the company on ‘spectacular service’ by innovating and partnering with the USPS in ways that most companies had never done, to assure the lowest postal costs but, most importantly, the nearly immediate delivery of the DVD to the consumer. This seems commonplace now, but it was spectacular then and created enthusiastic customers.

    I have confidence in Netflix (and Hastings) for those reasons. They know how to read the tea leaves (the studios are often incapable of that — for instance, are we watching the cable companies as they now beginning to notice ‘cord cutting’ and will begin to address it soon–rather than merely denying it?) AND they know how to serve the customer with what they want even before the customers KNOW what they want (for instance, have we noticed how big ol’ AT&T Wireless is proven this week to be incapable of that?).

    The mess that is upon us–what is going to happen to DVDs and what will happen with VOD–are two areas I think Netflix will…

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    • December 7, 2010

      the rest of that long post:

      The mess that is upon us–what is going to happen to DVDs and what will happen with VOD–are two areas I think Netflix will handle better than the studios, cable companies, and telcos will. Netflix is still the maneuverable speedboat while the studios, cable companies, and telcos are the massive cruise ships–full of complacency and difficult to turn.

      And on that note, here’s another ingredient to the soup: HBO may finally say, “Hey, maybe we’ll go ala carte on our own, since y’all are getting cozy with that Internet thing!” (HBO Could Be Offered Outside of Cable Packages)

      Looks like everybody is running their boats in circles; Netflix will start making “Sopranos”-like offerings, and HBO will start making Netflix-like delivery to the home.

      Yippee, this’ll be fun to watch!

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