Why Hollywood Should Be Afraid of Netflix … Very Afraid

Why Hollywood Should Be Afraid of Netflix … Very Afraid

By cornering the digital rental market, the subscription service represents not just a challenge to DVD sales but a threat to pay TV

Thanks to its digital strategy, Netflix is sitting on top of the world.

Tectonic changes have gripped the video-rental business over the past year, giving Netflix a clear victory over its brick-and-mortar competitors. As Blockbuster and Movie Gallery are waylaid by money problems, Netflix — by firmly embracing instant streaming — is charting the industry's future.

And by taking its place as a  New Media pioneer, it could create headaches for the cable and DVD retail business.

"We’re heading down the freeway in a Ferrari, and we’re fine-tuning the engine and polishing the chrome,” Steve Swasey, vice president of corporate communication at Netflix, told TheWrap. “We’ve built the three legs of the stool — convenience, selection and now we’re working on device ubiquity.”

These are heady times for the company. Thanks in no small part to its revolutionary streaming-distribution system, Netflix has become the biggest player in the rentals game. For as low as $8.99 a month, customers have access not only to the company's storehouse of DVDs, but to 20,000 movies and TV shows that can be streamed live.Thanks to a recent deal with Epix, this also includes making major movies from Paramount and Lionsgate available 90 days after their premium pay-TV window.

The service is a big hit with customers. In the most recent quarter, 61 percent of subscribers watched more than 15 minutes of a streaming TV show or movie, up from 37 percent in the same period last year.

But it's not just streaming. Overall, Netflix couldn't be in better shape. Revenues rose 27 percent to $519.8 million last quarter, up from $408.5 million in the same period last year.

More importantly, the company added more than a million subscribers to its rolls in the last quarter, taking it to over 15 million. It anticipates having between 17.7 million and 18.5 million by year's end.

It's also inked longstanding pacts with Relativity, Starz, and Nu Image, and signed release-window deals with studios that have assuaged Hollywood fears that the subscription business is cannibalizing DVD and Blu-ray sales.

But while tensions with the studios have eased, there are many who believe Hollywood should be worried about the changes that Netflix's business represents. A number of analysts and even industry members believe its streaming business, coupled with the growth of video-on-demand services like Hulu, could represent a shot across the bow of the paid-television industry.

“The more consumers find they can get more of the programing they want to watch at a reduced monthly cost, the more consumers are going to disconnect their cable and satellite,” one industry executive told TheWrap. “Why pay $150 if all you watch is ESPN and CNN?”

“They’re the big bad wolf,” the industry executive said. “They are disrupting the eco-system.”

Netflix maintains it doesn't present an existential challenge. "Netflix customers love movies, and just because they use our service doesn't mean they won't buy discs or pay for movie tickets or even go to a kiosk," Swasey told TheWrap.

And Netflix is paying the studios for rights to their movies — in many cases, paying a lot.

Indeed it's costing the company a great deal to offer digital content — something on the order of five cents per stream, not counting licensing costs. So while streaming may help grow its subscription base, with the bulk of its new customers opting for the Netflix’s bargain barrel $8.99 plan with unlimited streaming, those are expensive additions. The savings Netflix says it plans to reap from the $600 million it spends on postage annually will not pay for all those movies.

For the time being, Netflix is fine with loosening the purse strings to buy digital content, but as prices skyrocket, that may no longer be attractive. For instance, the $1 billion it coughed up to license box-office hits such as "The Last Airbender" and "Iron Man 2" as part of its Epix deal will eventually look like chump change, analysts say.

“Studios want as much money as they can get, so they’re going to continue to demand higher prices from Netflix for better content,” Edward Woo, an analyst with Wedbush Securities, told TheWrap.

But, pursuing that kind of lucre is remarkably shortsighted, analysts say. 'It's a deal with the devil, because they're undermining business over the long term," Tony Wible, an analyst with Janney Montgomery Scott, told TheWrap. "You would think Hollywood would have learned from past mistakes, but by providing unlimited streaming rights, Netflix has created an alternative to DVD purchases. It's allowing for usage in perpetuity with zero incremental costs for repeated viewings."

As for cable, Netflix insists its service is a complement, not an alternative. "We cost nine bucks a month, so you're more likely to give up your morning coffee than your cable," Swasey said. "We are not a broadcast channel, and people don't want to watch this year's World Series or the nightly news several months after they happen."

But cable watchers may already be voting with their feet. The pay-TV industry lost 216,000 subscribers last quarter, according to a study by research firm SNL Kagan. This marks the first time in history that the industry as a whole has lost subscribers.

It's not likely that Netflix will ever be able to offer a satisfying alternative to live programming. Still with most monthly cable fees running north of $70, digital alternatives such as those run by Netlfix and other video-on-demand companies are becoming increasingly palatable.

Even Netflix's chief rival Redbox has made noises that it will enter the digital fray, although it sounds less than thrilled by the prospect. Redbox President Mitch Lowe told TheWrap via email that the company has made no commitments to partners and doesn't have a finalized strategy in place, but he said: “Redbox will have a digital offering when the time and the solution is right.”

Of course, by paying top-dollar for studio deals, Netflix already has raised the barrier for Redbox and any would-be competitors.

“The more content Netflix locks up on an exclusive basis, the less there is available to other companies," a home video company executive told TheWrap. "Netflix is operating from an incumbent position, and that means new entrants will have to start from scratch.”