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Netflix About to Hit a Brick Wall With the Studios

The company will likely have to dig deep to renew its streaming deals with content providers when they expire.

In the past three years, Netflix has been merrily speeding ahead on the streaming highway.

It has induced a large portion of its 20 million mail-in subscribers to watch movies that are electronically transmitted, or “streamed,” to their television sets, computers, or mobile gadget. Perhaps 5 million or more of its monthly subscribers are now using the streaming service instead of getting their DVDs in the mail.

In the process, Netflix saves hugely in its postage and handling charges.    

While Netflix’s conversion of a mass audience to a geek technology in such a short time period is no doubt a phenomenal achievement, it is now heading straight toward a brick wall. Its crucial 3-year licensing contracts for the electronic transmission of both movies and TV programs will begin expiring in just 7 months. When Netflix had made these extraordinary deals in 2008-9, streaming movies was of such little monetary value to traditional media that its newly-created digital sales divisions were willing to license these rights to Netflix at a small fraction of the price that the rights for the same content was licensed to cable and pay-TV channels.  

What content-providers had not reckoned on in making these digital deals in 2008 was that Netflix’s streaming would directly compete with its cash cows such as cable and telecom systems. Netflix, with its bargain-basement licensing fees, could offer an unlimited number of streamed movies and TV programs, instantaneously delivered to their TV screens, for $8 a month, while pay-TV channels were charging $14 a month.

Not surprisingly, as Netflix became an increased threat by 2010, the cash cows made it crystal clear to the content providers that this bargain had to be ended when its contracts are renewed. 
The first speed bump Netflix will hit is in October 2011 when its contract with Starz Entertainment runs out.

Starz, which has output deals with Disney and Sony, had sub-licensed in 2008 to Netflix the electronic right to stream those movies for less than $30 million. That amount was about one-twentieth of what the studios charged pay-TV for the same movies.

But there is no way that Starz can renew that deal at the expense of its cash cows. Indeed, it has already assured its cable, satellite and telecom customers that it intends to establish “pricing parity,” as its CEO Chris Albrecht made clear. So if Netflix wants to continue getting Disney and Sony new movies via Starz, it will have to pay the equivalent as Starz’s conventional licensees. In dollar terms, according to industry insiders, this will mean that Netflix will have to pay an additional $300 to $400 million a year to stream new movies.

And this is just the beginning.  

As Netflix’s other contracts expire in 2012-3, its other content suppliers, including television networks, will also hike the price. To stay in the game, Netflix’s licensing cost will rise, according to the estimates of content providers, by at least a half billion dollars.  That is in addition to the $1.2 billion it is presently paying to license digital content (including its deal with EPIX).

Netflix would require 5 million or so new subscribers to offset the additional $500 million cost. Finding them will be far more difficult than when it launched its service and had no formidable competition in the streaming arena.  

Now it has competition from all directions: Amazon has just launched this year a movie streaming service that is absolutely free to its 10 million users of Amazon Prime. Apple’s iTunes store and Google (YouTube et al) are also moving more deeply into the streaming business.

Then there is Facebook.  Here Warner Bros broke the ice by using it to stream the Batman movie “The Dark Knight.” And by now all the major TV networks and Pay-TV platforms are streaming their programs from their websites on demand.  

Through the power of its brand and computer savvy of its management, Netflix may well garner a big enough herd of streamers to plow through the brick wall of rising licensing fee. But it won't be easy.

Edward Jay Epstein studied government and received a Ph.D from Harvard in 1973. His master's thesis on the search for political truth ("Inquest: The Warren Commission and the Establishment of Truth" and doctoral dissertation ("News From Nowhere") were both published as books. He has now written 15 books, including "The Big Picture" and "The Hollywood Economist" about the money considerations behind the movie business.