The market capitalization of Netflix at $11.7 billion means investors feel Netflix will be the future of television. Currently, Netflix has as many subscribers as Comcast Corporation, the nation’s largest television provider. The average Comcast subscriber is paying $67 a month for cable, whereas Netflix charges its subscribers $8 a month for a streaming subscription. Netflix is able to offer low costs to its customers because so far it has been able to cheaply buy titles which have attracted customers. If low costs for digital content persist and Netflix continues to accumulate titles, then Netflix has the media companies in the classic Schmidlap Maneuver, and the end game is near.
CEO of Time Warner Jeffrey Bewkes said, “Starz (a media company) undermined the business model of cable television.” Bewkes was referring to a deal that Netflix and Starz agreed to in 2008 in which Starz sold the rights to some 2,500 new movie and television titles for approximately $25 million. This was a coup by Netflix on innocent and fresh-faced Starz. The deal allowed Netflix to significantly broaden its content for a very small cost. "Why would anyone subscribe to Starz,” Bewkes said, “when they can basically get the whole thing for about nothing?" A media analyst was quoted as calling this “probably one of the dumbest deals ever.” The content deal with Starz comes to a close at the end of 2011, at which time Netflix has remained quiet on what will happen. What is certain is that the cost of licensing will rise.
The price of the Starz deal can be viewed as a one time gain when compared to other deals Netflix recently signed. For instance, it signed a deal with Epix for $900 million in August 2010 that will build its library by approximately 2,200 movie titles and will cost it $180 million for the next 5 years. Despite the content being much less attractive than that of the aforementioned deal, the cost increased by 5 times. The company later completed a deal with Relativity Media for more than $100 million a year for the right to show new films on Netflix after they leave theatres from Relativity. Relativity is still considered a small independent Hollywood film producer with limited content, but it produced best picture Oscar Nominee “The Fighter” this year, which stars Mark Wahlberg and Christian Bale. Netflix then signed a deal with Disney, which includes prior seasons of Desperate Housewives and Grey’s Anatomy as well as other television shows, for approximately $200 million.
Comcast Corporation, the largest cable provider in the United States, can be guessed to have an approximately $40 billion market capitalization attached to its cable division, since it makes up 2/3 of the company's revenues and profits. Netflix, at $13 billion, is quickly becoming viewed by the market as one of the largest television providers in the U.S. The difference between Netflix and other cable producers is the cost structure. Netflix selectively buys titles that its viewers want to watch, while cable companies have a broad range of channels, meaning costs are higher for the user. The business model of the cable companies may change going forward, if viewers begin to demand specific channels instead of paying for a collection of channels. The problem for Netflix is that if they cause companies to lose money, thereby causing the studios to lose money, the studios will demand more money from Netflix to compensate the lost money from the cable companies. If they cannot compensate them, then the traditional model will win out, likely with some new adjustments—perhaps fewer channels that include news, sports, and new television shows, and with a higher focus on video-on-demand access for older television and movies. If the Netflix model wins out, then the cost of a subscription for Netflix customers will be similar to that of a current cable provider.
In order for Netflix to pursue its dream of wrecking the cable companies, it will need to secure deals at reasonable prices. Netflix’s costs are rapidly expanding. Based on deals with other media companies such as Epix, the future cost of the deal with Starz will likely grow to $300 million per year, if not more. Netflix’s current deal with Epix is for $180 million a year, which includes old and new movie titles. The new deal with Relativity is for over $100 million a year, and includes newer movie titles, but they are mostly B movies. The new deal with Disney, which is for $200 million, includes prior seasons of some shows currently airing on television, and other cancelled shows. Netflix currently pays $80 million a year for all its other content not listed above. This means that in real dollars, Netflix’s costs will balloon from the $300 million they paid for their content library this year to at least $860 million in 2012. Netflix will need to rapidly accelerate its growth in order to be able to afford these high costs. The problem is that the more subscribers Netflix has, the more money the studios will want—which is why Netflix has bad economics.
The one variable that is not considered is the fact that Netflix is a middle-man controlled by the studios. People assume that Netflix’s competition will be from other online video providers such as Amazon, Hulu and Google, just as, for example, Blockbuster has had competition with other video rental stores. However, Netflix has created a paradigm shift such that they are actually competing with the studios, as opposed to traditional competition. Put it this way: the movie studios were never talking about how Blockbuster was ruining their business, but they are beginning to do this for Netflix. According to the First Sale Doctrine completed in 1909, a company which purchases a tangible piece of equipment can resell it to whomever it chooses. However, these laws do not govern the sale of intangibles, and for this reason, the studios will forever control the price that Netflix will pay for content.
The major studios all understand economics, and they control the ability for Netflix to grow. Netflix believes that it can expand everyone's piece of the pie. But this is hard to believe, since most cable companies charge $70 a month, and these companies pay fees to the studios for their content. Thus, Netflix will need to make up the difference of lost revenue from these companies in order to replace them. If Netflix cuts into the margins of the studios, then they can pull the plug on it by not selling it content; just as Netflix hopes that people will pull the plug on cable television, the studios can pull the plug on Netflix.
Part II to follow tomorrow.
Good Article. I have a couple questions though, What is built into Comcast's fee? They have to build a physical network, where as Netflix rides on top. The cost of internet access won't disappear, so will we end up paying Netflix $20 a month and $50 per month for internet access? Second, Neflix is currently paying a flat fee for content irregardless of how many people actually watch said purchase. At someone they surely would want to pursue a royalty per view, there by only paying a premium on the "valuable" content.
ReplyDeleteNFLX will necessarily bury cable as it is so much cheaper to subscribe to NFLX and the capacity of the internet is improving.
ReplyDeleteStudios are dumb the option is not cable the option is people stealing it and paying nothing. A low fee like netflix makes it worth the convience. It is like they learned nothing from the music industry! it is a 30 cent down load world and the 25 dollar CDs from a store are gone.
ReplyDeleteCable is dead already. Do you want to see any money hollywood or just end as an industry to be replaced by lower budget independants who can adjust.