Is Netflix the new HBO?

16th May 2012

Few companies demonstrate the disruptive impact of technology on a business model as much as web-based video broadcaster Netflix.

Beginning as a humble mail-based DVD rental company in 1997, Netflix is now the leading provider of film and made-for-television content streamed over the internet. At the last estimate, it controlled 61 per cent of the streaming entertainment market. What killed Blockbuster made Netflix even stronger.

As of March 31, Netflix had 26.5 million streaming customers – of which  3.1 million are outside of the U.S. The company launched in the U.K. in January this year.  

That said, the current competition isn't standing still either: One the one hand there are Amazon-owned LoveFilm with similar DVD mailing origins, and the ‘net native' Hulu; and on the other cable TV networks like HBO have moved into the ‘on-demand' and streaming space themselves; in the U.K, the above compete with Sky TV's on demand offering.

Content is King

But even a company at the vanguard of internet-based distribution like Netflix also sees the merit in revisiting the tried and tested: not a mass return to DVD mailing (a market it is not bothering with outside of America) but taking on the role of  a traditional broadcaster by commissioning original content. Last March the company announced the purchase of a David Fincher-directed political drama series House of Cards starring Kevin Spacey would be at the heart of its streaming strategy.

At the time, Reuters pointed out that Netflix's strategy was reminiscent of the  pioneers of the U.S. cable TV industry in the 1980s – Showtime and HBO, who had to start producing or commissioning exclusive ‘signature' content with which to differentiate themselves from each other as well as the established network broadcasters – CBS, ABC and NBC.

But nostalgia aside the move is in order to shore up any content shortfalls as a result of exclusive content deals with the likes  of Starz and Epix coming to an end and because cable networks are increasingly streaming themselves rather than licensing content. 

Any new contracts are likely to cost considerably more with less favourable terms, now that LoveFilm and Hulu are able to bid. As it is Netflix has earmarked $3.7 billion for exclusive content over the next five years, gambling on Forrester Research's forecast that by 2016 more than half of all TV content will be delivered via the internet and on-demand, with the PC and web-enabled television set having to concede some ground to mobile phones, games consoles and tablets.

Buying in exclusive content is also Netflix's way of trying to remedy a monumental mistake committed last year. In July it announced it would raise  video-streaming prices in the U.S. by 60 per cent and separate its streaming and DVD businesses effective from September. Its $305  share price spiralled by 70 per cent  and 810,000 subscribers left (first quarter losses this year were 8 cents a share on $840 million revenues). It now needs to offer something special to get that all back.

Big  on Data

In addition to original programming, Netflix will mine the considerable data it has amassed on its customers and their viewing habits in its bid remain the streaming leader.

The traditional ways of trying to gauge a hit film or television series ahead of broadcast are giving way to advanced mathematics in order to predict subscriber preferences and provide models for licensing or commissioning programmes.

Chief content officer Ted Sarandos explained the strategy this week: "Netflix has proprietary algorithms that take in variables-actors, genre, box office, etc.-and spit out predictions for how a given title will fare in the Netflix library …We have built regression models that would, say, produce a risk profile of a show."

Another way of using technology to maintain its first-mover advantage is to ‘fine tune' output on the fly: by re-editing programmes according to any new insights generated from subscriber data.  

What all this means for investors?

By combining old and new school models, Netflix is signalling a move away from selling commodity content towards its own exclusively commissioned fair,  the availability of which will be based in large part on what its algorithms throw up as recommendations.  It hopes this will enable it to capture niche, long-tail custom as well as the mass market.

Two questions come to mind:

  1. Will it miss out on a fundamental trick by eradicating serendipity from its commissioning process? Humans love to be surprised about as much as they like the safe, tried and tested.
  2. Will Netflix get the timing right in jettisoning its DVD base in favour of  streamed only, exclusively commissioned content? About half of its U.S customer base still rent DVDs.

$3.7 billion, albeit over five years, sounds like a high price to pay for prising open  a new market by anyone's standards.


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