Saturday, October 2, 2010

Is Netflix The Next HBO?

At a Liberty Media investor event yesterday, Liberty Chairman, John Malone, drew a comparison between Netflix and HBO.  He was discussing the relationship between his Starz unit and Netflix, and seemed to be acknowledging the amount of power that Netflix is gaining as home video moves online.

It's an interesting question - Is Netflix the next HBO?  What are the similarities, and does it make sense for Netflix to follow a similar strategy?

HBO was an early entrant into the pay cable segment -- a pioneer really.  It originally focused on sports programming, but gained power as one of a handful of premium cable movie channels.  However, HBO was positioned as more of a network than a cable system.  It created several channels with different themes, and made an early move to develop original programming.  The focus at HBO was always on content as its management recognized the value of owning intellectual property.

Arguably, the master stroke was developing dramatic series which took advantage of the commercial-free, less restrictive environment of pay cable.  First with OZ and then with The Sopranos, HBO was able to attract loyal audiences looking for edgier entertainment.  Its original series have allowed it to become a brand that stands for a certain type and quality of programming.

Today, Netflix is gaining substantial market share as an outlet for a wide variety of films.  It started as a more convenient way to get DVD's, with a huge selection and fast service, but Netflix management quickly saw the possibilities in  becoming a streaming service, looking to deliver films in overnight downloads as early as 2006.  It has since become a leader in streaming films directly to televisions, with its major competition right now being the PPV films offered by cable systems, but with many other formidable competitors on the horizon.

The question is whether Netflix will use its market reach to develop its own original programming and expand its brand, as HBO did in the 1990's.  Actually, in 2006, Netflix started the Red Envelope Entertainment division, first for providing distribution to original independent films, and then as a platform for developing its own programming.  However, that division was closed in 2008 -- ostensibly because Netflix did not want to compete with its studio partners.

My thought is that the vision was right on target, but perhaps just slightly premature.  Netflix currently has about 15 million subscribers.  HBO now has over 41 million.  So, Netflix still doesn't control nearly as many eyeballs as HBO, but it does command enough market share that it can't be ignored.  If the Netflix numbers continue to rise (in the face of stiff competition from Apple, Amazon, Walmart and others, including HBO), then studios won't be able to dictate the deal terms.  And if Netflix can use original programming to attract even more subscribers, then the studios will have to continue to supply films as the cost of not being available through Netflix would just be too great.

Eyeballs equal power in the media business.  It's always been true and nothing has changed in that regard.  If Netflix can dominate the streaming business and expand its market reach, then you can bet that it will be back in the original content business.  (Pete Putman at HDTV Magazine reached a similar conclusion in a recent article.)

I have always liked Netflix' prospects.  I think they do a lot of things very well, and make very few mistakes. Their primary risk at this point is that increased competition will put pressure on prices and their margins will suffer.  That would be bad in the short run, but if they can continue to expand their volume, the original programming opportunity will remain viable.

I'm interested to see what happens next.  These are very exciting times in the media business, my friends.  Stay tuned.


David Geertz said...

Nice post Roger.

In my opinion Netflix will stay out of the content development game to ensure a best in class business relationship that is not tainted with its own IP in the mix.

I watch a lot of HBO on Netflix and I think HBO might actually take offense to the idea that Netflix would try and develop content and fight for market share. This would make the deal flow between content owners and netflix a strained one.

I do see Netflix as becoming the leader of the long tail in media and they will be busy enough trying to figure out via way of their algorithms the acquisition price for all the media that is trying to get on now and in the future.

Roger Goff said...

That was my initial instinct too, David. However, a lot of players are now fighting for Netflix' space. They got there first, but it is a pretty hard position to defend. If it turns into a pricing war, profit margins will begin to evaporate.

I think their long term growth might depend on expanding to other revenue sources. Also, as HBO recognized, asset value is based on more than the ability to generate revenue and profit -- the market wants to know what you actually own. Distribution contracts only have real value if they have some degree of exclusivity.

I think Netflix may have no choice but to use its market position to develop its own i.p. If it doesn't, it could end up with dwindling profits and market share, and ultimately being sold at a fire sale.

But who knows...? I certainly see where you're coming from.