Sunday, January 16, 2011

The Love-Hate Relationship of Netflix and The Studios

This recent article in the Hollywood Reporter gives a comprehensive view of both the public and private statements of studio execs when talking about Netflix.  There are a couple of great points that shed light on the future for the current star of the home distribution marketplace.

First, it is clear that Netflix is an important buyer of films and television programming.  Studios are happy to have Netflix in the mix, taking up some of the financial slack from the collapsing DVD market.  It is also true that the prices being demanded of Netflix for premium programming are going up quickly. It appears likely that Netflix' acquisition costs for some programming may go up by a factor of as much as 10 from one contract period to the next.

So, Netflix is currently in a strong position, but facing a looming dilemma.  It has a distribution base that is quickly approaching 20 million subscribers.  That translates to revenue of somewhere around $2 billion dollars a year.  However, with acquisition costs going up, it is predicted that Netflix will soon be paying somewhere north of $1 billion in annual content acquisition costs, and the prices will continue to rise.

The studios are pressuring for the much higher license fees and Netflix is acting cool, but there is an even larger complication.  There are many aggressive streaming competitors currently entering the market.  If Netflix wants to maintain its market share and subscriber base, it needs to retain the position of being the premium supplier of streaming content.  That means maintaining access to all the best programming.  That won't be easy with more bidders in the mix.

If Netflix really wants to maintain a reasonable cost structure, it needs to bargain harder with the studios, and that means saying "No" to deals that are too high.  But each of those lost deals will go to a Netflix competitor who will get bragging rights along with the premium programming.  If that happens a few times, it won't be hard to start turning some consumers away from Netflix and towards the competitors.  And this will be happening at a time when Netflix might need to raise its prices in order to maintain margins (in the face of the rising acquisition costs).  Not a good combination - raising prices as competitors are publicizing victories in acquiring some desirable pieces of programming.

Bottom line -- Netflix is still one of my favorite companies, but it is going to be facing some real challenges in the not too distant future.  It's not going to fail; I don't even think it will lose money.  However, it is going to have to fight harder to remain successful.  Netflix made the switch to digital streaming look easy, and I suppose it was when competition was scarce.  With the heat being turned up by both studios and competitors, Netflix should start reexamining its strategy now and staking out a more defensible position.

I still believe original programming may be the key to maintaining the Netflix subscriber base when times get tough.

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