A New Era In Home Entertainment Started Today

With Amazon's entrance into the streaming business, the horses are officially out of the gate in the new race for home entertainment dominance.

My buddy, Jack Wrigley, emailed me today to point out the importance of Amazon's acquisition of LoveFilm which has allowed the Internet retailer to magically turn its Prime subscription shipping service into a film-streaming service. With the flip of a switch, Amazon becomes a force to be reckoned with in digital entertainment. 

In light of that development, I think it is fair to say that this week marks the real beginning of a new era in home entertainment.  Up until now, Netflix has been in a massive proof of concept stage, showing the world that there is money in streaming movies into homes.  Prove the concept they did, becoming a $2+ billion business in the process, with massive growth still ahead.  And then within a 24 hour period, Blockbuster acknowledges that its business cannot be revived and agrees to sell the remnants for less than $300 million, and Amazon makes its bold move into Netflix' streaming space.  Oh yeah...and Redbox is shouting a distant "Me too!" from its post in front of the 7-11 stores.

In saying a quick and fond farewell to Blockbuster, I can only note that its market value less than 10 years ago was over $5 billion.  It lost about 95% of that value sitting on its hands while Netflix took advantage of predictable (inevitable, really) changes in the home video market.  It is perhaps the most blatant case of corporate arrogance I've seen in my adult life.  There are plenty of lessons to be learned from that tale.

Redbox jumped into the home video game for some short term profits, with a model for better price and convenience that was never as good as the Netflix solution.  It was good enough to beat Blockbuster's rusty model, but Redbox ignored the obvious pending impact of digital delivery.  Redbox uses the Internet for payment and inventory control on its machines while it continues to deliver its films in a dying format.  It's somewhat convenient because the discs are available 24 hours a day in places where consumers already go, and you can return the discs whenever you want to any Redbox machine.  If there was no such thing as digital delivery of content, it would be a great business.

Of course, Redbox is a division of Coinstar -- a vending machine company.  Redbox was designed as a strategy for placing more vending machines, not for giving consumers what they really wanted.  It's a perfect example of a supply-driven strategy as opposed to a market-driven strategy.  It only works well so long as you happen to be supplying something the market wants.

Reed Hastings

Netflix was born as a market-driven company.  Its mission was to ease consumers' pain over late fees at Blockbuster.  It also started as a disc-renting company.  Its subscription model and cool envelope design were the initial competitive advantages.  But Reed Hastings is a software guy; he understands the power of digital technology.  More important, when he sees changes coming, he embraces them -- in fact, he jumps ahead and lets the world catch up to him.  That's what successful people do.

So, he focused on creating a superior web interface that his customers could use to line up their disc orders.  Then, with the flip of a switch (and some new contracts), he let them start watching the films right on their computer.  When the inevitable convergence of Internet and television finally arrived, there was Netflix (and its 20 million users) already eating popcorn on the couch.

Jeff Bezos

Jeff Bezos at Amazon is another visionary guy who truly understands the power of technology.  His company also has one of the best user interfaces on the Internet, and a massive number of loyal customers.  Amazon jumped into the digital streaming business in a pretty timely manner, but its pricing model reflected its "unit sale" roots.  With today's move into a subscription model, Amazon is officially acknowledging that consumers don't prefer to rent their entertainment in single unit packages.  Amazon has 10 million Prime members already paying an annual subscription fee.  That's a pretty good start at chasing Netflix for movie streaming dominance.

And while Redbox publicly acknowledges that it needs to be in the subscription streaming business, it is lacking some key elements.  First, it has no cool website as an integral part of its existing model.  There is no installed user base already making online payments, and no superior user interface.  It's a vending machine company.  No one wants to stream videos in front of their local 7-11, and that's where Redbox lives.  Again, this was predictable; if they wanted to be in people's homes, they should have built their model with a home-based component.  They didn't do that.

So, the bell has sounded and the race has officially begun.  In addition to Netflix, Amazon and Redbox (at the back of the pack), there is Hulu and Google/Youtube and Vudu and Apple and others.  Plenty of horses to bet on.  The winners will be determined by their ability to navigate their way onto consumers' televisions, their ability to cut the right deals with studios and other content owners and creators, and good old-fashioned marketing.

And as always, the winners will be the companies that can see around the curve, getting ahead of the trends and letting the rest of the world catch up to them.  There is no way to win by chasing someone else's success in today's entertainment business.  True vision and innovation are the only paths to long-term success in the new digital environment.  Blockbuster learned that lesson the hard way, and there will be more casualties before it's over.

Feedback on Netflix' Place in The Media Landscape

If you read my posts and tweets, you know that I am an avid observer of Netflix and its ongoing impact on the entertainment business.  I also spend some time chatting about it offline with other folks in our industry.  One of my favorite bantering partners is my friend Jack Wrigley of XStreamHD.  (By the way, XStreamHD is a very cool delivery and management system for HD content.  Check it out here.)


Jack sent me a couple of interesting items in response to my last post, and I wanted to share them with you.  First, one of Jack's friends is an industry insider who would prefer to remain anonymous.  He has a good perspective on how Netflix could evolve.  


He astutely points out that studios are highly unlikely to give Netflix rights which devalue their other distribution windows.  Therefore, he believes that the bulk of Netflix' streaming catalog will probably continue to be films that are past the pay TV window.  They will get some fresher titles from smaller distributors and perhaps Paramount and Lions Gate.  Those titles will be the marketing hooks, but the older titles will be the bulk of their business.

Reed Hastings

This would allow Netflix to survive as a non-competitive addition to offerings from cable companies, and that means that cable companies would actually be able to offer Netflix streaming as an additional pay service that does not threaten their existing relationships.  That's a potential win-win model for Netflix and cable.  Consumers could get Netflix streaming for $9.99 on a stable SVOD channel, or for $7.99 through their broadband connection (with its inherent fluctuations in delivery speed).  That actually makes a lot of sense -- probably more sense than Netflix trying to muster the money and power to fight HBO, Showtime, etc. for rights in the pay TV window.

Glenn Britt

With that said, recent comments from Reed Hastings and Glenn Britt don't seem to indicate that they see a natural partnership between Netflix and the broadcast side of the cable business.  They both see Netflix as a driver for broadband services, but if they think it could evolve into a SVOD service on the broadcast side, they aren't saying so.  It's possible that Netflix sees a cable SVOD model as potentially cannibalizing its existing service at a much lower margin, rather than creating incremental additional distribution.  As always, time will tell.

Ok, that's it on Netflix for a while.  I'll find some other interesting stuff to explore in the next post.

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.

Real Victories Are Won In The Marketplace, Not In The Courtroom

This may sound odd coming from a lawyer, but courtroom victories often have limited value.  In fact, winning legal battles can sometimes do more harm than good.

 In 1999, TiVo invented the DVR, and registered patents to protect its novel ideas.  Initially, TiVo was so successful in bringing its product to market, that the word "TiVo" actually became a verb (a good indicator of massive market acceptance).  If someone said, "I'm going to TiVo that program," you knew that they were digitally recording it so they could watch it later.  By January of 2007, TiVo had about 4.5 million subscribers -- millions of households that had TiVo boxes attached to their television sets, ready to receive all types of digital programming.

Now, only 4 years later, Apple and Sony and Google and Hulu and Roku and Netflix and several other companies are all fighting to be the leader in bringing digital programming to the world's TV's.  Certainly, TiVo is still in that race, but it is struggling to keep up.  TiVo was several years ahead of everyone else and now, when the stakes are becoming meaningful, TiVo is trying to remain relevant.  How did it lose such a huge head start?  

In its most recent quarter, TiVo's revenues are down to $41.3 million, with a net loss of $20.6 million.  It now has about 2.2 million subscribers -- less than half of what it had only 4 years ago and the number is still falling.  In the meantime, Netflix (which started around the same time as TiVo) has close to 17 million subscribers and continues to grow. What happened?

TiVo apparently decided early on that its patents were its most valuable asset - more valuable than a direct relationship with consumers.  This was a critical strategic decision that probably made perfect sense at the time.  TiVo recognized that cable and satellite companies were in the best position to sell or rent DVR's to consumers, so it began licensing its intellectual property to those companies.  But in 2001, Echostar decided it wasn't going to pay a royalty to TiVo.  In January of 2004, TiVo sued Echostar (and its now-former affiliate, Dish Network), and almost 7 years later, the litigation continues.  

And the most ironic (or perhaps saddest) part is that TiVo is winning!   TiVo has prevailed at virtually every stage of the litigation, but Echostar refuses to give up.  Instead, Echostar appeals and raises new issues and makes minor modifications and continues to fight, while all the while the clock is ticking on TiVo's patent rights.  (Echostar did pay TiVo about $100 million at one point in the litigation, but that money is being depleted by operating losses.  With that said, TiVo is not in financial trouble; it has plenty of cash for the time being.)

And while TiVo has enjoyed a lot of legal victories, the fights have not been easy or inexpensive.  In 2009, TiVo filed another patent infringement case against AT&T, and that lawsuit caused Microsoft to file its own infringement action against TiVo!  Then, earlier this year, a portion of the TiVo patents was potentially weakened by rulings in the U.S. Patent and Trademark Office.     

If you had a company that lost $20 million in its last quarter, would you want to be fighting simultaneous legal battles against Echostar and Dish Network and AT&T and Microsoft?  And what impact do you think that would have on your ability to compete effectively against Apple and Sony and Google and Netflix in bringing digital programming to the living rooms of the world?

Just to be clear, my purpose here is not to criticize Tom Rogers and his team.  I understand the importance of protecting intellectual property. (I counsel clients on that topic almost every day.)  Instead, I am pointing out the potential cost to a business when it focuses its resources on winning legal battles.  And I don't just mean its financial resources, but also its time, energy, human resources and the attention of senior management.

Echostar and Dish Network will probably be writing a big check to TiVo some day.  It might be as much as a billion dollars -- who knows?  And TiVo will then have a very healthy balance sheet and rightfully claim victory.   But where will its business be by that time?  If TiVo had viewed itself as a leader in consumer empowerment, and put more of its energy into further innovation of the consumer experience, it might still be leading Netflix, Apple and Google in the digital media business.  But that's not where it finds itself today.

A company's early strategic decisions are vitally important, and now more than ever, it is critical to focus on satisfying your customers.  Netflix decided early on that it was in the business of giving consumers the media experience that they want.  Apple is in the business of giving consumers experiences they don't even know they want until they get them!  Google is in the business of giving consumers access to all the information in the world.  

On the other hand, TiVo made that early decision (before Tom Rogers ever took over) to focus on the value of its intellectual property.  It now appears to be primarily in the business of protecting 10 year old technology that is becoming less relevant every day.  Given the choice, that's not a business I would choose to be in.  I don't think there is much of a future in it, no matter how many legal battles you win.

Netflix - Pushing The Red Envelope

There is a very good recent article in the NY Times discussing how Netflix gained its power, who is threatened by it and why.  On the one hand, the article feels a bit trite in that it looks at the recent offering of a streaming-only package as Netflix' "move onto the web."  However, in the body of the article, it becomes clear that digital distribution has been a part of the Netflix business for over a decade.

For me, the intriguing discussion is about how Netflix threatens the cable television business.  Again, this is a somewhat obvious point, but still worth making.  As online content migrates to the living room TV, it is clearly an alternative to cable.  That's not just Netflix, but Hulu and Vudu and Amazon and CinemaNow and Apple and GoogleTV and.....The point is that online media delivery to the television is making cable systems potentially obsolete, or at least less relevant.  (I covered this point in more detail a few weeks back in another post.)

Two points:  First, cable needs to change.  It needs to be as flexible as Netflix and find a fresh strategy that capitalizes on its unique qualities.  I'll give that some thought and perhaps comment on some possibilities in a future post.

The other interesting question is what Netflix can do to continue its cutting edge success.  Believe it or not, I think Netflix should be developing original short-form programming.  Netflix really is the next HBO, and HBO made its best move when it went beyond simply showing movies and developed its own cutting edge programming.  Netflix has an installed user base of 15 million households many of who actively use the online aspect of the service.  Neflix has a very good user interface and first-rate streaming technology.  It can best capitalize on all of these assets by offering some exclusive programs.

Reed Hastings has always viewed Netflix as a content distributor.  Well, every big distributor uses its distribution system to move some of its own content.  Netflix is a $10 billion company.  It is big enough to tackle that strategy and it should be doing that right now.  I renew my call for Netflix to re-enter the content business.  It is time to revive Red Envelope Entertainment and start making great episodic programs.

By the way, if you want to read a great discussion (and less optimistic view) of Netflix and the NYT article, check out this blog post from David Poland of Movie City News.  This guy really does his homework and makes some excellent observations.

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.