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 Time Failure and Success

As social media begins to dominate the Internet, it's more critical than ever that your first audience truly loves what you're doing.

Social media has been a part of the media landscape for about 5 years, and it's impact is already being felt in a big way.  As we approach the beginning of 2011, Facebook's Mark Zuckerberg and his team have built a cyber-city of over a half billion users.  There are probably around 200 million Twitter users and LinkedIn is close to 100 million.  These are big numbers in any medium.  But what's more important than the numbers is the trend that they represent.  People don't have ten times the number of friends that they did before 2005, but for many people the nature of communication within those relationships has changed a lot.  And the implications for business are enormous.

Consumers are now relying more heavily than ever on the opinions of their friends and other people whom they perceive as similar to themselves.  Communication within online communities -- groups of people with common interests or other similarities who interact through social networking -- now often has more impact on buying decisions than paid advertising or any other factor.  You can spend a lot of money to get your product noticed, but if the "buzz" is negative, that attention will not turn into sales.

This trend is expanding at an enormous rate as social media evolves, and it is extremely relevant to the entertainment business.  It used to be that a well-advertised film with a decent cast could expect some reasonable opening weekend numbers.  If audiences didn't like it, they might start telling their friends around the water cooler on Monday morning and a negative response would start to develop.  But the distributor might be able to adjust the advertising to try to find a different audience and maintain some momentum into the second weekend so that the numbers wouldn't fall too fast.

Now, if audience members don't like a film, they are telling their friends about it while they are still in the theater.  If the Friday night crowd hates it, the Saturday crowd never even shows up.  Films die in a matter of hours rather than weeks.  There's no time to adjust or respond.  The verdict is rendered and the sentence is carried out before the weekend box office numbers are even published.

By the same token, if audiences love something enough to tell their friends, it can create tremendous positive momentum.  If people are so excited by a film that they start tweeting or posting to Facebook, unexpected crowds of people will start showing up.  And those audiences will already be positively disposed towards the film and thus much more likely to enjoy it and tell their friends how good it is, and so on and so forth.

And the same trends are showing up in television and other media as well.  Content of all sorts is having its fate decided very quickly.  Success or failure can be decided by the time the first episode is over.  If a negative buzz develops, it may very well be too quick and too powerful to overcome.  But if a positive buzz develops, the rise in popularity can occur literally overnight.

Obviously, this means it's more important than ever, in this new social media environment, to make your films and programs great.  But the less obvious lesson is to be sure you are speaking to an audience that will respond passionately and positively.  From the moment you start your project, know for whom you are making it, and create and market the project with that audience in mind.

It is critical that the first audience for your work responds positively.  You might make a very good film or program, but if you end up with the wrong audience, and they tell their friends they didn't like it, your project may die a quick death.  There are not a lot of second chances in an environment dominated by real time reactions.

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.

Bricks, Mortar and Mobile: A New Paradigm This Holiday Season

It seems that online shopping and the in-store experience are coming together this holiday season, courtesy of the growth of the smartphone market.

Online holiday purchases have steadily increased each year for the past several Christmas seasons.  This year, it is a little different because many consumers now carry the internet with them in the form of a smartphone.  This means that they don't need to check prices online and then run to the store, or vice versa.  They can stand in front of a product in the mall and immediately check the pricing against online options.  A recent survey by IDC indicates that over 1/3 of smartphone owners intend to use that strategy this year.

Recognizing the trends, retailers aren't sitting on their hands.  Many retailers have developed custom smartphone apps to stay in front of connected consumers.  This not only gives them a seat at the comparative shopping table, but it also allows them to keep selling after they lock the doors at night.  Many consumers are shopping at all hours of the day or night, increasingly using their smartphone.  If they are looking at an app from Target or another retailer, there is still a possibility that they will go make the purchase at that store, or buy from the store's website.  And target is also making its website available through shopping kiosks placed throughout the store.

Amazon is working hard to lead the pack in the integration of in-store and mobile online shopping.  Consumers can scan an item's bar code in the store, take a picture of it or even say the name of the product into their phones, and Amazon's app will scan the Amazon inventory for pricing and availability.  If it looks good, consumers can buy it from Amazon on the spot.  (Of course, read further down in that article, and it points out that RedLaser already offers smartphone technology which will scan bar codes and compare prices on many different websites, not just Amazon.)

For a good discussion of the whole phenomenon, check out this article in the San Jose Mercury News.

So what does all of this have to do with the entertainment business?  As tablets will be one of the hot sellers this holiday season, and smartphone sales continue to grow, this trend towards mobile media and commerce will expand greatly.  There will be a huge demand for mobile content, as well as genuine opportunities for mobile brand integration strategies.  And the growth of mobile commerce means that many more advertisers willing to sponsor mobile content.

2011 will be the year that mobile devices break out as a separate category of entertainment, and a medium where creators will soon be able to make some serious money.  If you're developing content, think online and mobile first.  You can get it "on the air" quickly and build an audience while you chase a television deal.  Or just keep it in the digital realm and take advantage of the large move towards mobile commerce.

One Is All You Need

It seems every day there is another news story describing shock at the decreasing number of cable subscribers.  Like yesterday’s story with the headline, “Cable Subscribers Fleeing, But No One Knows Where.”  What??  With all due respect to the Associated Press, this is about as hard to figure out as a bad murder mystery.  The butler did it, now move on.  

Here is the truth.  We have reached the point where we don’t need multiple wires to carry data in and out of our homes.  Our phone line, cable television and high speed Internet are all doing the same job.  They are three different wires carrying packets of digital data to and from the same place.  We are simply waking up to the fact that there is no longer a need to pay for all three.  

It is like carrying three different smartphones for email, texting and phone calls.  It would be redundant and unnecessary.  If someone did that, we would think they were being wasteful, and even rather stupid.  In a very short time, we’ll feel the same way about anyone who pays for cable television and a phone line and Internet access. 

A connection to the data grid doesn’t know whether it is carrying audio, video, pictures, text or something else.  And it doesn’t care if it’s uploading or downloading.  It is all just packets of digital information going back and forth.  And the speed and capacity of a typical connection is now large enough that it can carry as many packets as you can send, as fast as you can send them.  You can have a house full of people communicating through email, texts and phone calls while watching 4 different programs on 4 different televisions, and one wire can carry it all.

None of this is shocking to anyone who is looking forward instead of backward.  I could write a very long history book about the technical, legal and economic reasons that we all have three different wires carrying data in and out of our homes.  But it doesn’t matter.  Those reasons are no longer relevant.  History is not news.  

News stories about the decreasing numbers of cable subscribers are like news stories about the decreasing number of CD sales.  You might as well be writing about the decreasing number of horses on the roads since the invention of the automobile.  It’s all the same story – things change.  That’s happening every day.  The real news is not about where we were, but about where we’re going.

  

So why are people giving up their cable subscriptions?  Simple answer: because it costs over $100 a month and they don’t need it.  A lot of people are giving up their land line telephone too.  They don’t need that either – they can use Skype or their cell phone, or Skype on their cell phone.  You only need one wire, and in fact, some day you might not even need that.  Before you know it, we will probably all be connected to the cloud 24-7 through a 4G connection (which will probably be a 7G or 8G connection by then). 

There, mystery solved.  Let's not spend any more time pondering the obvious.  Instead, let's think about the opportunities that are available in a world where everyone is connected to everything all the time.