Netflix Should Copy the Cable Model

Service Should Continue Pivot Toward Original Content -- and Consider Ads

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Television studios couldn't be more thrilled that Netflix has been ramping up its acquisitions, spending hundreds of millions of dollars to add TV series to its streaming arsenal. But acquiring repeats of popular series -- whether that 's "Mad Men" or "Gossip Girl" -- won't be enough for Netflix in the long run.

The Netflix business model is vulnerable, especially as competition grows and the cost to acquire content escalates. In 2008 Netflix paid Starz $30 million a year for the rights to stream its movies from Disney and Sony as well as the premium cable network's original content. Just three years later, the renewal deal fell through even though Netflix reportedly upped its offer to Starz tenfold, to $300 million a year. In an indication of how rapidly streaming rights costs have risen in a short period of time, Netflix will pay DreamWorks $30 million per film under a new deal with that studio -- the same amount it previously paid Starz per annum. One analyst projects that the cost for Netflix to stream content will grow from $180 million in 2010 to $1.98 billion in 2012 -- an eleven-fold increase.

Netflix is also still largely dealing in back seasons and old shows because they're cheaper and easier to secure. But there Netflix is merely taking a well-hewn path of TV business-building: Using older content to build a video distribution business is exactly how most cable networks began. And maybe Netflix should look a little further along cable's history for some inspiration of its own.

Back in the 1980s, many of the broad-based pay and ad-supported cable networks relied almost exclusively on off-network programs such as "The Andy Griffith Show," "MacGyver" and "Murder, She Wrote," all of which routinely ranked among cable's most-watched shows each week.

Soon afterward, several top-tier basic cable and pay cable networks began to invest in original movies that ultimately attracted millions more new viewers. Finally, many cable networks began to produce original content in order to distinguish themselves from their competitors. Today, most cable networks air original content all year long, and their brands are defined by that content.

While viewers might casually watch an old movie now and then, nothing creates passion, loyalty and repeat business like an original series that enthralls and enchants viewers.

Netflix has already started down this road. In March 2011, Netflix -- without even a pilot available -- paid a reported $100 million to outbid HBO and AMC for the rights to the original series "House of Cards." The 26-episode series from David Fincher stars Kevin Spacey and is expected to debut in late 2012. In October, Netflix acquired another original series, "Lilyhammer," a Norwegian drama about a mobster that stars Steve van Zandt. And it's been rumored that Netflix may bring back the Emmy Award-winning but low-rated comedy "Arrested Development" for new episodes.

As Netflix works to build itself into a legitimate provider of video content, it's headed in the right direction. Developing, producing and airing original content has helped brand and even reposition cable networks in an increasingly crowded media landscape, taking basic cable networks such as AMC and FX from runners of repeats to critically acclaimed powerhouses. The unique content has helped cable networks get more subscribers, more viewers, more revenue (from advertisers as well as increased carriage fees), more publicity and, at times, even critical acclaim.

One caveat, however: producing original content is a highly expensive proposition, and any new entry into this market should take time building a portfolio, as TNT, USA, AMC and FX have done. Trying to produce too much too fast -- as PaxNet (now Ion) discovered in the early 2000s -- can quickly burn through resources and cause trouble.

Still, offering quality original content will allow Netflix to offer subscribers something unique as competition stiffens from Amazon, Hulu, Apple, Blockbuster and others. With the dollars saved from the failed Starz renewal, revenue can be reallocated toward acquiring original content or partnering with a studio to create new programs and movies. Ted Sarandos, chief content officer at Netflix, notes that TV shows now account for over half of all of the service's viewing.

As for all the rising costs it faces, perhaps Netflix should follow another cable TV model and sell ad time in these series. For years, cable networks have benefitted from two revenue streams: subscriber fees and advertising dollars. Netflix should do the same.

Brad Adgate is senior VP-research for Horizon Media.
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