Why Netflix Has Already Won the Digital TV/Video War

How the Mail DVD Service Stole the Market From Cable and the Studios -- and Hulu, Apple, Google, Amazon

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Paul Verna
Paul Verna
Now that premium entertainment is becoming easy to stream from web to TV, the race to monetize growing consumer demand is becoming fierce. The stakeholders include nearly the entire internet -- Google, Apple, Amazon, Hulu -- and nearly the entire entertainment industry -- NBC Universal, News Corp., Disney and, soon, Sony, Viacom and Time Warner.

Unfortunately for them there's already a clear winner. Netflix. Here's why:

  • The company built its business on DVD rentals by mail but realized early on it needed to diversify to accommodate shifting consumer behavior -- which it successfully achieved with its streaming offering, Watch Instantly.
  • Over the past two years, Netflix has grown its subscriber base by 78% and its revenue by 54%, according to its recent earnings reports. These gains have come organically from steady quarter-to-quarter increments. The percentage of Netflix subsribers who stream video is growing even more dramatically. In Q2 2010, some 61% of subscribers used Watch Instantly for at least 15 minutes, compared with 55% in Q1 2010 and 37% in Q2 2009.
  • Netflix understands that it needs to invest heavily in content acquisition to beef up its library of streaming titles. The company just cut a film licensing deal with Paramount, MGM and Lionsgate worth an estimated $200 million a year for five years. That sounds like a lot of money until you realize that Netflix spends about $600 million a year on postage. If it can shave off those costs by converting more of its customers to digital, it will increase its licensing war chest.
  • Netflix has also been smart about partnering with makers of TVs, set-top boxes, video game consoles, Blu-ray players, tablets and smartphones -- not to mention Apple TV, which is essentially a competitor. The Netflix logo is ubiquitous on most of the major viewing platforms.
  • Netflix is perceived as more of a movie brand than a TV brand, but this is starting to change thanks to CEO Reed Hastings' aggressive pursuit of licensing deals for back seasons of popular TV shows. Netflix is determined to pull the rug out from under Hulu in the TV space -- at least when it comes to back catalog -- and seems to have the right strategy to do so.

Compare this to how other companies are approaching the digital onrush.

Hulu. Hulu earns more revenue from online video advertising than any other site on the internet, according to eMarketer estimates. But its ad revenue still consistently falls short of analyst projections and the expectations of its owners. Its next move: Create Hulu Plus, a Netflix-like subscription service for TV shows, with less total content and similar price point. Hulu has, however, floated the idea of an initial public offering, which presumably would raise capital to finance content acquisition.

Apple. Lowering the price of its Apple TV player to $99 and transitioning iTunes TV shows and movies from a download model to a rental/streaming model are good ideas. But it's hard to imagine massive numbers of people spending $99 on a separate gadget when they already own -- or plan to buy -- devices that enable them to watch online video (in other words, Netflix) on their flatscreens for no additional cost, including game consoles, Blu-ray players and internet-connected TVs. By the same token, many people would rather take advantage of Netflix's bundled offering, or free TV shows on Hulu, than pay $5 for a movie or $1 for a TV episode on Apple TV.

Google. The search giant has virtually owned user-generated video since 2006, when it purchased YouTube. The problem is user-generated video has proven very difficult to monetize. Will Google TV or a rumored YouTube premium HD subscription service help? It's too early to say how well Google will be able to integrate these products into technologies like internet-connected TVs, game consoles and set-top boxes, but if Google can afford to undercut Apple and other set-top box makers, it could gain a competitive edge. That, however, is a big "if."

Amazon. Amazon is reportedly considering adding a TV and movie subscription service along the lines of Netflix's Watch Instantly. Without knowing more about its offering, it's tough to say how Amazon stacks up against the others, but it's clear that Amazon is late to the party. Neflix, Hulu, Apple and Google have far more equity in the TV and movie industries, and it's hard to imagine that Amazon would radically change the dynamics of the market.

The Bottom Line. It will be years before TV and home movie viewing shift en masse from cable and broadcast to purely internet-based offerings. Until TV networks and movie studios start seeing dollar signs, they're not likely to make a critical mass of content available to digital video providers.

But with the advantage of having built and strengthened its user base for TV and web platforms during the past few years, Netflix has placed newcomers at a critical disadvantage: The potential users of Hulu, Google/YouTube, Apple, and Amazon TV offering are -- for the most part -- already loyal Netflix users. And as long as Netflix continues to get the content licenses it needs to keep its users happy, their attention -- and dollars -- will will continue to go to Netflix.

Paul Verna is a senior analyst at eMarketer.
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