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Summary:

Netflix CEO Reed Hastings has said that the company’s ability to offer more content through its Watch Instantly service was limited only by its ability to write big checks. Now it’s doing just that, with its spend on streaming titles increasing sevenfold over the past year.

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Everyone knows that Netflix’s future is in streaming, and as a result, the company is investing heavily in titles for its Watch Instantly service. But a closer look at Netflix’s financials underscore how the Internet has changed the movie distribution business, and how it is capitalizing on that trend. Netflix is spending its more money than ever on streaming video, in part because it costs less to deliver that content online than by mail.

According to its 10-K filing, Netflix spent $66 million in the second quarter 2010 to license streaming titles for its Watch Instantly service, compared with just $9 million that was spent in the prior-year period. (Hat tip to CNET) The acquisition of new and better content has helped drive its subscriber numbers up 42 percent over the past year, with 15 million subscribers at the end of the second quarter, compared with 10.6 million a year earlier. In addition, those subscribers are watching more streaming content than ever, with 61 percent using the service, compared to just 37 percent a year earlier.

But despite a huge increase in the amount of video streams it’s serving up through Watch Instantly, Netflix’s streaming costs haven’t increased proportionally. In the second quarter, the company said costs associated with delivery over third-party CDN networks only increased by $1 million versus the previous quarter. Netflix is benefiting from bandwidth costs continuing to fall exponentially as it grows its streaming business.

So the real cost of running its streaming business is in acquiring the content, not delivering it.

On the DVD side of the business, just the opposite is true. Netflix spent $24 million on DVDs last quarter, compared to $43 million during the previous year’s second quarter. For the first six months of 2010, the company shelled out $61 million on DVDs, which is down from $89 million during the first half of 2009.

But expenses associated with DVD delivery offset its reduction in purchase costs. According to Netflix, the costs of its DVD-by-mail business increased by $23.1 million in the second quarter. Due to the vast increase in its subscriber base, the number of discs shipped grew 9.3 percent, despite a 20 percent decrease in the number of DVDs per sub. Those costs could increase even further next year, as the U.S. Postal Service has announced plans to increase postage rates (again).

The good news is that Netflix’s streaming strategy appears to be working. It seems to have entered into a virtuous cycle in which it is able to sign up subscribers who are attracted to its streaming service, which enables it to reduce its spend on DVDs and put more cash toward acquiring streaming content, which will pull in even more subscribers.

Related content on GigaOM Pro: Three Reasons Hulu Plus is No Threat to Netflix (subscription required)

  1. It seems as though I reactivate Netflix every 3-6 months thinking that I’ll replace cable with streaming, but I always end up canceling Netflix and keeping cable.

    I also wonder if a combination of Netflix and Hulu Plus would have all of the shows that my wife and I watch. Is anyone doing this?

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    1. I wonder why Netflix isn’t also going after TV content. Or is it? Anyone know?

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  2. Neill -

    I agree with you. Netflix library of movies is horrible now . When I first subscribed it was good but been downhill ever since. I re-subscribed hoping it would be different no such luck. Hulu doesn’t have movies – just t.v shows – so if TV shows what your looking for Hulu is the way to go. Netflix has both but I don’t really watch t.v shows I like movies.

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  3. @Agreed: When was the last time you looked at hulu. At the very top it says movies.

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  4. True, the Netflix movie selection for streaming is less than the DVD selection but the streaming movies offer a different election, one that could be attractive to anyone who has unique tastes (http://www.ddmcd.com/movies/discoveries-via-streaming-netflix-1.html ). On the other hand, one reason I rent fewer DVD’s is the trend away from packaging extras with the DVD. I certainly buy fewer than I once did, partly because of the move away from extras.

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  5. [...] NewTeeVee hits exactly on my point: The Real Cost of Netflix Streaming is the Movie, Not the Bandwidth. Key quote: “…the real cost of running its streaming business is in acquiring the [...]

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  6. So what does this mean for filmmakers? Has anyone sold their film to Netflix for streaming only?

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    1. Great question. Come to think of it. Has any content producer sold a TV series to Hulu or another TV show online video service?

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      1. Re: Hulu — Yep. 19 Entertainment distributes “If I Can Dream” with them exclusively. “If I Can Dream” also bears the unique distinction of being a show on Hulu that is not geoblocked.

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    2. Netflix acquired our title for physical DVD via a well-established non-studio distributor. As producers, we retained the streaming rights. (This is when you could still do that.) We almost made a separate streaming deal with them a couple years ago, but the license fee they were offering wasn’t worth the trouble, especially since they switched at the last moment from a fee
      plus per “turn” royalty, to a flat fee only.

      However, our understanding is — and please correct us if we’re wrong — that there is currently a “per turn” component to the streaming licensing deals Netflix has been making with the studios, at least for brand new titles.

      Regardless, if they want to increase (and maintain) the quality of the streaming content/titles they make available to viewers, we believe they’re going to have to increase their license fees, and/or add a per view compensation component for content owners, whether purchasing studio libraries, or high quality, award-winning indie titles from individual producers, suppliers or aggregators.

      Would also be interested to learn what type of current licensing/deal terms any non-studio content owner(s) have been able to negotiate.

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  7. If only Netflix could ensure the quality of their streaming, or at least provide some options. For example, I started to watch “El Mariachi” streaming the other day, and stopped when I realized it was a dubbed version, rather than subtitled. I was watching an episode of the show “Campion” when I noticed that everything was out of sync, with scenes stopping early and cutting ahead (nope, wasn’t my computer as several other subscribers had similar comments). I’m all for online streaming, but quality control is a must.

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  8. Captain_Celluloid Thursday, July 29, 2010

    If bandwidth cost is not the issue it would be good for Netflix
    to INCREASE THE BANDWIDTH THE GIVE US AND INCREASE THE IMAGE QUALITY.
    NF’s streaming image quality is, in a word, dreadful. HULU’s video
    quality is, on average, FAR superior . . . . .

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    1. You really should check your own connection and ISP. I had Time Warner Cable and now have Verizon Fios — both have been very good for streaming netflix; in fact, Fios has been spectacular. With TWC, 95% of the time I got maximum quality streaming, and with Fios, it’s 100%. I am always impressed with the image quality, even where the streaming isn’t at maximum quality.

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    2. Wrong wrong wrong.

      Netflix streams all of their content, especially HD in bitrates that exceed those on Hulu. Hulu for 480p tops out at around 1Mbit/s… whereas Netflix is at 3.8Mbit/s. If you haven’t seen Netflix HD via an Xbox360, PS3 or Roku you absolutely should. The quality is ridiculously impressive.

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  9. [...] The Real Cost of Netflix Streaming is the Movie, Not the Bandwidth. from → Tech, news ← Help NPR beat FOX News No comments yet [...]

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  10. [...] “The real barrier to innovation isn’t the cost of bandwidth” and it looks like Netflix’s 10K filing confirms this.  Despite a huge increase in online content and users, bandwidth costs have barely risen. [...]

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