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Summary:

Hollywood studios and TV programmers are becoming increasingly uneasy about Netflix’s effect on the video industry and cannibalization of their existing business models. But refusing to work with a company offering billions for their content isn’t a solution — it’s just part of the problem.

hollywood sign

For an industry good at making big pictures, Hollywood is pretty lousy at seeing the big picture. Thursday, Reuters ran a story quoting several anonymous sources in the content industry that portray Netflix as a shark, out to steal their content — and the television and movie industry’s revenue. Unfortunately for Hollywood, Netflix isn’t the real enemy; broadband and the digitization of content is.

The studios and networks helped create this monster by selling Netflix streaming rights to their content, and now they’re finding they can’t control it. The feeling from content owners — that Netflix is going to eat their lunch if they aren’t careful — has got many rethinking their dealings with the company, and how they distribute digital content in general. Instead of blaming Netflix, movie moguls need to figure out how to make money as their industry moves online, just as moguls in the music and media industry are trying to do today with varying levels of success.

Netflix isn’t being a bad actor in all of this. It’s playing by the rules, writing checks and compensating content owners for the video streams it serves. In fact, the company has even made some concessions along the way, agreeing to a 28-day window for distribution of DVD releases and a 90-day window between when new movies are available to Epix pay TV subscribers and when Netflix users can stream them.

In some cases, however, it’s paying much less than one might expect for the content that it serves. For example, its deal with Starz Entertainment gives it access to films from Disney and Warner Bros. at a fraction of the price that cable providers pay for the network. The Starz deal is valued at around $20 million to $30 million, according to some estimates. Considering Netflix now has about 17 million users, it pays less than 15 cents per subscriber, compared to the $2 dollars per sub that cable companies typically pay for the premium cable network.

Of course, when Netflix struck that deal back in 2008, no one knew that it would grow into the streaming powerhouse it is today. Back then, Netflix had about half as many subscribers as it does today, and only a fraction of those users took advantage of its streaming service, which was relatively new at the time. The deal expires this year, but Netflix seems confident it will be able to re-up with Starz when the deal comes up for renewal.

On a recent earnings call, Reed Hastings said he was confident of a Starz renewal, saying, “We have money to pay and they are in the business of collecting money.” That’s really Netflix’s value proposition to the content industry: it spent $1.2 billion on securing streaming rights this year, and could nearly double that to $2 billion in 2011. But $2 billion isn’t much when compared to the revenue that broadcasters get from TV advertising or carriage fees from cable companies, and it won’t make up for the loss of revenue Hollywood studios are seeing from declining DVD sales.

At the same time, Netflix is only a symptom of a broader paradigm shift, one that the content owners are still learning to navigate. The transition from analog and physical distribution of media to digital distribution has rocked the music, newspaper and publishing industries, and now it’s got the TV and movie industries in its cross-hairs. Unfortunately, the broader video industry is poised to make the same mistakes that its forbears made, by shutting out new business models rather than embracing them. A few weeks ago, Om wrote:

“When I look at these industries and the failure — or impending failure — of these institutions, I see a fundamental mistake on their part to understand their own core businesses. They fail to see the world in a larger context, and instead, choose to focus on maintaining the status quo.”

And this gets to the heart of where the studios have got it all wrong with Netflix: They’re unhappy that their content is practically being given away for a subscription of $7.99 a month, and that consumers are getting a better deal than if they paid for cable or bought a DVD. But for all their worries about the destructive tendencies of Netflix’s business model, they can’t rely on the old way of thinking if they plan to survive the digitization of the video marketplace.

Transitions like this one are never pretty, and we’ll likely see some major pain as the studios try to negotiate this new territory. But if the content owners want to survive, they’re going to have to be forward-thinking in their approach to making their content available online. Refusing to work with digital distributors like Netflix isn’t a solution, but part of the problem.

Photo of Hollywood sign courtesy of Flickr user Sörn.

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  1. What’s sad is that these industries seem to overlook the cost savings they’ll be able to incorporate with the switch to digital. For Hollywood, it’s the expense of printing millions of DVDs, packaging, etc – while I realize most of the big studios don’t likely own their own DVD-printing shops, they most certainly pay someone to do it – thus, they could easily reduce those costs, giving themselves a bigger piece of the pie.

    I know that was a major consideration for me to ditch a physical movie collection and switch to digital copies – I don’t have to use up a closet storing physical copies, nor do I have to move them around all the time or worry about them wearing out.

  2. “Considering Netflix now has about 17 million users, it pays less than 15 cents per subscriber, compared to the $2 dollars per sub that cable companies typically pay for the premium cable network.”
    This isn’t a fair comparison. Cable gets the movies in HD. While Starz gives Netflix under SD quality. In fact this is the number 1 complaint people have with the streaming service. The horrible quality of Starz titles.

    1. It’s also not fair because at the time the deal was struck, Netflix only had 8.7 million users and a small fraction of that were streaming actively. Do that math and it gets closer to the $2 per sub/mo.

      By committing to a guaranteed annual contract with Starz so early, Netflix was taking decent risk if streaming never caught on.

    2. It may be the #1 complaint, but it’s still not a significant one. The necessity for super HD is overblown. I have no problem with Netflix’s current quality on my 5MB DSL. If the picture quality is adequate, there will be marginal, or no, impact on Netflix business. It’s just like iTunes and MP3s. A lunatic fringe complains about the “horrible” sound quality while 98% of the customer base doesn’t care. They can go buy Bluray,

  3. Hollywood and Thinking in the same sentence? That’s like Telcos and Service.

  4. Stories like this are clueless, Ryan. Give Hollywood an actual SOLUTION that allows them to make the same margins they’re used to and boom, problem solved. It’s ignorant to think the studios aren’t working their butts off to figure out a revised (and sustainable) business model. But until that solution is found, don’t expect them to change. in fact, expect them to push for more authentication and pull content from Hulu, Netflix, etc. Just because content is digitized doesn’t mean you can have it for free or at bargain prices.

  5. Ricky, guess what? Eliminating packing and physical product doesn’t mean the cost savings will be passed along to you. Case in point, Franzen’s new hardcover and Kindle edition are priced identically…

    Ditto for any CD and their digital counterpart on iTunes.

  6. I have argued with friends for the past few years that the end of disc-based media will be a sad day for the consumer. Yes, we are all enamored that for only $7.99 per month we can stream seemingly countless titles. It’s not going to last. The content owners will find their ways to put their own stops into the process, and charge us more than they ever have for less. Unfortunately DVDs are not like a CD where you might save money by only buying the songs you want online. The content kings will have us right where they want us once we can’t buy movies any other way. Yes, high speed internet is more and more prevalent everywhere we go, but you’ll need this subscription or that one, this box or that one, etc, etc. Kiss your fair-use rights goodbye. Once we rely on a “service” to offer our content and we all instinctively click past the fine print in the terms of service, there’s no guarantee that your collection will be there when you wake up in the morning.

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