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Cable Technology Feature Article

July 29, 2010

Is Netflix the Next 'Cable' ?

By Gary Kim, Contributing Editor

Most observers would likely consider Netflix a direct competitor to other video rental providers, a lesser competitor to Hulu (News - Alert) and other streaming services, but not a competitor to cable TV, DirecTV or telco multichannel video providers. The reason is simply the Netflix strength in movie rentals, where multichannel TV services rely more heavily on news, sports and other "live" programming. 

But everything in the video business is changing with the growth of interest in online distribution, both on the part of end users and content owners. As a rule, online distribution opens up new channels that compete with traditional multichannel video providers. The issues revolve around how widespread those newer channels might become, and what legacy portions of the video business are affected. 

Almost nobody seems to believe that online distribution is "good" for legacy providers such as cable companies, satellite or telco providers of multichannel video subscription services. What remains unclear is how "good" a shift might be for distributors such as Netflix, which logically competes directly with pay per view or video on demand services offered by other distributors. 

In the near term, money will matter, as it always does when release windows shift. If studios think they can make more money from favoring new channels, they will do so. Netflix seems to want to encourage that view. 

 In the quarter that ended June 30, 2009, Netflix spent $9 million on acquiring films and television shows for its streaming service. In the latest quarter, Netflix spent $66 million, more than seven times as much.

For the first six months of 2010, Netflix paid the studios $116 million for streaming content, compared with $31 million for the same period last year. 

Netflix has been able to do so without raising subscription prices, which might have been viewed as a negative, in terms of the firm's ability to keep adding new subscribers. What is different now is that Netflix now has reached a revenue scale that allows it to compete for content with the likes of Comcast (News - Alert) and other providers. Over the long term, that makes Netflix a more-viable competitor to legacy multichannel video providers, to a greater extent. 

Digital delivery also seems to be paying off as a way of cutting distribution costs. As it turns out, delivering digital versions of films over the Web is far cheaper than shipping physical discs. 

Netflix spent $24 million in its most-recent quarter shipping DVDs by mail, compared with $43 million during the same period last year, and despite adding millions of new customers. 

For the first six months of this year, Netflix spent $61 million on shipping costs, down from $89 million for the same period of 2009.

But the challenge will be managing new content acquisition costs. Today, studios bank on getting 50 percent of gross revenue from HBO. They get about 30 percent of Netflix revenue. As Netflix grows, it will face pressure to give more revenue to the studios. 

On the other hand, as Netflix grows its subscriber counts, it starts to become a more-important distribution outlet, as well. Netflix also is a distributor on the Roku, Microsoft (News - Alert), LG, Sony and Nintendo gaming or set-top platforms.

Subscribers who watched at least 15 minutes of streaming content in the second quarter grew 61 percent, up from 37 percent in the year ago period. 

From June 2009 to the same month this year, Netflix added nearly five million subscribers, a 42 percent increase. By the end of this year, the company says it could possess as many as 18.5 million subscribers.

Sometime in 2011, Netflix will likely top the 20 million subscriber mark, making it a peer to Comcast, the nation's largest cable company with 24.6 million cable TV subscribers.

That also should get attention. Netflix remains a financially-smaller player in the overall video and film distribution business than other contestants. But as the ecosystem shifts, so will the money, and so will the release windows and other deals that favor some players over others. 

It might be a bit early to view Netflix as a "cable competitor." But it is not early to note that if it can sustain its growth, and shift delivery costs to digital delivery, Netflix might start to emerge as a viable competitor to multichannel video distribution companies, at least in part.

That is an interesting development for a company that once was believed to be "toast," a victim of digital delivery, not its beneficiary. 

Gary Kim (News - Alert) is a contributing editor for TMCnet. To read more of Gary’s articles, please visit his columnist page.

Edited by Stefania Viscusi