Netflix: Far from immortal
October 16, 2014
I seriously doubt any media company has ever had as many namechecks as Netflix over this last couple of years. We are as guilty as any, but then that’s what happens if a business is a game-changer; the company appears in thousands of ‘wow what a success’ stories and just as many ‘oh my, what a threat’ reports.
There have even been a few ‘Netflix: not so clever now’ lines; remember the shambles of the splitting and re-naming debacle? But Netflix recovered, partly because it is a refreshingly forthright company – ‘hey, we had brain fade, sorry and we won’t do it again,’ but mostly because it was first to market with a beautifully simple supply proposition that met up with a seemingly limitless demand.
On its own it, dismantled the ancien regime of Blockbuster (Head in Sand World Champions a record five straight years), and it beat to market several online giants with arguably better resources for the task – Amazon and Google, for instance. Not to mention every existing pay-TV provider and channel producer, who were only beaten to the aforementioned HiS laurels by the amazing consistency of Blockhead, I mean Blockbuster.
So, Netflix has hit a series of home runs and is, surely, home free to carry on tearing up the market both at home (in the US), and internationally.
Well, not so fast. The trouble is Netflix success has within it the seeds of several major headaches:
1. The more subs it has in any given area the more bandwidth it uses. Its Plan A is network providers simply have to keep upping capacity to keep their broadband subs happy and thereby Netflix gets a free ride to their own subs. But not so fast – if you see what I mean. While still banging the drum of net neutrality (which for Netflix = free ride), it has had to concede a whole series of ‘interconnection agreements’ – a fig leaf for paying for guaranteed QoS to its customers. This must have always been Plan B – Netflix can never really have believed it would always and forever get a free lunch – but like all Plan Bs, it is definitely less profitable than Plan A.
2. The Content v. Price conundrum. A major part of Netflix rip-roaring success has been its very reasonable price, in particular in comparison to developed markets often eye-watering pay-TV tariffs. If a subscriber isn’t massively incentivised by live sport (the really expensive bit of pay-TV bundles) what’s not to like about a service with movies and drama on demand? Trouble is, studios and broadcasters with interests in other channels won’t license you their product, some of which your subscribers would definitely like to see. Netflix answer has been typically pragmatic and bold; ‘we’ll make our own killer content’. And they’ve done incredibly well with hits like House of Cards and Orange is the New Black achieving cult status and driving many more subs. But original production is expensive – you can only recoup the investment two ways; higher prices or lots more subs. Netflix (though it has raised prices a bit) has gone for the second option. But the problem here will be saturation point – maybe getting close in the States – so it has to expand rapidly overseas, which it is doing. But it has to go on running to stand still; a hard way to consolidate decent margins over the long term.
3. So, Netflix has made great content, but can it be a hit factory? No one else has. It has set out its slate signing a lot of creative deals including, for instance, a multi film deal with Adam Sandler. Mr Sandler has made some great movies and quite a few more that were a terrible waste of electricity and everything else. Studios can afford turkeys because they amortise them over different release platforms and territories. Admittedly this structure is in flux just now, but, in any event, it is simply unavailable to Netflix. Which brings us to…
4. The Content v Price v Security conundrum. Remarkably for such a widely viewed and highly regarded service Netflix has had very few security issues (except password sharing which, up to a point, can be counted as marketing budget). This is because it is below the tipping point price at which it is ‘worth’ stealing. If it puts its prices up enough to maintain margins against higher content spending it will, at some point, cross that threshold. It will only know it has crossed it when the service is leaking away. Those that know tell me Netflix current security level is not high and if breached the flood will be big and wide. Netflix fully recognises the security issue – for itself and in general – and that’s why it denies itself the luxury of spinning out successes over months and over multiple territory windows. It knows there would be no greater incentive to piracy than a binge hungry audience (another phenomenon it may regret creating) denied episodes 2, 3, 4 etc. of the latest mega hit.
5. Competition. Netflix knew it had to grow fast before the market woke up to what it was doing. When it finally did, a slew of defensive TV Everywhere propositions sprung up from incumbent pay-TV providers. They are free to users and offer the convenience of OTT rather than any new concept in content or packaging. They are, at best, ancillary as the providers begrudging embrace of Netflix on their platforms shows. There will be more competition from Amazon, Google and Apple (probably) but Netflix is a long way ahead; the only problem is the harder these guys try, the higher price of content will go. More of a problem are the people who really do understand how to make good content, and have massive content brands, finally figuring hey, why don’t we do a Netflix? I think the blow to Netflix share price was a lot more to do with HBO’s declaration of a US OTT service than it missing its own sign-ups forecast. Starz, CBS and others seem set to follow suit.
The dramatic fall in Netflix share price was a typical Wall St over reaction to a company doing just a bit less brilliantly than it had slightly rashly forecast. This is still an amazing business. As Hudson Square Research’s Daniel Ernst said, Netflix has proven it can bounce back from disappointing quarters: “They have got a good track record in growing past this turbulence.”
Netflix hasn’t made many tactical mistakes and when it has it has fessed up and corrected the misstep. But it is no longer marching alone to the sound of its own drum, and it needs some answers to these strategic challenges, otherwise future share price falls won’t be just blips.