Pointing fingers at Netflix

Streaming Video Following up on his comments at a UBS media conference last week in which he criticized Netflix for its low pricing, Time Warner CEO Jeff Bewkes was back with some even tougher words for subscription DVD and streaming service Monday in an  interview with the New York Times, calling it essentially a pip-squeak that will soon find itself out of its league.

“It’s a little bit like, is the Albanian army going to take over the world?”  Bewkes said. “I don’t think so.”

Why such animosity? Business Insider points to one likely reason: Netflix’s share price has surged nearly 250 percent this year while Time Warner’s has essentially flat-lined.

Clearly, Netflix is benefitting far more than Time Warner from the growth in digital distribution of movies and TV content. And investors are taking notice. As Nomura media analyst Michael Nathanson put it to the Times, “In the past six months, and because of concerns of Wall Street and concerns of cord-cutting, it’s influencing the investor conversations about the future of media. Now, the industry is very focused on Netflix, and what they can do.”

To hear Bewkes tell it, though, it was all a trick by Netflix.

From the Times:

Mr. Bewkes explained that in the late 1990s the media industry embraced Netflix as a new distribution outlet for renting DVDs — without foreseeing that the company would eventually accelerate the decline in the sales of DVDs, which for years had been the lifeblood of the film industry. Now, with its success online, Netflix has raised fears that consumers may stop paying for cable television — the much-debated phenomenon of cord-cutting.

Sony CFO Robert Wiesenthal piled on:

When Netflix first came around, the dog was the discs and the baggie,” [Wiesenthal said],  referring to the envelopes the discs are mailed in, “and the streaming was the tail.” But very quickly, he added, that situation was reversed. “And now the economics for the content companies are going to reflect that.”

As I noted in my previous post, the studios and networks have ample reason to worry about Netflix’s impact on consumer behavior and pricing expectations. But it is not true that none of it could have been foreseen.

Rentals have always cannibalized sales to some extent in the home video business, going back to the earliest days of the Betamax. The reason cannibalization has accelerated in these latter years of the DVD business is the studios did not respond to expanding consumer choices by repricing DVDs accordingly. Instead, they stuck to price points that preserved their margins but which gradually undermined the value proposition to purchasing movies and TV shows.

It also should have been obvious that a subscription rental model would be a lower-margin business for the studios than a transactional rental model. Yet the studios never really tried to structure direct-purchasing deals with Netflix where payments to the studio would go up the more a DVD turned over for Netflix. Instead, they largely left it to Netflix to buy DVDs through standard wholesale channels, which meant no back-end upside for the studios. It also meant Netflix was able to reap nearly all the value from the growth of its subscriber base.

As for Netflix’s expansion into streaming, I don’t recall Reed Hastings ever being exactly coy about his intentions. He had been saying for years, whenever asked, that the reason he called the company “Netflix”  instead of “DVD by Mail” is because he knew the future of the company ultimately lay in digital delivery. It should have been obvious then that subscription-based digital distribution would be a lower-margin business for the studios than a transactional system, where the studios could share in each online rental.

Heck, from the start Netflix has been offering streaming to its subscribers at no extra cost. If that didn’t tell the studios two years ago that Netflix’s streaming was not going to be particularly accretive to their business I really don’t know what would have.

Bewkes even admits to the Times to having been asleep at the wheel, if not in so many words:

As evidence of Netflix’s growing importance, Mr. Bewkes said decisions about deals that might have been made two years ago by a junior employee in a studio’s digital division are now reaching his desk. For example, Mr. Bewkes himself approved a deal to allow Netflix to stream “Nip/Tuck,” a drama produced by Warner Brothers’ TV studio.

So now the studios have woken up. But now Netflix has 17 million subscribers and its growth is accelerating. The studios have leverage in digital that they did not have with DVDs, thanks to the lack of a digital “first sale doctrine,” and can certainly raise Netflix’s content costs. But they still haven’t come up with a competitive consumer value proposition in other distribution channels to meet the demand Netflix is currently fulfilling.

Simply forcing Netflix to raise prices and calling it a day is not exactly a growth strategy. It’s more like an admission of defeat.