Netflix: It’s not about the cord

Over-The-Top Video Netflix is often credited (or blamed, depending on your perspective) for inspiring cable cord-cutting by cable and satellite subscribers, but don’t tell Netflix CEO Reed Hastings.

“While Netflix is likely to show huge growth again this year, we think MVPD cord cutting will be minimal to non-existent,” Hastings said in his letter to shareholders regarding the company’s Q1 earnings yesterday. “We hear some stories from customers who have Netflix and no MVPD service, but these are generally people who rely on free broadcast TV (which is now in HD) and supplement with Netflix, rather than switching from MVPD to online.”

His evidence?

“Since last year, online video use has more than doubled and the recession has receded somewhat. So, if online video use was driving cord cutting, the behavior would have intensified. On the other hand, if it was the recession that was driving people to drop MVPD subscriptions, cord cutting would have moderated. In fact, not only did cord cutting slow, it became cord mending with total U.S. MVPD households growing in the latest estimates.”

Hastings elaborated on the point in the analysts Q&A:

MVPD is a much different service. It’s premises-based. It’s more expensive, and it’s more considered an essential service so it’s really just quite different in all those dimensions.

Hastings has ample strategic reasons to down-play cord-cutting and Netflix’s contribution to it. As Hastings acknowledges in his shareholder letter, “Given what’s happened in the music and newspaper industries, producers of movies and TV shows naturally enough fear Internet services will hurt their existing business.”

That fear could make it harder for Netflix to license the content it needs to continue to grow and to fend off competition from other Internet services like Hulu Plus and what DISH Network does with Blockbuster.

Worse, it could lead producers to start treating Netflix like other MVPDs, demanding per-subscriber licensing fees for streaming rights, just as the networks collect per-subscriber carriage fees from cable and satellite providers.

That would be devastating b0th to Netflix’s short-term earnings growth and its long-term strategy. For all the concerns investors have over the company’s growing tab for streaming content — Netflix shares plunged on Tuesday, largely on Hastings’ admission that “substantially” higher content costs would slow earnings growth in upcoming quarter — the math would look far worse if those costs were set on a per-subscriber basis.

Right now, Netflix has the luxury (as it were) of paying  relatively high, but flat, licensing fees for high-profile content that attracts new subscribers knowing that all of the incremental revenue from that subscriber growth will fall to its own bottom line. If those licensing fees were calculated on a per-subscriber basis, however, content costs would grow in absolute lock-step with the subscriber count, severely attenuating the upside for Netflix.

As things stand today, I think Hastings has a point. I would agree that the declining in MVPD households seen in 2009 was largely a cyclical phenomenon driven by a decline in new-household formation, a tidal wave of foreclosures and high unemployment, not by significant levels of cord-cutting. That doesn’t mean MVPDs have nothing to fear from the growth of Netflix, however.

With nearly 23 million users in the U.S., Netflix has nearly as many subscribers as Comcast, the nation’s No. 1 cable MSO. By the end of 2011, it is likely to have more total subscribers than HBO, currently the largest subscription video service.

More to the point, with its embedded app available on more than 300 different SKUs of connected devices, Netflix’s potential reach already extends to far-more devices than that of any MVPD in the U.S., and it has the luxury of growing internationally — adding to its scale — while U.S. MSOs largely do not.

Right now, Netflix’s service — on-demand, a la carte — is highly personalized, whereas MVPD service — fixed tiers, bundled programming packages — is fairly standardized. As sufficient scale, however, even personalized content services will begin to have an aggregate impact that rivals that of pre-bundled, standardized services.

Hastings is just hoping to get there before anyone really notices.