The thing about technology and the global spread of the internet is that the early pioneers tend to spawn the competitors - and then the new innovations - which eventually surpass them as their costs go up and their customer bases flatten. JL
Joe Nocera reports in the New York Times:
Just because Netflix
has created this new world of internet TV (i)s no guarantee
that it could continue to dominate it. Netflix had streaming all to itself. As its costs continue to
go up, it needs to constantly generate more subscribers to stay ahead of
others.Even as Hulu and Amazon (are) emerging as rivals, the true competition is still
for users’ time: not just the time they spent watching cable. Netflix has a negative cash flow of almost $1 billion (but) once people start watching shows that don’t have
commercials, they never want to go back.
One
night in early January, a little after 9 o’clock, a dozen Netflix
employees gathered in the cavernous Palazzo ballroom of the Venetian in
Las Vegas. They had come to rehearse an announcement the company would
be making the next morning at the Consumer Electronics Show, the tech
industry’s gigantic annual conference. For the previous year, Netflix
had been plotting secretly to expand the availability of its streaming
entertainment service, then accessible in about 60 countries, to most of
the rest of the world. Up to this point, Netflix had been entering one
or two countries at a time, to lots of fanfare. Now it was going to move
into 130 new countries all at once, including major markets like
Russia, India and South Korea. (The only significant holdout, for now,
was China, where the company says it is still “exploring potential
partnerships.”) Netflix executives saw this as a significant step toward
the future they have long imagined for the company, a supremacy in home
entertainment akin to what Facebook enjoys in social media, Uber in
urban transportation or Amazon in online retailing.
Ted
Sarandos, who runs Netflix’s Hollywood operation and makes the
company’s deals with networks and studios, was up first to rehearse his
lines. “Pilots, the fall season, summer repeats, live ratings” — all
hallmarks of traditional television — were falling away because of
Netflix, he boasted. Unlike a network, which needs shows that are
ratings “home runs” to maximize viewers and hence ad dollars, he
continued, Netflix also values “singles” and “doubles” that appeal to
narrower segments of subscribers. Its ability to analyze vast amounts of
data about its customers’ viewing preferences helped it decide what
content to buy and how much to pay for it.
Sarandos
can be an outspoken, even gleeful, critic of network practices in his
zeal to promote what Netflix views as its superior model — on-demand and
commercial-free streaming, on any device. That glee was on full display
in these remarks. For years, he said, “consumers have been at the mercy
of others when it comes to television. The shows and movies they want
to watch are subject to business models they do not understand and do
not care about. All they know is frustration.” That, he added, “is the
insight Netflix is built on.”
When
Sarandos was done, Reed Hastings, Netflix’s chairman and chief
executive, took the stage. A pencil-thin man, he seemed swallowed up by
the empty ballroom. He squinted uncomfortably under the lights. He and a
number of other Netflix executives had spent the morning at a meeting
in Laguna, Calif., where a rare torrential rainstorm grounded air
traffic, forcing them to make the five-hour drive to Las Vegas. They
arrived only a few hours earlier. To make matters worse, Hastings was
feeling ill.
Haggard
and tired, he stumbled irritably through his presentation. But as he
neared the finale, Hastings broke out into a small, satisfied smile.
“While you have been listening to me talk,” he said, reading from a
monitor, “the Netflix service has gone live in nearly every country in
the world but China, where we also hope to be in the future.” Even
though this was only a practice run — and even though it would be a long
time before anyone knew whether global expansion would pay off — the
Netflix executives sitting in the ballroom let out a loud, sustained
cheer.
They had good reason to celebrate. Netflix, since its
streaming service debuted in 2007, has had its annual revenue grow
sixfold, to $6.8 billion from $1.2 billion. More than 81 million
subscribers pay Netflix $8 to $12 a month, and slowly but unmistakably
these consumers are giving up cable for internet television: Over the
last five years, cable has lost 6.7 million subscribers; more than a
quarter of millennials (70 percent of whom use streaming services)
report having never subscribed to cable in their lives. Those still
paying for cable television were watching less of it. In 2015, for
instance, television viewing time was down 3 percent; and 50 percent of
that drop was directly attributable to Netflix, according to a study by
MoffettNathanson, an investment firm that tracks the media business.
All
of this has made Netflix a Wall Street favorite, with a stock price
that rose 134 percent last year. Easy access to capital has allowed the
company to bid aggressively on content for its service. This year
Netflix will spend $5 billion, nearly three times what HBO spends, on
content, which includes what it licenses, shows like AMC’s “Better Call
Saul,” and original series like “House of Cards.” Its dozens of original
shows (more than 600 hours of original programming are planned for this
year) often receive as much critical acclaim and popular buzz as
anything available on cable. Having invented the binge-streaming
phenomenon when it became the first company to put a show’s entire
season online at once, it then secured a place in the popular culture:
“Netflix and chill.”
But
the assembled executives also had reason to worry. Just because Netflix
had essentially created this new world of internet TV was no guarantee
that it could continue to dominate it. Hulu, a streaming service jointly
owned by 21st Century Fox, Disney and NBC Universal, had become more
assertive in licensing and developing shows, vying with Netflix for
deals. And there was other competition as well: small companies like
Vimeo and giants like Amazon, an aggressive buyer of original series.
Even the networks, which long considered Netflix an ally, had begun to
fight back by developing their own streaming apps. Last fall, Time
Warner hinted that it was considering withholding its shows from Netflix
and other streaming services for a longer period. John Landgraf, the
chief executive of the FX networks — and one of the company’s fiercest
critics — told a reporter a few months ago, “I look at Netflix as a
company that’s trying to take over the world.”
At
the moment, Netflix has a negative cash flow of almost $1 billion; it
regularly needs to go to the debt market to replenish its coffers. Its
$6.8 billion in revenue last year pales in comparison to the $28 billion
or so at media giants like Time Warner and 21st Century Fox. And for
all the original shows Netflix has underwritten, it remains dependent on
the very networks that fear its potential to destroy their longtime
business model in the way that internet competitors undermined the
newspaper and music industries. Now that so many entertainment companies
see it as an existential threat, the question is whether Netflix can
continue to thrive in the new TV universe that it has brought into
being. Continued below...
To hear Reed Hastings explain
it, there was never any doubt in his mind that, as he told me during
one interview, “all TV will move to the internet, and linear TV will
cease to be relevant over the next 20 years, like fixed-line
telephones.” Viewers, in other words, will no longer sit and watch a
show when a network dictates. According to Hastings, Netflix may have
begun as a DVD rental company — remember those red envelopes? — but he
always assumed that it would one day deliver TV shows and movies through
the internet, allowing customers to watch them whenever they wanted.
Now
that future has begun to take shape. The television industry last went
through this sort of turbulence in the late 1970s and early 1980s, when
cable television was maturing. Previously, of course, television had
been mostly transmitted via the public airwaves, and the major networks
made the bulk of their money from advertising. But cable provided an
indisputably better picture, and the proliferation of cable networks
came to offer a much greater variety of programming. In time, consumers
concluded that it was worth paying for something — TV — that had
previously been free. This meant that in addition to advertising
dollars, each cable channel received revenue from all cable customers,
even those who didn’t watch that channel. By 2000, 68.5 million
Americans had subscriptions, giving them access to the several hundred
channels the industry took to calling “the cable bundle.”
Hastings
knew the internet would eventually compete with that bundle, but he
wasn’t entirely sure how. And so he had to be flexible. Sarandos says
that in 1999, Hastings thought shows would be downloaded rather than
streamed. At another point, Netflix created a dedicated device through
which to access its content, only to decide that adapting its service to
everything from mobile phones to TV sets made more sense. (The Netflix
device was spun out into its own company, Roku.) In 2007, even as
Netflix’s DVD-by-mail business remained lucrative, and long before the
internet was ready to deliver a streaming movie without fits and starts,
Hastings directed Netflix to build a stand-alone streaming service.
Netflix’s approach to what
it streams has been similarly flexible. At first, the company focused
on movies, logically enough: 80 percent of its DVD rentals were films.
But despite deals with two premium movie channels, Starz and Epix,
Netflix found the distribution system to be largely inhospitable.
Netflix usually didn’t get access to a new movie until a year or so
after it ran in theaters. It then held the distribution rights for only
12 to 18 months; eventually, the movie went to free TV for the next
seven or eight years. This frustrated customers who couldn’t understand
why something was there one month and gone the next or why, for that
matter, so many titles were missing entirely from Netflix’s catalog.
So
the company shifted to television. Cable networks like FX and AMC were
developing expensive, talked-about dramas, the kind HBO pioneered with
“The Sopranos” and “The Wire.” But these series, with their complex,
season-long story arcs and hourlong format, seemed to be poor candidates
for syndication, unlike self-contained, half-hour sitcoms like
“Seinfeld,” which can be watched out of order.
Hastings
and Sarandos realized that Netflix could become, in effect, the
syndicator for these hourlong dramas: “We found an inefficiency,” is how
Hastings describes this insight. One of the first such series to appear
on Netflix was AMC’s “Mad Men,” which became available on the site in
2011, between its fourth and fifth seasons. Knowing from its DVD
experience that customers often rented a full season of “The Sopranos”
in one go, Netflix put the entire first four seasons of “Mad Men” online
at once. Bingeing took off.
Television
networks lined up to license their shows to Netflix, failing to see the
threat it posed to the established order. “It’s a bit like ‘Is the
Albanian Army going to take over the world?’ ” Jeff Bewkes, the chief
executive of Time Warner, famously joked back in 2010. The occasional
voice warned that Netflix would become too big for the industry to
control, but mostly the legacy media companies viewed the fees from
Netflix as found money. “Streaming video on-demand” rights, as they were
called, hadn’t even existed before Netflix asked to pay for them. And
because the networks didn’t understand how valuable those rights would
become, Netflix got them for very little money.
Everyone
seemed to be a winner, including the shows themselves. In 2012, for
instance, Netflix began streaming the first three seasons of “Breaking
Bad,” the dark drama produced by Sony that ran on AMC. Though praised by
critics, “Breaking Bad” had not yet found its audience.
“When
the folks at Sony said we were going to be on Netflix, I didn’t really
know what that meant,” Vince Gilligan, the creator of “Breaking Bad,”
told me. “I knew Netflix was a company that sent you DVDs in the mail. I
didn’t even know what streaming was.” Gilligan quickly found out. “It
really kicked our viewership into high gear,” he says. As Michael
Nathanson, an analyst at MoffettNathanson, put it to me: “ ‘Breaking
Bad’ was 10 times more popular once it started streaming on Netflix.”
This
was around the time that network executives started to recognize the
threat that Netflix could eventually constitute to them. “Five years
ago,” says Richard Greenfield, a media and technology analyst at BTIG
who happens to be Netflix’s most vocal proponent on Wall Street, “we
wrote a piece saying that the networks shouldn’t license to Netflix
because they were going to unleash a monster that would undermine their
business.” That’s exactly what seemed to be happening.
Worse,
they realized that Netflix didn’t have to play by the same rules they
did. It didn’t care when people watched the shows it licensed. It had no
vested interest in preserving the cable bundle. On the contrary, the
more consumers who “cut the cord,” the better for Netflix. It didn’t
have billions of legacy profits to protect.
Yet
the networks couldn’t walk away from the company either. Many of them
needed licensing fees from Netflix to make up for the revenue they were
losing as traditional viewership shrank. Negotiations between a network
or a studio and Netflix became fraught, as the networks, understanding
the value of their streaming rights, sought much higher fees. In some
cases, those negotiations broke down. The Starz deal, for example, was
not renewed after it ended in 2012. (Chris Albrecht, the chief executive
of Starz, would later describe the original deal as “terrible.”)
This was also
the moment that Netflix started to plot its move into original
programming. In 2012, Sarandos began to argue internally that to stand
apart from the crowd, and to avoid being at the networks’ mercy, Netflix
needed exclusive content that it fully controlled. “If we were going to
start having to fend for ourselves in content,” Sarandos says, “we had
better start exercising that muscle now.” In short, Netflix needed to
begin buying its own shows.
“We
could see that eventually AMC was going to be able to do its own
on-demand streaming,” Hastings says. “Or FX. We knew there was no
long-term business in being a rerun company, just as we knew there was
no long-term business in being a DVD-rental company.”
Still,
Hastings was cautious. Producing original material is a very different
business from licensing someone else’s shows. New content requires hefty
upfront costs — one show alone would most likely cost more than the $30
million a year Netflix reportedly once paid Starz for its entire
library of movies. Developing its own series would thrust it into the
unfamiliar business of engaging with producers, directors and stars.
Back in 2006, the company set up a way to distribute independent films,
called Red Envelope Entertainment, but it failed, and Hastings shut it
down. (“We would have been better off spending the money on DVDs,” he
told me.) Now it was going to give original content another try — with
much higher stakes.
Sarandos
had a show he was itching to buy: “House of Cards,” a political drama
that was being pitched by David Fincher, the well-known director, and
would star Kevin Spacey. Sarandos knew that, according to Netflix’s vast
database, many of the company’s subscribers liked the kind of drama
that Fincher and Spacey wanted to make. But algorithms alone weren’t the
deciding factor. He and Hastings figured that Fincher, who directed
films like “Fight Club” and “The Social Network,” would create a
critical and popular sensation.
In
any case, Sarandos said, the potential reward vastly outweighed
whatever financial and reputational risk “House of Cards” represented.
“If it is a flop, we will have overpaid for one series,” he told
Hastings. “But if it succeeds, we will have changed the brand.”
In
winning over Fincher, Sarandos faced two other obstacles: a competing
offer from HBO, which also wanted “House of Cards,” and the fact that no
one had ever made a show for a streaming service before. For decades,
when movies went straight to video without a theater run, they were ipso
facto failures in Hollywood’s view; for a seasoned director like
Fincher, picking Netflix presented the same risk of marginalization.
Sarandos overcame both by offering freedom and money. “There are a
thousand reasons for you not to do this with Netflix,” he told Fincher.
“But if you go with us, we’ll commit to two seasons with no pilot and no
interference.” Sarandos also offered Fincher a reported $100 million
for 26 episodes, at the high end for an hourlong drama.
The
first season of “House of Cards” became available in February 2013. It
was an immediate hit with viewers and critics. Five months later,
Netflix posted the first season of “Orange Is the New Black,” which
Sarandos had ordered before “House of Cards” went into production.
Critics lavished praise on the new show as well. Having begun its life
as a Silicon Valley tech company, Netflix had somewhat improbably become
a television network.
Reed Hastings
doesn’t have an office. “My office is my phone,” he says. “I found I
was rarely using my cubicle, and I just had no need for it. It is better
for me to be meeting people all around the building.” On the several
occasions I interviewed him at the company’s headquarters in Los Gatos,
Calif., we met in the cafeteria. Although Netflix employees describe him
as an intense, blunt boss, Hastings comes across in public as relaxed
and undefensive. He spent our interviews leaning back in his chair, his
arms folded and legs crossed, tossing off answers to my questions as if
it were a day at the beach.
Born
and raised in the Boston suburbs — his great-grandfather was the
wealthy investor Alfred Lee Loomis, who played a critical role in the
invention of radar — Hastings, now 55, is one of those tech executives
who came to California to attend Stanford (grad school for computer
science in his case) and never left. The tech company he ran before
Netflix was called Pure Software, which made debugging tools for
software engineers. Before Netflix, Hastings had no experience in the
entertainment industry.
Although
news coverage now tends to focus on its shows, Netflix remains every
bit as much an engineering company as it is a content company. There is a
reason that its shows rarely suffer from streaming glitches, even
though, at peak times, they can sometimes account for 37 percent of
internet traffic: in 2011 Netflix engineers set up their own
content-delivery network, with servers in more than 1,000 locations. Its
user interface is relentlessly tested and tweaked to make it more
appealing to users. Netflix has the ability to track what people watch,
at what time of day, whether they watch all the way through or stop
after 10 minutes. Netflix uses “personalization” algorithms to put shows
in front of its subscribers that are likely to appeal to them.
Nathanson, the analyst, says: “They are a tech company. Their strength
is that they have a really good product.”
It
is no surprise that Hastings, given his engineering background,
believes that data, above all else, yields answers — and the bigger the
data set, the better. “The worst thing you can do at Netflix is say that
you showed it to 12 people in a focus room and they loved it,” says
Todd Yellin, the company’s vice president of product innovation. He
likes to note that customers will at most consider only 40 to 50 shows
or movies before deciding what to watch, which makes it crucial that the
company puts just the right 50 titles on each subscriber’s screen. (All
the data Netflix collects and dissects can yield surprising
correlations: For example, viewers who like “House of Cards” also often
like the FX comedy “It’s Always Sunny in Philadelphia.”)
There
is another underappreciated aspect of Netflix that Hastings views as a
competitive advantage: what he calls its “high performance” culture. The
company seeks out and rewards star performers while unapologetically
pushing out the rest.
One
person who helped Hastings create that culture is a woman named Patty
McCord. The former head of human resources at Pure Software, she was
also Hastings’s neighbor in Santa Cruz. She car-pooled to work with him
and socialized with his family on weekends. “I thought the idea for
Netflix was kind of stupid,” she told me. But she trusted Hastings’s
instincts and wanted to keep working with him. Her title was chief
talent officer.
The
origins of the Netflix culture date to October 2001. The internet
bubble burst the year before, and Netflix, once flush with venture
capital, was running out of money. Netflix had to lay off roughly 50
employees, shrinking the staff by a third. “It was Reed’s first
layoffs,” McCord says. “It was painful.”
The
remaining 100 or so employees, despite working harder than before,
enjoyed their jobs more. McCord and Hastings concluded that the reason
was that they had held onto the self-motivated employees who assumed
responsibility naturally. Office politics virtually disappeared; nobody
had the time or the patience. “There was unusual clarity,” McCord says.
“It was our survival. It was either make this work or we’re dead.”
McCord says Hastings told her, “This is what a great company feels
like.”
As
luck would have it, the DVD business took off right around the time of
the layoffs. By May 2002, Netflix was doing well enough to go public,
selling 5.5 million shares at $15 a share. With the $82.5 million
Netflix reaped from the offering, Hastings started hiring aggressively
again. This time, he and McCord focused on hiring “fully formed adults,”
in their words, go-getters who put the company’s interests ahead of
their own egos, showed initiative without being asked and embraced
accountability. Dissent and argument were encouraged, even demanded.
For
those who fit in, Netflix was a great place to work — empowering and
rational. There are no performance reviews, no limits on vacation time
or maternity leave in the first year and a one-sentence expense policy:
Do what is in the company’s best interest. But those who could not adapt
found that their tenure at Netflix was stressful and short-lived. There
was pressure on newcomers to show that they had what it took to make it
at Netflix; those who didn’t were let go. “Reed would say, ‘Why are we
coming up with performance plans for people who are not going to work
out?’ ” McCord says. Instead, Netflix simply wrote them a check and
parted ways.
McCord
also convinced Hastings that he should ask himself a few times a year
whether he would hire the same person in the same job if it opened up
that day. If the answer was no, Netflix would write a larger check and
let the employee go. “If you are going to insist on high performance,”
McCord says, “then you have to get rid of the notion of retention.
You’ll have to fire some really nice, hard-working people. But you have
to do it with dignity.
“I
held the hands of people weeping, saying, ‘I want to be here
forever,’ ” McCord says. “I would tell them, ‘Nothing lasts forever.’ I
would say to Reed, ‘I love them, too, but it is our job to be sure that
we always have the right people.’ ”
In
2004, the culture was codified enough for Netflix to put it on a
sequence of slides, which it posted on its corporate website five years
later. It is an extraordinary document, 124 slides in all, covering
everything from its salaries (it pays employees what it believes a
competitor trying to poach them would) to why it rejects “brilliant
jerks” (“cost to effective teamwork is too high”). The key concept is
summed up in the 23rd slide. “We’re a team, not a family,” it reads.
“Netflix leaders hire, develop and cut smartly, so we have stars in
every position.”
After
Hastings, the executive I spent the most time with at Netflix was
Yellin, a former independent filmmaker who joined the company in early
2006, when he was in his early 40s. Yellin quickly distinguished himself
by pushing back hard whenever he thought Hastings was wrong about
something. “There was a culture of questioning, but I pushed the
envelope,” he says. He also helped develop a style of meeting that I’d
never seen before. At the one I sat in on, there were maybe 50 people in
a small circular room with three tiers of seats, like a tiny coliseum,
allowing everyone to easily see everyone else. The issue at hand seemed
pretty small to me: They were discussing whether montages on the opening
screen of the user interface would be more effective in keeping
subscribers than still images or trailers. But the intensity of the
discussion made it clear that the group took the matter very seriously.
Various hypotheses had been tested by sending out montages to 100,000 or
so subscribers and comparing the results with another 100,000 who got,
say, still images. (This is classic A/B testing, as it’s known.) Every
person present had something to say, but while there were strong
disagreements, no one’s feathers seemed ruffled.
One
of my last interviews at Netflix was with Tawni Cranz, the company’s
current chief talent officer, who started under Patty McCord in 2007.
Five years later, McCord, her mentor, left. When I asked her why, she
visibly flinched. She wouldn’t explain, but I learned later that
Hastings had let her go.
It
happened in 2011, after he made his biggest mistake as chief executive.
He split Netflix into two companies — one to manage the DVD business
and the other to focus on streaming. Customers were outraged; for many,
the move meant a 60 percent price increase if they kept both the DVD and
the streaming service. With complaints mounting and subscribers
canceling, Hastings quickly reversed course and apologized. In the three
weeks following this episode, the price of Netflix shares dropped 45
percent, and Wall Street questioned the company’s acumen. Hastings
decided to re-evaluate everyone in the executive ranks, using the litmus
test McCord taught him: Would he hire them again today? One of the
people this led him to push out was McCord.
One analyst said, ‘Once people start watching shows that don’t have commercials, they never want to go back.’
“It
made me sad,” she said when I called to ask her about it. “I had been
working with Reed for 20 years.” Netflix had just given the go-ahead to
“House of Cards,” and McCord said she “didn’t want to walk away in the
middle of the next thing.”
But she also felt a sense of pride. She was gratified that Hastings had taken her advice so thoroughly to heart.
Bill Murray,
wearing a tuxedo with no tie, stepped out of a black car and meandered
through a throng of people toward Ted Sarandos. It was a crisp night in
December, and Murray had just arrived at the New York premiere of “A
Very Murray Christmas,” a loosely structured, thinly plotted
musical-comedy special directed by Sofia Coppola and including guest
appearances by George Clooney, Chris Rock, Michael Cera and others. In
the fall of 2014, when Coppola and Murray first cooked up the idea, they
went straight to Sarandos. By then, a year and a half after “House of
Cards” became available, Netflix had a reputation for deep pockets,
marketing savvy and a hands-off policy with the “talent.” The idea of
doing away with a pilot, born of desperation when Sarandos was wooing
Fincher, had now become Netflix’s standard practice, much to the delight
of producers and directors.
“Ted,”
Murray said, as they shook hands warmly, “you should get a promotion.”
He grabbed Sarandos by the lapels, pulled him close and added loudly,
“You are the future!” The two men laughed uproariously.
From
the time he arrived at Netflix in 2000, Sarandos has had the final say
on both Netflix’s licensing deals and its original programming. An
Arizona native, Sarandos was working for a large video-retail chain when
Hastings hired him to negotiate DVD deals directly with the studios.
Sarandos had been in love with movies all his life: He worked his way
through college by managing an independent video store. If he had chosen
a different path
it’s easy to imagine him having become a traditional Hollywood executive instead of an industry antagonist.
When the networks complain about Netflix, Sarandos is the one who usually shoots back. Netflix doesn’t publish ratings!
Ratings, he says, are irrelevant to Netflix because the only number
that matters is subscriber growth; Netflix doesn’t need to aggregate
viewers for advertisers, and it doesn’t care when consumers watch their
shows, whether it’s the day they are released or two years later. Netflix spends too much money for its shows! “Big Data helps us gauge potential audience size better than others,” Sarandos told me.
At
an investment conference late last year, David Zaslav, the chief
executive of Discovery Communications, which operates the Discovery
Channel, articulated the case for having networks rethink their
relationship with Netflix. Streaming video-on-demand platforms “only
exist because of our content,” Zaslav said, in an obvious reference to
Netflix. “To the extent that our content doesn’t exist on their
platforms — not to be too pejorative — they are dumb pipes. We as an
industry are supporting economic models that don’t make sense.”
Sarandos,
who had spoken earlier in the day, had clearly anticipated the
criticism: “Zaslav says that we built a great business on their
content,” he said. “That’s just not true. We did not renew their deal
when they wanted a premium. So we replaced it with other programming
that got us just as many viewers for less money.”
Those
who think Netflix will come to dominate television have a simple
rationale: Netflix has exposed, and taken advantage of, the limitations
of conventional TV. The more time people spend on Netflix — it’s now up
to nearly two hours a day — the less they watch network television. “Our
thesis is that bingeing drives more bingeing,” says Greenfield, the
Wall Street analyst. “Once people start watching shows that don’t have
commercials, they never want to go back. Waiting week after week for the
next episode of a favorite show,” he says, “is not a good experience
for consumers anymore.”
Still, despite the rise in Netflix’s share
price over the past few years, the company has no shortage of doubters
on Wall Street. Some distrust Netflix’s numbers, arguing that millions
of people no longer watch the service anymore but keep their
subscriptions because they are so inexpensive. Netflix has announced
that it will raise prices this year, and the Netflix skeptics believe
the price increase will cause subscribers to cancel in droves. Other
critics note the slowdown in the growth of domestic subscribers, by far
the company’s most profitable segment. In addition, Netflix, between its
content costs and the cost of adding subscribers, is spending more than
it collects in revenue. How long can that continue?
Finally,
the pessimists point out that Netflix makes very little profit: In the
first quarter of this year, for instance, Netflix had nearly $2 billion
in revenue but only $28 million in profit. Despite the significant moves
by Netflix into original programming, Wall Street still values Netflix
more like a platform company — a business that uses the internet to
match buyers and sellers, like Uber — than a content company, like a
studio or a network. Its valuation is currently $5 billion more than
Sony, for example. Hastings, who has been very blunt about the company’s
strategy of plowing money back into the business, has promised bigger
profits sometime in 2017. Whether he can deliver on that promise will be
a significant test of investors’ faith in him.
One
of the most prominent Netflix skeptics is Michael Pachter, a research
analyst at Wedbush Securities, a Los Angeles-based investment bank. In
his view, Netflix’s true advantage in the beginning was that it had the
entire game to itself, and the networks, not realizing how valuable
streaming rights would be, practically gave them away. He had a “buy” on
the stock from 2007 to 2010, he told me. But, he added, referring to
those years when Netflix had streaming all to itself, “If it’s too good
to be true, then it will attract competition.”
Now,
he said, the networks and studios are charging higher fees for their
shows, forcing up Netflix’s costs. Netflix doesn’t own most of the shows
that it buys or commissions, like “House of Cards,” so it has to pay
more when it renews a popular show. In addition to the money it now
spends on content, it also has more than $12 billion in future
obligations for shows it has ordered. The only way it can pay for all of
that is to continue adding subscribers and raise subscription rates.
And even then, Pachter says, the networks will extract a piece of any
extra revenue Netflix generates. “It is naïve to think that Netflix can
raise its price by $2 a month and keep all the upside,” he said. “I defy
you to look at any form of content where the distributor raises prices
and the supplier doesn’t get more. That’s the dumbest thing I ever
heard.
“Netflix,”
Pachter concluded, “is caught in an arms race they invented.” He
compared Netflix to a rat racing on a wheel, staying ahead only by going
faster and faster and spending more and more: As its costs continue to
go up, it needs to constantly generate more subscribers to stay ahead of
others.
And
if that doesn’t happen? If subscriber growth were to stall, for
instance, then Wall Street would stop treating it as a growth stock, and
its price would start falling. Slower growth would also increase the
cost of taking on more debt to pay for its shows. The company would be
forced to either raise subscription prices even higher or cut back on
those content costs or do both, which could slow subscriber growth even
further. Netflix’s virtuous circle — subscriber growth and content
expenditures driving each other — would become a vicious circle instead.
Five years
from now, will the networks have taken the steps they need to prevent
Netflix from dominating television? Will they have improved their
technology, withdrawn most of their shows from Netflix or embraced
streaming without sacrificing too much of their current profits? Or is
Netflix in the process of “disintermediating” them, offering consumers
such an improved viewing experience that the networks will instead be
pushed to the sidelines?
Matthew
Ball, a strategist for Otter Media, who writes often about the future
of television, thinks the latter is more likely. He says that today,
when you have a cable subscription, you have access to hundreds of
channels — in effect, they all share you as a customer. The cable bundle
puts you in a television ecosystem, and you flip from one show to the
other depending on what you want to watch. In the emerging on-demand
world, television won’t work that way: All the networks will have their
own streaming service and customers will have to pay a fee for every
one. The days when networks could make money from people who never watch
their shows will end.
One
consequence is that networks will have to have one-on-one relationships
with their viewers — something they have little experience with, and
which Netflix, with its ability to “personalize” its interactions with
its 81 million customers, has mastered. Another consequence is that as
streaming becomes the primary way people watch television, they are
highly unlikely to pay for more than a small handful of subscription-TV
networks. What they will want, Ball believes, is a different setup:
companies that offer far more programming than any one network can
provide. Netflix, clearly, has already created that kind of ecosystem.
“Netflix is ABC, it is Discovery, it is AMC, it is USA and all the other
networks,” Ball said. “Its subscribers don’t say, ‘I love Netflix for
Westerns, but I’ll go somewhere else for sci-fi.’ The old model just
doesn’t work in an on-demand world.”
In
this vision of the future, Netflix’s most potent competitor is likely
to be Amazon, which is also developing an extensive array of content,
including many of its own original shows. Early on, it, too, produced a
highly praised series, “Transparent.” It, too, has no allegiance to the
cable bundle. And it has the kind of revenue — exceeding $100 billion —
that neither the networks nor Netflix can approach. Compared to the
networks, Netflix may have an imposing war chest, but in a fight with
Amazon, it would be outgunned.
According
to Ball, what Netflix is counting on to maintain its primacy and to
start making big profits is “unprecedented scale.” That’s where the
effort to create a global network, the one that was announced in January
at the Consumer Electronics Show, comes in. In April, when the company
announced its first-quarter results, it said it had added 4.5 million
international subscribers. Yet success, and profits, are still some way
off, as Hastings is the first to acknowledge.
YouTube,
he notes, is available in more than 50 languages; Netflix can be seen
in only 20 languages. Netflix was primarily attracting people in its new
countries who speak English as it races to “localize” its service in
each country. Netflix is ordering shows with an international flavor,
like “Narcos,” but so far it has only a handful up and running. Netflix
wants to make “the best Bollywood movie that’s ever been produced,”
Hastings told an Indian publication; it wants to make Japanese anime; it
wants to make local films for every market; it wants global rights when
it licenses shows — something that, once again, contravenes Hollywood’s
conventional business model, in which rights are sold on a
country-by-country basis. The company still has much to learn about each
country’s quirks and tastes and customs, and it will be a while before
it can hope to earn a profit from its global customers.
To my surprise,
Hastings spoke to me about the current moment as a “period of
stability.” It took me a while to understand what he meant, given how
unstable the television industry seems to be right now. But Netflix has
spent much of its existence zigging and zagging, responding to the
pressures
marketplace.
“When
we were in the DVD business,” Hastings said, “it was hard to see how we
would get to streaming.” Then it was hard to see how to go from a
domestic company to a global one. And how to go from a company that
licensed shows to one that had its own original shows. Now it knew
exactly where it was going. “Our challenges are execution challenges,”
he told me.
Asked
what the competitive landscape would look like five years in the
future, he returned to the analogy he used earlier with the evolution of
the telephone. Landlines had been losing out to mobile phones for the
past 15 years, he said, but it had been a gradual process. The same, he
believed, would be true of television.
“There
won’t be a dramatic tipping point,” he said. “What you will see is that
the bundle gets used less and less.” For now, even as Hulu and Amazon
were emerging as rivals, he claimed that the true competition was still
for users’ time: not just the time they spent watching cable but the
time they spent reading books, attending concerts.
And
Hastings was aware that even after the bundle is vanquished, the
disruption of his industry will be far from complete. “Prospective
threats?” he mused when I asked him about all the competition. “Movies
and television could become like opera and novels, because there are so
many other forms of entertainment. Someday, movies and TV shows will be
historic relics. But that might not be for another 100 years.”
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As a Partner and Co-Founder of Predictiv and PredictivAsia, Jon specializes in management performance and organizational effectiveness for both domestic and international clients. He is an editor and author whose works include Invisible Advantage: How Intangilbles are Driving Business Performance. Learn more...
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