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David Poland

By David Poland poland@moviecitynews.com

Delivelution 102411: Netflix Q3 Spells Out The Future

I am really digging the Q3 Investors Letter from Netflix. (The Investors Call this afternoon didn’t add much insight.)

Unlike most media, I don’t care about the subscriber downturn. It was inevitable and frankly, it could have been a lot worse… as Netflix says repeatedly in the letter. If you’re looking at quarterly subscriber numbers and even the projections vs the actual financial results, you are looking too closely, which is to say, myopically… which is to say, like Wall Street usually sees things.

I’m more interested in the key phrases that point forward…

“As of today, less than half of our streaming subscribers also subscribe to our DVD service, and we expect that number to continue to fall, given that only 7% of new streaming subscribers also currently sign up for DVD.”

READ: DVD is dead.. long live DVD. Fewer than 2.5 million of Netflix’s 23.8m subscribers are DVD Only. Just over 10 million get DVD & Streaming. And about 10 million more are now getting Streaming Only. When that goes to 1m DVD, 5m DVD & Streaming, and 14m Streaming Only, look for the return of Quickster.

“An Oscar‐nominated film may be of less value to Netflix subscribers than “Pawn Stars,” because subs are watching the reality show more than the Oscar‐nominated movie.”

READ: Yeah… we know that we have almost none of the Oscar-winners in our streaming library. But our subscribers are happy to watch reality crap, which has more library value in part because it hasn’t been so aggressively exploited.

“We have recently closed output deals with DreamWorks Animation, Open Road, and The CW, as well as an ongoing deal with AMC, all of which will provide a unique differentiator from our competitors in the years to come. As more movies come from “mini‐majors” like Open Road, Relativity and Lionsgate relative to the big Hollywood studios, Netflix members will enjoy a steady stream of great new films in addition to the hundreds of movies recently added from partners including Paramount, Sony, Miramax, MGM, Universal, and Warner Bros. In the next few weeks, the new Johnny Depp film “The Rum Diaries” and the epic action film “The Immortals” will open in theaters and be among the films available to Netflix subscribers exclusively in the pay TV window. Other recent films include “Drive” and “The Killer Elite.” Current box office hits like “Paranormal Activity 3” and “Footloose” will also be coming soon for Netflix subscribers.”

READ: We don’t have deals past the next 5 months with any of the majors except Paramount, through EPIX. And Relativity, which withholds streaming from their Home Ent and Distribution deals, and is releasing product through WB, Universal, and Sony. We have deals with the semi-defunct MGM and Miramax. And we have deals with Lionsgate (EPIX) and rising indies Open Road and Film District. And sorry to add a “the” to Immortals.

But we WANT you to think we are in business with all of the majors. (The only ones we didn’t mention are Disney, even though we are still streaming their product via STARZ for now, and Fox, who we’ve never been in business with.)

Soon, you’ll be able to watch Kung-Fu Panda and Shrek Forever After as many times as you like. You also better love Mad Men, The Walking Dead, The Vampire Diaries, and The OC, because we will be the streaming home of all that stuff you get for free. And those two Paramount movies we closed with… watch for them on Netflix next summer.

Netflix has about ten times the streaming content selection of full Starz, in terms of what consumers actually choose to watch.”

READ: Don’t cry about Starz. Only 10% of our streaming was their content anyway. Never mind that 10% of our streaming content costs are or soon will be more than the $350m a year for which we could have closed that deal. (We’re targeting that money on specific reruns.)

“Hulu Plus is harder to analyze because we think most Hulu Plus subs are paying to get current season TV content, which Netflix does not carry”

READ: Yeah… we know that most of the current TV content streaming on Hulu is NOT available on Hulu Plus. And Criterion? Fugeddaboudit. Thier pay business is a blip because their content that streams past the desktop is weak. We don’t have to worry about them until they get their crap together.

“After launching the UK and Ireland, we will pause on opening new international markets until we return to global profitability. We plan to do that by increasing our global streaming subscriber base faster than we increase our costs.”

READ: We are like a shark… keep swimming or die. We have to see if the UK and Ireland are an investment that pays off, as we have competition from the larger media businesses that are already more advanced than the outlets in the US.

“Our future is in rapidly expanding streaming, but we will make sure that current hybrid subscribers continue to get a great and STABLE experience.” (my caps)

READ: DVD is dying… but perception means keeping it going. but we’re not going out of our way to improve your DVD experience anymore.

“We think DVD subscriptions will decline sharply this quarter, as reflected in our guidance, due to our price changes. Our weekly rate of DVD cancellation is steadily shrinking, as the price effect washes through, and in future quarters we expect DVD subscriptions to shrink more modestly. We don’t anticipate any additional material investment in equipment or other PP&E and a majority of our DVD library is fully depreciated; so at $7.99, the segment is profitable. We have yet to decide whether or not to offer video game discs. The decision will have little financial impact either way.”

READ: We’re done investing in DVD and we don’t really see a future in hard discs for video games. But we’re still making a few bucks, even though subscribers are dropping like flies.

“Overall for the quarter we expect slightly negative streaming net additions. Streaming hours are continuing to climb, as members who use streaming mostly stay with Netflix streaming. Our streaming hours year‐to‐date are up over 3 times from a year ago, and set new records most weeks.”

READ: People who are staying are using the service a lot. But some are losing interest in our product. (And please don’t look at the internet use caps that are standing over there behind the curtain.)

“We’ve been aggressively increasing our content spending, and in 2012 will nearly double what we’ve spent this year, putting us almost at par with what HBO, the biggest of the premium TV networks, spends in the U.S. and making the range and quality of content on Netflix the best it has ever been.”

READ: In just 3 years heavily in the streaming business, we are now spending as much as HBO took 30 years to build to. (What we’re not telling you is that they own much of their content and control it… and we own and control almost none of ours.)

“In television, by contrast, the networks (ABC, FX, etc.) have long relied upon exclusive content to differentiate among themselves. As video moves online, so too has this practice of exclusive content. HBO has an exclusive license to recent Universal movies that includes its online HBO GO, for example. Netflix has signed exclusive licenses for DreamWorks Animation, for Relativity, and others. In episodic television, exclusives are also the norm. Netflix doesn’t license “Deadwood” from HBO because they see strategic value in keeping it exclusive. Netflix licenses “Mad Men” and “House of Cards” exclusively for much the same reason.”

READ: We have spent a lot for non-exclusive content, but we are coming to understand that exclusivity is how we have to move forward. Don’t think about the fact that this means that we will be have less and less non-exclusive content in the years to come. Watch more Mad Men!

“We have dramatically more content than any other subscription service or network, but given the existing licensing structure of the cable network industry, the total content available will likely remain carved up between Netflix, Showtime, HBO, Hulu and others. Two services can license jointly, or from one another, like Netflix and Epix, where it is in their mutual interest, but to date that has been the exception rather than the rule.”

READ: These streaming deals in which a pay-tv service is the middle man between a streaming company and the content rights holders are about over. With real money in play, why would Disney or Sony need a middle man? Right now, we have dramatically more content available, even in streaming, than any other outlet. But that is going to continue to change, not in our favor, as these other streaming businesses continue to grow.

“While we and our competitors face the constraints imposed by the traditional licensing structure of cable, we have many advantages over linear premium pay networks. We are unbundled, and charge a very low price of $7.99 a month. We are pure on‐demand so we can create more compelling user experiences than a primarily linear channel. We are personalized, so each user interface is tailored specifically to the individual taste of a given consumer, helping them to easily find movies and TV shows they’ll enjoy. Finally, we can innovate at Internet pace rather than cable‐set‐top‐firmware‐update pace.”

READ: We see not being part of a bundle as an advantage (for now), as people see the 8 bucks a month as a different buy, not another addition to a big burden. With all of our streaming content being on demand, we see our experience as superior. And we can change faster than others (though change hasn’t gone so great lately).

Think of HBO as the smelly cheese section of Whole Foods, where the prices are even higher than the rest of the overpriced food… and us as Costco.

“Any given consumer will have only one of DirecTV or Comcast, say, for their video service. That is classic either‐or competition. But with premium television networks like Netflix, the more good experiences there are, the more consumers are willing to spend to have multiple channels from which to get enjoyment.”

READ: Again, we don’t see our business as competitive, but as a “multiple channel” addition to the entertainment pallet.

“We offer significant value to the television licensing ecosystem by creating additional revenue in the prior season window for networks, which allows them to invest in additional first run content”

READ: Netflix is good for the studios because we pay them well for old stuff too. So they shouldn’t fear us… even if they also own the cable companies with whom we are pretending not to want to compete.

“We won’t have every movie or TV series; but we do provide enough value that consumers also want to subscribe to Netflix.”

READ: Yeah… we don’t have everything. But you should be happy with what you get for 8 bucks a month.

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16 Responses to “Delivelution 102411: Netflix Q3 Spells Out The Future”

  1. Direwolf says:

    “These streaming deals in which a pay-tv service is the middle man between a streaming company and the content rights holders are about over. With real money in play, why would Disney or Sony need a middle man?”

    Good stuff, DP. Regarding the above quote,Starz is already trying to go with originals but what do you think happens with the rights they own for films from Disney and Sony in the pay window that goes out to 2016 I think?

  2. David Poland says:

    I expect that the pay-tv window will continue to exist and that streaming deals will be done separately… though both of these companies should be going rogue.

    Sony should be starting the PS3 Network… or something like that… which marries their library with their hardware (finally!) but also pushes the hardware as the ultimate set top box. They’re already going in that direction with the PS3 in terms of bringing on all the different streamers. They even created a new section for streamed content on the boxes software system.

    I expect Disney to create the Disney Everywhere Experience by 2016. $25 a month every month and you get special access across the brand spectrum to all devices. $40 a month and you get 2 DVDs/Blu-rays sent to you every month. Something like that.

    Warners is already heading down their own track.

    Fox tends to be a slow starter, but a fast player once they start rolling.

    Comcast is a real mystery at this point. And will they get into regulatory problems if they get too clever?

    Paramount is stuck in EPIX for now… but I think that will end with the end of the Netflix deal. The cable net is a non-starter. They are profitable on Netflix alone. Viacom can do better and will have other examples to look at by then.

  3. movieman says:

    When I first signed up for Netflix many years ago, it was an automatic given that virtually any new release I was interested in would be available to subscribers on the official “street date.”
    Not any more.
    Now it seems that half of the new releases in my queue routinely have their “Netflix availability date(s)” staggered by a month or longer. Everything from “Terri” to “Nutcracker 3-D” (yeah, I’m a completist; shoot me). And don’t get me started on “A Serbian Film” which Netflix listed as “unavailable” a month before the release date (!?)
    Amazon.com lists “Trespass” as a November 1st r/date, yet it’s still at the bottom of my N-flix “saved” queue with no mention of an availability date.

  4. Jason says:

    DP, would netflix have fared better if they had continued down their original path – offering all content, at the normal release date, via DVD and then trying to convert to streaming? It seems like netflix jumped the gun on streaming and now it is burning them (having to sacrifice content to make streaming available). I agree with Movieman, I was in it for netflix for getting all my rental options. DVD via mail wasn’t so bad. I would be on-board with converting to streaming if it didn’t mean sacrificing content. I wonder if netflix would be better at the behemoth “rental” place instead of just being a niche streaming option competing with HBO2Go and every other option.

  5. Direwolf says:

    What about Starz, DP? What do you think happens to the streaming rights they now control until they expire?

  6. JKill says:

    Movieman, TERRI is a lovely, very human movie, and I think it’s better than the director’s last work (the also strong) MOMMA’S MAN. I rented it at Blockbuster, where I think Fox (who has the DVD distribution rights) has an exclusive deal.

  7. movieman says:

    No Blockbuster (or Hollywood) Video in my town, JKill, so I’m pretty much at the mercy of ‘flix for non-blockbuster mainstream titles (which is pretty much all the Redboxes near me stock). They did finally commit to “a” release date, however. “Terri” is going to be available to subscribers beginning November 8th. Huzzah, huh?
    (Yeah, I was a big fan of “Momma’s Man,” too. And sure wish that more of Poppa Ken Jacobs’ stuff was available on dvd.)

  8. The Future says:

    That’s why there’s “MIXVID” free movies free games free music no hassle.

  9. hcat says:

    ” we know that we have almost none of the Oscar-winners in our streaming library. But our subscribers are happy to watch reality crap”

    They certainly are, are you suggesting that people are just streaming reality tv because they don’t have access to 27 Hours or Black Swan? It seems to me that Netflix has made clear decision not to go broke by overestimating the taste of the american public. The television deals provide a lot more hours of content than the movie studio deals and a large section of their subscriber base is more than happy to spend their downtime going through older shows. The Streaming is supposed to be a competitor with cable, the vast majority of cable is reruns of popular content, so providing one stop shopping for these reruns should be an effective way to compete.

    As for the Epix deal, yes they paid too much, but again unlike starz they were dealing directly with the studios for the content and not some middle man. If Epix does prove to be too much hassle for the studios to continue (which may be the case given how little new content it gets and since it doesn’t have nationwide distribution yet), isn’t it likely that Paramount and Lionsgate then move into a relativity type deal with netflix?

    “Yeah… we don’t have everything. But you should be happy with what you get for 8 bucks a month.”

    Damn right. For the cost of a movie ticket you get access to a huge variety of content, and not beholden to a cable programer’s schedule. Sure part of the price means the programming is at least a year old, but the low price does mean that you can afford to supplement it with things from Amazon or Redbox for things you are willing to pay more of a premium for.

  10. Paul MD (Stella's Boy) says:

    I’m with you hcat. I am extremely happy with what I get for $8 a month. Sure I wish there was more, but having access to lots of good movies and TV shows for that monthly price is great. I’ve watched 2+ seasons of Friday Night Lights and the first season of Luther. I’ve watched a ton of great horror movies. And a few times a month I use iTunes for a movie or TV show. I’m a satisfied Netflix customer, all things considered.

  11. hcat says:

    There is an audience for cable, and an audience for Netflix, in a lot of cases this will overlap with people who will have both services. As streaming becomes more prevelant, older audiences, who watch a ton of television, will come on board and increase the subscriber base. The DVD will be sold or dropped in a few years as David predicts because while still profitable, it will be more of a distraction from the streaming business, and customers will be able to supplement their rental needs through redbox or elsewhere (we still have a thriving brick and mortar rental company in the midwest called Family Video).

    All Netflix is doing now is ensuring their future. Overpaying for content to prevent others from starting up and keeping the content providers happy.

    The web is still pretty much the wild west for the movie and television studios, there is no way to tell how and where the chips are going to fall, and with a slight kerfluffle over the name change they have treaded these uncharted waters quite well.

  12. Mike says:

    I’m with hcat and Paul on the value for $8.

    I think it’ll be interesting to see if Netflix’s experiment with original content (the Kevin Spacey show)ends up paying off. If they had their own exclusve content (like HBO), it might change the perception that they can’t stand on their own if the studios make their own streaming sites.

  13. hcat says:

    I don’t know what ‘stand on their own’ would look like.

    They need to prove to the movie studios that they’re a better, more profitable, distribution channel than the studios themselves would be. The worst idea is each studio streaming their own content exclusivly so people would need to plunk down 8 bucks per studio, plus sports leagues, scripps, etc. Disney can go it alone due to nature of their unique branding and audience loyalty, but it would be harder for Paramount or Universal to attempt their own streaming networks. Just as not every studio created their own HBO, I can’t see every studio creating their own Netflix. Now Netflix just has to make the case that they can provide more value than any competition.

  14. Mike says:

    hcat, I hope you’re right, and that Netflix can become big enough to be the hub for all the studios (essentially what my cable company is for the channels now), but Dave’s thinking doesn’t seem to suggest it, nor do I think the majors want Netflix to get that big. Eventually there will be some company that all the majors own a piece of (hopefully better than the networks do with Hulu) that will give you access to everything in one spot – it just won’t be Netflix.

    I think Netflix has to be looking at a world where they don’t have any of the majors, or at least not anything new and exclusive, from the majors. That’s another reason they’ve been smart to go after tv.

  15. JS Partisan says:

    The Future… what in the h? I mean that seriously. That’s ridiculous.

  16. Krazy Eyes says:

    I’m a little late to the discussion but I’m interested in why Netflix was 100% behind adding video games when it was going to be Qwikster but now that they’re keeping the companies together they’ve backpedaled on video games?

    Was it a good idea or not?

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