Opinion

Felix Salmon

The new dynamics of Netflix

By Felix Salmon
July 13, 2011

I’ve received some very interesting reactions to yesterday’s post on Netflix, including David Leonhardt reminding me about his profile of the company five years ago.

There are three parts of that article which are particularly interesting today. The first is the thesis that Netflix’s success is based in large part on a long-tail model.

Every day, almost two of every three movies ever put onto DVD are rented by a Netflix customer. “Americans’ tastes are really broad,” says Reed Hastings, Netflix’s chief executive. So, while the studios spend their energy promoting bland blockbusters aimed at everyone, Netflix has been catering to what people really want.

The second is the idea that the economics of Netflix were far from obvious:

The stock trades for about $27, down about $12 from its 2004 high. One fifth of its shares are on loan to short sellers betting it will fall further.

You can understand the doubts, too. At a time when cable and phone companies are running fat data pipes into homes, Netflix can seem a lot like the Sears catalog of the early 21st century.

And the third is the look forward to Netflix’s own streaming offering:

The company has been hiring engineers to build its own download site, which, with a familiar brand name and all that information about what people like to watch, may be formidable.

But it could be years — 5? 20? — before downloading approaches the size of the DVD business.

Netflix’s stock, of course, has turned out to be a veritable wonder over the past five years: it’s currently at $291 per share, more than ten times its level when Leonhardt was worried about its prospects. It turns out that while people were worried about Netflix at $27 per share when it was based on a long-tail model, they’re much more excited about Netflix at $270 per share when it’s based on a live-streaming model.

The people who still think of Netflix as a queue-and-DVDs site, I think, are a bit like the people who think of Amazon as a bookstore, or of Apple as a computer maker. The whole reason that Netflix is at $270 a share rather than $27 a share is streaming, and if you have a subscription-only account at Netflix, the famous queue, which I loved, disappears entirely.

The queue was a great way of putting together a list of movies you really wanted to see, and then going through them slowly, at your own pace. Sometimes certain movies weren’t available, but that was OK — there were always other movies that were available, and you knew that sooner or later the ones that weren’t available would show up.

With a streaming-only account, however, all of that goes away. Let’s say you’re having a dinner conversation about arthouse thrillers featuring an A-list actor and a much less well-known but very beautiful female co-star, where nothing much happens amidst lingering shots of beautiful scenery. With the old Netflix, you could put The Passenger and The American into your queue next to each other, and probably watch them back-to-back, if you had four hours to spare. With streaming-only Netflix, you wind up being faced with something unhelpful like this:

passenger.tiff

There’s no option to add either movie to your queue; instead, your only choices are to sign up for the DVD option at $8 per month, or to watch something completely unrelated. If and when Netflix does manage to get either of these movies into its streaming library, you’ll never know.

Which is one reason why Netflix is going to serve up many fewer highbrow films on instant streaming — that’s what happens when you kill the queue. The long-tail business model turned out not to be the salvation of Netflix after all; rather, all that matters is convenience. The Passenger‘s not available? Never mind, let’s watch Frankenstein Must Be Destroyed instead.

What does this means for the future of Netflix? Probably a small minority of arthouse types will defect to GreenCine, but they won’t be numerous enough that anybody at Netflix will care. There’s always a tension between quality and and convenience — Kevin Maney wrote a whole book about it — and there’s no doubt which one wins in the marketplace: convenience, every time.

Netflix got its toehold in the market by being more convenient than Blockbuster; it’s now doing to its DVD business what it initially did to DVD-rental shops. The wonderful long-tail qualities turn out to have been an incidental benefit more than a core value proposition. The streaming service will be the main part of Netflix; the DVD service will be kept on by the arthouse long-tail lovers who don’t go to GreenCine.

The big questions is what will happen to the people wanting to see blockbuster recent releases. Will they sign up for Netflix DVDs? Will they move to Redbox? Or will they just make do with whatever happens to be available on streaming? Any ideas?

Comments
18 comments so far | RSS Comments RSS

since this mornings email about the netflix price change, i’ve already updated my netflix subscription to reflect just the streaming option. I’ll be going to Redbox for the new releases, 28 days earlier than netflix may offer them…

Posted by 49erfan3381 | Report as abusive
 

First off, streaming-only, is out of the question, considering the lack of content.

If you go with Redbox combined with Netflix streaming, you’ll miss out on all those long tail flicks, while only marginally improving your access to new releases.

My guess is, it’ll actually become popular to go with Hulu+ and Netflix unlimited monthly 1-DVD at a time.

The 1-DVD allows you to keep access to the long tail and new releases, while the Hulu+ combines entire current season shows available in HD streaming, of which Netflix lags behind. Yes, you still end up paying the same amount as the proposed increases, but you’ve actually opened up your content choices by crossing platforms.

In the transition, I – along with a few others – will go to DVD-only plans like it was 2008, then eventually to the hybrid cross-platform, assuming we get past the Apocalypse intact.

Either way, I don’t see how Netflix is going to boost margins, not after the 37K+ posts on their blog and Facebook.

Posted by GRRR | Report as abusive
 

I, for one, have been a Netflix user for about two years now. The only reason I tried the free month in the first place was because of my curiosity about all-you-can watch streaming. It turned out that I liked the service so I kept it. Along with that came the DVD option, but in the 1.5 years that I kept both services (I recently switched to streaming only), I watched exactly one DVD from Netflix. Whenever I want to watch something higher profile, I usually just choose a pay-per-view option from my cable company but I choose this option once a month at the max.

That said, I rarely watch movies on Netflix streaming, either. The movie library simply stinks. At least when it comes to movies that two or more people can agree on. My wife and I have had numerous nights of trying to find a movie through the menus only to give up and watch cable. The catalog is geared toward young men which works for me when no one else is home, but never with company. This makes sense since the core Netflix audience is techie young men that own an Xbox or Playstation. Most other people I know think that “internet tv” equates to sitting in your office at your PC to watch television.

For my wife and I, the real value in Netflix has been the TV show catalog. We generally pick a television series that we’ve either never watched before or that we picked up late in its life-cycle, and watch nothing but that series from start to finish. This usually takes weeks.

So as you can see, the separation of services isn’t going to affect me at all. I’d be willing to bet that a fairly large majority are in the same boat that I am and that the number of defectors will be somewhat small. Now the topic of the UI changes, don’t even get me started on that…

Posted by spectre855 | Report as abusive
 

I’m cancelling the day before the new account hits my account, and I’m currently waiting on hold with Netflix to let them know how I feel.

I’ve been with Netflix for years and years (since 2004), and I’ve recommended Netflix to countless friends and family. And to now get an email announcing a 60% rate increase is just insulting. Only oil companies are so greedy.

Sure, I could just cancel the streaming or DVDs by mail (I use both), but with a 60% increase, I feel I have no choice to but take my business elsewhere on principle alone. I already use Amazon’s streaming and Redbox occasionally, and I will use them exclusively.

Posted by slmsvblr | Report as abusive
 

If you go the DVD route, you get to choose Hulu Plus or Netflix for your streaming needs at roughly equal cost. In a sense, separating out the variables gives Hulu an advantage.

Posted by Piesmith | Report as abusive
 

I don’t particularly like Netflix’s limited streaming options, but the price I’ve been paying for it seems trivial. As far as I can tell, Netflix is as bad with availability of major studio movies as with arthouse or foreign movies. That’s frustrating, but my queue is still absolutely full of movies I want to watch when I get the time. I’m satisfied with the service I get for the price I pay. (Maybe that’s because I never subscribed to the mail-order service in the first place.)

Posted by RobertWBoyd | Report as abusive
 

The problem with Netflix’ streaming model is the math. So they charge $8/month for unlimited streaming. Let’s say, the cost of the servers for all that streaming and storage capacity, is $1/month per typical user (I would bet it’s more than that, but let’s give them the benefit of the doubt). And let’s say their bandwidth costs are also $1/month per user (also most likely higher). If the average user watches just two hours/day of content (to justify the growth of Netflix we have to assume people will be getting more of their video entertainment from them instead of cable and DVDs), that’s 60 hours per month. Do you think the studios will license all that content to Netflix cheaply, like half hour shows for five cents each and hour long shows for ten cents each? or 2 hour movies for 20 cents? And if they did, that would leave no money for salaries, let alone profits. If you increase the number of hours a user watches netflix, it gets worse.

I realize bandwidth and server costs will decrease (although that is factored in for the near future), but usage will also increase, offsetting any reduced operating expenses per gbyte. Also, increased viewing will increase licensing costs.

Or does somebody at Netflix have a magic wand?

Posted by KenG_CA | Report as abusive
 

@Piesmith: I think it’s probably a matter of taste but I disagree with you that Hulu has an advantage. At one point, I subscribed to both services. I ended up cancelling Hulu. I feel that Netflix offers up most of the television content that Hulu does while also offering (an admittedly small) movie selection as well. That coupled with the fact that Hulu also serves up commercials, which I despise, caused me to choose Netflix over Hulu.

Posted by spectre855 | Report as abusive
 

Or will they just make do with whatever happens to be available on streaming? Any ideas?

___

Nope. I will eventually dump Netflix. I’m running out of things to add to the queues and they are removing the things I would watch on streaming faster than I can find anything to add. We don’t watch the “popular” dreck churned out by the studios like Attack of the Mutant Teenage Bride (god can’t beleive that anyone who watches that garbage is allowed to vote let alone breed!)

Right now I only have 83 titles in the DVD queue (only put the first title of a series in to keep it simple.) The Instant queue has about 80 titles that we have not yet watched – and over 120 in the ‘no longer available’ purgatory where Netflix removed them from streaming. They are removing movies from the streaming list faster than I add them.

Recently I had switched from the 3 DVDS + streaming to just streaming as a temporary thing as we are working our way through a BBC series that has 54 1 1/2 hour episodes on streaming and we only watch 3 -4 a week. When we finish that I will NOT put it back to the 3 dvds + streaming with its 60% price hike. I will switch back to the 3 dvds only ($16 a month and less than I paid for the 3 dvds + streaming) while we work our way through some things on that list. Then I will change it back to only streaming when there is a cluster of things I wnat to see ($7.99 a month.)

Good move Netflix. I will spend LESS with you than I did before.

Basically Netflix’s streaming list SUCKS! It keeps suggesting cartoons for us when a glance at what we have watched any fool can see are Masterpiece and classic movies. They are rapidly adding total dreck that appeals only to brain-damaged 13 year olds.

And Hulu is appalling – it is where horrible Grade D movies go to die. Won’t waste 10 cents on it. And I refuse to pay for cable for junk like the home shopping channels when we would only watch maybe 4 or 5 channels out of a list of 500+ (which is what I have to pay for to get 2 of the 4 we would watch.)

BTW, PBS puts the recent Masterpiece shows up on line after they have run and leave them available online for about a month. And then Netflix gets them in DVD…..why wait for Netflix,eh?

I NEVER ‘make do’ when a seller starts trying to offer me inferioe goods or services for the same or more money. I walk away.

ANd there are these marvellous things called ‘books’ if you want entertainment….

Posted by onthelake | Report as abusive
 

MSNBC offered some Netflix alternatives earlier today. An option is the TVDevo website which seems to run faster and it supports slower connection speeds. Also has worldwide channels that regular cable doesn’t offer at all.

Posted by JenniferWeb | Report as abusive
 

The long tail theory is a convenient justification for Netflix’ inability to acquire the rights to current movies or television programs available.

If they could and they were honest, they would say, like anyone else in the content business, that most people are only interested in watching content that they’ve already heard of, and that (as with news stories) movies and TV rapidly lose their value as they age.

The convenience factor is Netflix’ core strength, not content.

If for example, HBO went direct to consumer with its HBO Go product, which has an extremely impressive film library, it could be the big winner, though if Netflix remained focused on niche content it could still hold on to most subscribers.

Posted by David4321 | Report as abusive
 

Um, I don’t know why I would want to go with GreenCine, it costs as much as Netflix DVD only options, I don’t think it has better selection. I know Netflix works for me with two day turns for DVDs (one day there, one day back), plus I can get streaming.

My issues with Netflix have been the delays for new movies, but Redbox also has the same delays, these are studios deals so Netflix and Redbox can get discounts on discs. I guess a can wait an extra month since I wasn’t interested enough to see the movie in the theater anyway.

I suspect that I will go from my two at a time to one at a time to cut my costs, but I’ll be staying with Netflix for now.

Posted by BottyGuy | Report as abusive
 

One more thing which I like with streaming is the availability of Documentaries. I find myself looking for documentaries on specific subjects when I want to see what else I can learn in addition to what’s returned in a google search.
I do not think I will ever add documentaries which are not well known to the DVD queue.

Posted by pot | Report as abusive
 

I’ve been very happy with Netflix though sometimes it is a bit of a trial to find a movie I want to watch. Not crazy about paying another 6 bucks to keep DVD availability but I’ve stumbled across some really good series offerings that will sometimes throw a DVD only episode or two into the middle or end of the series. Hopefully, they’re taking that into consideration ?? Or not. More likely “too bad so sad-sign up for DVDs”.

Posted by SGinOR | Report as abusive
 

I’m a great devotee of Netflix and, especially of their long-tailed model. (I still have not forgiven Felix’s insult of a few weeks past directed at us long-tailers: “Essentially, people like to think of themselves as sophisticates who go to art-house movies, even if in reality they’re much more likely to sit slack-jawed in front of some reality TV show.” But I digress…)

I’ve been a member of Netflix for a number of years, and I have been a great admirer of their business model. More than half the movies on my queue (217 of 393) are Instant (streaming). I would estimate that fully half of the total have been recommended to me by Netflix. The predictions of films that I would like in their five-star rating scale are rarely off by more than half a star. They have suggested movies that I’ve never even heard of — and that I’ve absolutely loved.

In addition, Netflix is the only subscription service — heck, the only business — that has decreased the fee I paid with no decline in service, in fact, with an enormous increase in capacity when they began free streaming with any subscription.

I’m not an expert in movie distribution, but I do have a guess about what has happened to justify the sudden about-face, and rise in prices. Just a guess.

The DVD business is essentially a purchase-as-you-use operation for Nextflix. Whether they buy 1 copy or 10 or 100 depends on how popular they think the movie is going to be. Their efficient distribution service — and it is efficient — takes care of the rest. (Sometimes they even shipped me an extra DVD while I was waiting for a shipment from a non-local distribution center.)

Internet streaming is different. There are huge upfront costs to purchase an entire library of movies — present and future. And while Netflix was once able to exploit the streaming niche for its own profit — and subscribers’ low cost — movie studios have caught on. (Perhaps internet providers, as well?). It is because of these huge up-front costs that Netflix must have a huge price increase, I believe. As it turns out, subscribers are going to have to pay a chunk of change for the convenience (and) wide choice of a new delivery medium.

I’ve just come across a blog-post by someone who knows a lot more than I do, that says pretty much the same thing:

“Let’s use 60 percent as a generous estimate of the portion of the Netflix subscriber base that streams. Now, let’s assume that these users stick with streaming only at $7.99 a month. That translates into $1.3 billion in top-line revenue. Relative to the content, international expansion and, now, potentially increasing DVD delivery costs Netflix faces, that number represents a spit in the bucket. Just think about the hundreds of millions of dollars Netflix will have to dish out to renew the Starz (LSTZA) and Epix deals alone. And there’s no guarantee that the composition of what effectively will be a brand new subscriber base will end up split 60/40 in favor of streaming.”
http://seekingalpha.com/article/279146-a re-movie-studios-calling-netflix-s-shots

Posted by jbernar | Report as abusive
 

Felix – I think your point about the killing of the queue is an important one. Years ago, in a moment of pique, I cancelled my account. I thought I had backed up the list of movies on my queue, but I hadn’t. I was devastated and a few months later I returned.

Now, I know you can use countless other tools online to manage a list of movie titles, but really, are any nearly as convenient? Especially now that there’s integration like the Flixster iOS/Android app that lets you browse the week’s movies and throw them onto your queue.

So in that sense you can think of that $8 dvd option as more than just a vehicle to get hard-to-find movies. It’s also a means to keeping your queue alive in the spot it’s been all these years.

Posted by mentavlos | Report as abusive
 

KenG_CA is completely right.

In the beginning, Netflix was a marginal media purchase for movie buffs. Most subscribers got Netflix in addition to Cable TV, movie theater visits and DVD purchases so studios viewed this as marginal revenue. Now more and more people are replacing cable with Netflix subscriptions (myself included), movie theaters are needing to turn to gimmicks like 3D as home theaters improve and DVD sales are way down. The content producers are realizing that Netflix is in fact a direct substitution for other forms of media consumption rather than a marginal additional source of revenue.

Consumers seem to be spending about the same amount of time watching content, so for Netflix to be a good deal for the studios the Netflix content rights deal need to replace dollar for dollar the revenues from the other content distributors they are stealing eyeballs from. Movie theaters, DVD sales, iTunes Store and TV networks pay way more per viewer-hour (usually at least $1 per viewer-hour) than Netflix currently does (assuming at least say 3 two-hour DVDs and 6 hours streaming per month for $10), and thus the studios are missing out on this revenue.

Posted by TurtleBay | Report as abusive
 

As the COO of Fandor (a new streaming service for people who love great independent movies), we’ve been seeing signs of this change for over a year from Netflix’s behavior in the film acquisition market. About a year ago they started backing off on streaming licenses for independent movies, and about six months ago started curtailing their purchases of long-tail DVDs.

So Felix is right — and it’s now becoming clear to everyone the shift in Netflix’s business model to mainstream content (tv and movies) and away from long-tail (or even mid-tail) independent, documentary, and international films. It’s a sensible business move – for one reason, it lets them free ride on all the marketing dollars that Hollywood puts behind their content.

The Independent published a great interview with Netflix on this subject in January. (http://www.aivf.org/magazine/2011/01/ne tflix_distribution_independent_diy_filmm akers) They’re only interested in content with proven “queue demand.” Query what that means anymore if they’re moving away from the queue for streaming customers?

That’s fine with us — it creates opportunity for companies like Fandor to help out customers who are looking for interesting, thought-provoking movies beyond what Big Hollywood has to offer.

Our belief: on-line delivery is critical to the success of independent and international film because it directly attacks the biggest obstacles people face to discovering and watching those movies: easy access, risk-free exploration, and ability to spread the word about great movies via word-of-mouth.

That’s what we built Fandor to do. I invite your readers to check us out at http://www.fandor.com!

Posted by MontgomeryKosma | Report as abusive
 

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