How the movie studios caused Netflix’s problems

By Felix Salmon
July 15, 2011
Adam Knight has a smart take on why Netflix is unbundling its DVD service from its streaming service:

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Adam Knight has a smart take on why Netflix is unbundling its DVD service from its streaming service:

The Internet’s memory is short so let’s go back a week ago to when Netflix lost the Sony movies and almost lost Starz. Why did that happen? Netflix WI subscribers passed a certain number specified in the contract with Starz and Sony and so they lost the right to stream that content. After some talks they came back online and now, one week later, Netflix is breaking apart their WI subscribers from their DVD subscribers. I find it hard to consider this a coincidence.

Having a ton of DVD viewers that are not using WI artificially inflated their WI subscriber numbers and almost invalidated a content contract. The only way to lower that number is to remove their access and only let people that want WI subscribe to it and pay into the service. So now WI isn’t a bundled service but one you ask for and pay for. This way, Netflix lowers their perceived WI subscriber count, keeps their content deals without renegotiations, and generally carries on.

This is all incredibly similar to the debate over cable-TV pricing, where the status quo is that you pay a flat fee for a bundle of channels, and there’s a vocal constituency — in which I include myself — saying that we should move to an a-la-carte pay-only-for-what-you-watch approach.

Netflix has always been about convenience, and a flat monthly fee, buried on your credit card statement somewhere, is certainly more convenient than paying for movies one at a time, as you have to do on say iTunes. But just because Netflix charges consumers on a flat-monthly-fee basis doesn’t mean that’s the best way for it to make deals with movie studios.

Up until now, it seems, Netflix has paid the studios a flat monthly fee, linked to the number of subscribers it has with access to their content. And when that got too expensive, it wound up cutting off streaming from its DVD subscribers to save on its own library-subscription costs.

Netflix paying a flat monthly fee for a bundle of movies is a bit like a cable-TV subscriber paying a flat monthly fee for a bundle of channels. The idea is that you pay the same amount each month whether you actually watch any movies or not; people who only use the DVD service and who never use the thrown-in streaming service are still very expensive for Netflix. (This is a big departure from the old business model, where people who barely used the DVD service were Netflix’s most profitable customers.)

It makes sense, under this model, for Netflix to unburden itself of DVD customers who barely stream any movies but who still cost Netflix itself lots of money in subscription fees. But that just means that everybody would be better off under a different model — for instance, one in which studios got paid every time one of their movies was streamed. (That kind of system would also be wonderful for independent filmmakers, who could upload their movies to Netflix at no charge and then get a stream of payments as and when Netflix’s subscribers started watching their film.)

Such a system would probably be better for the movie studios, too, since it would align their incentives with those of Netflix: they would get more money when people watched more movies and used Netflix more. As the studios and Netflix teamed up to persuade people to stream their movies, everybody would win.

So why isn’t this happening? Because the media business is calcified, and has to be dragged kicking and screaming into any kind of new business model. The studios have a reliable revenue stream from Netflix right now, and they have no real incentive to swap that for something less reliable, even if that would make them more money. It’s short-sighted, but Netflix certainly doesn’t have the power to make them change their minds. And so we end up with Netflix removing the streaming option from a large proportion of its subscribers — something I’m sure it absolutely hates to do. People are blaming Netflix here, but it’s surely more likely that the real villains of the story are the studios.


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While the studios are certainly responsible for the poor streaming options available to everyone, I don’t think it’s fair to call them the villains in this case. Netlfix started with a totally unsustainable, unscalable, and unfeasible business model, and it was destined to fail when they signed up enough streaming subscribers. I don’t know if Netflix never did the math, or did and hoped they could continue to get great deals from the studios, but given the prices that the studios normally charge for viewing their TV shows and movies, there is no way that Netflix could keep them and the subscribers happy, and that is their own fault.

That being said, the studios have objected to and tried to block television, then VHS, then DVDs, and yet every one of those new technologies increased the size and profits of the industry. They are now at war with the Internet, demanding all kinds of special treatment from the government at the expense of the rest of society, because they are too stubborn/ignorant to look outside of the business models they have utilized for the past decade or so. They think they have a reliable revenue stream from Netflix, but that’s only because they are incapable of understanding the implications of technology and cannot grasp the always-morphing habits of today’s viewers. The canary in the coal mine for the studios on DVDs should have been the decline in sales of them, but they insist of sticking with a soon-to-be obsolete distribution system. The only thing that has saved them from the file swapping that almost killed the music industry has been the greed and incompetence of the management of the broadband industry, for if the US had internet speeds like, say, South Korea, every title that was available for rent on netflix would be on P2P networks within hours.

Posted by KenG_CA | Report as abusive

I’m skeptical, primarily because Netflix maintains the analytical firepower to split out streaming and DVD subscribers to a much finer degree than intimated here. It may be the case that contracts as written used top-line subscriber data for thresholds, but as those contracts get renegotiated I think Netflix would have moved aggressively to supply more fine grained data.

Posted by Adam_Hyland | Report as abusive

I still don’t get why this is supposed to be such a terrible thing, that Netflix has done. I’m now paying $3/month LESS for my DVD service, since I no longer have to pay for their lousy streaming service, which even when I had reliable 6MB/s downloads in Mountain View, would have issues sync’ing audio to video, and frequent pixelization artifacts.

Posted by Auros | Report as abusive

I’m not sure that the studios caused netflix’s problems so much as netflix’s own success. Blockbuster and MovieGallery both went belly up due in large part to Netflix.

Studio’s have seen the physical rental market implode, and the physical dvd sales via retailers like WMT, TGT, & BBY dwindle. Also after comcast bought NBC you’ve got two of the largest content creators captive to cable companies who need to justfy their monthly fee to subscribers. For all the griping about NFLX’s increase it’s still what 1/4th the cost the basic family package for CMCS or TWX… that sounds like a deal to me!

MagicJack, DSL & NFLX streaming total = $45/month total and they work pretty well in my state, which is the most rural east of the mississippi. That’s 1/2 the cost of the cheapest promo rate on a tripple play bundle from any provider.

In the give and take battle between consumers and big media consumers are now winning in a rout.

Posted by y2kurtus | Report as abusive

I think the reluctance to change business models is mostly due to differing pricing expectations and uncertainty in their growth along with the fear of loss of control. It wants to maximize profitability more than profits, that is why it is more concerned with losses than gains.

Posted by MyLord | Report as abusive

I suspect that flat-pricing works rather better than a pro-rata model with respect to maximizing our enjoyment of our purchases. With a flat model, you swallow a monthly payment which is one ‘ouch’, but after that everything you use is ‘free’ allowing us to delight in it far more than if we paid for the individual item.

Of course, this is an irrational illusion, but that doesn’t make it any less real in terms of how happy it makes us.

Posted by TomWest | Report as abusive

What a coincidence, the streaming service has been down for most of this evening. Way to show everyone why they should now pay 60% more.

Posted by spectre855 | Report as abusive

I suspect the studios are quite keen to balance out their performance-based cinema revenue with revenue from other channels that is uncorrelated to whether anyone likes their films.

This must be one of the key benefits of TV deals for the studios – that it lets them use their market power and distribution control to guarantee revenue streams for films which might not otherwise get any. I assume this helps them sign stars (effectively by providing minimum guarantees) and maybe even to make films which might not otherwise get made.

Posted by LeighCaldwell | Report as abusive