Kate Bulkley, Media Analyst.

Netflix: rise of a pay-TV minnow

By Kate Bulkley

Broadcast News

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For Broadcast June 16, 2011

After more than doubling its subscriber base to 24 million, moving into online streaming and original production, US-based Netflix has set its sights on the UK

Just two years ago, Netflix was a blip on the horizon of the pay-TV landscape. It was a US-only, DVD-by-post service with 10 million subscribers that was moving slowly into streaming some of its films and TV shows on the web. If anything, Netflix was a niche distribution platform for Hollywood studios, not a company that turned many heads.

Now it is dominating web activity in the US and has one eye on taking on Sky, LoveFilm and Blinkbox in the UK.

The growth of the 14-year-old California-based company in the past 12 months has caused anxiety among some of the biggest Hollywood studios and US pay-TV operators. Its subscriber base has more than doubled in two years, from 10 million in early 2009 to nearly 24 million today, putting the service at nearly the same size as Comcast, the biggest of the US cable operators.



Netflix’s online streaming business is growing like crazy and it has signed deals for several new programmes, including the exclusive streaming rights to all seven planned seasons of Mad Men. UK shows on offer include blockbusters such as Primeval, Downton Abbey, Sherlock and Luther. It has successfully moved into Canada and Latin America is on its radar, alongside several markets in Europe, including the UK.

And it is making deeper in-roads: it recently took its first steps into original TV programme production, outbidding HBO to signifi cantly underwrite a new 26-episode adaptation of BBC drama House Of Cards, which will star Kevin Spacey.

Netflix’s rapid move from the edges of pay-TV to centre stage accelerated after last year’s $900m five-year deal with Paramount Pictures, MGM and Lions Gate Entertainment for the rights to stream their films. Hollywood studios and big pay-TV operators began to reassess how to work with the new kid on the block as subscribers flocked to the service and it began to grow its share of online movie and TV streaming.

By the end of March 2011, some 60% of Netfl ix’s 23.6 million subscribers were streaming content.

That same month, two of Netflix’s biggest content providers changed the terms of their deals. CBS removed all first-run programming such as Californication and Dexter from the Netflix streaming service. Meanwhile, Liberty Media-owned Starz, riding high on its 2010 hit Spartacus, put in place a 90-day delay between the first broadcast of its shows on its affi liated pay-TV channels and their availability on Netflix.

But Netflix surprised everyone with its move into original production, with first-run rights in the US and possibly several other territories.

In a presentation in London in March, Netflix vice-president of business development Bill Holmes underlined the company’s aggressive growth strategy. He admitted that Netflix is seen as a threat to existing VoD services because of its availability on a wide variety of connected-to-the-internet devices, from TVs to tablets and games consoles.

“Partners use Netflix to sell products. That is why they want to partner with us. Netflix communicates connectivity,” Holmes told the audience. “It is a great way for partners to headline an entertainment device message and drive consumers to connect.”

In May, analyst Sandvine reported that Netflix accounted for 29.7% of all peak downstream online traffic in the US and is now the largest source of US internet traffic overall.

Suddenly, broadcasters that had been at best ambivalent made moves to embrace Netflix. CBS chief executive Les Moonves told analysts in May: “It’s great to be in business with them and they are terrific.”

The same week, Time Warner chief executive Jeff Bewkes, who once likened Netflix to “a small Albanian army” unlikely to conquer the world, said it was a “welcome addition” to the video market. In recent months, Warner Bros, Lionsgate and Miramax have all signed up, with studios eager to find distribution partners to take advantage of any new revenue streams arising from digital syndication.

However, in his opening keynote at Banff this week, Fox co-chairman Gary Newman said that while Netflix would soon be an equal player in the syndication market, he doubted its ability to launch original programming.

International rollout

Internationally, Netflix plans to launch online-only services, and after winning over Canada - 900,000 subscribers in just nine months - it has proven it can create a sustainable business without a physical DVD operation as an anchor.

Maybe Canada was an easy win given its proximity to the US, and acquiring North American programme rights is not too difficult. But chief executive Reed Hastings clearly sees Canada as only the first step in an ambitious international rollout plan that could add two international markets per year from 2012.

When asked at last month’s D9 conference in California about the speed of the international rollout, he said: “It depends how well it goes. We tell investors that the better it goes, the more money we’re going to lose, because we’re going to invest faster. It takes one to three years for a new country to get profitable. In Canada, we’re going to get to profitability, we expect, within one year of launch, which is extraordinary.”

Latin America, particularly Brazil and Mexico, is likely to be next. And “very significant-sized” Netflix teams are in Europe at the moment deciding which markets present the most potential. “They are in serious negotiations with several studios for several markets,” according to a source familiar with the company’s plans. On the shortlist for European launches are the UK, Germany and Spain.

“If Netflix arrives in France, Germany or the UK tomorrow and it asks Hollywood for certain rights, it will face a lot of competition and will have to pay big minimum guarantees for content,” says Francois Godard, of Enders Analysis. “It will compete with Sky in Germany and the UK, and with Canal+ in France. The maths for Netflix mean it will have to pay substantial money up front.”

This is probably true, but according to people familiar with Netflix’s plans, the company is prepared to spend “billions” on programming and marketing in Europe to be successful.

In the UK, which not only has a strong pay-TV business but also competitors to Netflix such as Amazon-controlled LoveFilm, there may still be ways to make Netflix work, because the studios are keen to have a strong competitor to Sky. Some studio deals with the pay-TV giant are up for renewal at the end of this year, giving Netflix an opportunity to secure rights.

In addition, the UK is keen to make fast broadband a near-term reality, which would open Netflix to a larger group of potential users. And in economically tough times, big, free-to-air broadcasters are buying less from the studios, particularly films, and in some cases are relegating them to their digital channels, giving Netflix another possible opening.

It won’t come cheap, but one source close to Netflix says the company could be prepared to spend £50m to launch its proposition in the UK alone.

And if Netflix stays true to its US model of a low monthly, all-you-can-consume streaming price of, say, £10, it will be attacking not just LoveFilm but also Blinkbox, recently bought by Tesco, much more than the expensive pay-movie propositions offered by Sky. This has been its modus operandi in the US as well: focusing on TV re-runs and not attacking cable TV subscriptions head on. Nevertheless, HBO and Showtime are still wary of selling their product to Netflix.

And, of course, the other big differentiation point is original programming. Netflix has only just dipped its toe into the water with House Of Cards, but given its share price multiple and its ambitions, it is not such a leap to see the company putting more money into original content sooner rather than later.

“At some point, Netflix will have to choose to become a competitor to HBO or a re-run service with maybe one or two original productions a year to help with its marketing,”says Godard.

For now, it looks like Netflix is happy to stay squarely between these two extremes and see how it goes.

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