5 Threats That Could Kill Netflix

If you've been following along this week (here, here, here, and here), you'll realize that I'm a long-term bull on the prospects of video-content provider Netflix (Nasdaq: NFLX  ) . Besides David and Tom Gardner -- who have both named it a core stock for Motley Fool Stock Advisor subscribers -- I'm probably the strongest bull for Netflix at The Fool. Certainly more so than several other analysts here at The Fool (link opens an MP3 audio file).

Even the strongest supporter, however, cannot ignore the challenges a company faces. How these and Netflix's responses play out over the next few years will determine the fate of the company and any investment in it.

TV Everywhere
If News Corp. (NYSE: NWS  ) , Time Warner (NYSE: TWX  ) and others make more on-demand content available and make it more customer appealing, then it's possible that fewer people would pay for supplemental service such as Netflix's, despite needing to be a cable subscriber to access TV Everywhere.

However, making this happen successfully requires a bigger shift in thinking than many executives seem to be capable of. Television entertainment would not be the first industry where the old guard couldn't change rapidly enough to handle an upstart. Time Warner's CEO Jeff Bewkes seems to be a case in point, calling Netflix a 400-lb. chimp and comparing it with the Albanian army. In a recent CNBC interview, Netflix's CEO Reed Hastings politely said Bewkes was joking and then proceeded to produce a set of "Albanian army" dog tags, pointing out that he and his team are willing to work harder.

Hastings said Netflix is "focused on making our service better and better. And that's more content, better personalization, better U.I. ... 'Cause the better our service is, the more our consumers will love us."

Other subscription services
Hulu Plus and Amazon.com's (Nasdaq: AMZN  ) Amazon Prime are what's out there now, but they aren't perfect. For instance, Hulu Plus still has advertisements. Dish Network (Nasdaq: DISH  ) has acquired Blockbuster and will likely use that brand to roll out some sort of streaming service. So far, though, according to Goldman Sachs' recent upgrade, the competition is "underwhelming."

In order to effectively compete and acquire content so that subscribers would be willing to stay, any competitor would need to know in depth what its customers watch or use the "spaghetti" model I described previously. Netflix has a 10-year head start in collecting this information.

ISPs, usage caps, or throttling
ISPs can impose usage caps, charging $1 or more per gigabyte above some limit, even though marginal costs are very low. In fact, this is a problem in Canada. Netflix's solution was to lower the video quality some so that customers were less likely to exceed their caps.

I would expect, however, that customers will push back against such charges. And if Google's (Nasdaq: GOOG  ) experiment in Kansas City on really high bandwidth succeeds, competition will eventually drive those usage caps into the dustbin of history. Netflix is further prodding customer pushback and competition by publicly pointing out the actual throughput speed for the various ISPs.

Another problem arises if ISPs charge Netflix for the right to pass along data to the customer, even though Netflix already delivers the data to the "front doors" of the ISP. This already happens with some ISPs. Or, ISPs could selectively slow or block Netflix's data (or favor others preferentially) or get Netflix to pay to avoid a slowdown, which would be akin to extortion. Netflix is arguing vociferously that, "[ISP] customers already pay them to deliver the bits on their network, and requiring us to pay even though we deliver the bits to their network is an inappropriate reflection of their last mile exclusive control of their residential customers." This issue might end up in the courts.

Advertising-supported content
If targeted ads become successful enough so that Google and others are paid more than they currently are, then free, ad-supported content could become the dominant Internet video model. Personally, I find targeted ads a bit creepy. Besides, one must ask how many people would willingly sit through advertisements, even well-targeted ones, just to save a few bucks per month, especially when the option is to be freed from the tyranny of commercials.

Interesting factoid: I like the old Perry Mason episodes from the 1950s and 1960s; these are 52 minutes long, leaving eight minutes for advertising, which, of course, Netflix doesn't have. When I watch the more recently produced The West Wing, however, the episodes are only 42 minutes long, leaving 18 minutes for ads. Not having to watch even more ads makes me ask "Why should I go back to advertiser-sponsored fare?"

Cheaper content
Pay-per-view for movies or TV seasons could be consistently priced at $1, instead of $2 to $10 (or more). This might be cheap enough to shift subscribers away from Netflix in large enough numbers to hurt. However, the "all you can eat" model Netflix uses -- for less than the price of many single movies -- is very appealing.

In the end, of course, there will be more than one successful model. I fully expect Netflix to be one of the major players for years to come, overcoming challenges as it has in the past.

Google is a Motley Fool Inside Value recommendation. Google is a Motley Fool Rule Breakers selection. Amazon.com and Netflix are Motley Fool Stock Advisor recommendations. Alpha Newsletter Account, LLC has bought puts on Netflix. The Fool owns shares of Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Fool analyst Jim Mueller owns shares of and has an option position in Netflix along with owning shares of Amazon. He works for the Stock Advisor newsletter service.


Read/Post Comments (4) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 30, 2011, at 7:37 AM, mrcoffeeny wrote:

    I tried NFLX.......the quality of the films are noticeably poor. I like good quality picture. Might be a good stock, but yuck on the streaming.

  • Report this Comment On April 30, 2011, at 10:56 AM, racchole wrote:

    If you are caught up on the quality of the movies, then you are a typical spoiled American. I've never had a bad movie experience on Netflix because of the video quality. Then again, I am the type of person who likes movies with subtitles.

    Netflix streams you a ton of movies for $10 a month. Compare this to your options: 1) Go out to the movies, and spend $40 on one show; 2) Go out to a store and rent a movie for $2 a pop; 3) Unlimited movie downloads from "sharing" sites for a low price.

    If you don't feel like "breaking the law," Netflix is actually a godsend for movie-lovers, and the increase in stock price over the last 5 years shows that. What happens to Netflix in the future is on the top of my intrigue list. I own shares.

  • Report this Comment On May 02, 2011, at 2:36 PM, WhiteHatBobby wrote:

    Subscriptions will likely go down in the future as NFLX has made a change in philosophy that will hurt it.

    I agree on the picture quality. Netflix's 240/360/480 has even won the picture war against Blu-Ray's 1080i, so we see how convenience has replaced quality in many instances.

    NFLX is a tertiary video provider (since the studios won't allow them to have movies until a month after their release) The major change is as NFLX goes to a primary provider with their own television shows is it will require a huge hike in the per-subscriber rates, something that has affected cable. If NFLX will go into the HBO / Showtime type of programming, their costs will go to $30-$40 per month in order to pay for higher per-subscriber fees to produce the programming at minimum.

  • Report this Comment On May 10, 2011, at 1:29 PM, mc086249 wrote:

    I love Netflix and I have been with them ever since Blockbuster tried to mess with me over some late fees!! I find Netflix refreshing and I dont have to worry about sending my DVD back within a time frame, and I also have a wide variety of movies i can watch from all over the world!! and my monthly fee is very low, and since I am a patient person, I can wait for the movie to come out on Netflix and If I cant wait, I can go to Redbox and get it for $1. The only thing I might not tolerate is commercial Ads. I will absolutely not pay a monthly fee and still have to deal with Ads!!

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