Hollywood Isn't Netflix's Enemy

Two months ago, I forgot how to operate my DVD player. (Seriously.) At the time, I took my newfound addiction to on-demand programming as a sign of the rising dominance of Netflix (Nasdaq: NFLX  ) and vowed to open a position. I haven't yet -- missing out on a 10% gain over a period during which the S&P is down 4% -- but only because I can't seem to stop writing about this exceedingly interesting business.

It's getting more interesting by the day. Most recently, I found myself annoyed at being unable to get on-demand copies of The Big Bang Theory seasons 2 and 3. Amazon.com (Nasdaq: AMZN  ) says it's in negotiations at the page for the popular CBS (NYSE: CBS  ) comedy while Apple (Nasdaq: AAPL  ) has yet to include the show in its iTunes catalog.

But then, right at my moment of maximum frustration, I realized how stupid I'd been. Netflix has DVD copies of all three seasons of The Big Bang Theory. As a subscriber, all I needed to do was add them to my queue for shipping. Call it the latest episode in my continuing adventures as a DVD moron.

Studios to Netflix: We won't be small-f fooled again
TV producers can be forgiven for not rushing to offer digital copies of all their shows via Netflix, iTunes, and Amazon's Instant Video. DVD sales can be extremely lucrative. Just collect a season of shows, add some cast commentary, press a few hundred thousand discs, and sell them for $19-$39 apiece. The math gets really impressive once you realize studios tend to enjoy a healthy 30% margin on DVD sales. Blu-ray disc sales may yield even more.

Either way, it's big money. Combined, DVD and Blu-ray accounted for $6.8 billion in revenue last year. The bad news? DVDs alone accounted for $7.97 billion in revenue in 2009, according to researcher SNL Kagan. Digital delivery is catching on too fast. And that's a problem on both the top and bottom lines. Sure, digital distribution might eliminate shipping and other incremental costs, but e-distributors charge fees of their own.

Executives also worry about digital files being more prone to piracy. As Canada's Macleans magazine put it in an article recently, we may be witnessing television's Napster moment. The implication? Uncomfortable though it may be, television executives have no choice but to figure out a workable system for distributing content via all the digital networks.

No doubt that's going to take months or even years to get right since neither Walt Disney (NYSE: DIS  ) nor Time Warner (NYSE: TWX  ) nor NBC Universal wants to give away too many rights too early in the shift to digital. For them, Starz is a cautionary tale. Some studios had included digital distribution rights in their arrangements with the cable channel owned and operated by Liberty Starz Group (Nasdaq: LSTZA  ) , rights that Starz resold to Netflix for instant streaming of new movies, including recent releases from Disney and Sony Pictures.

Why Hollywood needs Netflix
Not even five years later, Netflix now accounts for about one-third of prime time Internet bandwidth usage. And that's with a relatively modest library. I'm not referring to volume so much as popular programming; you won't find TV's top shows on Netflix. Some aren't even on iTunes. DVD paranoia simply runs too deep. But here, too, the logic gets twisted from time to time.

Again, take The Big Bang Theory. Right now, Target is running a promotion in which you can buy any of the three seasons on DVD for $15. Can you imagine? At those prices, I can buy all 23 episodes of season 2 for $0.65 apiece, or less than your average DRM-loaded iTunes audio track.

This is why I think rights rather than pricing is the issue. Hollywood only wants to ensure it gets paid every time a video is rented or downloaded. Executives would probably also prefer a payload built into digital files that would either (a) make it incredibly difficult to rip and share via BitTorrent, or (b) disable media files upon tampering. Users would naturally prefer to have access to content anywhere, anytime, with no restrictions.

The Foolish bottom line
So long as this divide persists -- and it could for a while -- Hollywood is stuck with Netflix. Why? Consumers like me. We may prefer on-demand delivery, but we also want access to shows that are only collected on DVD and Blu-ray (e.g., The Big Bang Theory). With the demise of Blockbuster and most other mom-and-pop video rental shops, Netflix and the local library have become our only means to get these discs. And if timeliness and quality is an issue, it's really Netflix that serves us (and investors) best.

Do you agree? Disagree? Let us know using the comments box below, and when you're done take a minute to watch this free video right now. You'll walk away with a better understanding of how the online channel has given rise to cloud computing and changed everything in the process.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He owned shares of Apple, Time Warner, and Walt Disney at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader.

The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Netflix, Apple, Walt Disney, and Amazon.com. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Motley Fool newsletter services have recommended buying puts in Netflix. 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.


Read/Post Comments (8) | Recommend This Article (5)

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 June 13, 2011, at 3:24 PM, jhelmoreii wrote:

    I have chosen not to use Netflix, Hulu, VUDU, Pandora or any other streaming service due to the new pricing of AT&T for data not just bandwidth. Comcast and AT&T feel Netflix and other streaming services are not in their best profit interest for their old unlimited internet plans now. Even though I own AT&T stock I am weaning myself off their services (Uverse, phone and internet). Apparently the over $3200 yearly I spend with them is not enough to provide a good profit. At some time in the near future I will also sell my shares of AT&T.

  • Report this Comment On June 13, 2011, at 4:03 PM, MKArch wrote:

    I think you inadvertently pointed out why Hollywood doesn't need or want NFLX Tim. They *DON'T* get paid every time a NFLX sub watches their content.

  • Report this Comment On June 13, 2011, at 4:48 PM, scoelen wrote:

    "all I needed to do was add them to my queue for shipping." ...uh.. Tim that is all anyone has ever needed to do after their paid monthly subscription. So how is Netflix going to get you to pay more other than moving up a tier?? its not just about subscriber rate, for a paltry $9.99 I can view unlimited amount of content without my cost going up. Netflix has no pricing power.

  • Report this Comment On June 13, 2011, at 4:58 PM, TMFMileHigh wrote:

    @MKArch,

    >>I think you inadvertently pointed out why Hollywood doesn't need or want NFLX Tim. They *DON'T* get paid every time a NFLX sub watches their content

    Exactly right. This is why I think the renewals are taking a while to figure out. Hollywood doesn't want to give away too much and Netflix, Apple, and Amazon don't want to overpay.

    What fills the gap in the meantime? Discs. Who ships more discs than anyone else? Netflix. My point is that Hollywood can't easily get rid of Netflix, even if it wants to.

    Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On June 13, 2011, at 5:03 PM, TMFMileHigh wrote:

    @scoelen,

    >>Its not just about subscriber rate, for a paltry $9.99 I can view unlimited amount of content without my cost going up. Netflix has no pricing power.

    History doesn't support this claim. Netflix took in 37.2% of revenue as gross margin in 2010, the highest rate in company history.

    To me, this suggests CEO Reed Hastings and his team are working towards an increasingly effective value-pricing mix.

    FWIW and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On June 13, 2011, at 10:19 PM, kruwreka wrote:

    I couldn't understand why you were having problems getting The Big Bang Theory from iTunes until I looked on the US iTunes and it wasn't there. The Canadian iTunes has had all the episodes available for purchase and download since season 1.

    Weird how the licensing works.

  • Report this Comment On June 14, 2011, at 1:17 AM, lucasmonger wrote:

    While Netflix appears to be leading the streaming side of things and Hulu is struggling to get subscribers, everyone else including Apple seems to be struggling to get a streaming model in place.

    Price and selection are key here. People currently tolerate the incomplete Netflix library because it is still better than everyone else's library. What I don't get is why a whole season of Big Bang Theory can be bought for $15 while a season of Star Trek Voyager is $50-60... I think the studios are getting a it greedy here, especially since last Summer and entire season download was $12.99, now the price has more than quadrupled.

    This really makes the Netfplix monthly service fee seem tolerable for all you can stream content. But the real investment question here is whether Netflix can continue to dominate, and whether you're willing to pay over $200 for a share of stock. Oh, if we only had a time machine to go back to when Netflix stock was dirt cheap before they took down Blockbuster. I'm personally staying on the sidelines on this one waiting to see what happens and hoping to catch the next rising star in the streaming business.

  • Report this Comment On June 19, 2011, at 4:35 AM, lowmaple wrote:

    Lucas. what if all the stars are brown dwarfs?

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