Will some customers run out on Netflix (Nasdaq: NFLX ) now that the company has created separate plans for streaming and disc rental? A poll run yesterday here at Fool.com says yes, but I'm not so sure. Between Hollywood's inattentiveness and cable channels' idiocy, an entertainment gap has formed that, increasingly, consumers turn to Netflix to fill.
Call it the TV gap, wherein disappointed consumers are turning to a combination of discs and the Web to make (ahem) "on-demand programming" live up to its name.
The rubes running the tube
Sound harsh? I suppose it is, but I'm not the only one who's seen the ruse of on-demand in action. Foolish colleague Travis Hoium also subscribes to Comcast's (Nasdaq: CMCSA ) XFINITY TV service and has found it to be ... well, here, judge for yourself:
Last week the upgrade to XFINITY made its sweep through my local market. After, I couldn't decide if I had been upgraded or sent 20 years into the past. It's great to have on-demand access to TV shows I've missed recently, and I even came across a few I didn't know existed. But I couldn't help but think Comcast was trying to bring DOS back from the dead. Menus are grainy and difficult to navigate and I have no idea what will be available when. One of my best hopes of competing with Netflix fell flat on its face on my television.
He's right. The best thing about XFINITY is the online service that allows me to set the DVR to record. Of course, if that sounds like TiVo (Nasdaq: TIVO ) circa 2006, you're right. Therein lies the problem with so-called on-demand services. Few are modern, and none allow me to choose what to watch, whenever I want to watch it, on my terms.
Even the good features have serious flaws. XFINITY's brand of on-demand stores recently aired shows, so my wife and I can catch up on USA Network shows we like but missed. Trouble is that using the service means suffering through ads I could've skipped through by recording the show. This is what counts for innovation?
Still more programs simply aren't offered via the on-demand model, but that's also understandable. Creators and studios are smart to get as much as possible from their intellectual property, and networks are in the business of making a profit. Negotiating a fair deal can get tricky. But again, if the shows aren't there, this also isn't "on-demand." True "on-demand" would be comprehensive and instant. In at least one of these areas -- comprehensiveness -- only Netflix gets close, and that's because of the dual nature of its service. Doesn't that deserve a premium?
With comprehensiveness comes cost
Interestingly, despite its many holes, the on-demand strategy is working for the likes of Comcast, DISH Network (Nasdaq: DISH ) , and DIRECTV (NYSE: DTV ) . In a study published last month, media researcher Nielsen found that Americans are watching 22 more minutes of TV per month than they were a year ago. Internet viewing was up 34%, mobile device viewing rose 20%, while couch potatoes spent 0.2% more time planted in front of the tube.
In short, giving consumers a taste of what on-demand programming could be like has enticed consumers to add roughly one half-hour sitcom's worth of viewing each month. I know that doesn't seem like much. But with each 30-second ad spot comes hundreds of thousands of dollars in ad revenue. Hollywood has a lot at stake in making on-demand work.
Merits of taking the low (cost) road
By contrast, Netflix isn't a network and thereby has the freedom to pursue on-demand differently. And it has. Instead of building Watch Instantly as a tease -- with only a few, if highly desired, titles -- CEO Reed Hastings chose instead to build a massive database of lesser-known titles that had just enough appeal to be useful, all the while keeping a DVD-by-mail business capable of filling gaps. The result? Hastings' company is the closest thing as there is to a one-stop shop for movie and TV programming rentals.
Unfortunately, none of this comes cheap. As my Foolish colleague Rick Munarriz rightly points out here, Netflix pays substantial fees to keep discs flowing to those who want them. Comprehensiveness, meet cost. That's why Netflix earns a 38% gross margin on what, effectively, is an Internet business. Amazon.com (Nasdaq: AMZN ) has the same problem. Distribution is never, ever cheap -- especially when you commit to doing it well.
Looking back to look forward
We've seen this sort of thing before. Remember when Apple (Nasdaq: AAPL ) cut the price of the iPhone just weeks after release? Early buyers were outraged. Some may have even left the platform for other devices. But today, nearly four years later, there's little doubt CEO Steve Jobs made the right call, even if it meant losing some customers at the time.
So while I get that some are angry over the price hikes -- more than 30,000 have expressed their displeasure on Netflix's Facebook page -- investors should be thrilled. Netflix is charging what it should for a need that, right now, it fills better than alternatives. There's also historical precedent for losing some customers in the short term to preserve the health of the business over the long term. I can't think of a more Foolish thing to do. Bravo, Mr. Hastings.