How to Grow a Global Business and Alienate Skeptics

Netflix (Nasdaq: NFLX  ) is stretching its red tendrils further and faster than you might've thought.

Reports from film industry rag ScreenDaily confirm earlier reports that Netflix streams are coming to Spain in 2012. That market is ravaged by heavy piracy, so that's an important test of the Netflix model versus other ... let's call them "low-cost services." Observers say that piracy downloads outnumber theater ticket sales by a factor of 4-to-1 in this market. Even Apple (Nasdaq: AAPL  ) reports having a tough time with its recent launch of iTunes service in Spain.

We already knew this, but it's always good to see independent confirmation of early rumors. ScreenDaily quotes an executive of European movie production organization FAPAE this time.

But wait, there's more!
But that's not all: Another report from the same periodical says that "select Asian territories" are next on the Netflix expansion schedule.

Densely populated and broadband-connected markets like Japan and South Korea would be on tap "by the end of next year," ScreenDaily says. Here, we don't have any named sources -- just the usual "people with knowledge of the situation." That said, Southeast Asia with its high-tech tendencies must have Netflix drooling at the business opportunity. All of this also lines up with Netflix's stated ambition to launch into new markets in the first quarter of 2012.

In most of these new markets, Netflix faces only token competition from the local cable companies' on-demand services and premium channels, perhaps with a sprinkling of home-cooked digital offerings. But the all-you-can-eat subscription approach remains almost unique even here, as everyone from iTunes to Blockbuster Total Access under the wing of DISH Network (Nasdaq: DISH  ) sells rentals piecemeal. Even the Amazon.com (Nasdaq: AMZN  ) Instant Video service offers mainly pay-per-view rentals with less than 10% of the available titles going into the Prime subscription product.

So by the end of 2011, Netflix intends to blanket North and South America with several further expansions already planned for 2012. At the same time, the company is making dramatic changes to its domestic pricing plans. Is Netflix moving too fast for its own good, or just striking while the iron is hot?

A Fool's current analysis
The way I see it, Netflix is blazing new paths across the media landscape everywhere it goes. In the DVD-mailing market, it killed Blockbuster and made mighty Wal-Mart (NYSE: WMT  ) cry "uncle!" The Redbox service by Coinstar (Nasdaq: CSTR  ) and the equivalent Blockbuster Express boxes have a tendency to follow Netflix moves like the 30-day new release delays and even price hikes. Yep, Coinstar is testing 15%-20% higher prices these days.

In short, the Netflix model scares traditional media giants, and they're not likely to cut the trailblazer off at the pass until these sacrilegious business practices have been proven to work. But work they do (said Yoda), leaving Netflix to grab the first-mover advantage largely unopposed.

And then the virtuous cycle at the heart of the Netflix model kicks in. More subscribers means more and better content licenses, more low-cost word-of-mouth marketing, and a bigger R&D budget to expand on the company's technical head start. All of that leads to even more subscribers, and then we're back at square one again. Lather, rinse, repeat until every reasonably attractive market has reached full saturation. That will take many, many years.

Netflix isn't protected by the high barriers to entry that Sirius XM Radio enjoys, for example -- satellite launches are expensive, but online video is technically a very inexpensive product. But as we've seen, the company sits behind a moat of industry inertia and the reputation afforded by more than 20 million subscribers. And the lack of expensive hardware makes it both cheaper and easier to expand worldwide.

Foolish takeaway
So I remain a faithful Netflix shareholder as the company sets its sights on distant shores. As for the much-maligned new prices, I can't find a better entertainment deal than $16 a month for never-ending catalog streams plus the occasional fresher DVD. After getting over the sudden 60% sticker shock, I think most subscribers will arrive at the same conclusion. We'll know for sure when Netflix reports third-quarter results in the middle of October.

Netflix is a Freestyle Love Supreme investment, according to chief Fool Tom Gardner. After this raft of expansion hits plus a nearly 20% drop from recent all-time highs, I think the stock looks cheap here in relation to mid-term and long-term growth. I call it a correction, but others see the beginning of the end for this story stock. Where do you stand? Discuss in the comments below.

Fool contributor Anders Bylund owns shares of Netflix but holds no other position in any of the companies discussed here. The Motley Fool owns shares of Apple and Wal-Mart Stores. Motley Fool newsletter services have recommended buying shares of Amazon.com, Apple, Wal-Mart, and Netflix. We have also recommended creating a diagonal call position in Wal-Mart and a bull call spread position in Apple, as well as 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. You can check out Anders' holdings and a concise bio, follow him on Twitter or Google+, or peruse our Foolish disclosure policy.


Read/Post Comments (6) | Recommend This Article (2)

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 August 18, 2011, at 5:18 PM, Alchumie wrote:

    Motley are you a FOOL? What business can alienate, anger and look heartless to their consumers in an economy where people are hurting...and SURVIVE!

    Netflix screwed up big time, and you will see the results of the anger next month. Their service is a pleasure not a necessity, who needs to give his money to greedy pigs. Not I, as I will be dropping them FOREVER end of this month. Keep the red sleeves and I'll keep my $20!

  • Report this Comment On August 18, 2011, at 7:37 PM, TheCabbageMan wrote:

    Companies do it every day. It sounds more like the consumer reaction is as though they've been betrayed by a good friend.

  • Report this Comment On August 19, 2011, at 9:41 AM, MKArch wrote:

    You have the virtuous circle backwards Anders they are not adding content unless you mean volumes of tv re-runs they are losing it. Showtime announced they were cutting back on content to NFLX and Starz followed suit shortly after, they already lost Sony content and there was a recent analyst note that Starz is telling NFLX in their current negotiations that they need to start charging their subs on the order of what Cable charges for a Starz subscription.

    It's exactly what Starz CEO said about 6 months ago: "If Netflix wants cheap content they'll just get less of it". If NFLX even does another deal with Starz they'll pay 10X more than they do currently and get the bottom of the barrel of their content library. Even Hastings admits the recent price hike is needed to pay for content. That's a 180 from the virtuous circle lie he's been pushing. Did you miss this one:

    http://allthingsd.com/20110816/fox-starts-its-web-pullback-a...

    <<<Asked repeatedly about his Web and digital video strategy, Iger said he was all for distributing his stuff via nontraditional outlets like Hulu and Netflix — as long as it didn’t disrupt his existing relationships with the cable guys who are paying him big money for his shows. And that’s the main point of authentication — keep the cable guys happy.>>>

    Translation NFLX will get what ever content the cable guys don't care that they get. Hence Hastings has embraced the re-run tv moniker lately and bends over backwards to dispel any notion that his company is fostering cable cutting. That would just mean less content and higher costs to NFLX.

    As to international prospects, Canada has already nearly ground to a halt and they are practically our 51'st state. It's not going to get better where pirated content is ubiquitous, the vast majority of the population lives in poverty and what little broadband penetration exists sucks.

    Finally, NFLX had ~8M subs walk in 2010 and would have ~14M walk in 2011 before the price hike (service cut) fallout. Over the next year or two the virtuous circle will turn into a death spiral as the U.S. saturates but existing subs continue to walk away in droves. NFLX has alienated their skeptics as much as AOL did in 1999. A service so cheap you can get tons of people to just give it a shot does not make a sustainable business although it can look good for a while.

  • Report this Comment On August 25, 2011, at 11:25 AM, MKArch wrote:

    http://www.thestreet.com/_yahoo/story/11230903/1/netflix-we-...

    NFLX doesn't need new content or can't afford new content? Do you really think re-run tv is a business built to last? Worth $11.5B?

  • Report this Comment On September 01, 2011, at 9:18 PM, MKArch wrote:

    The virtuous circle just resulted in the loss of all Starz content. No problems they'll make it up with I love Lucy re-runs.

  • Report this Comment On September 06, 2011, at 9:39 PM, Popnfresh100 wrote:

    There's one big problem I see with the streaming business model: Netflix is dependent on their competitors for infrastructure.

    Think about it- who streams content over dial-up or 3G?

    Not too many people- if you stream videos, you do so over your AT&T or Comcast broadband. The same broadband that's already equipped to provide you with on-demand movies, dvr, and hundreds of channels at any time.

    If the cable companies feel threatened- they can simply institute a quota system or charge by the byte to make netflix streaming untenable.

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