Here's How Netflix Beats Apple

Here's something you don't hear every day: Somebody is beating Apple (Nasdaq: AAPL  ) in a game of digital-entertainment sales.

The identity of the Apple masher might be another shock, especially if you judge a company by its stock chart. I'm talking about Netflix (Nasdaq: NFLX  ) , whose recent market performance compares this badly with Apple's:

NFLX Chart

NFLX data by YCharts

But it's true: Netflix passed Apple last year in a crucial market. According to the market watchers at IHS iSuppli, Netflix came out of nowhere to crush Apple's online movie revenues in America last year.

Apple's iTunes ruled supreme in this space up to 2010, when it controlled 61% of the market. At the time, Netflix did offer a streaming-only plan, but most customers chose to coast along with the free streaming component of their DVD mailer plans: The company's revenue share was a measly 0.5%.

All that changed in a hurry last summer. Netflix separated the streaming service from the DVD plan, forcing users to either pay about 60% more for the same dual-media experience or just pick one service over the other. Millions of angry customers left Netflix altogether, vowing to find a better deal from Apple or Amazon.com (Nasdaq: AMZN  ) . But enough of them stayed with the streaming service to make it a revenue-producing powerhouse.

So in 2011, Netflix snagged 44% of all digital-movie revenues versus Apple's second-place finish at 32%. Amazon isn't even on the list, perhaps because those users are sticking with the freebie video service that comes with an Amazon Prime free-shipping subscription.

How did this happen?
It's an unusual position for Apple, but not very surprising. IHS analyst Dan Cryan explains that the Netflix model is what consumers want: "All the significant growth in revenue in the U.S. online movie business in 2011 was generated by rental business models, which provide temporary access, not permanent ownership," he noted in a statement. "Rental delivers unlimited consumption with a low monthly fee for older titles as well as cheap rentals of new releases, providing the kind of value that online consumers want."

Apple's model, where you pay per view or simply purchase the content you want, is popular with the studios because they get a bigger cut from each transaction. But that strategy is "stuck in the doldrums," Cryan says -- there's virtually no growth on that side of the fence. The lone exception is Wal-Mart (NYSE: WMT  ) -- yeah, I know -- whose pay-per-film service known as Vudu tripled its share of the iTunes-dominated transactional market. IHS points out that most of that growth came "at the expense of other providers, not Apple."

The gap between Netflix and Apple will grow even wider in 2012 because Netflix's new pricing plans affected only four months of the year. In 2012, it's wire-to-wire. Streaming sales will absolutely explode this year.

I doubt that Apple CEO Tim Cook is terribly annoyed about this state of affairs, though. Netflix has been a close ally of Apple over the years, often held up as a reason to buy the latest iPad or iPhone. And the two companies cater to very different corners of the entertainment market anyway: Apple wrangles new releases at a premium price while Netflix provides deep value but a less sparkly catalog (though exceptions confirm the rule, of course). It's not a zero-sum game, and you can have more than one winner in the digital video space. Our senior technology analyst thinks Apple has plenty of opportunity ahead of it, which he details in our new premium research report on Apple.

Digital video is revolutionizing how movies are made, distributed, and enjoyed. That's just one of many technology sea changes going on right now. In a special report penned by the Fool's finest analysts, you'll find the only stock you need to profit from the new technology revolution in Big Data and business intelligence. The report is totally free, but it won't be available much longer, so get your copy right away.

Fool contributor Anders Bylund owns shares of Netflix and has created a bull call spread position on the same stock, but he holds no other position in any of the companies mentioned. Check out Anders' holdings and bio, or follow him on Twitter and Google+. The Motley Fool owns shares of Amazon.com, Apple, and Netflix. Motley Fool newsletter services have recommended buying shares of Amazon.com, Netflix, and Apple, creating a diagonal call position in Wal-Mart Stores, and creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (7) | 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 02, 2012, at 8:35 PM, midnightmoney wrote:

    digress

  • Report this Comment On June 03, 2012, at 5:51 AM, H3D wrote:

    Any fool can take top spot by trading at a loss short term, to try to build market share.

    Are Netflix making more money than Apple?

    Do Netflix have any reason to expect last years service customers to stay with them next year?

  • Report this Comment On June 03, 2012, at 8:46 AM, jb757 wrote:

    Excellent report. Netflix doubters and haters should understand that Netflix is, and will be, the #1 movie rental service for many years to come. They just added 1.74M subscribers in 1Q12 and likely, according to estimates, will reach 30M domestic streaming and DVD subs by end 2012. It's an amazing turnaround after the 2011 price turmoil. A flat earnings or small loss is expected for 2012 as international struggles to turn a profit, but 3M foreign subs may grow to 5M this year.

  • Report this Comment On June 03, 2012, at 10:07 AM, FoolSolo wrote:

    Netflix stumbled badly last year, and they may be getting back on their feet, but this is a crowded field, and the key thing Netflix needs is not under Netflix control; Internet Bandwidth. Additionally, to significantly grow subs, Netflix needs to ramp-up abroad.

    88% of Netflix subscribers are in the US. Netflix can likely grow a bit more domestically, but to really grow subs they have to seriously focus on Europe, Latam and Asia. Europe is reasonably well connected to the Internet, but they are fickle about content. Latam and Asia have a long way to go.

    Despite being 88% in US, Netflix accounts for 30% of all bandwidth. In fact, streaming video accounts for 50% of all Internet traffic. The cable companies are not impressed. They are trying to govern the traffic, charging tolls, and they are fighting back with their own offerings.

    The content providers are always looking to get higher royalties. Netflix has pretty stale content in most cases, so a lot of people who use Netflix also use Hulu or some other provider to get newer content.

    If Netflix is being squeezed on acquisition of content, and it is being squeezed on delivery, that can only lead to lower and lower margins. I'd be careful about that, Netflix's profit margin is a mere 4.8%, and operating margin is 8.1%. Not a lot of room left there for any more squeeze.

  • Report this Comment On June 03, 2012, at 10:10 AM, TMFZahrim wrote:

    @H3D, even better than that: many of the customers who left in Qwikster disgust are coming back. CFO David Wells at the recent JPMorgan Global Tech conference:

    "We think there's room to grow. But the improvements in retention and our growth in Q1 and Q2, since Q3 and Q4 of last year make us feel pretty good. Rejoins, or our folks joining -- rejoining the service, still remain about 1/3 of our new subscribers that are coming in. So that is an encouraging stat. We think -- we've said before that, the brand hit will take years to recover from and I think that's still true. With the bulk of the recovery coming in the first year, and I think we still feel that way. So we're encouraged by what we see, but there's probably still plenty of room for improvement, going from here."

    Anders

  • Report this Comment On June 04, 2012, at 11:58 AM, JimmyZangwow wrote:

    I think NFLX just beat everyone else to the inevitable correction that is going on in front of us. I am still skeptical about their moat.

    How are they going to continue to fend off other players? Verizon, Amazon, Hulu/Plus, and all those cable outfits that are sooner or later going to jump into the same exact game. How do they keep the content out of the other players' media vaults and keep that $8 monthly fee? Subscribers went apoplectic last time that was messed with!

    I'm especially concerned about a longer-term showdown with Amazon which has so much brand recognition in other areas. It's the web analog of RedBox - people stop somewhere to pick up something they need, then realize that the place they are at has streaming video.

    All I know is Netflix better keep saturating the airwaves with commercials to keep the brand front and center.

    Would like to hear some more from others on how they think NFLX beats these competitors - not so much in metrics terms, but how Netflix can continue to qualitatively differentiate its label from the competition.

  • Report this Comment On June 04, 2012, at 12:31 PM, BioBat wrote:

    Anders,

    David Wells comment is just another example of Netflix spin. I believe him when he says 1/3 of subscriber ads are former subscribers but they're at least as likely, if not more likely to be members who have hopped in and out of the service over years (of which there are tens of millions) as opposed to people who cancelled over the service cut/Qwikster fiasco. I'm one who left and just don't see any value in a service I can't get any new releases with or only have seasons 1 and 2 of a TV show available.

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