We Can't All Cut the Cord; Netflix Needs Cable

You may have heard the phrase "Netflix  (NASDAQ: NFLX  ) is the future of television" before.

Perhaps in some ways it is. The idea of giving people what they want, when they want it, however they want it, has grown increasingly popular throughout the cable industry. We now have things like TV Everywhere services from operators and the option to watch Conan online because I fell asleep in front of the TV again last night. We have cord-cutters and cord-nevers and people campaigning for a la carte cable service.

But the idea of Netflix (or a combination of Netflix-like services) replacing the current cable bundle is far fetched. For some, this might be a viable option. For others, it's not. But to me, and many others, Netflix is more an extension of the cable bundle than an alternative; it's more like a premium cable channel that you can get without a subscription -- a la carte.

Without cable, Netflix doesn't exist like it does today. Even if every one of the 100 million households in America with a pay-TV subscription dropped cable for Netflix, the company couldn't support entertaining all of them for just $8 per month.

Budget
Netflix currently spends about $2 billion per year on content.

Compare that to the amount of money television channels spend on content. 21st Century Fox spent $1.5 billion on just its original content last year. Time Warner Cable spends about $5 billion on its television networks.Simply put, the amount of money being poured into cable programming dwarfs Netflix's budget.

What's more, content costs at Netflix have ballooned in recent years due to increased competition from other streaming platforms such as Amazon.com (NASDAQ: AMZN  )  and Hulu. In fact, content prices have outpaced subscriber growth requiring Netflix to pick and choose what content it keeps.

Netflix is still getting a deal
But in the grand scheme of things, Netflix is getting this content on the cheap.

Remember a couple paragraphs ago when I pointed out how much a couple of major networks spend on content? That's because they're paying for first-window exclusivity -- the right to be the only place to see a show for a certain amount of time.

After that window expires, Netflix or Amazon will negotiate a deal for a fraction of the price the original network paid. For example, Amazon recently paid over $200 million for a package of over 4,000 TV episodes from Viacom.

In contrast, original content and the first window exclusivity is significantly more expensive. The average show on television costs between $2 million and $3 million to produce (compared to the $50,000 per episode Amazon paid Viacom earlier this year). Some networks will use deficit financing to license a show from a production studio, in which case, the costs to the network are lower, but the distribution rights stay with the studio.

That's what Netflix does with its original content. It placed a bid to license House of Cards along with HBO and AMC Networks last year, and won the right to premier the first two seasons for $100 million. Currently, Netflix is spending $100 million each year licensing five or six original shows and a few one-off specials. That amount is expected to climb significantly in the near term.Hulu spends even more on its original content. Last year, the site paid $500 million for original shows.

By comparison, licensing the rights to reruns and old movies is much cheaper than licensing or buying original productions.

Now, take away cable
Netflix money is just icing on the cake for content owners. The vast majority of their money is made through traditional pay-TV. Take that away and there's no way Netflix can afford the kind of prices they demand.

For Netflix to capture the entire pay-TV audience, it will have to be everything to everyone. That means paying for all sorts of first-window content. It will essentially become cable. As such, it would have to charge a cable-like price.

At $8 per month, 100 million subscribers works out to $9.6 billion annually. Considering television is currently a $140 billion industry, we're looking at a price well over $100 per month to replace the lost revenue from cable.

To be sure, Netflix would not be nearly as affordable without cable subscribers subsidizing its content costs. It certainly wouldn't be able to take the risk of spending relatively large amounts on productions like House of Cards or Arrested Development. And it likely couldn't support the breadth of entertainment that the cable bundle does. It's simply not a service worth cutting the cord for.

So, if Netflix is a threat to the cable industry, it's just as much a threat to itself.

So, in what ways might Netflix be the future of television?
Americans reportedly spend nearly 34 hours a week watching television! With TV viewing taking up almost as much time as the average work week, the potential for profits in the space is enormous. The Motley Fool's top experts have created a new free report titled "Will Netflix Own the Future of Television?" The report not only outlines where the future of television is heading, but offers top ideas for how to profit. To get your free report, just click here!


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