Comcast's VOD Library May Rival Netflix

Netflix (NASDAQ: NFLX  ) is reportedly in talks with Comcast (NASDAQ: CMCSA  ) to bring its streaming video service to the cable company's set-top boxes. I've previously questioned whether such a move is in the best interest for Comcast, as I believe the company is capable of creating a rival service for its subscribers with its Video on Demand platform. In fact, VOD content may soon rival the content available through Netflix.

A matter of content
Netflix currently offers about 60,000 television episodes and movies available for streaming for about 1/10th the price of the average cable bill. But Netflix's library size is set to shrink, even as its subscriber base grows.

The rising cost of content has become a limiting factor for the company's growth. That trend became painfully evident earlier this year when Netflix let its contract with Viacom lapse, losing over 2,000 titles from its library. Reed Hastings made it clear, in his first quarter letter to shareholders, that Netflix's willingness to pay for bulk content deals is declining.

But that's exactly the kind of business Comcast is in. Unlike other pay-TV providers like Time Warner Cable and DIRECTV, Comcast has been a very friendly partner with its content providers, which makes them more amenable to Comcast's requests regarding VOD.

Currently, Comcast is able to offer its subscribers 36,000 titles through its set-top VOD service and 270,000 videos online. While some of those titles cost a premium, Comcast has been steadily growing its free VOD content library, and viewership over the last three years.

In that time, the company has added 20,000 net new titles to its set-top streaming service. Last year, Comcast increased VOD hours by 14%. I expect that trend to continue as there are several driving factors for content providers to expand their VOD content.

Monetizing long-tail viewers
Time-delayed viewing is growing in popularity. It's particularly popular for science fiction shows and serialized dramas. AMC Networks (NASDAQ: AMCX  ) gets a huge audience increase from DVR viewers.

Last year, Breaking Bad's and Mad Men's audiences grew 130% and 127%, respectively, when adding DVR views up to a week after the original air date. Comcast's NBCUniversal owns three of the top five shows receiving a bump from DVR viewers: Warehouse 13 (127%), Covert Affairs (117%), and Suits (110%).

But DVR's aren't particularly great at monetizing those views. Content owners receive ad revenue for commercials watched up to three days from its original airing. That does not include commercials through which viewers fast forward. According to CBS research, DVR households fast-forward through 70% of commercials.

Video on Demand often disables fast forwarding, which means for every VOD view that replaces a DVR view within the first three days, content owners receive an average of 333% more advertising revenue. Moreover, new ads can replace old ads after three days to continue monetizing the content into perpetuity. That means a network like AMC, which sees more viewers watch its top shows delayed than live, could more than double its ad revenue if all of its DVR viewers switched to VOD.

Added advertising revenue in itself is a huge incentive for networks to draw viewers into the VOD ecosystem by adding more content. Now, VOD also offers content makers the opportunity to improve their ad-rates.

Better ad rates
Last year, Nielsen started counting VOD views within three days of the original air date toward its viewer ratings. As a result, networks are making more titles available on demand in order to draw in more viewers. Viewers are slowly becoming more educated about what's available to them on demand and when, which has led some to trust the platform more than their DVRs.

ABC has been very aggressive in its VOD strategy. Last year, it counted VOD viewers as 3% of its prime-time audience that it sells to advertisers. Additionally, it increased VOD viewership 32% over the previous year.

With higher ratings, networks are able to charge more per commercial spot -- both live and on Demand.

Moreover, if Comcast's Video on Demand service sees an increase in the number of hit shows, it will see subscribers flock to its service. An uptick in VOD use for Comcast will allow it to bring in better-paying advertisers for its dynamic ad-insertion program (ads inserted into VOD plays more than three days after the original broadcast). That should bring more hit programming to its VOD service creating a virtuous cycle.

Something Netflix can't offer
The dual revenue opportunity of VOD is something Netflix can't offer. Comcast can pay providers to add content to its VOD platform, and then help them further monetize it with advertising. Dealing with Netflix, however, content owners get a set amount of money up front. There's no way to capitalize if a show like Breaking Bad becomes extremely popular until that contract expires.

This could lead content owners to favor VOD over Netflix for its most popular content, perhaps causing the cost of content for Netflix to increase even faster as networks seek a risk premium for missing out on VOD ad revenue. What's worse for Netflix is that the content it wants, the most popular content, is the content the owners may be most hesitant to give up.

Thus, we may continue to see Netflix's content library shrink as Comcast's VOD library grows.

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