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Morgan Stanley downgraded Netflix (NASDAQ: NFLX ) earlier this week, sending shares of the video streaming giant tumbling. The analysts cited rising competition from other players in the Internet-streaming space, most notably Amazon.com (NASDAQ: AMZN ) , Hulu, and Time Warner's (NYSE: TWX ) HBO.
While it's possible that more demand for original programming could drive up Netflix's costs, better competitors should actually be a net benefit to Netflix's business in the long run.
Netflix's competitors are improving
It's true that Netflix's competitors are making strides, both in the quality of their content and in their distribution tactics.
According to analysts at Macquarie, Amazon now has about 20 million Prime members, making it roughly half as popular as Netflix. But it's difficult to tell how many of these Prime members signed up because of the video, since membership includes much more than streaming content, most notably free two-day shipping and Kindle book rentals.
Amazon has followed Netflix into the original programming game, releasing two series, Alpha House and Betas, late last year. Amazon Prime Video isn't accessible on as many streaming boxes as Netflix, but Amazon is widely rumored to be working on its own set-top box, in which Prime Video will undoubtedly play a large role.
Meanwhile, Time Warner's HBO hasn't done much to improve its content -- it continues, as it has for many years, to rely on a steady stream of hit shows, including Game of Thrones and Girls. But Time Warner's premium network is becoming more like Netflix in other ways.
In October, Comcast launched "Internet Plus" in select markets, giving non-cable subscribers the option to purchase a subscription to HBO's streaming service, HBO Go. The deal marks a sea change in Time Warner's thinking about how to sell subscriptions -- prior to that, HBO was only available as an add-on to expensive cable packages.
Other competitors are moving forward in other ways -- both Hulu and Microsoft announced their own original programming, and Redbox Instant has become accessible through more devices. Still, this isn't necessarily a concern for Netflix's shareholders.
Streaming services are complementary goods
While some subscribers may choose Amazon over Netflix, or HBO Go over both, these services may serve more as complementary goods -- not substitutes. There's still some overlap in their catalogs, but as these services offer more original programming, they're becoming more different.
If you want to watch Netflix's House of Cards or Orange Is the New Black, you must have a subscription -- Amazon just won't cut it. Conversely, if you need to binge-view Alpha House or the Amazon-exclusive SpongeBob SquarePants, neither Netflix nor HBO Go will satisfy your needs. Amazon and Netflix have some of the same movies, but HBO's offerings are unique.
Making cord-cutting viable
In actuality, the more these services improve, the better Netflix's business prospects become in the long run. Netflix has a lot of great content, but by itself it doesn't have enough to replace a cable package. But if one bundles it with HBO Go and an Amazon Prime membership, cutting the cable cord begins to look far more attractive. Buying all three services would cost around $30 per month, which isn't cheap, but it's still much less expensive than most cable packages.
If Netflix shareholders are banking on Internet video replacing cable, then they should cheer on Netflix's competitors. Ultimately, Netflix alone cannot create a viable Internet-based content ecosystem.
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