Amazon's Threat to Netflix Is Bigger Than You Might Think

After Morgan Stanley analysts downgraded Netflix (NASDAQ: NFLX  ) stock last week, citing increased competition from Hulu and Amazon.com's (NASDAQ: AMZN  ) Prime Instant Video, bulls came rushing to Netflix's defense. Yet bulls' pro-Netflix arguments take too much comfort from the company's current success and misunderstand what Netflix needs to do to keep growing.

Can Amazon compete with Netflix for the next wave of streaming video growth?

Put simply, Netflix has become a household name in the U.S. by appealing to young adults and, to a lesser extent, to parents. Its content library reflects this focus. By contrast, Amazon's content selection appears to be designed to please an older demographic, with shows like Downton Abbey, The Good Wife, The Closer, and even Under the Dome.

The problem for Netflix is that it is already starting to saturate the younger part of the market. Amazon is in a better position to compete with Netflix for the 49 and up age group, which is where much of the remaining growth of streaming video will occur.

It's not just about the youth crowd
In recent weeks, Netflix's defenders have highlighted the service's appeal to young adults. One claimed that most young adults don't have cable, so the growth of Hulu and Prime should not be worrisome; cord-cutters could potentially subscribe to all three! (My Fool colleague Sam Mattera recently made a similar argument.)

Another commenter noted that tweets about Netflix vastly outnumber tweets about Hulu Plus and Amazon Prime. But not surprisingly, Twitter users skew very young. It's no secret that Netflix has "won" among young adults. A recent study by Harris Interactive found that 43% of people ages 18 to 36 in the U.S. subscribe to Netflix. It seems likely that even more people in that age range use Netflix, either through friends' or parents' accounts.

That's a blessing and a curse for Netflix. On one hand, it's great that it has been so successful in its core demographic market. On the other hand, since it's unrealistic to expect Netflix to ever reach 100% market share, the company appears close to saturating the young-adult market.

But while 31% of those ages 37 to 48 also subscribe to Netflix, only 21% of adults 49 to 67 and 13% of those 68 and older are subscribers. For Netflix to hit its long-term target of 60 million to 90 million domestic subscribers, the company will need to make serious headway in that older demographic.

A different focus
Amazon Prime will be a more serious competitor in this next stage of the streaming-video race. First, it's important to remember that Amazon was late to the game and has only compiled a competitive content library in the last year or two. So while Amazon lost the first round (i.e., young adults) by default, it is getting in near the ground floor for the race to sign up baby boomers and even senior citizens.

Second, Amazon has built a content library that is much more targeted toward older viewers than Netflix's catalog. This makes a lot of sense. Netflix has effectively appealed to cord-cutters who can't afford cable TV -- although it's worth noting that most Netflix users also have a pay-TV package.

Amazon, by contrast, is in the streaming business to attract consumers to the Prime service. It hopes that these new Prime members will increase their Amazon spending by hundreds or even thousands of dollars. In other words, it wants to attract people with discretionary income.

Appealing to different demographics
To see how Netflix and Amazon differ in their content choices, let's take a look at some of the top items of content on each service. A third-party analysis of Netflix viewing for 2013 found that the two most-watched shows were Breaking Bad and Family Guy. Three of Amazon's top titles are Downton Abbey, Under the Dome, and The Good Wife.

The demographics for the original broadcasts of Amazon's shows skew much older. For example, on Sept. 29, 2013, the season premieres of Family Guy and The Good Wife aired, as did the series finale of Breaking Bad. Breaking Bad drew 10.3 million viewers, with a 5.2 rating among adults 18 to 49. Family Guy was about half as popular overall and among adults 18 to 49, with 5.23 million viewers and a 2.6 rating.

By contrast, The Good Wife drew 9.15 million viewers, but only scored a 1.5 rating among adults 18 to 49. In other words, it had significantly more total viewers, but significantly fewer viewers ages 18 to 49 than Family Guy, and less than a third the 18-to-49 viewership of Breaking Bad, despite a similar-size audience.

Similarly, Under the Dome's season finale hit a 2.8 rating among adults 18 to 49 despite drawing more than 12 million viewers (i.e., half of the Breaking Bad finale's 18 to 49 audience despite more total viewers). Downton Abbey does not get traditional ratings because it airs on PBS, but its audience also skews older. The show's top sponsor, Viking River Cruises, has described its target demographic as "affluent baby-boomers, 55-plus." Enough said!

Foolish wrap
Netflix certainly has plenty of content that could appeal to older viewers. House of Cards, its first major foray into original content, was primarily targeted at that demographic, although it ultimately attracted more young viewers than Netflix expected. But most of the top shows on Netflix are geared toward the younger audience that represents its core subscriber base.

By contrast, Amazon Prime's catalog is much more focused on the 49-and-up crowd. Amazon's "signature" content deals include Downton Abbey, Under the Dome, The Good Wife, and The Closer -- all shows with large audiences but relatively low 18-to-49 ratings.

With the under-36 market becoming increasingly saturated and the 37-to-48 market not far behind, much of the remaining growth in streaming video will come from adults 49 and up. In this new frontier, Amazon Prime could be a much more fearsome competitor for Netflix.

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Read/Post Comments (10) | 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 January 14, 2014, at 10:02 PM, AceInMySleeve wrote:

    That's an interesting and plausible observation. In Amazon's business model, it's all about bringing in dollars through merchandising. This btw, I think argues against the idea of a standalone streaming service for them (which of course it thus far has not been).

    I'd wager Netflix has an excellent sales force and they're called the young. It's on their prompting and assistance that stale old ma 'I don't know how to use this technology' and pa 'This is how I've always watched TV' get brought into the future.

    Possibly more to your point however, and donning my perma-bull cap to compete with your perma-bear one, I'd say Netflix is completely flexible and capable of migrating into new demographics. I would be nearly 100% sure that Netflix analyzes the success of any particular piece of content amongst other things by the demographics of those watching. So you have to ask yourself if Netflix passed on some of the programs you mentioned simply because they felt they would be relatively poor returns on investment thus far...

  • Report this Comment On January 14, 2014, at 10:40 PM, PrivInvest wrote:

    First, let me declare myself a user and Netflix investor trying to be partial on the article.

    Second, let me thank you for the whole lot of useful information contained in it, sincerely, not pun intended.

    It seems, in your words, that Netflix and Amazon are not direct competitors, since they play in the same market but not the same segment, and that fact would put me at ease rather than make me nervous. The real threat seems to be market saturation of the segment. Let me comment: If I were to favor a segment I'd rather choose the young adults segment over the baby boomers' segment, just because the growth potential going forward seems much larger on the first -as it is still young and the children of that segment is influenced by it while the baby boomer population will be sadly decreasing-. Expansion into other segments is the normal course of a saturated service, not always successful I must agree, but here is where Netflix has the best cards because of their rating service data base -which gives them the faculty to opt for the audiences they wish to attract-. Strategically it would seem logical to gain dominance in their segment before moving into the next one and start making the appropriate expenditures (producing or buying content) to gain access to a new one.

    Yes, it would be harder to enter a new segment that is already dominated by a top player, but in the end Netflix has the faculty to grow with the population of their segment while still capturing the new generations. That is my view... a rather simple one I must confess.

  • Report this Comment On January 15, 2014, at 12:17 AM, sliderw wrote:

    @PrivInvest

    "the baby boomer population will be sadly decreasing" -- This is factually wrong. It is increasing.

  • Report this Comment On January 15, 2014, at 12:54 AM, PrivInvest wrote:

    @sliderw

    You may be right, I meant it in the following first sentence statement, but I might have misinterpreted in the sense the article really meant it:

    *"A baby boomer is a person who was born during the demographic Post–World War II baby boom between the years 1946 and 1964, according to the U.S. Census Bureau[1] The term "baby boomer" is also used in a cultural context. Therefore, it is impossible to achieve broad consensus of a precise date definition, even within a given territory. Different groups, organizations, individuals, and scholars may have widely varying opinions on what constitutes a baby boomer, both technically and culturally. Ascribing universal attributes to a broad generation is difficult, and some observers believe that it is inherently impossible. Nonetheless, many people have attempted to determine the broad cultural similarities and historical impact of the generation, and thus the term has gained widespread popular usage."

    *from Wikipedia

  • Report this Comment On January 15, 2014, at 2:14 AM, Fo45 wrote:

    Amazon prime has a serious impact on Netflix future growth. The price of content has skyrocketed since Amazon is betting for content too. With Net neutrality gone Amazon is well placed to pay for its content Delivery to its members than Netflix because prime member are 10 time more likely than non member to shop from Amazon due to free 2 days delivery of the items bought from Amazon.com.

  • Report this Comment On January 15, 2014, at 4:11 AM, AlanPithy wrote:

    Amazon is mostly just coasting. They are surely losing money on Prime. First, Prime was not originally a streaming service. It was a free 2-day shipping service designed to attract customer shopping loyalty to AMZN. Throwing Prime video on top just makes Prime even more expensive to operate. AMZN likes to play in as many sandpits as it can, but it too will eventually have to pay the piper, and growing the content streaming business will be costly. When AMZN starts spending $2B a year (less than half of what NFLX spends) then you can say they are serious rival. And when they do, their shareholders (who are used to seeing AMZN eke by with small losses, not large quarterly losses) will brit a shick.

    Moreover, NFLX has multi-year deals with major studios to obtain exclusive content. That means that anyone who seriously wants diversity of streaming options, NFLX is the first choice. Even for older people. Its kind of funny to read such generalities such as "older people will choose Prime because of shows like Downton Abbey". What, older people don't like Kevin Spacey? LOL, such broad generalities will miss a lot of subtlety.

    I do believe that the content owners need an aggregator to monetize their old content, and they benefit from having a major provider as opposed to multiple providers even if they can temporarily play them against each other. Most content owners - especially syndicated content (think Breaking Bad or even Sons of Anarchy) - will want to go with a service that delivers the most eyeballs.

    As for customers signing up for multiple services, possibly so. And if so, it will be NFLX and AMZN, because NFLX value truly is the content while AMZN value is the gravy of a few extra shows, or, free shipping on tangible goods. I don't see room for a third in the long run. Content seekers will want to look for filmed entertainment in the same spot, just as most people search using GOOG. AMZN has done very well tying it to Prime, but its still an afterthought, remains available on a limited number of devices (NFLX is available pre-loaded on TVs, Blue Ray Players, Game Consoles, Pads, Pods and Puters), and doesn't have anywhere near the monetary support behind it NFLX has.

  • Report this Comment On January 15, 2014, at 6:22 AM, Liana wrote:

    NFLX is a core. Babyboomers are big time clients for nursing homes so will not be ordering NFLX or AMZN. They will not tip the balance in favor of AMZN. The rest of us who are young at hart like NFLX just fine.

  • Report this Comment On January 15, 2014, at 10:02 AM, Scotpond wrote:

    From a 70 yr old pre-boomer

    Amazon Prime is not playing

    on my iPhone without a

    WiFi connection.

    NETFLIX does't require WiFi

    Plays using data connection.

    And, plays well.

    Amazon loses even though I do love

    Alpha House.

  • Report this Comment On January 15, 2014, at 10:11 AM, TMFGemHunter wrote:

    @AlanPithy: Netflix spent about $1.85 billion on domestic streaming content this in 2013. Amazon doesn't break out what it spent, but Reed Hastings estimated AMZN's spending at $1 billion for 2012. Amazon added a lot of content last year, so I think it's reasonable to guess that it's in the $1.2-$1.5 billion annual range right now. Definitely less, but not such a wide gap as you suggest.

    I don't think that anything other than price matters in terms of distributors, except possibly for shows still airing new episodes. All the content owners want to do is maximize the value of their content. It's hard to see how giving Netflix a discount would do that.

    As for diversity of content, remember that most people in this 49 and up group that I'm talking about are keeping cable (either for sports, new content, convenience, or something else). So they already have access to a great diversity of content. Some may add on both NFLX and AMZN, but a lot will choose. My guess is that many (though not all) will pick the service that lets them catch up on shows they already watch. Just looking at the audience demographics for top NFLX and AMZN shows, AMZN is at least in an equal position, if not better off.

    @AceInMySleeve: That's a good point about kids potentially setting up Netflix for their baby-boomer parents.

    Of course Netflix knows the demographics of who is watching. But in this case, it would need to know the demographics of non-members that might sign up over time if a set of shows that aren't on Netflix were added to the service. The fact is Netflix has a relatively set content budget and content costs are rising. It has to prioritize, and it's prioritized making its current base happy. But that leaves an opportunity for Amazon to get a greater share of older viewers.

    FYI, according to the 2010 census, there are about 47 million households 44 and under, about 25 million 45-54, and about 45 million that are 55+. To hit 60 million domestic subs, Netflix will need to sign up a lot of people over 50.

    Adam

  • Report this Comment On January 15, 2014, at 5:53 PM, AceInMySleeve wrote:

    So yeah to the earlier poster, Baby Boomers are defined as when they are born, so that pool doesn't increase.

    Adam,

    "it would need to know the demographics of non-members "

    Sorry, I don't think that's a challenging analysis for Netflix.

    " it's prioritized making its current base happy."

    That's an assumption. Presumably you'd want to assume they prioritize for the largest subscriber base possible.

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