Apparently, Walt Disney (DIS -0.55%) is finally starting to recognize that Netflix (NFLX -0.08%) isn't just a helpful new revenue stream -- it's also a humongous long-term threat to the House of Mouse.
Disney may be rethinking its relationship with Netflix. Photo: The Motley Fool
Disney CEO Bob Iger has dramatically changed his tune when talking about Netflix in the past few months, as The Wall Street Journal recently pointed out. In August, he called it "more friend than a foe" -- now he is willing to consider cutting back on licensing content to streaming companies if it's hurting Disney's core business.
However, Iger just might find that he -- and other Big Media executives -- have created an unstoppable force. Netflix is using their content to build a moat that will make it an even bigger threat to companies that rely on the pay-TV ecosystem in the future.
Disney gets chummy with Netflix
Walt Disney has forged a close partnership with Netflix in recent years. Most notably, in late 2012, the two companies signed a deal that will give Netflix exclusive rights to air Disney feature films during the "Pay-1" window -- which starts just a few months after a movie leaves theaters -- beginning next year.
The two companies are also in the midst of a separate multiyear deal to bring a collection of live-action original series based on Marvel characters to Netflix. The first such series, "Daredevil," arrived earlier this year, while the second installment, "Jessica Jones," will become available for streaming later this week.
Thanks to these two streaming deals and others, Netflix will be paying hundreds of millions of dollars annually to Disney for the next few years. Disney may eventually find that this revenue comes at a high cost, though.
Netflix is liberating itself from pay-TV giants
Today, Disney clearly recognizes Netflix's disruptive potential. For a recent Netflix deal, Disney negotiated the right to include a four second "pre-roll" shot featuring the ABC logo for episodes of "How to Get Away With Murder" and a number of other shows. The goal was to promote ABC (a Disney brand) and make sure that viewers know where the show's new episodes air.
But it is probably too late for Disney (or anyone else) to neutralize Netflix's disruptive potential. Once subscribers get hooked on Netflix, they usually keep the service for a long time. Netflix puts a lot of effort into promoting its own original series -- which are rapidly growing in number -- to increase the likelihood that customers will stick around.
There are enough TV studios that it's not feasible to freeze Netflix out from original content. (In a worst-case scenario, Netflix could always produce its shows in-house.) So as original content becomes a bigger part of the Netflix value proposition, Netflix will rely less and less on Disney and other pay-TV giants.
Disney is cannibalizing its best business
At the same time, the more that Netflix subscribers get hooked on Netflix's original series, the more likely they will be to cut the cord. There's so much to watch on Netflix that you'd have to spend a lot of time watching TV (or be very picky) to run out of interesting content on the service. Given the vast price gap between a Netflix subscription and a cable TV subscription, this is a compelling rationale for cutting the cord -- unless you're a sports fanatic.
Netflix's content library has an embarrassment of riches. Photo: The Motley Fool
Disney and other top pay-TV channel owners are finally realizing that this is an untenable situation. But keeping prime TV content off of Netflix is no longer likely to keep people hooked on cable.
If competitors stop selling syndicated content to Netflix, it will just ramp up its original programming investments even further. With a total cash content budget of more than $6 billion and rising, Netflix can afford to make a lot of originals. (Even a relatively pricey original series like "House of Cards" reportedly costs about $50 million per season.)
In essence, Disney and its peers have given Netflix the content it needed to attract an audience of tens of millions of subscribers in the U.S. alone. By the time they are contractually permitted to take that content away, Netflix won't need it anymore, because most subscribers will be loyal viewers of Netflix originals.
Disney still gets more than half of its operating income from its Media Networks business. If the growing strength of Netflix leads to faster erosion of the pay-TV subscriber base in the next five years, Walt Disney executives and investors are likely to regret the company's decision to treat Netflix as a partner rather than a dangerous rival.
