Will Amazon Be the Death of Netflix?

Competition for Netflix (Nasdaq: NFLX  ) may finally be on the way.

Tech blog Engadget reported over the weekend that Amazon.com (Nasdaq: AMZN  ) revealed an inadvertent preview of a service that will offer members of its premium Prime loyalty shopping access to digital video streams from its modest catalog at no additional charge.

This, in of itself, isn't news. The Wall Street Journal broke this story nearly two months ago.

However, now that Engadget has the screen cap to prove it, we can begin to assess the opportunity that this presents for Amazon, the challenge it will be for Netflix, and what this will mean for the video industry in general.

Advantage: Amazon
Offering 5,000 commercial-free flicks and television shows may be a quarter of the digital catalog that Netflix has amassed over the past couple of years, but it's a strong start. Netflix rolled out its service four years ago with just a thousand titles. That worked out pretty well for Reed Hastings and his crew. Netflix's subscriber base went on to nearly quadruple in that time.

Amazon isn't just starting from scratch the way that Netflix pioneered this space with a flashlight and a prayer book in 2007. The world's leading online retailer already has many of the deals in place to deliver content into set-top boxes.

It's been selling piecemeal digital video through TiVo (Nasdaq: TIVO  ) and Roku boxes for years. Logitech's (Nasdaq: LOGI  ) Revue box that came out a few months ago? It also plays nice with Amazon's Video on Demand service.

Perhaps more importantly, Amazon does something that Netflix right now does not. Amazon sells and rents digital copies of more than 75,000 flicks and television shows on a title-by-title basis. If there's nothing you want to watch through Amazon's Prime Instant Videos, you can fork over a few bucks for a streaming rental of new releases that would never be available through Netflix's streaming service.

Amazon doesn't have the video-game console deals in place that Netflix does. But they'll come if this catches on. The flood of tablet and mobile streaming apps will follow.

Amazon also is a retailer of physical goods. It sells the TiVo, Logitech, and Roku boxes. It sells DVDs. It can use every sale as a lead to promote its new service. If it convinced millions of avid book readers to embrace the Kindle, just watch it win over the couch potato.

It's also coming in with an installed membership base. Amazon has never revealed how many of its loyal customers are paying $79 a year for Prime memberships that offer free two-day shipping on Amazon-stocked goods and steeply subsidized overnight deliveries. However, just as Netflix was able to shoehorn streaming as a freebie to existing DVD renters, the included streams will take off quicker than as a standalone product starting with a user base of zero.

One final point to respect Amazon in this space: Lovefilm. Amazon has had a minority stake in the European DVD and streaming service for years, but last month it went ahead and swallowed it whole. Netflix has plans to expand outside of North America this year, and Amazon already has a head start overseas.

Advantage: Netflix
The longer it takes for Amazon to officially roll out Prime Instant Videos, the bigger the lead Netflix gets.

The flick flicker closed out 2010 with 20 million subscribers -- 3.1 million more than it had three months prior and 7.7 million more than it had a year earlier. It expects to tack on an additional 2 million or so net subscribers during the current quarter.

Historians will be left scratching their heads. Amazon and Apple (Nasdaq: AAPL  ) are some of the savviest consumer-facing tech giants around. How could they have spent years trying to push piecemeal rentals as Netflix's smorgasbord grew to become the country's largest premium entertainment subscription service -- which it will become once it passes up Comcast (Nasdaq: CMCSA  ) in a few months?

Apple was vindicated in sidestepping the digital music buffets. The iTunes model clearly proved more lucrative than Napster, Zune Pass, and Rhapsody. However, the writing's been on Netflix's wall for years. Cable providers have been offering on-demand rentals of new releases for ages. Consumers like the "all you can eat" model when it comes to eye candy.

Netflix may also have the movie studios on its side for a change. If $7.99 a month for Netflix's "streaming only" service is belittling the perceived value of digital video, what will Hollywood think of Amazon offering it as a bonus to an even cheaper subsidized shipping service?

Studios will be reluctant to fatten Amazon's library beyond titles that are largely unmarketable. Amazon's catalog won't be bare. It has strong relationships with the studios as a leading DVD retailer, but Hollywood can't continue to devalue its celluloid.

Advantage: Consumer
Competition is typically good for consumers. Netflix will have to keep its rates in check, and it may even be susceptible, given last month's rate hike. Netflix and Amazon will be in an arms race for content, and that will move this revolution along a lot quicker than if it was just one hungry party here.

However, there may be some drawbacks. Netflix and Amazon may now be tempted to begin brokering deals for exclusive streams to stand out, restricting access to users of a rival platform.

Amazon's entry may also put an end to Coinstar's (Nasdaq: CSTR  ) dreams of digital delivery. The Redbox parent promised details last year, but those fireworks fizzled. Many analysts assumed that Redbox would offer a branded service through Amazon, but Jeff Bezos is apparently going it alone.

If Amazon sticks to its model, it will be hard for a third player to dive in at a lower price point.

In the end, Amazon will widen the streaming market, but it may not necessarily come at Netflix's expense.

The plot is starting to thicken. Please pass the popcorn.

Can Amazon dent Netflix's market? Share your thoughts in the comment box below.

Apple, Amazon.com, and Netflix are Motley Fool Stock Advisor recommendations. Logitech International SA is a Motley Fool Hidden Gems recommendation. The Fool has written puts on Apple. Motley Fool Options has recommended a write covered call position on Logitech International SA. The Fool owns shares of Apple, and Logitech International SA. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Longtime Fool contributor Rick Munarriz has been a Netflix shareholder -- and subscriber -- since 2002. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (8) | Recommend This Article (15)

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  • Report this Comment On February 01, 2011, at 3:50 PM, Pandorabelle wrote:

    It's the beginning of the end for NFLX. Given the shennanigans by the NFLX execs, they deserve to be outed, then stomped.

  • Report this Comment On February 01, 2011, at 5:20 PM, PadiwanJoseViii wrote:

    I own both of these great companies. I don't see either knocking out the other. I foresee a consumer model where they subscribe to Netflix for day to day content and then go to Amazon for premium content. There are already Netflix buttons on the remotes of some major brand TV equipment, so hard to beat them in the day to day space. If you ask me, it's the cable companies that should be nervous.

  • Report this Comment On February 01, 2011, at 10:35 PM, JayShaw wrote:

    Sundolly, what "shennanigans" are you talking about?

  • Report this Comment On February 01, 2011, at 11:07 PM, jaas11 wrote:

    Jay...

    Check the income and cash flow statement. The CFO resigned -- historically a warning sign. Insider selling. No forward guidance. etc, etc....

    Pair this with expiring streaming content that will be renewed at 10x more, and potential increased comp... this does not add up to a 50x fwd PE stock

  • Report this Comment On February 01, 2011, at 11:52 PM, wjcoffman wrote:

    I chickened out of my position in NFLX back when WMT and AMZN were 'threatening'. I was in at about 25, watching it dip into the low 20s, and sold at 27. I thought about getting back in but seeing a line outside of the Red Box (?) kiosks at the gas stations and inside WMT entrances gave me pause.

    Now it's at what - $220? Bet against the brothers Gardner at your own financial 'peril'!

  • Report this Comment On February 02, 2011, at 1:07 PM, Pandorabelle wrote:

    NFLX ACCOUNTING GIMMICKS!

    Jay, they have been (MISREPRESENTING)playing games with their accounting for several quarters. Here:

    Since 2009 EPS at NFLX has been the function of an ACCOUNTING GIMMICK. …..Amortization is the entire scam.....delaying expenses on the income statement---and the reason why CF & NI don’t match...they are spending 2X the money on streaming content costs vs DVD historically, then amortizing (over the contract term) them instead of expensing, because they don’t really have 10M streaming customers............!!! Thus NI growing 2-3X vs. CF in 2009 & 2010.

    Look at the table below……

    2005 2006 2007 2008 2009 2010

    CF 46.0 78.7 68.8 121.1 132.0 152.5

    71% -13% 76% 9% 16%

    NI 42.0 48.8 66.6 83.0 115.9 160.9

    16% 36% 25% 40% 39%

    CF 37.8 75.5 52.2 114.0 134.3 12.5

    ex A/P

  • Report this Comment On February 02, 2011, at 1:08 PM, Pandorabelle wrote:

    NFLX will be the death of itself.

    You don't need an accounting degree to see the charade.

    Revenue increases: $553 to $595 = $42 million

    Subscription costs: $292 to $336 = $44 million

    Fulfillment goes from $52 to $52 = $2 million

    Thus $42 million in additional revenue actually costs NFLX $46 million….so the move to streaming is LESS profitable.

    How do you make money losing $11MM for every $10.5MM you sell??

    SOMEONE answer this.

    If they pay A/P on time, their cash drops by $70MM this quarter.

    What about incremental costs on their streaming content to the studios that are eating up the subscription revenue??

    We know content costs are going to rise, but it may be even more aggressive based on streaming usage….

  • Report this Comment On February 02, 2011, at 1:18 PM, Pandorabelle wrote:

    PS...re: the 1:07 post, source: Reuter's Knowledge

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