There's a lot riding on Comcast's (NASDAQ:CMCSA) X1 platform. The cable company is pointing to its new set-top box as a differentiator for its service against satellite and telco services. It features advanced search capabilities as well as the ability to view on-demand and streaming video content from the cable operator's owned networks and partners.
Now, the company is adding another big partner to the X1 platform: Netflix (NASDAQ:NFLX). Re/Code reports that Comcast and Netflix have reached an agreement to incorporate Netflix into X1. While the two companies have been contentious in the past, the move comes at the right time for both. Here's why the deal is a win-win for Netflix and Comcast.
Netflix gets a big domestic marketing partner
Comcast had 22.4 million video subscribers at the end of the first quarter, and nearly 35% of them have an X1 box in their homes. The company believes it can reach 50% penetration before the end of the year, and it's back to growing its video subscribers. That means over 11 million households could soon have easy access to Netflix right from the same remote they use to watch the rest of their TV programming.
While many of those subscribers will already have a Netflix subscription, Netflix is coming up against saturation in the U.S. market, so every little bit counts. The streaming service disappointed investors with its first-quarter results and even more dismal second-quarter outlook. The company expects to add just half a million net subscribers in the U.S. for the second quarter, compared to 900,000 a year ago.
Netflix is also facing potentially higher churn rates after its grandfathered pricing discount lapsed earlier this summer. Some longtime subscribers are seeing a $2 increase in their monthly subscription rate. Making it easier for them to access Netflix content -- reminding them of the value it provides -- should help reduce churn rates. With less churn, Netflix needs fewer gross subscriber additions to increase its total subscriber count.
Of course, this comes at a cost for Netflix. The deal is reportedly similar to those it has in place with Apple and TiVo. Netflix will pay a percentage of the subscription fees it collects via X1 signups to Comcast in exchange for placement and promotion on the platform. That expense falls under Netflix's marketing expenses. Domestic marketing expenses increased nearly 20% from 2013 to 2015. The recent price increases should help offset additional marketing expenses.
Comcast keeps customers on X1 instead of third-party boxes
FCC Chairman Tom Wheeler recently proposed that pay-TV companies should allow third-party devices to access video feeds, providing consumers with more hardware choices. Currently, customers are all but locked into the hardware their cable company mandates, or they can use the cumbersome process of a cablecard system like TiVo.
The move to incorporate one of the most in-demand internet video services to its X1 is a show of goodwill to the FCC that Comcast can play nice with competitive services and offer its customers plenty of choice. Its hope is to reduce the terms of the FCC's original proposal that it provide a stream of content to any hardware company.
Controlling the set-top box with which users access its content also means Comcast is able to position its own services better than they would otherwise be presented on a third-party box. If a lot of Comcast subscribers are also Netflix subscribers, Comcast has an interest in allowing its customers to access Netflix through X1. While it means there's a chance it will see less on-demand viewing through its X1 platform, it beats the alternative of customers completely leaving the ecosystem to access video content elsewhere. At least this way, Comcast stays in the game.
It's the classic "if you can't beat 'em, join 'em" situation. Comcast is facing attacks from multiple sides, and its best option at this point is to partner with Netflix. The move will help keep customers on its set-top box longer (even if they're not necessarily watching Comcast content), appease the FCC to some degree, and bring in a bit of revenue from Netflix subscriptions while it's at it.