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This Could Be Netflix's Biggest Weakness

By Jeremy Bowman - Oct 13, 2017 at 7:11AM

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Increasing competition from Hulu and others may be breaking Netflix's grip on licensed content. Though its originals get much of the attention, licensed content is still the key driver of the company's viewership and performance.

It's a great time to be Netflix Inc (NFLX 2.90%).  Shares of the leading video streamer just shot to record highs after announcing a price increase. Not only will the company soon see rising operating margins, but investors are rewarding management for the move.

Meanwhile, analysts are bullish about next week's earnings report, and the company just won 20 Emmy awards after garnering a company-record 91 nominations at the annual television celebration.

Netflix's success with original programming along with the performance of the underlying business and stock price has taken over the narrative of the company. The service is now associated with hit shows like House of Cards and Stranger Things, but its growing reputation for original content belies an important truth about the company -- most of its programming budget and viewership revolves around licensed, not original content.

Netflix's head office in Los Gatos, CA.

Image source: Netflix.

Though its hit shows are the ones that get headlines, Netflix Content Chief Ted Sarandos acknowledged that the "vast majority" of next year's $7 billion budget will go to licensed content. Within a few years, Netflix believes it will spend half of its budget on original content, but currently the company is heavily dependent on partners. For example, a recent survey of Netflix's "Trending Now" suggestions found that most of the recommendations were not Netflix originals.

Here comes Hulu

The company faces an increasing number of competitors as traditional networks like CBS (PARA 2.15%) and Disney (DIS 1.84%) have launched or announced plans for their own streaming services, but the most underrated of its rivals may be Hulu, a joint venture between several of the major broadcast networks.  

Backed by the likes of Disney (via Disney ABC), 21st Century Fox, NBC Universal, and Comcast (CMCSA 2.68%), Hulu looks like a business that was designed to stand in Netflix's way, and after its debut series The Handmaid's Tale won Best Drama at the Emmys, the company has momentum like never before. Hulu recently stepped up its challenge of Netflix by outbidding it for the popular NBC series This Is Us, and acquiring the rights to 30 Rock, which stopped streaming on Netflix last month. Among the other shows Hulu recently acquired are Black-ish, Will & Grace, and NYPD Blue, giving the service a reliable library of reruns that have proven to be popular.

In another shot across the bow at Netflix, Hulu just announced it would lower its monthly fee for new subscribers from $7.99 to $5.99 with commercials, seemingly a response to Netflix hiking the price on its most popular package from $9.99/month to $10.99/month. The move should help draw attention to Hulu as it beefs up its content library.

Moving to originals

Netflix has carefully developed its strategy around original content, as the streamer would rather invest to create its own programming that it controls in perpetuity and can stream around the world. 

That strategy makes sense for Netflix as content creators like Disney are becoming reluctant to sell to it, but investors should remember that the streamer has no inherent advantage when it comes to creating content. Like its competitors, Netflix has had hits and misses, and is often simply bidding alongside Amazon (AMZN 3.15%), Hulu, HBO, and others as new shows become available. As Hulu's Emmy win shows, all of the streamers and premium networks are capable of churning popular shows.

Turmoil inside Amazon Studios, meanwhile, has become apparent as that company has been unable to land a Game of Thrones-type hit despite spending $4.5 billion on content this year, and CEO Jeff Bezos has called for a shakeup in the division's strategy.

Netflix's advantage may come from its global reach and paying audience of over 100 million, but it's worth remembering that syndicated shows are an important anchor for the company's audience. As it steps up its focus on originals, the company needs to be careful not to lose too many of the classic hit shows that have delighted its members for so many years.

 

   

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Netflix, Inc. Stock Quote
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The Walt Disney Company
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Amazon.com, Inc.
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Comcast Corporation Stock Quote
Comcast Corporation
CMCSA
$40.29 (2.68%) $1.05
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Paramount Global
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