Earlier this year, Walt Disney (DIS 1.84%) announced it's pulling its films from Netflix (NFLX 2.90%) when its contract expires in 2019. And Disney isn't the only company pulling its content: Twenty-First Century Fox hasn't been renewing licenses for its popular series, and neither has NBCUniversal.
But Netflix isn't too concerned with losing a lot of its licensed content catalog. Speaking at an investor conference earlier this week, Chief Content Officer Ted Sarandos said viewers don't value the back catalog very much even if they do watch it. "People do enjoy the entertainment value of spending a lot of time on Netflix, but it's not that distinctive," he said. "A lot of those shows you can buy on DVD, you can buy on iTunes, so we're not that destination oriented around those shows."
Providing the best value to subscribers
When Netflix is trying to determine how to spend its content budget, it's looking for the most efficient use of the next dollar. That may mean a $100 million original production that attracts tons of new viewers and watch time, but it also might mean licensing a small niche production for a few hundred thousand dollars that keeps a few viewers thoroughly entertained for hours and hours.
To that end, some of its most efficient content spending is on its original productions. Originals allow Netflix to differentiate its product, especially among a growing list of competing services from established premium cable channels and media start-ups.
Original productions are just as much about keeping Netflix's existing customers entertained as they are about attracting new viewers to the service. Licensed content doesn't do much to attract viewers to the service, so it's only working on one of those growth drivers. Additionally, since subscribers don't value it as much (even if they watch it), they don't mind giving it up in favor of content they might value more -- like more originals on a different service.
Sarandos said Netflix will achieve its goal of 50% original content by 2019. No doubt that's driven largely by Netflix's global expansion, as it's much easier to get global rights to content as the producer instead of a licensor.
Still a need for licensed content
There will always be a place for high-value licensed content on Netflix. People love to watch their favorite movies and TV shows over and over again. Sarandos has previously held up Disney as a company with great intellectual property and whose fans will watch its movies repeatedly.
As media companies pull content from Netflix, Netflix has been proactive in licensing new content. It's working with traditional U.S. media companies to co-produce shows, and it receives the first-window license to stream those series outside of North America. Sarandos says it's already taken this approach with 30 series including Star Trek Discovery and Designated Survivor.
Netflix can still get a lot of value out of a strong back catalog of content. But as the price of content increases and some is taken off the table entirely, it's leaning more heavily on its original productions.
Netflix may be able to lower its costs by increasing its co-productions, but it also needs some tentpole classics like Friends. While losing some of those classic shows as media companies retain more streaming rights could hurt, Netflix should be able to navigate the terrain.
Getting more out of its content budget
Netflix has one of the biggest content budgets of any media company -- far surpassing rival streaming services. It also has over 100 million customers streaming video for tens of hours every week, which provides a better data set than any of its competitors have. Netflix can use those data to make its content budget go a bit farther.
Netflix uses the data to help determine which original productions to take on and whether to renew licensing deals. More importantly, however, it uses the data to suggest new shows to viewers, so there's always something new or interesting for subscribers when they log in. The ability to mine its catalog for that next show or movie a user wants helps Netflix get the most out of it.
Netflix says its artificial intelligence (AI) increases its bottom line by $1 billion per year. Losing major licensing deals from Disney and others won't be a huge burden if its AI algorithm continues to do its job. And with a growing set of data to use, the algorithm is likely only getting better.