Two months ago, I forgot how to operate my DVD player. (Seriously.) At the time, I took my newfound addiction to on-demand programming as a sign of the rising dominance of Netflix (Nasdaq: NFLX) and vowed to open a position. I haven't yet -- missing out on a 10% gain over a period during which the S&P is down 4% -- but only because I can't seem to stop writing about this exceedingly interesting business.
It's getting more interesting by the day. Most recently, I found myself annoyed at being unable to get on-demand copies of The Big Bang Theory seasons 2 and 3. Amazon.com (Nasdaq: AMZN) says it's in negotiations at the page for the popular CBS (NYSE: CBS) comedy while Apple (Nasdaq: AAPL) has yet to include the show in its iTunes catalog.
But then, right at my moment of maximum frustration, I realized how stupid I'd been. Netflix has DVD copies of all three seasons of The Big Bang Theory. As a subscriber, all I needed to do was add them to my queue for shipping. Call it the latest episode in my continuing adventures as a DVD moron.
Studios to Netflix: We won't be small-f fooled again
TV producers can be forgiven for not rushing to offer digital copies of all their shows via Netflix, iTunes, and Amazon's Instant Video. DVD sales can be extremely lucrative. Just collect a season of shows, add some cast commentary, press a few hundred thousand discs, and sell them for $19-$39 apiece. The math gets really impressive once you realize studios tend to enjoy a healthy 30% margin on DVD sales. Blu-ray disc sales may yield even more.
Either way, it's big money. Combined, DVD and Blu-ray accounted for $6.8 billion in revenue last year. The bad news? DVDs alone accounted for $7.97 billion in revenue in 2009, according to researcher SNL Kagan. Digital delivery is catching on too fast. And that's a problem on both the top and bottom lines. Sure, digital distribution might eliminate shipping and other incremental costs, but e-distributors charge fees of their own.
Executives also worry about digital files being more prone to piracy. As Canada's Macleans magazine put it in an article recently, we may be witnessing television's Napster moment. The implication? Uncomfortable though it may be, television executives have no choice but to figure out a workable system for distributing content via all the digital networks.
No doubt that's going to take months or even years to get right since neither Walt Disney (NYSE: DIS) nor Time Warner (NYSE: TWX) nor NBC Universal wants to give away too many rights too early in the shift to digital. For them, Starz is a cautionary tale. Some studios had included digital distribution rights in their arrangements with the cable channel owned and operated by Liberty Starz Group (Nasdaq: LSTZA), rights that Starz resold to Netflix for instant streaming of new movies, including recent releases from Disney and Sony Pictures.
Why Hollywood needs Netflix
Not even five years later, Netflix now accounts for about one-third of prime time Internet bandwidth usage. And that's with a relatively modest library. I'm not referring to volume so much as popular programming; you won't find TV's top shows on Netflix. Some aren't even on iTunes. DVD paranoia simply runs too deep. But here, too, the logic gets twisted from time to time.
Again, take The Big Bang Theory. Right now, Target is running a promotion in which you can buy any of the three seasons on DVD for $15. Can you imagine? At those prices, I can buy all 23 episodes of season 2 for $0.65 apiece, or less than your average DRM-loaded iTunes audio track.
This is why I think rights rather than pricing is the issue. Hollywood only wants to ensure it gets paid every time a video is rented or downloaded. Executives would probably also prefer a payload built into digital files that would either (a) make it incredibly difficult to rip and share via BitTorrent, or (b) disable media files upon tampering. Users would naturally prefer to have access to content anywhere, anytime, with no restrictions.
The Foolish bottom line
So long as this divide persists -- and it could for a while -- Hollywood is stuck with Netflix. Why? Consumers like me. We may prefer on-demand delivery, but we also want access to shows that are only collected on DVD and Blu-ray (e.g., The Big Bang Theory). With the demise of Blockbuster and most other mom-and-pop video rental shops, Netflix and the local library have become our only means to get these discs. And if timeliness and quality is an issue, it's really Netflix that serves us (and investors) best.
Do you agree? Disagree? Let us know using the comments box below, and when you're done take a minute to watch this free video right now. You'll walk away with a better understanding of how the online channel has given rise to cloud computing and changed everything in the process.
