A popular critique of video streaming service Netflix (NASDAQ:NFLX) is that the company cannot bring in enough revenue from customers alone to keep up with the need to continue purchasing new content for their service. Financial writers and analysts always launch into the refrain: "Netflix needs advertisements to bring in more money." Netflix's response has always been a solid "No." And it's a very wise "no," given what Netflix knows about its customers.
Streaming video companies have a big advantage over the cable companies: they have detailed viewership statistics, and can use those statistics to determine what programs to buy and how much to pay for them. The fact that these services have so much children's programming available and keep loudly proclaiming that they're acquiring more is a sign that appealing to parents and kids alike is a major key for retaining existing subscribers and bringing in new customers. And the one thing that would cause parents to cancel their subscriptions to Netflix is advertising.
No ads leads to more trust from parents
Children are particularly susceptible to advertising on TV. Adults can watch a commercial for Ford trucks or Budweiser beer and not instantly jump up and down and demand a new truck or a beer right now. Small children don't have the same maturity to resist advertising messages. 30 minutes of typical cartoons on TV means parents subsequently get bombarded with a list of new toys that their kids need to have and whining about more TV shows that they need to watch later.
"Research has shown that young children—younger than 8 years—are cognitively and psychologically defenseless against advertising. They do not understand the notion of intent to sell and frequently accept advertising claims at face value."
As Internet streaming services have become mainstream, parents are realizing that they finally have entertainment companies that are working to help them out with the everlasting battle over TV time with their kids. Parents are an important part of the customer base for streaming video services because, while adult viewers might binge watch every episode of "Breaking Bad" but never watch it again, children have no problem watching every episode of "My Little Pony" over and over and over again. Kids get addicted to having their favorite shows available on-demand no matter what time of day they're allowed to watch TV, and parents stay with the service month after month to keep the kids happy watching ad-free content. Maintaining great children's programming content keeps subscriber churn low among households with children, and it's likely a better return on investment than other types of content.
While the prized target customers today are the parents, Netflix appealing to young viewers early is itself a form of advertising. Kids who grow up watching Netflix are more likely to become customers themselves one day. My own children already equate Netflix with watching TV, and they're still in elementary school. (Never mind that they are watching "My Little Pony," itself a 22 minute Hasbro commercial; we're already knee-deep in ponies and picked our own poison with that choice.)
In short, the companies that do the best job of keeping parents happy will have the best chance at being the dominant companies in the future media landscape. So who are those companies?
Who is winning the battle for parent subscribers?
Netflix is the purest business model based on generating Internet video streaming subscriptions, making it, in my opinion, the best business to invest in to capitalize on the changing media landscape. Netflix is the leader in using viewing statistics to drive their licensing deals, so their regular announcements of new content deals for children's programming implies that Netflix knows they can keep bring in new subscribers and keep churn low by keeping parents happy. Netflix currently has exclusive deals for shows with Disney (shows such as "Jake and the Neverland Pirates"), Dreamworks Animation (films like "The Croods" and "Turbo"), and Scholastic ("Magic School Bus", etc.), plus a huge selection of non-exclusive content from those content owners and others.
Like Netflix, Amazon.com's (NASDAQ:AMZN) streaming service has always been ad-free as well. The streaming video selection is a major draw to sign up for the Amazon Prime service, which in turn leads to more on-line purchases from those members. Amazon has been working hard to grab parents' attention this year. After Netflix declined to renegotiate a new deal with Viacom earlier this year, Amazon swooped in and grabbed a license, getting shows from Nickelodeon and Nick Jr. as two of the most highly touted prizes ("Dora the Explorer" and "Spongebob Squarepants", for instance, which Netflix no longer has). Amazon isn't a pure play on the future of TV, since they currently use streaming video as a gateway to gaining more traditional e-commerce business, but they're taking it seriously and look like they will emerge as one of the big players in the future of the industry.
Hulu has long been derided for having ads in all their programs, even if you subscribe to the premium "Hulu Plus" service. But even Hulu got on board with the Attract and Retain Parents thesis this summer, introducing a new ad-free "Hulu Kids" section. Hulu Kids doesn't yet have the same large selection as Netflix and Amazon, but they're in the game and playing catch-up with an exclusive deal for children's shows from the Jim Henson Family company (including "Fraggle Rock"). Like Amazon, Hulu also has Nickelodeon programming. There's no direct way to invest in Hulu currently, but you can own a piece through the three companies that own it as a private joint venture, Disney, News Corporation's 21st Century Fox, and Comcast's NBCUniversal. Of those three, Disney is one of the most important producers of children's programming in the world, making them look like a winner on both sides of the Internet TV battle for the hearts and minds of parents.
Mike Steele owns shares of Walt Disney, Netflix, and Amazon.com. The Motley Fool recommends Amazon.com, Netflix, and Walt Disney. The Motley Fool owns shares of Amazon.com, Netflix, and Walt Disney. 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. The Motley Fool has a disclosure policy.