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Will Streaming Subscriptions to Cable Networks and Other Competitors Hurt Netflix?

By Nicholas Rossolillo - Feb 17, 2016 at 8:20PM

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Let's use Porter's Five Force model to determine the competitiveness within Netflix's industry, and see if the company still has an edge over the rest.

The competition in the Internet TV space has been heating up as the trend to ditch cable and satellite subscriptions intensifies. Netflix (NFLX -1.04%) has seen many new players enter the fray, from cable network collaboration Hulu to Internet retail giant Amazon.com (AMZN -0.17%). Rumors  have started to emerge about cable networks launching stand-alone packages to compete in the space. Does Netflix still own a competitive advantage in the growing Internet TV arena? And how will this affect longer-term profitability for shareholders?

To answer those questions, let's take a look at Netflix using Porter's Five Forces model:

Diagram created by author.

Competitive rivalry within the industry
Competition is high between a few major players in the TV streaming industry, those being primarily Netflix, Amazon Prime Video, and Hulu. However, consumers have many options to choose from when watching a movie or TV show. In addition to streaming services, there are a slew of streaming devices to choose from (discussed below). Actual movie rentals also still own some market share, chief among them being Outerwall's Redbox rental kiosks. Here is a breakdown of market share within the industry:

Source: Data courtesy of www.statista.com

Threat of substitute services
I believe this to be the biggest threat to Netflix's business. A substitute service is one that is different but still viewed as an acceptable alternative. Netflix has seen many of these pop up over the years and could continue to see more appear in the years to come -- streaming devices from privately held Roku, as well as Amazon, Apple (AAPL -0.57%), and gaming consoles. While most of these streaming devices are compatible with Netflix, they also offer other services and video on demand that ultimately compete with Netflix for subscribers.

In a fight against axing cable packages, many traditional TV networks have been threatening to launch their own stand-alone streaming service or have launched apps available on streaming devices. Disney (DIS 0.35%) is one such example, having released its sports network ESPN as an app on streaming devices like Apple TV. Disney has also talked about launching ESPN as a stand-alone streaming service at some point in the future. Time Warner (TWX)-owned HBO has also recently been released as an app on streaming devices. Not to be left out of the mix are the old broadcasting stations, which have similarly launched streaming or on-demand versions of popular TV shows.

As a result of the fierce competition and broad array of substitute services, much downward pressure has been placed on Netflix's profits. For the 2015 calendar year, Netflix had an operating margin of 4.5% and net profit margin of 1.8%, leaving any growth in profits coming primarily through subscriber growth and expansion in international markets.

Threat of new entrants
This is a competitive edge that Netflix does hold, as a threat of new entrants into the market is low. Barriers to entry are high in the online-TV streaming industry. Besides the large amount of capital needed to build the infrastructure involved in delivering video directly to someone's device, negotiating power is also needed with content providers. Netflix has been able to successfully deliver that over the years, providing a large library of TV shows and movies for subscribers to choose from.

With the exception of Amazon and Hulu, many upstart companies have been unable to deliver content by negotiating deals with TV show networks and movie production companies. Even Apple, with its long-rumored streaming service still pending, has had difficulty in getting television networks to come to an agreement. Apple has been reported to want to offer a streaming TV package for a price point between $30 and $40 a month, but TV networks and other content providers expect to be compensated at a higher rate that makes Apple's plans unrealistic at this time.  

Netflix has also seen great success in the past few years in rolling out original movies and series. For example, Netflix's original series House of Cards has won two Golden Globe awards and six Emmy awards, and Orange Is the New Black has won four Emmy's. This places yet another obstacle before a new entrant, as Netflix instantly has the competitive edge in offering extra titles a newcomer couldn't.

Bargaining power of suppliers
The bargaining power of suppliers, in this case studios and TV networks that produce movies and shows, is moderate. Early on in the industry, this power of suppliers was quite high. As more and more subscribers got on board with Internet streaming, Netflix and others in the industry have increased their pull with production studios. As a result, the company has been able to negotiate an increasing number of contracts over the years.

As mentioned, Netflix has also seen increasing success in producing its own shows and movies. This has also helped remove some of the leverage suppliers have within the Internet streaming space, placing more power in the hands of Netflix.

Bargaining power of customers
The collective power of buyers is also quite high within the industry. Cable-cutters ditching traditional TV packages are typically trying to save money. As a result, costs are kept quite low and uniform in the TV streaming industry. Monthly subscriptions usually cost in the low double digits or single digits. It's quite easy for consumers to cancel their subscription and switch to a competing service, and there typically are no upfront costs locking them into any contracts.

As a result, there is little to no pricing power for Netflix, as costs charged are kept fairly uniform across the different providers. (Netflix service starts at $7.99 a month, Amazon Prime is $99 a year, and Hulu starts at $7.99 a month.)  This ultimately puts a damper on profits the companies operating in this space can expect going forward.

Will the competition hurt Netflix?
The competition in the Internet TV market has gotten crowded, but I don't believe it will hurt Netflix's business yet. The company's service is priced competitively and has a head start on newer entrants. Netflix's growth more recently has come from expanding into international markets. Its fourth-quarter 2015 letter to shareholders reported that it surpassed 75 million subscribers, as its service is now available "virtually everywhere but China." The company sees another net 6 million subscribers in the first quarter of 2016.

For the foreseeable future, I see Netflix continuing as a business growth story driven by increasing subscribers worldwide and having a head-start on competitors and new entrants.

Nicholas Rossolillo owns shares of Apple. The Motley Fool owns shares of and recommends Amazon.com, Apple, Netflix, and Walt Disney. The Motley Fool recommends Time Warner. 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.

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