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Here's Another Way Netflix Is Disrupting Television

By Jamal Carnette, CFA - Mar 9, 2016 at 3:41PM

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Cable networks are spending big money to ape Netflix.

House of Cards is one of Netflix's critically acclaimed shows. Source: Netflix.

To say that Netflix (NFLX -1.65%) is a disruptive company is an understatement. After being turned down when it offered to be purchased by its then-larger competitor Blockbuster, Netflix helped bankrupt the big-box movie-rental company with its DVD-by-mail business. Not happy with simply being a better delivery vehicle for DVDs, the company turned to streaming-based content delivery as its primary business model.

Netflix now has a new target in its sights: traditional television. It aims to compete with media companies like Discovery (DISC.A), Time Warner (TWX), and Viacom (NASDAQ: VIA) for viewership. Netflix appears to be winning: According to Canadian network-equipment company Sandvine ( via Quartz), Netflix now commands 35% of peak-period primetime Internet traffic in North America, up from 22% in 2011. This growth terrifies traditional television because consumers binging on Netflix's content are not watching traditional, ad-supported television.

Cable networks have traditionally held the upper hand in negotiations with Netflix due to the fact that these companies held the content rights for shows that Netflix needed to keep subscribers. However, Netflix's recent string of critically acclaimed original programming -- including House of Cards, Orange Is the New Black, Unbreakable Kimmy Schmidt, and Narcos -- has mostly mitigated this threat, and is quickly turning content into a source of strength for the company.

An "arms race" for original content
This isn't cheap for Netflix. According to media-analysis firm MoffettNathanson (via Bloomberg), Netflix is on pace to spend a massive $5 billion on original content in 2016. The solution among competitors seems to be to join Netflix in what Bloomberg calls an "arms race." According to MoffettNathanson information reported by Bloomberg, Time Warner is expected to spend $4.5 billion on non-sports original programming this year, and Viacom is looking to shell out $3.82 billion. Discovery is estimated to spend $2 billion on original content this year in an attempt to develop market share stealing content in the race for eyeballs.

While Discovery is among the lower of the mentioned companies, it is perhaps the most-aggressive cable network in pursuing original content. It has increased its original programming expenses an estimated 55% in the last three years, or nearly 16% annualized during this period.

Additionally, Discovery has taken a small stake in film and television studio Lions Gate, buying 3.4% of the company. MTV and BET owner Viacom has increased original-content spending 25% during the last three years, according to the Bloomberg report, as it attempts to limit defections among its millennial-heavy, technology-savvy demographic to streaming-based services like Netflix and Hulu.

Will spending hurt investors?
There's a risk in spending large sums of money on untested original content, of course. The fail rate for network shows is always high. From 2009-2012, on average, 65% of new network television series were canceled in their first season, according to screenrant.com. While the economics of original content shows are better for a company, as the company profits from being both the production studio and the network, it's still risky to sink large amounts of money into these shows in hopes you'll create a large-scale hit. 

And, according to Nielsen, this spending hasn't helped traditional television. Viewership in the highly desired 18-49 age demographic is down 5% for cable networks this season. Against this landscape, investors in traditional cable networks should ask if doubling down in hopes to create a massive hit is the best use of capital.

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