January 2014 30 Blockbuster and worked well because they were able to buy DVDs in retail stores, and copyright laws allowed them to rent those DVDs out. Netflix’s video streaming instead went headto-head with giants such as Amazon, Hulu, iTunes and YouTube (which is now moving into subscription TV with its own 50 channels), but it succeeded because of its original programming strategyandscheduling,whichallows subscribers to binge-watch entire series. Now, by entering the cable and satellite delivery model, Netflix is getting closer to an HBO-like service, complete with original programming. Indeed, Netflix sees itself as the Internet counterpart to HBO, especially considering that HBO’s business model, which relies exclusively on cable and satellite subscribers, makes it difficult to offer its HBO Go Internet service to non-cable subscribers. “The network that we think is likely to be our biggest long-term competitor for content is HBO,” Netflix stated in its annual report. IntheU.S.Netflixhas31.2millionsubs,compared to HBO’s 28.7 million. Netflix’s worth is estimated at $12 billion, the same as HBO if it were to be spun off from parent company, Time Warner. To aid the Internet-cable transition, the U.S. Congress is considering a bill that would give online TV services like Netflix, Google’s YouTube and Hulu the same access to programs as cable and satellite get today. Netflix’s business model has four main components. On the cost side, there are content, marketing, shipping and bandwidth and technology expenditures. In the revenue column, for now, there’s only subscription fees. According to some accounts, because of programming costs, Netflix is spending itself into a corner. In particular, digitalmedia analystMichael Pachter calls Netflix’s model “unsustainable” (however in the past he overvalued Blockbuster, which recently went bust.) Netflix now spends about $200 million annually on original programming, about 6.7 percent of the company’s $3 billion 2014 budget on program licensing. It has already committed to spending$5.4 billion on content deals, with $2.5 billion of that due during 2014. According to Pachter, Netflix’s original content and top-rated shows are merely licensed on an exclusive window. “They have the rights to show the stuff for two years and that’s it. [That’s] unlike HBO, which owns some of its original content,” he primetime Internet traffic, dominating the online video business. YouTube follows with 18.7 percent. Reportedly, Netflix pays about 2.5 U.S. cents to stream a film and/or a TV show. It is calculated that streaming on AWS costs about $0.05 per GB, which for Netflix represents $250 million per year. This compares to $600 million yearly, which was used for shipping DVDs in their peak years. While most video contracts with thirdparty Content Delivery Networks (or CDNs, a distribution system that accelerates the Internet delivery of audio and video files) are typically priced on a per-gigabyte-delivered model, Netflix (and other large content distributors) pay the CDNs (like Akamai Limelight and Level 3) on a per-megabyte-per-second-sustained model. Netflix doesn’t pay for the total number of bytes it transfers each month, but rather the total amount of bandwidth it peaks at each month, a pricing model also referred to as 95/5. This means that customers can burst above their committed rate of megabytes-per-second less than five percent of the time with no penalty, but once they go over that, Netflix pays for overages. A report in the Wall Street Journal claims that at this time, Comcast, AT&T, Time Warner and Verizon are not willing to give Netflix space in their datacenters, expressing concern that doing so forNetflixwouldallowother content providers, such as Amazon, to demand the same access. It should also be noted that some of those ISPs are also in the business of content providing, and improving the performance of Netflix is certainly not in their interest. Plus, they are considering caps, though Netflix doesn’t mind if the “amount of bandwidth consumed by our product can be adjusted down to reasonable caps.” Canada — where Netflix has been operating since 2010— imposes a bandwidth cap and Rogers Cable bases broadband fees on usage, so Netflix allowsuserstoscalethequalityoftheirconnections tomanage the caps. In addition, if cable companies want to raise their broadband profits, most likely the increase will come from the consumers who want faster speeds and not from Netflix. For its part, Netflix announced that 4K video stream would be available in 2014, with the lowest-end stream requiring 15 Mbps connections. But it’s mainly the cost of content that is hurting the company’s profit growth. In 2012, for example, Netflix posted revenue of $3.61 billion but an operating income of just $50 million and a net income of $17 million. By comparison, industry estimates peg HBO’s revenue in excess of $4 billion in 2012 and its operating income at more than $1.6 billion. This is acknowledged by Netflix in its annual report: “The onematerial differenceworth noting is original content production is cash-intensive and that means for us that cash is front loaded relative to the P&L.” This is because, in order to permit binge-viewing of original series, all episodes need to be paid to the producer at once. Even though Netflix has been good at adapting to the marketplace and technology, future challenges are expected to grow along with its business. The problems cover all aspects: leveling sub growth rate, escalating programming costs, stronger competition, streaming caps and increasing shipping costs for DVD delivery. By Dom Serafini reported.However, oneproducer explainedthat, for their territories Netflix retains four-year exclusive rights on original programming (after that, the SVoD window on perpetuity) and that they do not fully pay for production costs, pointing out that, to get distribution rights, Sony Pictures put up $1.5 million for the MRC-producedHouse of Cardsseries ordered by Netflix and for which they spent $100 million on its two-season remake (26 episodes). This is how Netflix explains it: “Our licensing is generally time-based, so that we might pay for a multi-year exclusive subscription video-ondemand (SVoD) license for a given title. Typically our bids are for exclusive access to the SVoD rights.” A U.S. studio executive added, “they’re smart and know what they’re doing.” The fact remains that Netflix needs to spend money on content — licensed or original — to continue to grow its subscriber base, while keeping its cancellations (which can reach five percent a year) at bay. According to some analysts, Netflix will reach peak penetration of 50 million U.S. HH and that same level internationally later on. This scenario is based on a total subscriber base of 140 million with 70 million in the U.S. and 70 million internationally. For its part, Netflix CEO Reed Hastings stated that the company could reach 60 to 90 million subscribers over time, but struck a note of caution. “The larger we get, the harder it is to grow,” he said in a video webcast. Netflix faces competition from Amazon, Hulu and the newly announced Warner Bros. streaming venture with Facebook, as well as churn that makes it hard for subscription-oriented businesses to grow beyond a certain point. In addition, to promote its services, this year Netflix will invest $500 million in marketing and over $400 million in streaming delivery, sign-up and billing technology developments. Original programming is costly to produce and to stream, since dialogue has to sync with the video being shown at different Internet connection speeds — unnecessary steps when Netflix licenses library content, which often has the technical work already done. Netflix’s streaming service is accessible on any of the 800 compatible Internet-connected devices, accounting for viewers who have different Internet connection speeds, various screen sizes and different technologies running the devices. Streaming also costs money. Watching Netflix requires ISPs (they mostly use Amazon’s AWS 10,000 servers) to move a lot of data and, according to some analysts, Netflix’s streaming service accounts for 28.8 to 33 percent of all U.S. Netflix’s Magic in LATAM (Continued from Page 28)
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