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Netflix Looking to Re-energize Disc Rentals

1 Jun, 2011 By: Erik Gruenwedel

CFO eyes new movie ‘ball game’ when studio, pay-TV deals expire, beginning in 2013

After years of giving disc rentals the cold shoulder, Netflix is considering giving its packaged media roots some love — if nothing more than reduced indifference, according to CFO David Wells.

Speaking June 1 at the Bank of America Merrill Lynch 2011 Technology Conference in New York, Wells said the economics between Netflix’s streaming-only subscribers and hybrid (disc and streaming) subs remains an apples and oranges comparison due to the former’s marginal fixed costs and the latter’s variable costs such as shipping and handling.

Wells said the $2 surcharge hybrid subs pay monthly (Netflix does not offer a disc-only option) does not cover its variable fixed costs — a reality management intends to overcome by focusing more attention on disc rentals.

“We’re looking down the road at both re-energizing DVD functions and paying a little bit more attention to it, or at least stop really de-emphasizing it as well right the economics of that business,” Well said.

While the CFO didn’t elaborate, the fact that Netflix is even considering packaged media, including Blu-ray Disc, represents a change of sorts within the Los Gatos, Calif.-based service’s corporate mindset, which had all but dismissed physical content.

Indeed, online blogs and forums devoted to Netflix have showcased increased frustration by subscribers complaining about receiving DVDs instead of requested Blu-ray titles and/or not being able to rent select catalog fare on disc.

With much of Wall Street’s focus on Netflix’s license fees for streaming content, Wells said the sums mentioned in the media regarding major content deals focus on the totality of multi-year agreements versus what they actually cost Netflix on a quarterly or annual basis.

Without addressing directly a media report earlier in the day that suggested Netflix would pay Starz Entertainment $350 million annually when its license deal with the pay-TV channel expires next year, Wells said some of the reports are accurate while others aren’t.

“The deals we’re making are well within the [14%] operating margins,” he said.

Wells said he was pleased that Wall Street has moved past the amped “paranoia” from 2009/2010 regarding whether content owners doing a license deal with Netflix was good or bad.

He said 2011 is more of a year of experimentation based on deals done on a perspective basis in 2010 and content owners realizing they were actually better off and able to make money, especially in markets that didn’t have secondary TV syndication or other types of distribution.

“People [are now] coming us with deals as opposed to us driving to them with deals and opportunities,” Wells said.

When asked what competitors keep him awake at night, Wells said Amazon, Apple and Google all have the resources and infrastructure to compete effectively with subscription VOD.

“Any one of those companies can throw in. They are well-capitalized and very consumer-centric,” Wells said. “Their DNA is very similar to Netflix. It is not something that ultimately alters our behavior because you live under the specter of [competitive] entry all the time. When it happens, we’ll react in certain ways. It does keep us maniacally focused on improving the quality of the service.”

The CFO said Amazon has yet to make is Prime Video service commensurate Netflix, which he said would take hundreds of millions of dollars. He did say Amazon has wisely licensed independent fare that Netflix subs typically gravitate towards.

“The films they have work well for us as well,” Wells said. “We see that in terms of the data we see on viewership. Again, they have the DNA to be a very good competitor. It would take an uplifting in commitment in the U.S., and a willingness to advertise against us.”

He said Amazon would have to ultimately separate the streaming service from its Prime loyalty program if “they’re serious about it.”

Wells said Netflix would stay away from entertaining so-called “adjacent markets,” which include advertising, video games and transactional VOD, among other options.

“Our core addressable market is large enough and important enough that we are going to win in this space or lose in this space, [and] not because we added adjacency bets,” he said.

When asked whether Netflix would bid on movie rights heretofore locked up by pay-TV channels through 2015, Wells used a baseball analogy to describe the status on acquiring new streaming content.
He said acquiring major studio feature films (not independent fare) was in the eighth inning, while TV content licensing was is in the fifth inning.

“There’s lots of TV content out there that hasn’t been licensed,” Wells said.

He concluded that there exists the potential to create a new “ball game” in the future for major motion pictures when studio agreements with pay-TV channels such as HBO and Showtime expire.

“There is going to be a lot of experimentation, evolution and feeling out in terms of the deals, the length, the terms, what rights are included,” Wells said, adding he expects changes to occur as early as 2013 when Warner’s first pay-TV agreements expire.

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