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Netflix and Hollywood: What's the Deal?

20 Oct, 2010 By: Thomas K. Arnold

I came across an interesting story in The Wrap that alleges Netflix could have wound up being owned by the very same studios that are greedily eyeing the subscription rental service's 36% share of the home video rental market.

According to The Wrap story (to read it, click here), when Reed Hastings launched Netflix in the late 1990s, he cut a deal with Warner Home Video to share revenues on DVD rentals in return for warrants in his company. Other studios soon cut similar deals, The Wrap says, citing "two individuals with knowledge of the deal." But in 2002, when Netflix went public, the studios began selling their stock in the young company, and a year later all had given up their ownership stakes.

Talk about the one that got away. If The Wrap story is true, the studios would have been wise to hang on to Netflix, since it effectively controls the rental business and, what's more, its stock is now valued at tenfold the IPO price.

But those were different times, and one can hardly blame the studios for selling out when they did. For starters, the only reason Warner and the other studios got involved with Netflix in the first place was to attempt to rein in Blockbuster, which at the time was making what the studios considered unreasonable demands on product pricing and availability. Blockbuster wanted more copies of the hits at a reduced rate, and the studios worked themselves into a tizzy trying to placate Blockbuster while at the same time not running afoul of the law by offering similar copy-depth deals to all retailers. Netflix, with its revolutionary new model, was regarded by Blockbuster as a threat, and that's probably the only reason Reed and his team even got the studios' attention.

Fast forward to 2002. DVD had come onto the scene five years earlier, but hadn't really hit its stride until the turn of the millenium. As consumers flocked to stores to buy discs and sellthrough kept posting double-digit year-over-year gains, the rental business appeared to be on its last legs. DVD sales would flourish forever and rental was doomed to extinction, so why would any studio want to even be associated with a company whose primary business was renting videos?

The first signs of trouble didn't appear until the fourth quarter of 2005, when sales growth slowed from the double digits to the single digits. Then came the recession and sales began to decline, while rental, given up for dead, suddenly found new life, fueled by the cost-effectiveness and simplicity of renting by mail.

Netflix was hailed as the savior of rental, but by then, of course, the studios were long gone.

In hindsight, the studios would have been on Easy Street had they maintained an ownership stake in Netflix, but I have to give a nod to The Wrap writers Dylan Stableford and Brent Lang for noting, "Of course, the innovation that has fueled Netflix's success and move into digital distribution might not have happened had so many sprawling publicly traded companies owned a piece of it."

Now, there's some food for thought.

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