Studios Are the King Makers

Netflix executives, during the past month or so, may have been wishing all the attention were still focused on their old nemesis Blockbuster. As long as Blockbuster was around, Netflix looked like the new, younger kid; the cool kid; the entrepreneur; the next big thing. Netflix represented the future, Blockbuster the past.

Unfortunately, Netflix had to grow up sometime, and its growing pains are starting to show in the company’s stock price, which has dropped precipitously as it has raised subscription prices to offset greater costs and grow its streaming business internationally.

There are a lot of advantages in being the new phenomenon on Wall Street, which is looking for outsized growth, even if it does come by undercutting an older, established business weighed down by debt like Blockbuster. While Blockbuster struggled to move with an enormous debt shackled to it, Netflix could bob and weave and build a better rental mouse trap, one that didn’t involve cumbersome real estate or a debt load and that got great pricing on streaming licenses from content holders who had not yet realized what streamed content was worth.

Now the entertainment landscape has shifted, and Netflix is in the spotlight. The company can’t get the kind of pass offered to new ventures; it will have to grow and prosper under the weight of expectations — and new, higher licensing fees for streamed studio content.

Oh, for the good old days when Blockbuster took much of the heat, Netflix executives must be thinking. But those days may be past for Netflix, which may now find out that the studios can be king makers in the distribution pipeline. Content holders favor whichever distribution avenue will offer them the most profit, and will wring ever more money from distribution pipelines that use their content.

Content is king, and the studios that own it can make or break a distribution partner. In the case of Netflix, I think executives may be finding out they have more in common with Blockbuster and other past studio distribution partners than they thought. Just as Netflix overtook Blockbuster, there are competitors in the wings targeting Netflix.

Netflix Loves Latinos

If you read my July 8 blog, Latinos Love Netflix, you may have caught my suggestion at the end for Netflix to create original Spanish-Language content. Well, I apparently (and unknowingly) was reading their minds.

A few weeks ago, BTIG Research analyst Richard Greenfield tweeted: “Netflix takes 1st “baby” steps toward creating original content outside US, “The Burrow” in Brazil.” See my colleague Erik Gruenwedel’s report.

Greenfield included a link to an from Jornal O Globo with more info, if you can read Portuguese. According to O Globo (with some help from freetranslation.com), I learned the show is called “A Toca” (The Touch) and is a comedy comprised of skits, based on “The Office.”

The show is written and produced by Felipe Neto, a popular comedian on YouTube from the channel Parafernalha.

Neto told O Globo he had complete creative freedom — sounds similar to what “The Arrested Development” and “House of Cards” producers said of Netflix — and the program touches on subjects traditionally taboo on TV, similar to Neto’s YouTube show “Não Faz Sentido.”

“A Toca” is new content adapted from Parafernalha, and according to Andrew Wallenstein’s from Variety, the show appears exclusively on Netflix, which licenses the series.

The program debuted Aug. 9 with three 30-minute episodes on Netflix, which has been available in Brazil for two years now.

Unlike Netflix’s other shows, "A Toca" will be available only in Brazil. Jonathan Friedland, chief communications officer for Netflix, told O Globo that the show is “very Brazilian” and that comedies don’t translate to other countries as well as dramas do. He pointed to “Arrested Development,” which is doing great in the United States, United Kingdom and Canada, but not so well in Latin America.

“A Tocar” marks Netflix’s first original programming outside of the United States. I think it’s pretty cool the service chose a Latin American country for this milestone.

Netflix’s House of Cards

I found it quite interesting that Netflix’s stock price plunged — by as much as much as 11% in after-hours trading July 22, even though the company appears healthier than ever.

Its subscriber count was up from last quarter, revenue continues to trend upward, and a week earlier Netflix snagged more than a dozen Emmy nominations for original series such as "Arrested Development" and "House of Cards," the first Internet series to be nominated in major categories.

Attribute this apparent dichotomy to the fact that Wall Street is a demanding beast, with high expectations. Netflix reported it added 630,000 streaming customers in the United States in the second quarter, a healthy number, by any measure — except, of course, to analysts, who had expected an average of 700,000.

And yet analysts aren’t exactly being “tiger parents” with unrealistic (and, perhaps, unattainable) expectations. Netflix’s own high-end forecast was 880,000.

While the Street and analysts fret about subscriber growth rates, they ignored the 800-pound gorilla buried in the financials: Netflix lost nearly 500,000 disc subscribers in the quarter. It was the first uptick in packaged-media attrition since Netflix began separating disc and streaming results in 2011.

So what, right? Wall Street, analysts, media, pundits and Netflix management have been preparing packaged media’s obituary for years. The only problem with their “perfect” streaming world is that packaged media is what keeps Netflix’s bottom line from turning the same color as its red logo.

Indeed, Netflix generated a $109 million contribution profit on $232 million in revenue from DVD, Blu-ray Disc and hybrid streamers in the quarter. That’s nearly a 47% contribution margin, and more than twice the 22.5% contribution margin heralded by Netflix on its domestic streaming business.

In fact, packaged media represented the bulk of Netflix’s overall operating profit when factoring in technology, marketing and rising content costs associated with streaming. And don’t forget, Netflix’s ambitious international expansion, which it claims is being supported by domestic operations, lost $66 million in the quarter.

Michael Pachter, research director with Wedbush Securities in Los Angeles, contends Netflix neglected to attribute $137 million in G&A and technology spending toward streaming expansion both domestic and abroad. If this spending would be properly allocated, Pachter writes, domestic streaming would generate an operating profit of only $65 million for the second quarter, while domestic DVD would generate an operating profit of $79 million.

And Netflix plans to bow service in Holland by the end of the year, furthering expansion costs that must be minimized elsewhere in the business such as packaged media.

Yet, when asked during Netflix’s inaugural live video webcast July 22 about management’s apparent indifference toward disc rentals, CEO Reed Hastings — as usual — shrugged off concern. He reiterated that 7.5 million subscribers opt for packaged media from Netflix, which he said carries any conceivable title worth renting — more so than SVOD.

In their letter to shareholders, Hastings and CFO David Wells wrote, “The world is moving from linear TV to Internet TV, and Netflix is leading that evolution.”

And that may be true. But until it gets there, Netflix would be wise not to ignore its by-mail disc roots.

“The company’s lack of concern about declining DVD subscribers is baffling, and management optimism about contribution profit from domestic streaming growth is misguided,” Pachter wrote in a July 23 note.
 

Latinos Love Netflix

For years and years … and years, we’ve all been hearing about the rising power of Latinos. This isn’t new. But what is new is the recent report from Centris Marketing Science, which is yet more evidence of our rising power in entertainment.

The U.S. Communications and Entertainment Insights report shows that Latinos are watching more videos online than the rest of the U.S. population. But the finding that I found interesting was this: Thirty-three percent of Latino households subscribe to Netflix, versus 25% of U.S. households overall.

Netflix doesn’t have a lot of “Latino” movies or even that many Spanish-language films. And what the service has is filed under regular genres or foreign films. You have to really dig to find them. The company has even fewer films dubbed in Spanish, and it’s mostly animated movies. And as far as I know, there haven’t been any major marketing campaigns aimed at U.S. Latinos.

I would like to note that for its Latin American subscribers, Netflix does have a , a page and a Twitter (@NetflixLAT).

Some might think Netflix is leaving money on the table by not marketing to Latinos in the United States, which historically overindex in entertainment consumption in general. But I tend to think Netflix would be spending money frivolously if they did do a huge campaign. Blockbuster has long had their Latino sections and marketing, but did they ever work out that well? It’s pretty well known that Latinos prefer to watch the mainstream blockbusters.

While I do wish Netflix offered more Spanish-language movies and Latino fare, I don’t think a move like this would necessarily boost Latino subscribership. Latino films, if well made, would appeal to anyone, just as the good non-Latino films appeal to Latinos. 

And speaking of well-made content, maybe Netflix in the future will create original Spanish-language content, which could also appeal to their subscribers in Latin American countries. With Netflix trying to compete with HBO, it would be nice to see the company compete with HBO in its HBO Latino programming such as “Epitafios” and “Capadocia” — both of which I absolutely loved and own on DVD.

The Kids Aren’t All Right

One of the backbones of the sellthrough business has always been the kidvid genre. Kids will watch the same content over and over again, and buying a title is a good investment if they plan to watch it 20, 30, 100 … however many times. Kids like what they like, and they are obsessive about it.

More recently kids are having an effect on the subscription video-on-demand business as well. It seems there are subscribers who use services such as Netflix and Amazon Prime to access stuff for the kids. As I am writing this, I’m at swim practice for my 11-year-old. If I had a toddler with me, I can imagine accessing Netflix or some other subscription service to entertain him or her for the 45-minute lesson. Obviously, TV episodes would fit the bill. Perhaps I had been accessing “Blue’s Clues” for months during these lessons via my Netflix account, and suddenly “Blue’s Clues” (owned by Viacom) isn’t available. The horror! The tantrums!

That’s the consumer experience of what is happening in the SVOD universe. Now, thanks to a $200 million deal between Amazon and Viacom, subscribers who want “Blue’s Clues” have to turn to Amazon instead of Netflix.

Ted Sarandos, the savvy chief content officer at Netflix, downplayed the loss of Viacom kids content, saying kids’ TV has a short shelf life. That may be true. I certainly didn’t watch “Blue’s Clues” as a child, and my kids have no emotional attachment to most of what I grew up watching. (That doesn’t include “Scooby-Doo,” which seems to be timeless. Go figure.) But if you’ve ever had a kid who could be calmed by nothing but “Dora the Explorer,” the lasting value of the show is sort of beside the point.

This, I think, is where a scheme such as UltraViolet shows its value. Via the content locker, a family can simply buy exactly the content the kids like, without having to worry whether Netflix or Amazon sign with a particular content owner. This is UltraViolet’s advantage. Ultimately, consumers want easy access to the content they like, not to the content a particular subscription service is willing to pay for. That goes for the adults, as well as the kids.

Netflix Coming Into Focus

About six months ago, I wrote a column titled “Netflix Needs Some Focus.” The column asked what Netflix wants to be when it grows up: a content distributor or content creator. I really don’t think it can do both equally well, and based on recent developments, neither does Netflix management.

Every company needs a laser focus on its vision and market, and perhaps Netflix is solidifying its own. The company is concentrating on building its content creation business, funding original productions such as “Lilyhammer,” “House of Cards” and “Hemlock Grove.” And they know what their customers like. Netflix knows what you are watching, when and how. It’s how they determine what content to greenlight and license.

In the old days, the TV was on, and it was mostly somewhat educated guesswork as to what anyone was actually watching. Now, a streaming company can know exactly what you are watching. And they know the exact value of each old movie they license. That’s why Netflix is indicating it may be more choosey as to which old movies and TV shows it licenses and will no longer buy content in bulk. The company is letting its Viacom deal expire, signaling the change in direction.

“As we continue to focus on exclusive and curated content, our willingness to pay for non-exclusive, bulk content deals declines,” reads the April 22 letter to shareholders from Netflix CEO Reed Hastings and CFO David Wells. The letter was released just before Netflix announced boffo earnings, sending the stock into the stratosphere.

That must send shivers down the backs of studio executives, who saw dollar signs when they looked at Netflix and its competitors and who hoped to get bulk catalog license payments from them.

In the end, Netflix seems to have come to the realization that its status as “first mover” can only go so far in the bulk streaming business. But the quest to be the next streaming AMC or HBO is a more profitable goal. The key is exclusive content, especially original content.

Whether consumers will buy the new Netflix really remains to be seen.

UltraViolet Needs to Burnish Shine

UltraViolet, the studios’ answer to digital ownership, is going through some growing pains — or a sophomore slump, if you will.

Based on a spectacular idea — the ability to buy a title once and play it anywhere on any device — and boosted by a vote of confidence from the largest sellthrough retailer Walmart, UltraViolet got off to a strong start.

But the initial surge of enthusiasm is in danger of waning, as noted by Michael Lynton, CEO of Sony Pictures Entertainment.

“It’s early days and part of the issue is the interface is not as good as it could be,” Lynton said. “They already have 10 million people signed up, but they’re not using it enough. And part of the reason they’re not using it enough is that it’s not easy enough to use.”

As an ambitious idea spanning various digital platforms and formats, UltraViolet got a pass on having to be perfect in the initial rollout, but that pass won’t last forever. If UltraViolet is to be an enduring format, those behind it need to both make it easier to use and let consumers know what it’s all about.

Walmart did a fine job in the beginning of advertising the promise of UltraViolet through its Vudu service, but more needs to be done.

When I ask my neighbors what Redbox is, they know. When I ask them about Netflix, many are subscribers.

But UltraViolet? Do they know what that is?

For the most part, the answer is no.

Every format has had its hiccups. Even DVD at times looked iffy. Certainly, Blu-ray Disc had many hurdles to overcome in  defeating HD DVD as the next-generation high-definition format.

There are pivotal points in each format’s evolution, points at which the studios make crucial decisions to galvanize public opinion.

This may be one of those points for UltraViolet.

Those companies and executives that think UltraViolet is the future of the business should accelerate their actions. Consumers have to be informed about the format’s advantages — and, yes, it needs to be easy to use.

TV Binge Viewing Still a Habit

During the neighborhood New Year’s celebration, a friend said she had gotten hooked on “Pretty Little Liars” via Netflix, viewing initial episodes on its streaming service. With the new season about to start, she wanted to know how to catch up on the episodes in between. Netflix didn’t have them yet for streaming, so I suggested buying the episodes on disc or renting them piecemeal on disc.

It’s just too bad the studios can’t take advantage of this avid audience. No doubt, had my friend been able to immediately purchase the succeeding episodes on disc or via electronic sellthrough on Netflix, she would gladly have done so.

A few days later, Meredith Vieira, guesting on the “Today” show, noted she had gotten “Homeland” on disc and had become hooked. She had planned to wait for the next season to come out on disc, but decided to subscribe to Showtime instead because she just couldn’t wait.

A phenomenon that developed during the heyday of DVD — watching whole seasons of TV episodes in succession — seems now to be a habit with many viewers, whether they watch them on disc or online. And once these fans are hooked, they often crave immediate gratification with the next installment of episodes.

Studios profited handsomely from this habit when consumers could only purchase whole seasons and series on disc. Now that they can view whole seasons (albeit not the latest ones) via streaming on services such as Netflix, the marketing task is a bit harder, but no doubt could help studios squeeze more revenue from costly content.

In a fragmented content business, studios will need to cater to the consumer who discovers a series on broadcast TV, on disc or via streaming or syndication. Paying heed to this growing audience of TV junkies who are not necessarily tied to the TV schedule could pay big dividends if marketers time advertising and access to disc and digital releases wisely.

It will require more communication between studio divisions — syndication, home entertainment, etc. — and an eye to that consumer when content owners make deals with the likes of Netflix and other distributors.

Subscription Model Not So Broken

Last year at this time, analysts were wondering if Netflix’s all-you-can-eat subscription model was broken. The company was reeling from an ill-advised price hike, with its stock plummeting on the subscriber backlash. But recent developments are showing the subscription model Netflix pioneered is alive and well.

Netflix this month signed an exclusive landmark deal with Disney to offer the studio’s top titles in the pay-TV window, giving the service a major boost in quality content.

Meanwhile, yet another competitor is poised to join the market that also includes Amazon’s Prime subscription streaming service (offered at no additional charge to those who subscribe to the company’s shipping service).

Redbox’s streaming service — first hinted at more than two years ago — is finally getting off the ground. Priced at $8 per month, Redbox Instant powered by Verizon plans a consumer beta test this month. The service offers unlimited streaming of movies, including coveted titles from pay-TV service Epix, with four one-night credits per month for new releases on DVD at Redbox kiosks. For $1 more, or $9 per month, customers can opt to redeem their four credits for rentals on Blu-ray Disc at the kiosks.

Unlike Netflix, Redbox Instant will throw in disc rentals for the Netflix price, as well as electronic sellthrough (EST) and transactional VOD options for new releases on street date from Lionsgate, NBC Universal, Paramount, Relativity and Sony Pictures.

This seems to be key.

Redbox, analysts say, is getting a break on content licensing costs from studios in exchange for promoting the kind of consumer consumption studios prefer to subscription streaming —  transactional VOD and EST. Studios are willing to grow a subscription model if it also helps expand the revenue pie for higher-cost digital options.

Until Netflix comes to heel on higher-cost consumer options for digital, the studios seem determined to make the company pay dearly for content (Disney’s Netflix deal is estimated at as much as $300 million).

Subscription services are being squeezed for more revenue and cooperation, but the model is far from broken.

Netflix Needs Some Focus

Netflix has officially launched subscription streaming in several Scandinavian countries last week.

It was just the latest international expansion for a company that is looking to grow its way out of its domestic problems, which include competition from Hulu and Amazon. The philosophy seems to be that if Netflix can expand fast enough in the streaming arena, it will outrun all other competitors.

“We remain concerned that Netflix is expanding too quickly internationally with incremental content commitments and mixed results at a time when domestic competition is increasing,” analyst Eric Wold wrote in an Oct. 17 note.

At the same time, Netflix is trying to get into the content creation business, funding original productions such as “Lilyhammer” and “House of Cards.” The story here is that content creators and owners are making them pay too much for content, so why can’t Netflix create its own?

The missing ingredient in Netflix’s plan seems to be focus. Does it want to be an international streaming distributor or a content creator?

Certainly, Reed Hastings has made no secret of the fact that streaming is the company’s focus (even though disc rentals are the major profit center). But, even within the streaming realm, it seems to me that Netflix needs to find a target: distribution dominance both internationally and domestically, or content owner/driver.

Underneath all of Wall Street’s bleating about Netflix being a “broken model” is the question of just which model Netflix wants to follow: omnipresent distributor or content creator. I’m not sure it can be both.

In the end, the label of “first mover” can only get Netflix so far in the streaming business. And its quest to be the next AMC or HBO is up in the air as far as its original programming. The company needs to define itself more clearly, and figure out how to make money at it.

What does Netflix want to be when it grows up? A content distributor or content creator.