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Netflix has rapidly emerged as a powerful new distribution channel for digital video, in both physical and online form, but the success of the ‘all you can eat’ subscription model that Netflix and others use is changing the commercial dynamics of the studio’s distribution network. Telco 2.0 examines the success of Netflix’s business model, its consequences for the studios, and looks at new ways in which telcos might enable studios to maximise their online revenues and create a more balanced distribution network.
Following on from our previous overview of the opportunities that exist for telcos and content owners to work together to the benefit of both sectors (Digital Hollywood – How to Out-Apple Apple) and in advance of our invitation only Brainstorm with senior execs from both studios and telcos being held on May 5th alongside the Digital Hollywood event, this article focuses on the specific issues raised by the growing success of Netflix, the US supplier of DVDs by-post and online film and TV content streaming.
In the last month, three studios - Fox, Warner and Universal – have signed deals with Netflix that mean the company cannot distribute either physically or online any movie until 28 days after it is released for DVD/Blu-ray physical sales and rental. In return Netflix gets to build its back catalogue with extensive ranges of film and TV content held by the studios. These deals come after an extended period over which time Netflix has tried to woo Hollywood execs, while at the same time building its subscriber base and revenues to strengthen its bargaining position.
Netflix’s revenues reached $1.67 billion for the 2009 fiscal year, a rise of 22 percent from the previous year, while its subscriber base reached over 12 million by the end of 2009, up 31 percent year-on-year. It has become a serious player that cannot be ignored, and its online business is growing ever more rapidly - 55% of subscribers watching streamed content via its Watch Instantly service during the first quarter of 2010, compared with 48% during the previous quarter.
These deals and the emergence of Netflix are important because they change the business model for rentals in the physical domain and set subscription up as a standard model for online film and TV services, setting up a serious challenge to the pay-per-view (PPV) models that have so far dominated the physical and online environments. For Telcos, frustrated by the lack of revenue being generated by content and interested in working with Hollywood’s studios it highlights an important addressable need of this market.
Netflix’s strategy is to grow a large subscription business based on providing streaming and DVD-by-mail content for one low monthly price. It has three tariffs but it is possible for subscribers to have as many movies and/or TV shows from the Netflix catalogue for $8.99 per month. Compare that to a $2.50-$5 range for a single movie hired through pay per view online, or even pay per day for physical hires and you can see what an impact it makes on the pricing paradigm. Neither does the disruptive impact stop there, as by removing the ties between the individual piece of content and the price, Netflix also undermines the revenue share model.
Netflix is not alone in eroding the pay-per-view and revenue share model. Similar businesses exist in other countries, most notably LoveFilm in the UK and Redbox kiosks, which provide rentals for $1 per day with no revenue share for studios, have also made an impact and been said to be destroying the value of movies. However,Netflix’s combination of physical and online distribution makes it a more important long term player.
Revenue does flow from Netflix to studios from direct purchases, licensing agreements and from some revenue sharing. According to the company, its revenue sharing agreements with studios are based on obtaining titles for a low initial cost and sharing a percentage of subscription revenues or paying a fee based on utilization, for a defined period of time, or the ‘Title Term’. This typically ranges from six to twelve months for each title but we understand it can be limited to as little as six weeks. The key here is that the revenue share is linked to the number of users not the amount of titles views. This is fundamentally different from the traditional DVD market and perhaps more akin to the supply of movies to TV which is less profitable for studios, if similar in revenues.
Historically, studio revenue comes from the distribution of their movies through a chain of different channels and the importance and value of second rights (those following movie theatre viewings) has grown over time to produce the kind of revenues and splits seen below.
This has developed from a well defined process based on format, geography and time in the form of exclusive distribution periods or ‘windows’ for each format. For example, movie theatres typically have 16 weeks (although this is now being squeezed down to 14 and even 12 weeks) to screen films before DVDs are released for sale. Again, the retailers have a period to sell DVDs before rentals begin and so on down the line, as illustrated below. The position of each window is defined largely by its value to studios both in terms of its own revenue and the impact it has on those below it. For example, it is widely accepted that if a movie was released on DVD before it went to movie theatres, the number of movie goers would be significantly reduced.
The movie industry has been wrestling with where online fits into this flow. Online could come straight after the movie theatres, or alongside DVDs, or even after TV. With traditional providers of services for each of these windows capable of offering online, all are possible and in fact being tried but the placement is key not only to maximise revenues from the new format but to minimise losses to it from existing ones.
For example Video on Demand (VoD), with its pay-per-view model and revenue share for studios, makes a far more appealing proposition for studios than Netflix subscription model and therefore VoD services are getting access to movie releases earlier. All online video services are not created equal and for studios those that offer the greatest revenue share get the best benefits.
What this slightly convoluted description demonstrates is that it is both the traditional renting model and the window concept itself that studios are trying to protect in order to maximise the opportunity of the new format and minimise the cannibilisation of revenues from its existing streams.
The problem for studios though is that once they release a film for rental, any purchaser of a licensed rental copy can rent it out for whatever price they choose and the same goes for online. Studios have no control over pricing, just license conditions, such as time, geography and revenue share. While they had developed a favourable relationship with traditional retail rental companies, such as Blockbusters, these are now struggling under massive debt. Therefore if there is a massive shift in pricing paradigms as with Netflix, Redbox or even Apple through its iStore, their comeback can only be given in limiting access to content which is perceived negatively by consumers.
So what can studios do? Should they try and cut Netflix and the likes off and starve them of content, compete directly with them and set up their own online distribution channels, or should they stick their heads in the sand and hope it all goes away or finds its own solution?
The ‘head in the sand’ approach certainly didn’t work for the music industry and isn’t advised. Indeed, studios are showing little signs of making the same mistake and are instead promoting the benefits of windows and their associated formats as well as their preferred online model - pay-per-view VoD.
For example, Universal Pictures, through the NBC Universal player is offering VoD movies on the same day as it releases DVDs and Blu-Ray for sale. Clearly, it sees VoD as at least a partial replacement for the physical format in that it isn’t being given a separate window and it’s using its position as content owner to make the most of first distribution online. However, Universal also includes mobile capabilities (remote control and iPhone/Android app) as part of its Blu-Ray packages, recognising both the value of Blu-Ray’s ability to store special features beyond the film itself, which differentiates it from VoD, and the value of mobile as an incremental channel.
At Telco 2.0, we believe that differentiation through additional value is where studios should be playing online (as well as in physical formats), and where telcos can help by providing ‘value added services’ (VAS), such as payments, content delivery, customer experience across 3 screens, interactive marketing/CRM and customer care to studios as upstream customers.
The ‘content is king’ mantra is one that telcos will be more than familiar with but both they and studios know it is not everything. Content without scale is unappealing for content owners and service providers and content that is not easy to use or cost prohibitive instantly turns consumers off. At Telco 2.0, we see the relevant business of telcos as that of enabling and enhancing online content distribution, not aggregation or production.
Netflix has built scale so cannot be ignored and it has also hit a sweet spot with consumers on pricing and also on ease of access. Netflix is obviously available on PCs but also through all three major games consoles (X-Box, Wii and PlayStation) and the growing number of connected DVD/Blu-ray players and TVs. This makes it a full home cinema experience and not just a PC service. There’s already an iPad app, as well as apps for iPhone, Android and Nokia devices through Ovi, although with the exception of the Apple products these are for trailers not full viewing. The Netflix service is not tied to any specific piece of hardware and has gone a long way to bridging the ‘last 10 feet’ from the web to TV.
Furthermore, the Netflix operation has the physical logistics set up as well as payment processing, customer care and a recommendation engine, all supporting the customer’s experience, while a free API allows developers to add on new services, such as adding the New York Times to their viewing queue, a search function within the ‘Watch Instantly’ listings, and access to reviews, all of which improve the customer experience.
However, Netflix is not without problems and critics. Connectivity and quality of service remain issues for some and it has been suggested that a change in player technology to one that dynamically reacts to the bandwidth available has actually reduced the quality of the viewing experience for those with the lowest quality connections as it no longer allows them to buffer the entire film and watch it uninterrupted. Also, not all of its new features have caught on, and its Friends feature which allowed friends to recommend items to each other began to be phased out with the sites’ redesign in March.
So there is undoubtedly room to compete for studios that have the trump card in the content and a possible role for telcos to take the pain of developing and running effective and compelling online video services. This could be in form of Quality of Service (QoS) support for a superior delivery of similar services, or by enabling studios to deliver even more and greater value services, such as the friends recommendation functionality that Netflix has controversially withdrawn from, easy one click payment through a telco bill, providing personal online libraries in the cloud and seamless support across multiple devices.
Telcos and studios also both have a range of ways in which to compete. They both have complete online distribution capabilities – telcos through IPTV and studios through the on-demand services provided by their sister TV channels. However, the direct sell approach has it challenges. Telcos are currently not making much if any additional revenue from content. Instead they are using it as a customer acquisition and retention too, bundling VoD and IPTV services to sell their broadband connectivity. This is good for telcos looking to compete against cable companies but does little for studios. Meanwhile, studios are looking to develop the kind of enhanced online presence that can compete with the likes of Netflix and therefore both are looking at more to derive value from the online distribution value chain, as illustrated below.
Figure 3: Moving up the Online Value Chain
Going it alone is possible but getting more than a ‘me too’ service limited by the scale of either party is going to require a lot of creativity and investment in new competencies. We believe that by working together, core competencies can be shared and real differentiation made possible. Working from the options laid out in Figure 3 amongst the options for collaboration are the following:
1. Telco IPTV as a Preferred VoD Distributor - Studios provide telco IPTV VoD services with early/first access to online distribution of new releases for a favourable revenue share.
2. QoS Guarantees to Studio’s Online Service - Telcos provide studios running their own online distribution services with QoS guaranteed connectivity.
3. Telco Assets used to Support Studio’s VAS Online Service - Telcos deliver a range of value-added upstream services, based around the five core assets defined in our ‘How to out-Apple Apple’ report, namely: payments, content delivery, customer experience across 3 screens, interactive marketing/CRM and customer care, as well as cloud-based services such as personal libraries.To read the rest of the article, covering...
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[Ed. We will also be focusing on Content Distribution opportunities at our April 28th-29th 2010 Executive Brainstorm in London, at our 1st Hollywood/Telco 2.0 Brainstorm in Santa Monica on May 6th 2010, and in our future research programme.]