10.5 CASE STUDY Netflix: How Does This Movie End? he Emmys are the television industry's annual awards, the equivalent of the movie industry's Academy Awards. The Emmys provide insight into who's winning and losing in TV land and who will likely be around for the next few years. Netflix is the come-from-behind kid that started as a DVD rental company, and beginning in 2014, began to move into the ranks of original award-winning TV shows. In 2018, Netflix garnered 112 Emmy nominations, beating its content rival HBO with 108 nominations, the first time in 17 years that HBO was not first. HBO has been king of the hill in award-winning TV shows, known best for The Sopranos and Sex and the City, while Netflix is best known for House of Cards and Orange is the New Black. In the final awards contest, HBO and Netflix tied, with each winning 23 Emmys. HBO won Best Drama with Game of Thrones, and Netflix won five Emmys for The Crown, including best historical drama. Amazon won for the first time with The Marvelous Mrs. Maisel for Best Comedy. Netflix is quickly becoming the non-cable alternative to cable TV. By producing its own content, Netflix is able to differentiate itself from cable TV shows and attract sub- scribers looking for new shows, not retreads from the cable networks. However, original productions are much more expensive to produce than licensing existing content. And there are plenty of other streaming services with very large budgets, among them Amazon, Google, Apple, Facebook, and Hulu, not to mention AT&T (which purchased 21st Century Netflix - Watch TV Shows Online, Wad https://www.nette.com He Tools Fox's movie library and production facilities) and Verizon (which purchased AOL and Yahoo), both of which have TV content ambitions. While Netflix does not release the number of viewers for any of its original series, executives credit these shows with driving Netflix to a record 130 million worldwide sub- scribers in 2018 (with about 56 million in the United States, accounting for 43% of its subscribers). In 2018, Netflix operates in all foreign markets except China. Its subscriber growth rate in the United States has slowed considerably in the last few years because ils market penetration is so high. Netflix's shares have increased by over 8,000% since il first went public in 2002, and in 2018, its shares have advanced over 80%, despite a drop of 14% in the second quarter of 2018 on news that its subscriber growth was half of what analysts expected. Its shares are currently selling at over 170 times its projected earnings, much more expensive than Google (51 times), Facebook (24 times), or Apple (20 times) because it is still perceived as an extraordinary growth company with significant upside 017 were $11.6 billion, up 329 from 2016, but profits were a paltry $146 million, with a profit margin of 4%, about the same as a retailer like Walmart Founded by two Silicon Valley entrepreneurs, Marc Randolph and Reed Hastings, in 1997, Netflix got its start as a mail order company renting DVDs of older Hollywood movie titles, delivering them to customers by postal mail. In 2000, it switched to a subscription model where customers could receive DVDs on a regular basis for a monthly fee. By 2006, it had delivered its billionth DVD and became the largest subscription provider of DVDs. In 2007. Netflix began a video-on-demand streaming service of movies retains a DVD subscription business. In 2018, Netflix is the largest player in the TV series streaming market, and consumes over 35% of the U.S. Internet bandwidth to serve its customers. Netflix is one of those Silicon Valley stories that might make a good movie, or even a television series, because of its potential for disrupting the American television (or what's called premium video) market. It's a dream-come-true story of accomplishment, pluck, innovation, and Internet technology. In a few short years Netflix created the largest DVD rental business in the country, then created the largest streaming video service. Today Netflix accounts for 36% of digital TV streaming subscribers. Netflix has created the largest database on consumer video preferences and built a recommendation system thal encourages consumers to see more movies. Netflix is as much a technology company as a content company, it has developed its own proprietary video encoding system and distributes its video using over 1,000 servers in the United States located close to its cus- tomers to ensure high speed and quality delivery. Netflix discovered that older TV series had strong niche followings and built a new model of "binge watching," where consumers could watch all the episodes of a series in several sittings. Netflix has entered the content creation business by developing original TV series. For this reason, Netflix is an example of convergence in the media industry, where an Internet company becomes a media content producer. Other pure media companies have taken notice and begun to develop their own streaming services, but what they lack is a database of viewer preferences that Netflix has developed over a ten-year period and which helps Netflix make recommenda- tions to subscribers. For this they will have to be in the market for several years, giving Netflix an advantage now. In the movie and TV business, there are only two ways to make money: either own the content or own the pipes thal deliver the content. It is even better if you can do both. Netflix has become recognized as an important pipeline to a very large audience. For instance, Netflix has attempted to strike deals with Hollywood movie producers to become the exclusive subscription TV home studio for that content. This puts Netflix into the same league as premium channel distributors and in direct competition with other cable networks like HBO, Starz, Showtime, and A&E for the rights to show movies about eight months after their theater run is corriplele. Nelflix also has a deal with Warner Brothers to be the exclusive Internet distributor of the Batman prequel, Gotham, and with 21st Century Fox for the FX series, American Crime Story. In one possible ending scenario for the Netflix movie, the company challenges the much larger cable television industry, which is based on an entirely different technology and business model, namely, selling expensive bundles of hundreds of TV channels that few people watch, then raising monthly fees faster than the rate of inflation. In 2018 for the first time the number of people using OTT streaming services exceeded those using cable TV streaming services. Given Netflix's large national audience of streamers, in this scenario, the company will find it relatively easy to make new friends" in Hollywood and New York, who are looking for ways to distribute their shows to a new online, mobile, and social world and Hollywood will stretch the distribution window so that Internet distributors like Nelflix get the sarre treatment as cable systems by allowing them to show the latest movies and shows at about the same time as cable systems. And the cable television industry will be forced to retreat from its bundling practices and offer customers the ability to select just those channels they actually watch. As a result, cable industry revenues would plunge while Netflix's would increase. This would be a dream scenario with a happy ending for Netflix! But happy endings happen mostly in Hollywood. The outcome of this movie depends on how well Netflix can deal with some consider- able challenges. For instance, one source of Nelflix's poor profitability is that the costs of content are very high, both purchased older series as well as new content, which is far more risky. The owners of older cable TV series and Hollywood movies charge Netflix for the privilege of distributing their content as much as they do established cable TV networks. In 2018 Netflix reported streaming content obligations to content producers of $18 billion in the next five years, Netflix barely makes any profit on the content it must purchase, Netflix is, after all, mostly a database and delivery platform, and the company is in a constant bidding war with both cable and Internet giants all looking for the same thing-popular TV series with a built-in or potential audience. But content owners have wised up to the value of their backlist TV series and have raised their prices accordingly. Series just a year old are very expensive or not available. Netflix is paying hundreds of millions lo Disney, Paramount, Lionsgate, and MGM to licerise hic shows and movies. As a result of content owners charging more for older cable shows, Netflix has taken the more risky option of developing its own original series. But this is very expensive as well. The critically acclaimed House of Cards cost Netflix $100 million for 26 episodes, $4 million an episode. Newer shows like The Crown cost an estimated $130 million for the first two seasons, and will run about $1 billion for seven seasons. In 2018 Netflix plans to spend $6 billion on new original content alone. Original content is very costly and is becoming more so as new entrants compete for the samne talent. It's possible that Netflix does not scale, and that the more subscribers it has and the more il attracts them with original expensive content, the less profit it will make because the cost of doing business will rise as fast or faster than revenue. This portends low profit margins for an extended period. A second challenge Netflix faces is the risk of creating new content. It's not as if wealthy Silicon Valley entrepreneurs can fly to Hollywood or New York with lots of cash and simply purchase new content. As one pundit noted, this might lead to a mugging, bul not a successful TV series or movie. Silicon Valley is generally not the place to go if you're looking for storytellers, writers, producers, directors, talent agents, and cinematog- raphers. Algorithms don't come up with new ideas for novels, plays, movies, or TV series, and they have not proven to be good at guessing what series will succeed in the future, Older series are proven series, and Netflix can identify which of its customers watched the series in previous years, and estimate the audience size, and whether new subscribers will be attracted by the replays. But when it comes to new TV series, Netflix has tried to use its algorithms to predict what new series its customers might be interested in with mixed results, Netflix has produced some real winners according to critics, but it has also produced some losers that did not get critical acclaim, like Lillyhammer, Hemlock Grove, Bad Samaritans, Richie Rich, and Mitt. The only technology company previously that has been successful with content production for movies or television is Pixar, which pioneered computer-generated animated feature-length movies. It is impossible to know how well Netflix's original content is performing because the company refuses to release this data. Nielsen has begun a rating service for Netflix shows. This service is paid for by the content producers who will base their charges in part on how many Netflix subscribers stream their shows. This information is not public. While Netflix stands out as a powerful Internet brand today, Netflix has many power- ful competitors. Netflix does not have unique technology. In fact, streaming technology is widespread. The success of Netflix's streaming model has allracled Amazon, Disney, Amazon, Apple, Google, and content producers like Hulu and HBO to the fray. In 2017 Disney announced it was starting two of its own streaming services and removing its content from Netflix. In 2018, Verizon is planning a free, ad-supported mobile streaming service aimed at smartphone TV viewers. Some of these firms are lech firms with very large Internet audiences, strong brand names, and a good understanding of what their millions of online customers wanil. Apple is the leader in downloaded movies where customers purchase or rent movies, and of course, it owns iTunes, the world's largest online media store for the purchase of music, videos, and TV series, HBO, founded in 1972, is the oldest and most successful pay television service in the United States with over 140 million cable TV subscribers world- wide, and the originalor of a long list of highly successful original TV series and movies such as Sex and the City, The Sopranos, The Wire, Game of Thrones, and True Blood. If Netflix has a direct competitor on the creative front, it is HBO, a more traditional programmer that does not use computer algorithms to design its content, but instead relies on the hunches and gifts of producers and directors to produce its content. Netflix's competitors have very deep pockets. This means Netflix also has competitors for talent and the production of new content, and perhaps price pressure as well. Along SOURCES: Disney Unweils New Streaming Services to End Netflix Deal," by Erich Schwartzel and Joe Flint, Wall Street Journal August 8. 2017: "Netflix Is Winning the Streaming RaceBut for How Long?" by Mathew Ingram, Fortune, March 10, 2017. Hon YouTube TV Will Stack Up In The OTT Market" by Trefis Team, Forbes, March 7, 2017; "Netflix Fuels a Surge in Scripted TV Shows Some See a Glut" by John Koblin, New York Times, August 9, 2016: "Netflix and 20th Century Fox Television Distribution Announce First Global Agreement, Netflix Media Center, July 25, 2016 "Netflix Stock History: What You Need to Know," by Dan Caplinger, Fool.com, July 11, 2016, Netflix to Review 725 with Hulu, Amazon has emerged as the biggest competitor to Netflix's streaming services. For instance, Amazon offers free streaming to its 95 million U.S. Amazon Prime customers, and has taken on HBO TV series to stream to Prime customers without additional fees. Amazon has also moved into original series production with The Man in the High Castle, Transparent, Mozart in the Jungle, and others, winning 16 Emmy awards. Apple iTunes and Amazon have far larger databases of subscribers and their preferences. Google is actively pursuing long-form content creators for its video channel program. There is no cost to Google users because the service is ad supported. So another possible ending for the Netflix movie is that ultimately it can't compete with Amazon, Apple, Google, Hulu, or the content producers like HBO Now, Disney, and CBS, all of which have started their own streaming services. Generating a negative cash flow of $4 billion a year to purchase content, Netflix may run out of investors who make up the difference. How can the company show a profit if cash flow is negative? It finances the purchase of content over many years, and its liabilities grow. The decline in subscriber growth in the U.S. market is causing analysts to wonder if the business model will work. Netflix's profitability may be reduced to less than shareholders can tolerate. Netflix may have created a new world of streaming, bingeing, and content production, but it may ve the world it created. This show is not over until the last episode is finished. Stay tuned. Be Exclusive Global Streaming Home of Ex's American Crime Story Franchise in 2017, Netflix Media Center, July 25, 2016, 'Netili Chews Up Less Bandwidth, As Amazon Video Streaming Surges." by Todd Splanger Vanety, July 22, 2016; "Amazon Prime Members Now Outnumber Non-Prime Customers by Audrey Shi, Fortune,.uly 11, 2016: "Can Netflix Survive the New World It Created?' by Joe Nocera, New York Times, June 16, 2016: Amazon Challenges Netilix by Onening Primeta Monthly Subscribers," by Nick Wingfield, New York Times, April 17, 2016, "Verizon to offer Free Mobile TV Service, Hoping to Draw Millen- nials" by Emily Steel, New York Times, September 8, 2015; "Netflix Viewership Finally Gets a Yard- stick' by Joe Flint and Ben Fritz, Wall Street Journal August 26, 2015. Case Study Questions 1. What are three challenges that Netflix faces? 2. What are the key elements of Netflix's strategy today? 3. Why is Netflix in competition with Apple, Amazon, HBO, and Google, and what strengths does Netflix bring to the market