Essential trends investors should watch when evaluating Netflix

Market Realist

A shift in viewing habits

Over the past several years, consumers have begun to show signs that they’re shifting their television viewing habits. Since the introduction of DVR devices such as TiVo, consumers are increasingly favoring services that allow them to watch television on demand according to their own schedule. This is evidenced by the growth of services such as Netflix (NFLX), Hulu, Amazon Prime (AMZN), Roku, or Aereo that use data connections to stream content without the use of a traditional broadcast or cable network. These are referred to as “over-the-top services” (or OTT).

Cost pressures drive Netflix’s success

Cable TV companies purchase rights to broadcast channels from content producers such as CBS (CBS), Disney (DIS), AMC, or Time Warner (TWX). Channels with higher-rated programming generate higher payments as consumers demand access to the most popular media. For example, ESPN, which is owned by Disney, charges cable companies approximately $5 per month for each subscriber that receives the network—the highest of any non-premium channel. Disney is able obtain these steep fees because of programming such as NFL Football that’s in high consumer demand.

The high value of programming content has resulted in rapidly rising costs for cable companies, forcing them to try to pass these costs to their customers in the form of price hikes or to accept lower profitability instead. As a result, the price of cable TV packages has continued to increase, causing consumers to consider the value they receive from a cable bundle compared to the cost of other options.

Over-the-top services such as Netflix, Hulu, and Amazon Prime have benefited from this trend, as they offer access to a significant amount of content at attractive prices. For example, a subscription to Netflix costs $7.99 per month and includes an extensive library of TV shows and movies. Plus, programming content produced by the company such as House of Cards, Orange Is the New Black, and Arrested Development has proven extremely popular with users. This compares to the typical cable channel bundle cost of $75 per month.

Outlook

Netflix has been the clear leader in the success of OTT viewing. This is due in part to aggressive spending on content, as the company must continue to invest in building a library of popular shows and movies in order to appeal to subscribers. Longer-term, the company’s success may depend on its ability to preserve its attractive price point while investing in a growing library. However, in the near term, as content costs continue to drive up the price of cable subscriptions, Netflix will likely continue to gain subscribers due to its attractive relative price point.

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