Netflix: Riding a Death Spiral to Insolvency

TheStreet.com

NEW YORK ( TheStreet) -- Reed Hastings uses plenty of smoke and mirrors to spin the Netflix story positive. Hastings has a way about him which creates the false perception that Netflix sits in the driver's seat in a space populated by loads of new players and a still wildly successful old guard.

One of Hastings' latest memes gobbled up and passed along to clients, CNBC anchors and the general public by Wall Street analysts: Netflix uses the treasure trove of viewing data it collects from its subscribers to make better-informed decisions on what type of content to license and produce. As per usual, Hastings' public perspective only tells part of the story.

There's no doubt Netflix can analyze the Netflix content Netflix subscribers watch and use it to guide future buys. Of course. But these data aren't nearly as valuable as Hastings would have you believe. That's primarily because the hours of viewing statistics Netflix looks at represents a relatively small portion of the overall content Netflix subs view. I feel comfortable making this assumption. Much more comfortable than I do simply accepting Hastings' contention that he has some sort of edge because he can analyze Netflix usage habits.


In some cases, I argue that the analysis of these numbers exposes one of Netflix's inherent weaknesses: it cannot secure premium content if it continues to effectively give it away -- unlimited -- at its $7.99 per month price point.

I'll relay two pieces of information to support this contention.

First, the one that practically every analyst chose to ignore and somehow managed to spin positive. You have to go back to mid-2011 for this.

Sony pulling its content from Netflix as part of the latter's deal with Starz. And Starz's subsequent move to not negotiate a new contract with Netflix.

On its company blog, Netflix referred to the Sony thing as a "temporary removal." Not true. At the time, over on Seeking Alpha, I defended Netflix against the notion that it did not properly warn investors that something like the Sony move could take place. It did, quite clearly, in the risks section of its annual reports.


But it was not forthright about the real reason for Sony's choice. Simply put, Netflix's subscriber base grew too large; as such, Sony did not want to continue providing all-you-can-eat content for $8 a month. That aligns pretty much perfectly with Starz's rationale to later cut ties completely with Netflix:

This decision is a result of our strategy to protect the premium nature of our brand by preserving the appropriate pricing and packaging of our exclusive and highly valuable content. With our current studio rights and growing original programming presence, the network is in an excellent position to evaluate new opportunities and expand its overall business.

In sentence one, Starz illustrates a major Netflix conundrum -- it cannot attract premium content with its current pricing scheme in place. Thus it's desperate and unsustainably expensive move into original programming. In sentence two, Starz reaffirms the reality that content owners hold the cards in relationships with glorified bootleggers such as Netflix.

Fast forward to April 2013. Something I experienced over the weekend proves that nothing has changed.

I discovered and watched the first two seasons of comedian Louie C. K.'s excellent FX show Louie on Netflix. The other night I wondered about the availability of season three so I searched for it via the excellent Roku 3's upgraded interface. (Check out my article on the new Roku 3).

Come to find out you cannot get season three on Netflix streaming (it's available on DVD); however, for $19.99 in standard definition and $29.99 in high-definition, you can secure it through Amazon.com's Prime Instant Video or Wal-Mart's streaming service Vudu.

I bet Netflix's crunching of its numbers shows viewers lapped up the first two seasons of Louie. Excellent! So, if you're News Corp's Fox Entertainment Group, owner of FX, you take that same data and make your decisions on how to license to season three.


It should come as no surprise that the content owner went with Amazon and Wal-Mart's on-demand options over the Netflix $7.99/month, unlimited viewing option. Sony and Starz made this dynamic clear in 2011.

Netflix has been able to survive since then thanks largely to a mix of cash bailouts and that way Hastings has about him. But part of Hastings' aura contains a stubbornness of epic proportion. And his refusal to include tiered pricing and/or on-demand options, amidst massive spending on originals and international expansion, will doom Netflix to insolvency.

--Written by Rocco Pendola in Santa Monica, Calif.

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