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Netflix: Can Better Platform Tech Fend Off Competition?

As 2019 has wound down, the streaming wars have only heated up.

Netflix Inc. (NASDAQ:NFLX), long the undisputed king of streaming, is facing fresh competition from deep-pocketed media players. Disney+, the streaming service launched by the Walt Disney Co. (NYSE:DIS) this month, has made serious waves. Big investments by tech giants Amazon.com Inc. (NASDAQ:AMZN) and Apple Inc. (NASDAQ:AAPL) into their respective streaming platforms promise to further escalate the competition in the year ahead.


While Netflix may appear to be in serious trouble in the face of such vigorous, deep-pocketed competition, some boosters have continued to argue that the first-mover retains one distinct advantage: technology.

Better targeting through tech

The bull argument for Netflix's tech advantage boils down to two factors. First, it has a clear advantage of scale, boasting radically more subscribers than any other streaming platform. Second, Netflix has by far the largest repository of user data, which it can use to better understand, and meet, the desires of subscribers.

With 155 million subscribers and more than a decade of user behavior to draw upon, Netflix is believed by some analysts to have a radically deeper understanding of user preferences, as well as the power to activate those preferences through targeted content recommendations (and even targeted content development) and best-in-class user experience (UX) interface.

A skeptic might argue that this technological advantage is overstated. However, on Nov. 26, Andrew A. Rosen, a market newsletter publisher and former Viacom Inc. (NASDAQ:VIA) (NASDAQ:VIAB) digital media executive, took to Twitter to offer an "insider" view that spoke favorably of this tech advantage thesis:


"It is a lazy assumption that somehow legacy media companies can built streaming services with pricing and libraries, and ignore user data (whichNFLX has 20 years of), and UX (which NFLX has the best in business, bar none)...NFLX has THE best engineers, has engaged in THE most experimentation with UX and library, has tested the limits of personalized recommendations much further thanDIS's CEO has told the WSJ he is comfortable with, & you thinkDIS can match this? Let's be real for a moment, HOW?"



There can be little doubt that Netflix does indeed enjoy a degree of technological advantage that could prove difficult - and certainly expensive and time-consuming - to replicate. But does that really even matter?

Immitation impossible

Netflix bulls often seem to labor under the impression that, for a Netflix rival to succeed, it must be able to replicate what Netflix has already created. However, this is simply not the case. For streaming platforms like Disney+, there does not appear to be anywhere near as great a need to invest so heavily in granular targeting and content-matching technology. The Disney library is well known and much beloved, making matching and targeting fundamentally less important. The House of Mouse also enjoys control over numerous strong content dissemination and marketing channels that can magnify its message immensely.

Fundamentally, Netflix's whole approach may be suspect. After all, it has failed to generate much in the way of profits. Positive net earnings in the third quarter of 2019 beat analyst expectations, though it later transpired that the beat was due to a gain from foreign currency adjustments, not operational improvements. If Netflix still cannot turn a substantial profit, despite market conditions more favorable now than they are ever likely to be again, it does not bode well for the company, or its business model.

Comparative advantages are critically important to companies operating in a competitive environment. However, not all advantages are created equal. In the case of Netflix, its considerable lead in platform technology may not be worth all that much in the grand scheme of things. Fundamentally, Netflix is a content company, not a tech company. The product is not the UX or matching technology, impressive though they may be. Rather, it is the library of content available to subscribers that ultimately defines its value. After all, the best UX and targeting in the world cannot make a subscriber engage with content they do not like - or that does not exist.

For media companies, content is - and always has been - king. Yet, as Hedgeye Research's Andrew Freedman observed last month, Netflix is "a content company that doesn't own much content." As more and more content producers migrate their content off Netflix to rival (or their own) streaming platforms, Netflix is likely to struggle to replenish its content library, especially as licensing the most desirable series and IP becomes increasingly costly.

Verdict

Netflix has achieved incredible scale through phenomenal cash burn. It has spent billions of dollars licensing, producing and marketing content to consumers worldwide. Unfortunately, that scale has failed to translate materially into an economic advantage. A technological edge can be a useful thing to have, but it simply is not what makes a great media company.

Disclosure: Author is short Netflix and long Disney.

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This article first appeared on GuruFocus.