Can Netflix Survive the Apple Tablet Onslaught?

| Analysis

When assessing the competition, one has to look at the opposition's strengths and weaknesses and compare them to your own. Digging into the financial situation for Netflix vs. Apple, one finds that Apple has a key strength that will eventually lead to the demise of Netflix.

Netflix has paraded out an impressive series of announcements lately related to hardware platforms that will support Netflix. The most recent was forthcoming support for the Nintendo Wii. Compared to the lonely hobby of the Apple TV, it would appear that Netflix is smashing the world of Apple's quiet little video box.

 

Apple TV

Apple TV - a Lonely Hobby?

The fact is, Apple doesn't need to be very concerned about these continuing announcements because they suggest that the Netflix strategy is based on a weak foundation. Think of it like the first Gulf War with Iraq. Iraq announces a new shipment of anti-aircraft missiles arriving every week. But the U.S. knows that no matter how many missiles Iraq has, they're all doomed to failure thanks to the Wild Weasel technology.

Netflix: Operating but Cash Poor

The blitz of announcements from Netflix regarding the different platforms one can use to access content is deceptive. First, these are static platforms, and we're entering the age of mobility. Secondly, Netflix has to spend a lot of money developing its data center and obtaining licensing rights to movies. Hollywood continues to fight Netflix on some fronts. The result is that Netflix remains under-monetized. It has just enough revenue and profit to spend a little money on the side to move itself from a DVD rental company to an Internet streaming service. This was all laid out in a recent Wall Street Journal article.

Reed Hastings

Netflix CEO Reed Hastings, credit: Microsoft

In that article, Nick Wingfield described how co-founder Reed hastings (who sits on the Board of Directors of Microsoft) is a purported student of how fast changing technology has left some companies behind. Accordingly, Netflix is working to divest itself from the "DVD in the mail business," even though it'll remain a cash cow for years. The math is simple. It costs Netflix US$0.70 to mail you a DVD and return it. It costs a nickel to stream the same movie to you.

The problem is that Netflix remains a relatively small company by modern high tech standards. Its annual revenue is in the US$1.6B range. Worse, when Netflix spends profits on licensing and data center capabilities, it subtracts from share value. "By virtue of mathematical coincidence, every million dollars that Netflix C.E.O. Reed Hastings spends to build a digital download service for his DVD-by-mail company sucks away roughly one penny of profit from each share of its stock," wrote Daniel Sorid for Wired back in 2008. In other words, its own investors are fighting Netflix for what little money it's making and has available for R&D.

The Missing Ingredient

Netflix is missing a key ingredient that could have relieved that pressure. As Mr. Wingfield in the WSJ article cited above said, Netflix had a bit of "Apple Envy" and delved into hardware with the Roku box. That adventure wasn't greatly profitable because Netflix isn't a hardware company and didn't have the corporate expertise to make a case for and build really cool hardware. Also, in 2009, new HDTV customers were wary of additional boxes that required an Internet connection and cluttered their living room.

Since the Roku misadventure, Netflix has settled instead into agreements with Blu-ray makers, Microsoft and the Xbox, and others. The Roku box is still available, but customers ask themselves why they should buy another box when they can have the same functionality for free in an increasingly wide range of modern Blu-ray players.

The core issue is that with only modest growth, no hardware revenues, and limited resources for R&D, Netflix will continue to struggle with Hollywood's licensing demands. From the WSJ article: " 'Netflix has yet to show that it has the resources and profitability to be in the markets where licensing is the business policy,' says Warren Lieberfarb, the former head of Time Warner's Warner Bros. home video division, who helped develop the DVD format." That says a lot about the plight of Netflix.

In summary:

  • Netflix must finance its infrastructure migration out of its customer subscription revenues.
  • The financial resources it can bring to bear to develop infrastructure are a small fraction of Apple's.
  • Netflix's shareholders are seeking short term gains at the expense of long term infrastruture, essentially competing with Netflix for its profits.
  • Netflix hasn't shown a knack for hardware development and has no hardware revenue to help finance infrastructure and licensing.
  • Netflix is targeting the static living room while Apple is targeting the mobile society.
  • The question has been raised as to whether Netflix has the profitability to be in a market that depends on licensing of content.

 

The Apple Edge

The key strength Apple brings to bear in this online entertainment war is its phenomenal hardware, designed from the bottom up for the mobile age. Revenues from the Apple tablet will support Apple's cash flow and R&D in way Mr. Hastings could only dream about. Apple's shrewdly maintained cash assets, over US$30B, allow it to invest enormously more money than Netflix could ever muster for its own transition to Internet streaming. Apple's revenues and profitability will allow it to pay, when necessary, favorable licensing fees to Hollywood.

iTablet concept

Apple Tablet Concept: Credit Gizmodo

In the end, Apple will deliver a quantity of streamed movies and TV shows that will swamp the Netflix business model. Young people will find themselves on the move with the iTablet, accessing newspapers and books and games and the Internet. By habit, they'll use it for movies and TV delivered from the cloud as well. Sometimes it's a matter of convenience and habit, especially when the hardware is so damn cool and fun to use.

I did a simple calculation that showed that a 10-inch iTablet at typical 20-inches viewing range presents about the same subtended viewing angle as a typical home theater HDTV. What that means is that the 10-inch screen choice is no accident. The iTablet is designed to provide the same home theater experience, visually, yet for the mobile user.

The bottom line is that Apple has had and will have the financial muscle to negotiate with Hollywood for a very robust, secure, streaming video signal to millions of iTablet owners. (In addition to its curent millions of Apple TV owners.) It has the funds to build a data center that'll be many, many times bigger than Netflix could ever afford. It'll have fabulous, cool hardware that everyone will already be using as a personal "knowledge navigator." That hardware revenue will eventually break the back of cash starved Netflix as that company struggles to move to a subscription-only business model of Internet delivery to someone else's cool hardware.

So every time Netflix PR publishes a story about another HDTV or hardware platform it has partnered with, it would be a rush to judgment to read that as a tidal wave that's swamping the Apple TV and the forthcoming Apple tablet.  Instead, it's the reality of Netflix's situation: an attempt to achieve more market awareness -- without actually building a better financial basis on which to maintain a war against Apple.

The iTablet/iSlate hardware revenues will become Apple's key strength. That cash flow will eventually close out the game against Netflix.

_______

Netflix was contacted for comments about this article, but had not responded by the time of publication.

Comments

jfbiii

And yet, I don’t want to pay for tv shows and video content that I will watch and enjoy approximately once. I especially don’t want to pay for it and have it drm’d so that I can only watch it on one device. TV shows and movies aren’t consumed the way music is, for the most part. If I do want to see something more than once and I don’t mind buying it, I’m buying a DVD that I can rip and utilize on my TV, desktop, laptop, or whatever.

jfbiii

Kontinually having to turn off Kontera ads is VERY annoying. In an age of persistent cookies, I shouldn’t have to opt out continuously.

jfbiii

LOL…extra special: turn it off, post a comment, and they’re back immediately.

trrll

Nevertheless, there is a good reason why I go to Netflix first if I’m looking for a movie or TV show. For my monthly subscription fee, Netflix offers an unmatched library, even if most of it is available only by mail. If something is not available (yet) from Netflix, maybe I’ll look for it on iTunes, but more likely I’ll watch the latest disk that arrived in the mail from Netflix, or stream one of the 60 or so movies on my “Instant Watch” queue, using one of the multiple devices in my home that is capable of Netflix streaming. If Apple convinces me to buy a tablet, there’s a good chance I’ll end up watching more movies streamed to it by Netflix than movies bought or rented from Apple.

As for the Roku box, I don’t see it as an unsuccessful attempt to move into hardware, but rather the first step in a plan to make Netflix streaming available to virtually all consumers through one device or another. As it happens, I gave a relative a Roku box for Christmas—if you already have a Netflix subscription, it’s still the cheapest way to get movies on-demand.

dodgingcars

A few things:

Was Roku really considered a Snafu? Some estimates say that Roku has sold about 1 million units.

As for whether customers would rather buy a BD player instead—certainly that’s true for some, but considering only about 33% of US households have HDTVs, they may opt of a cheaper ($80) solution that works with their current TV—or they may already own a BD player they’re happy with and don’t want to replace it with a (usually) pricey Wi-fi enabled Netflix streaming player.

As for whether mobile entertainment will be more lucrative—I’m not so sure. Certainly, I’m a 33 year old married guy with a 2 year old—so I’m biased. I’m not very mobile (I’m at home or work, generally). I drive to work and don’t take public transport. Mobile media is not very important to me. I’d much rather watch my TV/movies on my 50” TV than on a 10” or smaller screen.

Unless Apple can provide an entry level device and a good pricing structure—it’ll never compete with Netflix. I can stream unlimited Netflix for $9/mo with almost any device.

When Apple can do that, then I’ll say Netflix should worry.

dhp

Unless Apple uses some of the huge hardware profits to lower the price of renting video, Netflix still has a huge value lead, IMHO.

Since you are basing your argument on speculation, so will I: For the price of an iTablet (even a lowball estimate of $700), I can get a Roku box (or Blu-ray player) *and* 2-3 years of access to video in disc or streaming form. With the iTablet, I still have to pay Blockbuster-esque prices for movies and $2 for TV shows.

I’m not saying there’s no market for it, but it won’t kill Netflix.

Where did you get the idea the Roku is a failure?

John Martellaro

The WSJ article (linked to) described how Netflix was unable to keep the Roku in house as a money maker.  Nevertheless, it has sold fairly well.

John Martellaro

What we have to remember here is that large scale demographics. I too am a Netflix customer, and I find it a valuable service.  That doesn’t mean, however, that a one-off opinion on the usefulness of Netflix overrides the big sales numbers Apple will have. 

You can bet that Apple wouldn’t ship such a product unless it understood the potential market and the potential demand.  Eventually, the mathematics of big numbers will take a financial toll on Netflix. How long it will take is hard to pinpoint.

dodgingcars

AppleTV?

G4 Cube?

Newton?

boogiedj

A well-written, thought out, yet completely slanted view of the current market. The object of the game is not who has the most money, it is market penetration. I am a fan, and owner of several Apple products (typing now on a MacPro), so I understand all too well the slant that a site like MacObserver would have against Netflix, whose very CEO is a Microsoft board member.

Let’s just cut through the crap shall we? The ROKU box is not a product of Netflix. Neither are the almost 100 devices that will stream Netflix content. They do just what Microsoft does, license their product/content/etc. to the manufacturers. These give the opportunity to the public to choose how they get Netflix streamed to their homes. The ROKU box was intended to be a catch-all; including those that haven’t yet upgraded their televisions. Believe it or not, there are ACTUAL people who still have their tube televisions.

The heart of the matter is this: we are comparing completely different business models. While Apple does have a good amount of content, they are strictly (at this point) a glorified Pay Per View service. Portable content, on whatever device Apple sells, is their strong suit.

Netflix, on the other hand, is treading water in other ways. They already have their main competitor, Blockbuster Video, on the ropes. At a standing 8 count. I live in the Dallas area. Blockbuster is based here. And they are closing stores faster than one can count them. They won the video battle effectively 2 years ago. The little company that mailed DVDs to your door proved to topple the Blue and Yellow Giant.

Their next goal seems to be a bit loftier: Cable/Satellite. For those that may not know, for your $8.99 a month, not only do you get access to any DVD they carry, but their fledgling streaming service. It is growing. Growing this costs money. That would be all fine and dandy, but they keep adding content partners. Enter ENCORE.

Not the biggest or most powerful of networks, but Encore has a pretty wide selection of first run movies as well as original programming. Their entire selection of ON DEMAND programming is available to all Netflix streaming customers. This is a first step in what every cable/satellite customer has yearned for: a la carte programming. As they add more content providers (NBC already has content available), they are now and will grow to be a viable option for those that want to “cut their cable”.

The fact that they are a little cash-strapped is a road block, indeed. But by taking initiative to get their streaming network accepted by almost every major home electronics manufacturer can’t be an accident. And certainly, no one is doing this for free.

As for Apple’s tablet, let’s all just tap the collective brakes for a second. The announcement will be next week. And no one REALLY knows what the product will be. Certainly no one that writes stories for THIS site. Whatever it is, I’m sure it will be cool, expensive and tied to the iTunes Store, where you can buy the entire season of 24 for only $50 DOLLARS.

spudgeek

Interesting article… and comments. I agree with the dispute between iTunes Movie sales/rentals & TV Show sales versus NetFlix subscriptions. If Apple launch subscription based services then I’m interested… very interested and NetFlix can begin cleaning out their closets.

There’s been rumors of Apple trying to work with the content providers to offer subscription services, and I guess it’s a battle because Apple want to dictate how to do it right! Maybe Apple should just buy NetFlix to acquire the licensing rights and get on with it… why are we waiting so long?!

graxspoo

I have both Netflix streaming (via Samsung BR player) and AppleTV connected to my HDTV. My wife and I watch something on Netflix perhaps 3 or 4 times a week (and she much more on her laptop).
Conversely we rent maybe 1 movie a month from my AppleTV. Often less than that. 
We also watch programs on Hulu quite often, from her laptop to the HDTV. We don’t pay for cable.

Free wins out over pay per view.

The Netflix subscription cost is low enough that it’s very much worth it. Great value for what you get, especially since streaming is included with even the cheapest plans. I think its Apple that needs to reassess their model. They should bundle Boxee with AppleTV for starters.

spudgeek

What do you think of the likelihood of Apple opening up “Apps” for the aTV? Maybe Boxee or NetFlix could be apps., or possibly not due to business conflicts. I mean why would Apple allow NetFlix on their aTV just to take revenue away from them… nonetheless, it’s food for thought wink

rjackb

I agree with many of the points that @graxspoo made. I don’t see Netflix disapppearing anytime soon. I use Netflix frequently (via my BD player) while I very rarely use my Apple TV.

The offerings for rental on Apple TV really suck because they are extremely limited. They have hardly anything I’m interested in watching. Plus, renting a movie on Apple TV is very expensive relative to Netflix.

With Netflix, I can watch virtually anything because of their gigantic library (via DVD or Blue-Ray if it’s not available for streaming). My only knock against Netflix is that they don’t offer surround sound with their streaming.

Time may prove me wrong but I think your argument about Netflix’s financial situation is questionable and possibly even either wrong or irrelevant.

paikinho

Certainly all of this information could be true, but I am also more likely to just keep on using my netflix account with my mac be it tablet or otherwise.

I never have used itunes to buy any music or watch any video. I find a subscription service that is cheap is more to my liking. As netflix moves to an entirely streaming service I will become even more satisfied. On demand on my terms.

Perhaps apple will move to a subscription service and I am sure that if they did, they could use their capital to destroy netflix. I am not sure that this is in their interest however.

Netflix could be a value add to apple so why not buy it and add it to the fold. I am not sure that this is interesting to Apple, but I am not sure that Apple cares about Netflix or competing with Netflix. They have bigger fish to fry… aka google.

Dean Lewis

While the plural of anecdote is not data, I’ll add my anecdote to the flurry offered here by others: I prefer to own my entertainment. While there is a place for subscriptions, I don’t want iTunes’ model to go away (and, it seems to be making plenty of money, so shouldn’t go away any time soon). I want to buy songs and video and keep the files myself when I really like them. I prefer this to constantly streaming or renting things I like. And, contrary to what many might say, there is plenty of information in the form of trailers, samples, reviews, and word of mouth for me to know if I want to buy something. Another bonus of owning: if I’m broke one month and can’t afford the subscription, I don’t lose access to what I already own. If I’m broke for a year, I still have my CDs, DVDs, and downloaded files.

I don’t believe Apple is competing with Netflix either. Their business model is just fine and growing—it’s often mentioned in the same articles as Netflix when someone is writing about the dying breaths of Blockbuster.

Niel

If the persistent rumors of iTunes offering a subscription service ever come to pass, then I’ll be able to stream TV to my AppleTV, and movies to my Wii (once Netflix ships their disk this spring).  Both Apple and Netflix will get my business and can peacefully coexist in my living room.  The big losers will be the cable providers.

trrll

Subscription services have never been particularly successful for music. People tend not to get tired of their favorite music, and familiar music can be played in the background as a complement to other activities. So when you buy music, you build up equity that you can use indefinitely.

Video is a bit different. Most adults don’t care to watch a movie or TV show more than 2 or 3 times, at most (although children often have favorite shows that they watch over and over), so there is less incentive for ownership, and subscriptions make more sense. Of course, some people are collectors, and enjoy ownership for its own sake, but most collectors will prefer the physical bluray disk, as the highest quality option, over compressed HD delivered over the internet. Renting individual shows is another option, but the cost tends to be higher unless you watch very little (perhaps this is an area where Apple could make improvements) and many rentals come with onerous restrictions that require you to watch the show within a certain period of time.

pete

why would i buy a tablet costing up to a thousand dollars to watch tv shows, when i can buy a $100 roku box and watch unlimited shows for 9 bucks a month?

macjeffff

Netflix may not be in the same league as Apple, as a media company, but it’s not a zero sum game between the two. Netflix is so rediculously inexpensive that they will always appeal in the livingroom, even as people watch other content on their tablets. For $9/month, why not have it all?

madprofessor

Wow John, are you stuck in the past.  Like I’m going to trade my cable company for Apple.  Net gain zero.  The whole idea of the Internet is choice.  Does AppleTV give you choice about where you get content?  Would you buy a DVD player that only plays Paramount movie content?  Why would we all move to just one service? 

Typical of mac zombies to insist that the world will “follow their leader”.  I personally would never purchase any media with DRM attached.  A string tied back to the content provider and Apple. 
...Sheep

dhp

Typical of mac zombies to insist that the world will ?follow their leader?.? I personally would never purchase any media with DRM attached.? A string tied back to the content provider and Apple.?
...Sheep

Obviously there aren’t many “mac zombies”/“sheep” here because virtually every comment takes issue with the article’s analysis.

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