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 - 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.
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.
- 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.
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.