October 21, 2014

Cheap Premium

Though HBO and CBS (rightly) dominated industry discussion last week, another worthy announcement was overshadowed. Netflix announced that new customers who want access to 4K content must sign up for its highest-tier $11.99/month plan, which also allows up to four simultaneous streams. The handful of brave souls already streaming 4K content from Netflix are grandfathered under the current $8.99/month two-stream plan.

The service’s current 4K content library includes Breaking Bad and House of Cards (Season 2 only, how weird is that?), plus a couple of movie titles and a nature series. Netflix also announced that 4K content would get its own promotional area in the Netflix UI.

While this might not qualify as earthshaking news, it reveals two trends that will loom large as the 4K content ecosystem starts to take shape…

1. 4K is Premium
There are two basic ways for technology innovations to enter the consumer market. First, they can arrive on a relatively egalitarian basis without price playing a defining role. The entry of color TV largely had this quality. Color television sales were slow for a decade because popular shows like I Love Lucy continued to be broadcast in black-and-white. This changed in the fall of 1965 when NBC announced that its entire primetime schedule would be broadcast in color. Other networks quickly followed and color television sales skyrocketed. Similar comments could be made about home computers, dial-up Internet, and, more recently, Wi-Fi. The diffusion of these technologies was first driven by their appeal to Early Adopters, not by a ‘low’ price.

Second, technological innovations can enter the market at the high end, as a premium offer. Tesla and the electric car market is a perfect example of this trend. By positioning all-electric cars as the ‘new luxury,’ Tesla took the high road with premium positioning and distinguished itself from the low end of the electric car market, which is dominated by hybrid gas-electric products like the Toyota Prius.

4K video, despite occasional protests to the contrary, is clearly following the second model (at least in the US). Today, 4K televisions are viewed as expensive and of limited interest to mainstream consumers. TDG research found that only 3.4% of adult broadband users would ‘definitely purchase’ a 4K television at a $999 price point (and the numbers decline dramatically as price increases). Netflix clearly understands this reality and decided to follow suit, and other 4K content sources (e.g., Blu-ray discs and 4K pay-TV VOD services) will do the same. Bottom line: those who want 4K video are going to have to pay extra for it. As with the Tesla example, this will both help the 4K ecosystem (by creating a financial incentive to roll out services) and hurt it (by limiting the market to high-end consumers).

2. OTT is Cheap
The most striking thing about this story is not that Netflix put 4K in the highest tier, but just how inexpensive the highest tier is: $11.99/month for premium Netflix. Really? Even HBO (a single premium TV channel) is not currently available for this price at any tier.

A couple of reference points for comparison. First, Hollywood continues to charge a significant premium for Blu-ray (1080p) discs versus DVDs (480p). A quick check of Amazon for a new release title like Guardian of the Galaxy shows Blu-ray at $24 and DVD at $17 (a $7 premium for a single title, and this for HD quality which doesn’t hold a candle to 4K). Second, the FCC’s May report pegged the average cost for ‘expanded basic’ television packages (i.e., more than just broadcast channels) was $64.41/month. The next most-popular tier was $77.05/month. In other words, a basic monthly pay-TV bill is still roughly six times the price of a ‘high end’ OTT service. This is a massive gap that is unlikely to narrow any time soon (though it does point to an opportunity). Legacy pay-TV providers will (eventually) add 4K services and, when they do, they will undoubtedly charge more than a $3/month premium for this privilege.

Conclusion
Netflix, Amazon, and Hulu have created powerful ‘cheap premium’ positioning for their SVOD OTT services. They offer a host of compelling features, including on-demand original content without ads on all of the consumer’s screens, both inside and outside of the home. At the same time, these services are incredibly inexpensive relative to existing alternatives (even in relatively basic form).

By adding 4K content for an additional $3/month, Netflix is developing both aspects of this value proposition. Legacy providers have their work cut out for them (and that’s putting it mildly).

Stick with TDG and stay ahead of the curve.

Joel Espelien is a Senior Advisor for TDG and serves as an advisor and Board Member to the video ecosystem and technology companies. He lives near Seattle, WA.

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