December 16, 2015

No More Mr. Nice Guy

Ted Sarandos of Netflix made news this past week at the UBS 43rd annual Global Media and Communications Conference in New York with some very pointed comments about the media industry. Sarandos, who has led content acquisition for Netflix since 2000 and tends to be pretty genteel and politically correct at public events, had some tough love for both Hollywood and the sports leagues this time around. What can we learn from Netflix’ newfound transparency?

Two things.

1. Netflix Is Becoming Content Independent.
Netflix may well be the greatest content bootstrapper of all time. Starting from nothing, Netflix first availed itself of copyright’s first-sale doctrine, which allowed it to buy DVDs once and then rent them out endlessly to subscribers of its DVD-by-mail business. Later, Netflix acquired streaming rights to old TV shows that were begging to build an early audience of streaming users. Next, Netflix signed a five-year digital deal with Epix that gave it access to big name Hollywood movies which it could use to further market streaming. By 2012, Netflix had the scale to begin producing original content for itself, launching House of Cards in February of 2013. By next year, Netflix will be producing 31 different original scripted series as well as over 10 original feature films (plus kid’s series, documentaries, and original comedy specials). Sarandos himself said he believes Netflix originals would be the most viewed shows on cable today if ratings were tracked comparably and all devices were taken into account. Although Netflix is notoriously vague in its public statements about viewing, I believe both their behavior and public statements strongly indicate that a majority of all viewing on Netflix is Netflix original content (and still climbing). In short, Netflix’ need for third party content is declining, even as Netflix itself continues to grow. The consequences of this are obvious. Netflix has greater and greater leverage when it sits down at the table with content companies. This does not bode well (to say the least) for content companies with Netflix SVOD deals coming up for renewal in the coming year.

2. Netflix Has No Interest in Preserving the Status Quo
The legacy pay-TV industry is based on nested and mutually interdependent relationships between MVPDs and providers of linear content programming. By way of analogy, think about the symbiotic relationship that used to exist between record labels and music retailers like Tower Records. In both cases, companies that were (and in the case of pay-TV, still are) financially and legally independent of one another over time become economically dependent on each other and the common business model they share. In the case of pay-TV, affiliate deals provide a consistent, multi-year revenue stream for content producers in return for a consistent, multi-year stream of linear programming for MVPDs. Sports leagues provide an additional nested layer of interdependence by signing multi-year rights deals with the content providers in return for the live sports content that keeps subscribers paying their MVPD every month.

Netflix does not give two hoots about any of this. Mr. Sarandos was unusually explicit this past week on this point in at least two respects. First, he made it clear that Netflix does not like ‘output deals’ with providers like AMC and Discovery in which Netflix takes all of a provider’s shows that are in the SVOD window. In other words, the on-demand equivalent of the ‘affiliate deal’ that has been the very lifeblood of the legacy TV industry for decades has no appeal for Netflix. The reason is simple – data. Netflix knows exactly what people watch, and the viewing data reflects a short tail of a relatively small number of high quality shows. Everything else (i.e., the long tail) is basically interchangeable (Mr. Sarandon’s own words) and therefore doesn’t matter. As a result, Netflix strongly prefers to license (i.e., cherry pick) individual shows that it believes will drive real viewing, and leave the rest.

Second, Netflix has no interest in bidding against legacy TV providers like ESPN for sports rights from the traditional leagues. Netflix (correctly) understands that all this would do is bid up already stratospheric rights deals even further. Instead, Mr. Sarandos suggested that Netflix would only participate in sports if and when it could create, produce, and own its own sports event(s) similar to what ESPN did with the X Games. In other words, Netflix is happy to do sports as long as it can create global events that it owns in their entirety, cutting both the traditional rights holders and the traditional sports broadcasters out of the loop entirely. Calling this disruptive is an understatement to say the least.

For the past decade Netflix has played by the content industry’s rules. Mr. Sarandon wrote big checks to Hollywood for VOD window content, and built a huge global subscriber base in the process. The folks from Los Gatos now have the scale (and the data) to start rewriting those rules. Legacy TV providers are not going to like it.

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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