February 5, 2015

The Emergence of Netflix 3.0

Netflix has become the poster child for how to successfully challenge — and change — the television industry. It has built its success with a content strategy that involves innovative original programming mixed with a much larger base of older network shows (we used to call them “reruns”).

But that may all be about to change.

Netflix is facing two very serious challenges to its current hegemony over OTT streaming, and its business may never be the same.

The first challenge that Netflix is facing is the more immediate of the two: that is, the networks from which Netflix has procured content rights for the past few years may no longer want to play ball. The TV networks have come to realize that selling Netflix the rights to their older shows is no longer in their best interest. It made sense at first — Netflix was mostly buying up older seasons of shows that weren’t yet available for syndication and paying top dollar for them.

This initially seemed to be a great deal for the networks, which were getting millions of dollars for episodes that would have otherwise sat on the shelf. As well, the success of shows like Breaking Bad and The Walking Dead proved that viewers who caught up with shows on Netflix would often start watching them live, thus bringing new traffic to the networks.

Unfortunately, this halcyon period was short-lived. The networks began to see their own viewership numbers decline as audiences spent more time with Netflix, especially once the service began expanding its original programming. The networks also started to question whether they could make more money and gain more control by setting up their own OTT services and hosting the shows themselves. This new mindset is the driving force behind the wave of new standalone network OTT offerings coming to market, a trend we believe will only grow more significant as time passes.

That said, there are still many issues that may serve to maintain the status quo. For one, many of the network deals Netflix has in place are long term, so an immediate change in status is unlikely. Second, the networks relish the (not-insignificant) revenue they receive from Netflix, which will be hard to give up. Finally, few networks execute OTT very well. User interfaces have proven to be a major challenge for the networks. As well, since the networks make money from advertising, not subscriptions, the shows featured in these apps will have ads on them (the absence of which is a key benefit to Netflix viewers).

Netflix is also an aggregator with a very large content library that makes for seamless one-stop shopping. Viewers may not cotton to the idea of having to switch between a dozen network apps to find the shows they want to watch, especially if network apps feature the aforementioned inferior UI and force viewers to sit through commercials.

The second threat to Netflix’s dominance is less immediate and centers on the relevance, or lack thereof, of advertising to the Netflix model. To wit, Netflix has trained an entire generation to watch TV without commercials and, in doing so, may have killed the goose that lays the golden eggs. Remember, all those network TV shows Netflix runs were originally funded with advertising dollars. Without this revenue, networks couldn’t afford the big production budgets and high-priced talent.

But Netflix is teaching viewers to avoid commercials, and so they’re time shifting, using DVRs, and otherwise avoiding ad-supported television; none of which is good for the television advertising market, currently valued at around $16 billion.

This is the fly in Netflix ointment: less TV ad revenue means fewer high-quality shows, shorter seasons, and eventually, less content from which Netflix and other OTT aggregators can draw.

Here again, none of this will unfold overnight, but if the ad market continues to shrink, changes will occur. Case in point: NBC, whose research chief recently admitted that only 60% of network programming is watched live, noting if DVRs were their own network, they’d be four times the size of the four largest networks combined. That’s a lot of people fast-forwarding through commercials and it’s only a matter of time until advertisers tune into this reality.

So should we be worried about Netflix’s long-term prospects? Probably not. It’s proven itself to be one of the most adaptable media companies in history. Remember that Netflix started out doing mail-order DVD rentals, pivoted to a subscription streaming service for movies, pivoted again to a streaming service that mostly featured older episodes of TV shows, and then pivoted a fourth time to a network producing award-winning original programming.

This capacity for remaking itself in mid-stream will prove valuable as Netflix faces these new challenges. Rest assured, TDG will be closely watching as Netflix 3.0 materializes.

Alan Wolk is one of the industry’s most influential thought leaders and futurists. He writes frequently on advertising models, OTT and social TV.

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