A couple weeks ago when Netflix (NASDAQ:NFLX) finally acknowledged it had been in talks with several cable-television companies as a possible distribution channel, the market cheered the news by buying into the stock.
Makes sense. Anytime a company opens a new revenue door, it’s an exciting prospect. Though the cable industry is losing customers, as a group it still provides cable programming to 58.3 million customers per year, and earns about $97 billion per year in doing it. Netflix, by comparison, services approximately 21 million subscribers. Even if only a fraction of cable customers add the Netflix service, the bump in revenue still could be a significant one for Netflix.
The enthusiasm and subsequent rally, however, lasted only a few hours — not because the cable company partnership idea was a bad one, but because investors likely sensed what those cable television companies already know: Netflix is an unsalvageable sinking ship, for a couple of unfixable reasons.
Content Versus Cost
Let’s not mince words here. When Netflix decided to make dramatic changes to its pricing policy in the middle of 2011, it wasn’t part of some master plan to evolve the organization into something even more potent and profitable. The company was desperately trying to figure out how it could remain profitable when the cost of its content was increasing, but its pricing power wasn’t.
You might recall, shortly before (and around) the time of the pricing changes, Netflix was in negotiations to renew its contracts for access to the movies and television programs it was serving to subscribers. Now that Netflix had proven itself a worthy distributor, the content providers wanted a bigger piece of the pie.
Those negotiations did not go well. Indeed, they went so badly, Starz — owned by Liberty Media (NASDAQ:LMCA) — turned down a hefty $300 million offer and decided to stop supplying Netflix with movies and programming altogether. Similarly, Time Warner’s (NYSE:TWX) HBO stopped selling DVDs (for rental customers) to Netflix at wholesale prices. If Netflix wants to offer them to its mail-in customers, it must pay retail price to get them first.
It’s unlikely any of this is news to most investors. In fact, most consumers probably are aware Netflix has been losing content — quality and quantity — during the past few months as programming providers decide not to renew their deals.
What most investors might not realize is that this trend is only going to further develop as time goes on, for one reason — Netflix is a middleman, but doesn’t add any value to the studios and distributors.
To be fair, it wasn’t always that way. Back in 2008 when online streaming television was new, Starz, Time Warner and other content providers didn’t mind throwing Netflix a bone just to see where digital TV went. Now that online television has actually gone somewhere worthy, though, the content providers want a bigger piece of the pie, or they’re not playing ball; they can digitally distribute their stuff through other venues on more favorable terms.
And they are, which underscores the second reason why Netflix as we know it can’t survive.