Lately, there are two questions I get asked whenever I speak, and whenever I see old friends.
The first is “Can I get rid of my cable yet?” It’s a tempting thought; customers like the brands of the new players, still hate the cable company, and would save maybe $1000 a year . Given the number of options – Netflix, Hulu, Amazon, iTunes, Google etc. – it seems worth a shot. But it’s not as easy as it sounds. We’ll come back to this question soon.
To answer that, let’s begin with the second, bigger question: “Will online video sites (like YouTube) and new services (like Netflix) kill cable?”
The short answer is No. But the reasons are non-obvious, so we’re going to lay them out in a in a series of posts, which should throw some light and what all of these companies are jockeying for, and where we’re likely to go from here. In this first post, let’s talk about the most popular contender, Netflix.
Netflix is a smart, innovative company that’s ridden a bullet train from nowhere to global recognition in less than a decade. I’d argue that, rather being a clever strategy for conquering cable, Netflix created a new, evolving category, and that it did this via four smaller plays: two market inefficiencies they exploited, and two opportunities they seized.
1. The Economics of DVD. As the CD was for the music business, the DVD format was heroin for the film industry: a high-margin, low-effort means of remarketing existing content. Unlike VHS, DVD was a theoretically non-degrading format, providing a great chance to sell folks the stuff they already loved – but this time in a “permanent” format. This was a big success, creating massive new cash flows for studios from assets they already had – old wine in new bottles.
But as homes filled with old DVD boxes and content moved online, studios faced massive declines in DVD sales – not to mention huge DVD inventories and wasted replication plants.
As a bulk purchaser of DVD product, and (from 2003-2008 or so) Hollywood’s new best friend, Netlfix paid a good price for thousands of DVD. They also created a tremendous mechanism for getting this content discovered and viewed (see 3 below), thus creating value for customers, producers and studios alike.
2. The US Postal Service. The USPS is not a super-efficient business. But many a good business is built on the back of someone’s else sorrow. There’s no way that Netflix could have built a business paying $1 to mail a disk without some government-subsidized rail to ride on. By exploiting a below-market rate, Netflix was able to build a great business on the backs of a subsidized federal service.
3.The Power of Recommendation The other place Netflix led by a mile was the (completely undervalued) power of recommendation and curation. By pumping millions into R&D (see here, for example) to increase the power of its recommendations, Netflix magically paired customers with content they’d often never heard of– and often fell in love with. By extension, they fell in love with Netflix – and eventually the markets followed.
4. Ubiquity No one has done a better job of getting on as many devices as Netflix. From Xbox and PS3 to Roku and AppleTV, TiVo to Boxee, almost every major device now has Netflix (see here) – strengthening the presence and value of the brand.
So clearly, Netflix did some critical things extremely well. The questions is: how much is that worth?
Enter the market.
Meteroic Rise As Netflix presence grew, the talk of a new leader in TV and movie distribution caught fire. As it closed in on Comcast, temporarily surpassing it as America’s #1 subscription service in the US (see here, for example) , bulls poured on the gasoline. A chart I ran in Feb 2011 (see top of page) tells the story: it compares the 12 month market value of Comcast, the S&P, Apple, Amazon and Netflix.
Netflix is the one in blue. And this was nowhere near the high.
In fact, after an impressive move from ≈$243M EOY 02 to $1.47B EOY 05, Netflix sat around $1.75B through 2008, before climbing to $3B in 09, doubling in value.
Then, in 2010-11 the cord cutting story really gathered steam. And NFLX exploded, its market cap climbing to over $16 billion in July. In other words, as the idea of Netlfix as a cable killer grew, the company’s valuation increased over 500%.
…and Sudden Fall But on Wall Street and elsewhere, Netlflix had always had skeptics, analysts who argued not to believe the hype. And after years of murdering short sellers, NFLX gave them a victory. Shorty after that remarkable run-up, Netlfix began to stumble… and then tumbled like a stone. In fact, Netflix moved from a July high of 304 to an October low of 74 – meaning the company that ninety days later, the company was worth about 76% less.
What happened? And what’s next for Netflix? We’ll talk about this in the next post. Then we’ll move on to talk about Hulu, Comcast and others – and what you can expect if you cut the cord.
If you have any questions or there’s anything else you’d like covered, please let me know.