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How Netflix came to dominate Hollywood

Assif Shameen
Assif Shameen1/30/2019 11:17 PM GMT+08  • 9 min read
How Netflix came to dominate Hollywood
SINGAPORE (Jan 28): On Jan 22, the Academy of Motion Picture Arts and Sciences announced the nominees for the 91st Oscars awards, which will be presented at its annual gala event on Feb 24. And the winner… at least in so far as nominations go, was not o
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SINGAPORE (Jan 28): On Jan 22, the Academy of Motion Picture Arts and Sciences announced the nominees for the 91st Oscars awards, which will be presented at its annual gala event on Feb 24. And the winner… at least in so far as nominations go, was not one of the once-giant Hollywood studios Walt Disney Pictures, 20th Century Fox, Paramount Pictures, Sony Pictures, Universal Pictures or Warner Bros Pictures, but Netflix, the video-streaming pioneer and the world’s biggest producer of filmed entertainment.

It was not surprising that Netflix was nominated for 15 Academy Awards, including 10 for Roma, a black-and-white emotional portrait of a domestic worker’s journey set against the political turmoil in 1970s Mexico, but rather that Roma is the first “Best Picture” nominee with no reported box-office revenue in the US. The movie was released in a few small US theatres that Netflix had booked for a couple of days, so nobody paid to watch it. Most people watched Roma at home with their Netflix subscription.

Few consumer technologies have been as disruptive as video streaming. High-speed broadband access allows us to download a whole movie within minutes. That has fuelled a boom in video content. You do not have to be in a cinema or sit in front of your TV to watch a Netflix TV series or movie. You can watch it on the go, whenever you want, on your smartphone, tablet or any other device. If content is king, ­Netflix has helped prove that distribution is the key to the kingdom.

Splurging on content creation

Having disrupted the old pay-TV model, Netflix — already the largest global entertainment subscription business with nearly 150 million subscribers worldwide, including 61 million in the US — is powering ahead by rapidly expanding its content assets. Last year, it splurged US$12 billion ($16.3 billion) on new content creation. That is 80 new movies, or more than any other studio. This year’s budget to create new original filmed content could top US$15 billion. BMO Capital Markets estimates Netflix may spend nearly US$18 billion in 2020. That is more than the combined budget of the six big Hollywood studios in 2017. As it spends more on original content every year, it builds a vast archive of films and TV serials that subscribers can access anytime, anywhere on any device. The bigger the archive and the larger the annual content creation budget, the stickier Netflix becomes.

To be sure, Netflix has been a key beneficiary of “cord cutting”, or removal of pay-TV cable bundles. Nearly 24% of 135 million households in the US have already cancelled their pay-TV subscriptions and almost all of them have switched to Netflix or its smaller competitor Hulu. Americans pay an average of US$65 a month for a pay-TV bundle that includes over 200 channels, or slightly more if they add internet access as well. The average Netflix subscription, after the recent hike, now costs US$13 a month. (It costs US$15 a month to subscribe to just HBO.)

The key to Netflix is not that it spends US$15 billion every year producing content but that its algorithms remember what we watch, when we watch, then dishes out more of the same the next time we log on. Netflix uses artificial intelligence for content promotion and targeting, programmatic marketing and improving streaming quality. One recent experiment has been creating software-edited trailers that are personalised for each subscriber, increasing the likelihood of those viewers watching the movie, documentary or TV serial. Last year, it spent US$1.3 billion on technology. This year, tech spend is likely to top US$1.5 billion. Higher tech spending allows Netflix to differentiate itself from rival streaming services that are just spending money on content.

Netflix has not relied on cookie-cutter solutions like Hollywood, which just dubs its English shows into local languages when it comes to exporting content overseas. Netflix has been making content in German, French, Spanish and Italian and has poured money into local original programming in India. It has announced seven new local series to be produced in India this year, although rival Amazon.com is said to be producing more than 20 original local series there over the next 12 months. In Indonesia, most Netflix programming is dubbed in Bahasa or has Bahasa subtitles. Thai, Tagalog and Bahasa movies are coming.

Netflix started out selling and renting DVDs by mail in 1997 and branched out into streaming movies a decade later. Streaming services are in a sweet spot. There are more than one billion pay-TV subscribers worldwide, mostly paying a monthly fee for a cable or satellite TV bundle. About 950 million households around the world have access to broadband, with 200 million streaming subscribers. Netflix and its rivals are not just trying to convince those who subscribe to expensive pay-TV bundles to switch to streaming but also targeting a much wider audience of over 2.5 billion or so broadband internet-enabled smartphone and tablet users. The pay-TV boom was helped by its buffet-like offerings of 30 to 300 channels. Instead of offering 200 channels, of which only 10 are watched, streaming providers offer a rich library of content with a promise to keep filling it with new compelling entertainment every year.

Soaring stock price

To understand just how successful Netflix has been, look no further than its soaring stock price that has made it one of the best-performing large-cap stocks over the past decade. In January 2009, in the aftermath of the global financial crisis, ­Netflix shares were trading at a split-adjusted US$4.27 per share. Last June, they surpassed US$423, or a surge of almost 100-fold. Since then, the stock has pulled back and is trading 23% below its all-time high, but that is still 76 times higher than where the stock was just 10 years ago. Netflix stock was up 60% in 2017, 39% last year, 24% this year and has been up more than sevenfold since January 2015.

Detractors say Netflix’s long dream run may be nearing its end. For one thing, a bunch of rival streaming services are set to be launched over the next 12 months. The Walt Disney Co, which last year acquired the entertainment assets of Rupert Murdoch’s 21st Century Fox, is due to launch its own streaming services later this year. US cable TV giant Comcast’s NBCUniversal plans to launch its streaming service in early 2020. CBS and Viacom, which share common ownership and are reportedly seeking to merge, are readying the launch of their own ad-supported streaming service. AT&T, which bought Warner Media last year, is also expected to launch a streaming service.

Then, there is competition from existing streaming players such as Amazon Prime and Hulu, which has 25 million subscribers, as well as Google’s YouTube and ­Apple’s new streaming service that is expected to be launched later this year. Can Netflix really cope with such fierce competition? “Netflix is the leading global streaming player in a business where scale matters,” notes Mark Mahaney of RBC Capital Markets. “Netflix has six times as many subscribers as its closest global competitor and whoever has the most subscribers generates the most revenue, which enables more content purchasing, which leads to more subscribers and generates more revenues,” he says.

Another worry: How much price elasticity does Netflix have? The US’ premium cable and satellite television network HBO hit the brakes when its monthly subscription reached US$15 and the core Netflix subscription is already priced at US$13 a month. Netflix clearly has pricing power because “it offers a truly compelling value proposition with global appeal”, notes Mahaney. “So compelling that it is embarking on its fourth successful price increase in the last five years.”

Last week, rival Hulu cut prices for some subscriptions to expand its own base.

Netflix’s critics say the streaming giant was probably forced to raise prices because subscriber growth in the US may be perilously close to saturation point.

In 2017, CEO Reed Hastings mentioned Netflix had the potential to reach 60 million to 90 million subscribers in its home market of the US. Within the next few weeks, Netflix will cross the 60 million mark, just before rival media giants start rolling out their own Netflix-lookalike services.

Will investors still pay a premium?

The big question for Netflix is: How long will investors keep paying a huge premium for its stock? Alongside e-commerce giant Amazon, Netflix remains one of the few large-cap stocks whose investors have been willing to overlook short-term profitability for years for future gains. The streaming giant burnt US$3 billion in cash last year and its stock currently trades at about 80 times this year’s earnings, or 47 times next year’s earnings. Most of the growth in the future is likely to come from international operations, and its proponents argue that ­Netflix may have better margins outside the US, in part because content creation in Europe or India is cheaper. So far, at home and abroad, Netflix has had a low churn, meaning people who buy a subscription do not cancel it to go back to their pay-TV.

Unlike Apple or Amazon or indeed, Uber, Netflix is not a platform nor does it have an ecosystem that allows it to cross-sell other products or services. However successful Netflix might be, it is just streaming filmed entertainment. A company that will spend US$15 billion cash on content creation this year to retain and gain subscribers needs to show that it can continuously rake in more subscription revenues to justify its lofty valuation. Yet, comparing Netflix with other high-flying internet peers may be missing the point even though they are all harvesting users’ data. Since it is not advertising supported business and is funded exclusively by subscription, Netflix is less susceptible to regulatory scrutiny than firms such as Facebook and Google’s owner, Alphabet.

Netflix can deflect the onslaught from media giants such as Disney and tech titans such as Amazon and Apple if it can focus on churning out hits like House of Cards, Orange is the New Black, Stranger Things and Bird Box.

Assif Shameen is a technology writer based in North America

This story appears in The Edge Singapore (Issue 866, week of Jan 28) which is on sale now. Subscribe here

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