As an avid user of both Netflix and Apple TV (Nasdaq:AAPL), I thought some of his arguments are especially pertinent to the question of how Netflix is to survive. Briefly stated, for the average viewer of movies, Netflix’s selection sucks. What set Netflix apart from its original competitor, Blockbuster, was that it could offer a vastly larger selection of movies than could Blockbuster. Blockbuster was locked into the very high costs of having physical stores, and so it tended to have only the most popular movies for rent, because these movies generated buzz and buzz generates foot traffic, and foot traffic generates revenues, and revenues pay rent and salaries. Netflix, however, eschewed physical locations in favor of large warehouses whose costs were paid by millions of subscribers paying monthly fees. This allowed Netfix to have a vastly larger selection of movies than Blockbuster. Add to this larger selection the convenience of having movies mailed directly to you, and it was clear that Blockbuster was not long for this world. Netflix vanquished Blockbuster.
But, now everyone is turning to the streaming of movies over wireless internet connections. Because the movies studios intuit that streaming of videos is a viable business, and because of legal distinctions between licensing content for streaming versus renting out movies, the fees that Netflix et al have to pay to stream content are higher than those associated with rentals. This poses some problems for Netflix. In order to offer the most popular content for its subscribers, it will have to pay higher licensing fees than it has chosen to do so far, or else increase its subscription fees. The former option would squeeze its margins, and the latter would curtail its growth. Neither of these are especially attractive options.
Businesses that achieve scale don’t cater primarily to the people interested in film noir or documentaries. Netflix, and other streaming movie businesses, have to attract those customers whose cinematic aesthetic skews more towards Avatar (NYSE:NWSA) and Titanic than Irréversible or Ran.
Take a look at this table, taken from page 17 of Tilson’s report. The table is a list of the top-50 grossing movies of all time. It does not appear to take inflation into consideration, as all of the movies, save the original Star Wars movies, are from the 1980s through today. But, these are, for the most part, the movies that most people are interested in watching, and they are the movies that cost the streamers the most to license. Movie studios are not stupid; they know that they can extract larger fees for The Dark Knight or Alice in Wonderland (NYSE:DIS) than they can for movies that don’t have as large an audience.
Box office gross is a good proxy for popularity. Companies that do well serve their customers’ interest. Customers generally are more interested in more popular fare than they are interested in less popular fare. Therefore, the service that offers more of these movies for streaming should do better than the service that offers fewer of these movies. Netflix offers 7 of these movies; iTunes offers 25.
Apple, of course, has a much larger amount of cash on its balance sheet with which to pay movie studios’ high licensing fees. As of the most recent quarter, Apple has $41.6 billion in current assets, compared to Netflix’s $492 million. Apple has almost 100 times as much cash with which to pay movie studios licensing fees to stream their content. Admittedly, Apple is a much larger company and has many other liabilities that lay claim to those current assets; nonetheless, it is safe to assume that Apple has more money to throw at the movie licensing problem than does Netflix.
Finally, a subjective note about the relative picture quality of Netflix and iTunes. I have found that when I stream movies via Apple TV, the movies I rent from iTunes have a better picture quality than those that I stream via Netflix. I don’t know what accounts for this. Perhaps Apple degrades the picture quality of Netflix’s offerings in order that its own look better. Perhaps I am biased towards Apple and there is really no appreciable difference. But what matters here is perception. If I am not the only person who has noticed that, it can’t bode well for Netflix.
About the author: David Friedman is the Editor-in-Chief of our sister site Wall St. Watchdog, which aims to bring back “truth, trust and transparency to Wall St.” Please take a moment to visit us, follow our Twitter feed, and join our Facebook fan page.
The Other Side of the Argument: Check out Wall St. Cheat Sheet Managing Editor Elliot Turner’s Questions for Netflix Shorts >>