Richard Martin Blog: How Netflix Faced Down the Studios

How many companies have significantly improved their performance while seeing the cost of their primary raw material multiply by 10?

That’s basically what Netflix has accomplished while making the transition from primarily a rental service for DVDs-by-mail to a streaming movie service. According to the company’s latest earnings report this week, the company has signed $1.2 billion in contracts for streaming content deals, up from $115 million at the end of 2009. Yet Netflix’s share price hit a six-month high today, and it’s now being talked about as a leading candidate for acquisition by Apple, which has about $51 billion in cash lying around and has obliquely said it plans to use it on “game-changing" acquisitions.

The Netflix story powerfully illustrates how the rapid evolution of TV and at-home movie viewing is upending longstanding relationships while thrusting content providers and distribution services into new types of partnerships with previous adversaries. David Pakman, the former CEO of eMusic.com and a partner with venture firm Venrock, provides a fascinating look at how Netflix beat the odds, and the fierce opposition of the major rights-holders, to succeed.

“The movie studios wanted Netflix dead," writes Pakman. “Only problem was, they couldn’t kill them."

That was largely thanks to the “first sale doctrine," which says that, once you buy something you’re free to resell it or rent it however you choose. Unfortunately, first sale does not apply in the digital world (which is why Apple is able to strictly control what you do with songs or shows from iTunes), so Netflix has had to actually go out and buy the rights to content that it streams. Fortunately for Netflix, the money it saves on postage more or less makes up for its additional content rights costs. When Netflix CEO Reed Hastings “waved a $1 billion check in front of the studios’ eyes, suddenly all those restrictions on pricing and limited viewing went away," remarks Pakman.

Which brings us to Google TV and the current efforts of the major networks to bar its access to their programming. This effort is as doomed as the studios’ attempts to quash Netflix turned out to be. Like the movie studios and the record labels before them, ABC, NBC and CBS are conducting a futile rearguard action to resist the forces of change, armed with overwhelming consumer preferences. The networks are attempting to maintain “a false and meaningless distinction between screens," writes Will Richmond on SeekingAlpha; in so doing they are neglecting a major new source of exposure and potential revenue. Barring your customers access to your product in the ways they want to consume it is no longer a viable business strategy; a new report fromSay Media found that about one-third of all adult viewers have eliminated or drastically reduced the time they spend watching TV live (i.e., when the networks say they’re supposed to watch it).

“As connected devices proliferate," concludes Richmond, “sustaining these artificial boundaries will only frustrate viewers and make the networks look increasingly foolish and irrelevant."