Netflix delights studios with big checks

The rental service has often said that once the streaming-movie business took off, it would mean bigger bucks for the studios. That transition has begun.

Greg Sandoval Former Staff writer
Greg Sandoval covers media and digital entertainment for CNET News. Based in New York, Sandoval is a former reporter for The Washington Post and the Los Angeles Times. E-mail Greg, or follow him on Twitter at @sandoCNET.
Greg Sandoval
5 min read

LOS ANGELES--Netflix probably won't get a star on Hollywood's Walk of Fame anytime soon, but the Web's top video rental service has recently become a blockbuster hit with film industry chieftains.

Just nine months ago, sources in the film industry told CNET that Netflix's long string of Wall Street-wowing earnings reports hadn't gone unnoticed at the studios. With all that money rolling in, many studio decision makers weren't happy with their cut--especially when it came to the company's blossoming streaming-movie service.

Netflix CEO Reed Hastings has apparently solved the problem--at least for now--by writing checks.

The numbers in Netflix's earnings report show dramatic spending on streaming content, but those numbers are misleading, a company representative said Friday. In the quarter that ended June 30, Netflix reported that it spent $66 million and only $9 million on streaming content a year ago during the same period.

For the first six months of 2010 (PDF), Netflix paid the studios $116 million for streaming content, compared with $31 million for the same period last year.

Netflix said Friday, a day after this story first appeared, that spending on streaming content is up this year, "but not nearly to the degree" the above figures indicate. "The [numbers] only represent the spending for content which gets capitalized on our balance sheet," Netflix said in a statement to CNET. "Over time, if we're successful, you'll see lower DVD expense and higher streaming expense."

The Netflix representative said that for competitive reasons, it doesn't disclose total spending on content.

Netflix's ability and willingness to shell out big bucks for higher and higher grades of movies and TV shows was clearly illustrated earlier this month, when the company announced that it had struck a $100 million deal with film financier Relativity Media to acquire about a dozen movies per year, starting in 2011. As part of the agreement, Netflix will offer the upcoming film, "The Fighter," starring Mark Wahlberg, Amy Adams, and Christian Bale.

And don't bother to check whether your Netflix charges have shot up. The company has paid these millions of dollars to the studios without raising subscription prices 1 cent. What Netflix did do is boost the number of movies and TV shows in its streaming service, which everybody assumes is the company's future. In the past nine months, Netflix seems to have answered a major question, one asked by the likes of Mark Cuban and many others: could the company generate the kind of revenue needed to pay for premium films and TV shows without raising prices?

This appeared to be a real threat to Netflix. Had the studios refused to deal, they might have choked off content and hobbled the company's fledgling streaming service in its infancy (remember, Hollywood tried numerous times to prop up brick-and-mortar rental chains by trying to prevent Netflix from obtaining specific DVDs).

What Netflix's recent performance indicates is that the company has the bankroll and the stature in Hollywood to compete for content with the Comcasts and HBOs of the world. This should come as welcome news to consumers who may be looking to dump their cable bill.

So, how did Netflix do it?

First, delivering digital versions of films over the Web is far cheaper than shipping physical discs. As Netflix users have opted to watch more streaming movies and receive fewer DVDs delivered by mail, the company has been able to trim postage and DVD acquisition costs.

What's more, Netflix didn't just throw money at the content acquisition problem. In January, the Los Gatos, Calif., company agreed not to rent any new releases from Warner Bros. Studios for 28 days to help protect that shop's DVD sales. The thinking was that if discs weren't available for rent, people would be more inclined to buy them. In exchange, the studio agreed to license more titles for Netflix's streaming service.

"In order for Netflix to continue to thrive, they are going to have to cut the studios a bigger piece of pie."
--Michael Pachter, security analyst

Clever horse-trading and old-fashioned cash payments are important because Netflix likely needs the studios more than they need Netflix. Film industry managers aren't going to hand over premium content for less than what they're getting from the cable companies, said Michael Pachter, a financial analyst at Wedbush Morgan Securities.

"The studios have to be thinking, 'We're getting 50 percent of revenue from HBO,'" Pachter said. "Netflix's streaming service is only paying something like 30 percent of revenue. In order for Netflix to continue to thrive, they are going to have to cut the studios a bigger piece of pie."

That, of course, could make investors nervous, because spending bigger with the studios could cut into Netflix's profits. But at some point, the studios may end up courting Netflix as enthusiastically as its executives are now courting them.

None of Netflix's competitors has managed to move Web video content from the PC to subscribers' TV sets as elegantly. Netflix cut numerous deals with set-top makers such as Roku, Microsoft, LG, Sony, and Nintendo, just to name a few. This has apparently made Netflix more attractive to consumers.

Last week, the company reported that subscribers who watched at least 15 minutes of streaming content in the second quarter grew 61 percent, up from 37 percent in the year-ago period. From June 2009 to the same month this year, Netflix added nearly 5 million subscribers, a 42 percent increase. By the end of this year, the company said it could have as many as 18.5 million subscribers.

Sometime next year, Netflix will likely top the 20 million subscriber mark, making it a peer to Comcast, the nation's largest cable company, with 24.6 million cable TV subscribers. Comcast, which reported earnings of $3.6 billion for 2009, still dwarfs Netflix, with its $115 million in earnings for last year. But when it comes to eyeballs, there won't be that big of a difference.

"It took Netflix how long to reach 20 million subscribers?" asked one film studio executive, who was referring to the 12 or 13 years the company took to reach the mark. "Now look at how long it took Comcast to reach 20 million customers. You don't have to look, 'cause I can tell you: it took like 20 years."

Update, 12:30 p.m. on Friday: This story has been updated to reflect Netflix's note that the numbers in its earnings report under "acquisition of streaming content" and "acquisition of streaming content" are part of the company's cash flow statement and do not give the full picture. These numbers represent spending for content that gets capitalized on the company's balance sheet and may not include such items as revenue-sharing deals with the studios.