Some on Wall Street wonder if Netflix has peaked

This week, several analysts downgraded Netflix. If you believe that the future is about digital film delivery, then the company's future is unclear.

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
3 min read

Wall Street is once again fretting over Netflix.

Some analysts didn't know what to do with themselves on Tuesday when the share price of the Web's top movie rental service shot past their performance expectations. Sure, Netflix continues to return boffo earnings, but after the company's share price hit $70, some brokers took a hard look at Netflix's prospects for the future, according to a MarketWatch story by reporter Therese Poletti.

Greg Sandoval/CNET

What the analysts found was a Web video-on-demand segment filling up fast with competitors. That apparently spooked analysts at Bank of America/Merrill Lynch, Susquehanna Financial Group, and Kaufman Bros. They all issued downgrades on Netflix, Poletti wrote. Perhaps, investors have reason to worry.

It's true that Netflix now stands triumphant over film disc rentals, after leaving rival Blockbuster in a heap. But it's also true that when it comes to digital distribution, Netflix must start all over again with a much different business model. Those huge warehouses, sorting machines, and complex mail-order systems were huge barriers to entry for a business distributing DVDs. They won't help a lick, however, once consumers opt for movies streamed to them over the Web.

Sure, Netflix is off to a good start in digital. The company jumped into an early lead, at least among tech-focused companies, by convincing makers of Internet-connected TVs (Sony for the Bravia) or set-top box companies (Microsoft for the Xbox) to offer Netflix's streaming service. That handed subscribers the ability to watch Netflix's flicks on their TV screens instead of just their PCs.

But when talking about the long love affair U.S. consumers have had with movies, content is truly king. The fact is, Netflix as a digital distributor doesn't possess as much sway with film studios as it did when the game was exclusively about discs. Netflix bought enough DVDs to often seek favorable terms when negotiating with Hollywood. The law was also on Netflix's side. When the studios tried to protect DVD sales by refusing to sell movies to the video rental store, Netflix simply obtained discs from other retailers.

Once that happened, the so-called first-sale doctrine gave the company the right to do whatever it wanted with DVDs it bought legally. The rental service, however, won't be able to do that for the Web. To show movies online, Netflix will need to get licenses.

That means Netflix is going to have to stand in line with everyone else: Apple, Comcast, HBO, Amazon.com, Wal-Mart Stores, and Best Buy. Even if the studios hand rights out to everyone, Netflix is unlikely to receive price breaks. The big cable operators have more subscribers, have longstanding relationships in Hollywood, and have for decades paid billions of dollars for movies. More than likely, they're in much better position to demand terms.

But I heard it said recently, "you bet on the jockey, not the horse." If you take that advice, Netflix CEO Reed Hastings has ridden to one victory after another. What he has going for him is a head start--and plenty of experience in digital distribution, since he and his troops have been working on streaming video for years now, while the likes of Best Buy and Wal-Mart are barely out of the gate.

Streaming movies is also much cheaper for Netflix. Dan Rayburn, who blogs about the online video industry at Streamingmedia.com, estimates that to deliver one two-hour film in standard-definition costs Netflix 6 cents. A two-hour film in high definition would cost 9 cents.

"Based on those numbers, their streaming offering looks like it would save them tons of money," Rayburn wrote last year. "Netflix spends about 78 cents out and back for standard presort first-class mailing of their DVDs."

Rayburn's numbers, however, don't include the licensing fees, which would send costs up in a hurry. At this point, all seems to hinge on how well Hastings can manage his suppliers. That will tell us if he and Netflix have come as far as they can go, or whether they can once again break away from the pack.