What was Hollywood's role in Netflix price hike?

Some of those searching for clues about why Netflix unexpectedly raised prices last week appear to be convinced that the trail leads to Hollywood, the home of the top six film studios.

After Netflix announced Tuesday that prices would rise by 60 percent, a popular theory was that CEO Reed Hastings sought to build up his war chest. Acquisition costs for streaming content are soaring.

Last week The Hollywood Reporter wrote that Netflix renewed a multiyear licensing agreement with NBC Universal for a fee of as much as $300 million a year. That's more than 10 times the $22 million a year Netflix paid for NBC content in the prior deal. Starz, the premium pay-TV channel that owns the streaming rights to movies and shows from Sony Pictures and Disney, is also looking for a bump. Starz receives $25 million to $30 million a year from the current contract, but Rich Greenfield, an analyst with BTIG Research, predicts Starz could get about $250 million this time around.

Michael Pachter, an analyst with Wedbush Securities, estimates that Netflix's total streaming-content costs were $180 million in 2010 but could balloon to nearly $2 billion in 2012.

If that sounds like a lot of money for a company that generated $2.1 billion in revenue for all of 2010, Netflix managers aren't saying much. But they have denied that content costs have anything to do with the increase in subscription rates. The company has said for years that paying for content is a cinch. In Netflix's first-quarter earnings report this year, execs wrote: "While the size of these deals and their impact on our (profit and loss statement) is often speculated about in the press, spending typically takes place over multiple years and the amortized cost of these deals is taken into consideration in our 14-percent target operating margin model."

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Films and TV shows will pay for themselves by attracting larger and larger numbers of streaming subscribers, which pumps more subscription fees into Netflix's coffers, Hastings has said. That extra money is then spent on acquiring more content and the whole process repeats itself. Hastings calls this a "virtuous cycle." But if that's all there is to it, then why doesn't Netflix offer a better selection of streaming movies?

I wrote two weeks ago that subscribers are figuring out that Netflix's streaming library leaves a lot to be desired. It's early yet, and a lot of shows and movies are on the way, including the critically acclaimed series "Mad Men" and the original series "House of Cards," to which Netflix acquired exclusive rights. Still, the supply of quality movies doesn't appear close to meeting demand. When you combine the dearth of good movies with a price increase, it's no wonder thousands of Netflix customers are fuming about the rate hike.

Netflix said Tuesday that starting in September it would split DVD rentals and the streaming service into two separate subscription plans. Instead of $10 a month for access to both (one DVD at a time per month and unlimited streaming), each plan would cost $7.99 per month, or $15.98 for both. The option of renting DVDs helped fill gaps in the streaming library, but now that becomes more expensive. The implied message from Netflix is that those customers who don't want to pay for both plans and favor streaming are just going to have to wait until managers can expand the selection.

Building the library out may not be as easy as Netflix says. The suggestion that all Netflix has to do to acquire content is wave a checkbook stirs some resentment with some of the film industry execs I speak with. They say they're thinking much more strategically than that. Some are reluctant to license streaming content to Netflix because they want more competition in the sector and don't want Netflix maneuvering into a position where it could exert too much control. They already know Netflix is out to a huge lead in the sector, thanks in large part to the many set-top boxes and video-game consoles that enable subscribers to watch streaming video on TVs.

They also want to manage the public's expectations. Let me give you an example: I recently rented "The Bourne Supremacy" from YouTube when I couldn't find it on Netflix. The experience was good, but to rent a single title cost me $2.99. Readers and friends asked why I would spend nearly the equivalent of a third of my monthly Netflix bill on a single title. At Netflix, I watch about two movies a week, or eight per month. Under the $10 a month hybrid plan, I pay about $1.25 per view (under the upcoming plan I would pay $2). A person who watches four videos per week and is on the same plan spends 62 cents per view or $1 when the increase kicks in.

An indication that Netflix's content supply may be more tenuous than the company lets on occurred two weeks ago when Starz was forced to pull Sony Pictures titles, including "The Social Network," off of Netflix. In the contract between Sony and Starz, there's a cap on the number of viewers allowed to view the movies online, and Netflix, with more than 23 million subscribers, blew through that number. The parties have said the issue will be resolved soon.

Adam Knight, a blogger and software developer, believes there's a connection between last week's price increase and the Starz-Sony hiccup. He says that since Netflix's hybrid plan includes a lot of people who only rent discs, its possible Netflix separated the DVD and streaming plans to reduce the number of streaming users.

"Having a ton of DVD viewers that are not using (Netflix's streaming service) artificially inflated their...subscriber numbers and almost invalidated a content contract," Knight wrote. "The only way to lower that number is to remove their access."

But a need to separate disc and streaming renters doesn't explain the price increase. Eric Garland, the CEO of Big Champagne, a company that tracks legal and illegal consumption of digital media online, told CNET he is convinced Hastings is trying to pressure the studios into licensing more streaming content. The discs are sufficient now as a means to help supplement the lackluster streaming library, but forcing streaming fans to pay more for them will only ratchet up dissatisfaction with them while raising demand for better streaming content. Garland and other experts have concluded that if the studios don't provide legitimate ways for consumers to acquire their content, they'll turn to illegitimate sources.

"Reed is deliberately creating dissatisfaction," Garland said. "He's creating dissonance precisely because that title availability, those first-run titles, need to be more immediately and widely available as a (video on demand) or a streamed offering. So this is a leverage play. This is Reed saying (to the studios) you can't bifurcate. He's saying you're going to have to make all of your content available in a way that your customer has clearly indicated that he or she wants...that dissonance is going to demand remedy. "