Netflix’s distribution channels

Having spent enough time on the cost side of Netflix, I want to write a bit on the sales and distribution channels.  When Netflix started offering their streaming video service 7+years ago, I remember that I can only use the service on a browser window that runs on a Windows PC.  Fast forward to 2012, almost all of our entertainment devices are connected.  There are additional categories of products where Netflix can be watched such as televisions, blueray players, network streaming player, tablets, and smart phones.

Let’s review them briefly:

Category Dominant players Dominant Platform/OS 2012 units (source: Qualcomm Analyst Day presentation, Asymco, various) Have Netflix?
Smart phones Apple, Samsung, HTC iOS, Android 500m+ yes
Tablets Apple, Samsung iOS, Android 70m+ yes
Smart Televisions Samsung, LG, Vizio various (Linux/BSD) 30m+ yes
BluRay players Samsung, LG, Vizio various (Linux/BSD) 40m+ yes
Gaming devices, Streaming players Xbox, PS3, Roku various (Linux/BSD) 100m+ yes
Cable/satellite STB Comcast, DirectTV various (Linux/BSD) 70m+ no

From engineering stand point, Netflix has done a good job of getting their streaming software running on these various platforms relatively quickly.  From business/value chain point of view, signing these consumer product OEMs and platforms to Netflix is relatively easy given the pull of the Netflix brand from consumers.  20m+ Netflix subscribers want to watch Netflix content on their new devices and having a new TV/Blueray player that can stream Netflix will allow device manufacturers to up sell new or replacement product.  From marketing perspective, Netflix is prominently displayed in various consumer product packaging or promoted in App Stores with very good product placement.  They now have a much better distribution channels compared to other competing service.  Amazon is catching up, Verizon does not have a product, Comcast and Dish offer the service as defensive strategy to keep their subscribers.

The number of devices can mislead you into thinking that this is Netflix’s potential.  However, the real potential number for Netflix is 100m+ US households + their international expansion.  Each household will pay for 1 service and share the account with the family members.  At 20m+ subscribers, there is still room to grow.  At $8/month, this is 2-3 cups of Latte per month.  The price is so low it could almost be an impulse buy.  With much better consumer sentiment, why can’t they go to 35m-40m households with a bunch of niche contents, a few blockbusters, and original series (on-demand cable channel)? 70% of American households have shown that they are willing to pay $80/month for pay TV.

On the international side, DirectTV has proven that South America can be a big market as they grew their Latin America subscribers to 7m+ in 5 years.  Their satellite operation allowed them to have wider coverage for their service.  I am not convinced that the internet infrastructure in Latin America can reach many potential subscribers to be Netflix’s growth engine.

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How much does it cost to offer pay TV service?

I want to know how much it cost for providers to offer pay TV service.  Especially, I want to compare the cost to offer pay TV services between cable TV MSOs, satellite TV providers, and over the top providers (direct over the internet).

Note I used the word subscription versus subscribers.  Comcast ended 2011 with 22.3m video subscriptions, 18.1m broadband subscriptions, and 9.3m voice subscriptions.  However, they did not mention how many unique subscribers (households) use their service.  Each household may have 1 or more subscription (i.e.: video and internet).  To get the number for Comcast, I divided Comcast’s cable business operations cost with the total number of subscriptions at 49.3m at the end of 2011.  ARPU is also lower because broadband and voice pricing are lower than cable TV.

DirectTV can generate $80/month from each of their 20m+ subscribers and spends $60/subscriber/month to attract, install, retain, and offer programming services.  About 40% of the cost goes to contents (cable channels, sports, movies, TV shows).

Netflix does not require cable/satellite dish installation, set top boxes to lease, or cable equipments to operate.  They just borrow the internet to offer the service and therefore only spends $9/subscriber/month to offer the service.  They offer the video service over the internet where the infrastructure is already built by Telcos and MSOs.  They do however spend ~40% of the revenue on streaming content.  Content Delivery Networks (CDN) cost and renting servers from Amazon is insignificant to the size of their revenue.

From technology stand point, the internet is definitely the future of pay TV as it can offer the service with the lowest operational cost.  There is no technology barrier today that prevents the same contents you get on cable channels via the internet.  However, as I mentioned in my previous blog, the cable and satellite operators who are also content owners will starve the internet-only player from contents.  At the same time, they are also offering similar services as Netflix as additional feature for their subscribers (see Xfinity Strempix, Verizon/Redbox).

The cable and satellite operators seem to be winning the war so far as they are able to maintain (lose less for Comcast) their subscribers in 2011 and come up with their own internet streaming solutions.  Netflix, on the other hand, is positioning itself as a premium cable channel where they are producing their own original programming (see NYT article).

Click the image for details

US Pay TV market overview

Recent earning reports from DirectTV, Dish, and Comcast have indicated substantial subscriber growth in the industry. I want to compare the metrics in these companies and also compare them with over the top player such as Netflix.

motion chart for US pay TV market

I have to make some assumptions to build the chart as I need to consolidate financial reports from different companies.  I will write some articles on my takeaways in the next few days.  The chart is work in progress and I will keep updating as I learn more about the companies.