Netflix and the Anarchical
Revamp of Television
By: Alan Fu
Advisor: Richard Linowes, Kogod School of Business
For: Honors in Business Administration
Completed: Spring 2015
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Abstract:
This report explores Netflix’s strengths and weaknesses in a rapidly diversifying industry of home
entertainment. Netflix currently leads the U.S. as the most popular video subscription service at
over 40 million subscribers. However, incoming competitors with deep pockets such as Amazon
and with vast production expertise like HBO and Hulu test Netflix’s hold on the world of digital
TV, while financial challenges in the form of massive upfront content licensing fees, sometimes
at millions of dollars per episode for mere reruns, are a cause for concern as digital rights values
soar. As U.S. subscribership reaches a saturation point, Netflix looks to international expansion
for new growth opportunities, recently announcing the goal to be in 200 countries by the end of
2016. Netflix has financed this expansion with $1.5 billion in senior notes this past February, but
with international margins expected to be negative for the next two years, it is crucial that
Netflix maintains the profitability and stability of the U.S. subscriber base. In order to sustain
domestic growth, Netflix should partner with Kickstarter to build a new branch of original
crowdfunded content with independent filmmakers. Meanwhile, providing its millennial-heavy
subscriber base with more comedy options and an expanded branch of relatable minority
characters will solidify Netflix’s reputation as a consumer-centric entertainment hub.
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April 30, 2015
FROM:
Alan Fu, Young People Consulting
TO:
Reed Hastings, CEO, Netflix
CC:
Ted Sarandos, Chief Content Officer, Netflix; Greg Peters, Chief Streaming and Partnerships
Officer, Netflix; Richard Linowes, Assistant Professor, American University
RE:
Pursuing Consumer-Centric Innovation
Executive Summary
Netflix has not only revolutionized entertainment, it has spurred a linear TV counter-culture. By
giving users the power to dictate television to their schedules rather than vice-versa, Netflix is
breaking the upfront advertising model that has been the precedent of TV broadcasting for five
decades. As the first-mover in video streaming subscription services, this former exclusively
DVD-by-mail service has enjoyed a rapid growth in subscriptions over the past few years.
However, competitors with large financial war chests like Amazon, and traditional networks with
proven production capabilities like HBO have begun adapting to Netflix’s monthly subscription
model. Concurrently, inflated licensing fees have made Netflix’s role as a pure distributor
unsustainable, so the company now produces original content to create lasting value and
differentiation within this new flagship platform of home entertainment.
U.S. subscriptions may stagnate in a few years, and Netflix plans on tapping into international
markets for growth opportunities. The international expansion is aggressive, with the hope of
having the VOD service operational in 200 countries by the end of 2016. Consequently, Netflix
plans to repurpose a sizable chunk of the U.S. marketing budget to help raise awareness of its
brand overseas, yet this cannot excuse Netflix to rest in the U.S. where competition is fiercest.
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The streaming experience of Netflix has been effective because it is consumer centric: viewing
histories personalize recommendations, the digital library stays open 24/7, and users watch
however long they want, completely free of advertisements and distractions. Yet the innovative
never sleep, and Netflix should launch a crowdfunding program for independent show creators,
boost its level of original comedy content, and connect minority audience members with
relatable onscreen characters to bring the consumer power of choice beyond the viewing
experience and into the production process.
Background
With 57.4 million subscribers at the end of 2014, Netflix is the U.S. leader in video-on-demand
streaming services. The online entertainment platform was established in 1998 when current
CEO Reed Hastings created a DVD mailing service designed to make home video rental hasslefree (Netflix, Company Overview).
After several years of losses and grinding price wars against video giant Blockbuster, Netflix
finally emerged victorious. Rental stores became obsolete, Blockbuster went bankrupt, and
Netflix’s convenient by-mail delivery combined with its personalized queue system made it the
new cornerstone for home video consumption. Netflix shipped its billionth DVD on February
25th, 2007, and steady growth seemed promising (Roettgers). However, CEO Hastings realized
that without innovation, Netflix would share the same fate as Blockbuster.
So early in 2007, Netflix introduced streaming, bringing full movies to the computer. The
concept was so new that a research analyst for Wedbush Securities thought Hastings “was nuts.”
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The stream service initially offered a limited library of 1,000 movies that were considered to be
bottom-of-the-barrel disasters (Reed Hastings Revealed). Nonetheless, streaming was a
companion service for all DVD subscribers, so it was free. As infrastructure made the Internet
more accessible and higher bandwidths a standard, Netflix’s streaming services took off. Netflix
began to offer streaming plans only, and the company signed licensing agreements with Starz,
Dreamworks Animation, Relativity, AMC, CW, and other studios. By the end of 2011, Netflix had
twice as many streaming subscribers as DVD subscribers.
Today, Netflix has market penetration in 50 countries and is available on virtually any
entertainment device from the laptop to the game console (Spangler, “Netflix Wants…”). To
combat the costly strategy of licensing content from other providers, Netflix has begun
launching its own. One of Netflix’s premiere series, House of Cards, was launched in February
2013 to critical acclaim. Six months later, Orange is the New Black broke gender roles and
gained a massive cult following. These shows prove that Netflix is no one-trick pony—it has the
resources and talent to produce great content and deliver it.
The Battle of Fees
TV shows, movies, and documentaries are the intangible products of Netflix’s business model.
Unfortunately, with the increasing customer preference for streaming, studios have ensured
that licensing fees nearly keep pace with revenues. In 2014, Netflix earned $5.5 billion in
revenue, yet it reaped only $267 million in profits. Netflix’s content licensing obligations total up
to $9.4 billion, nearly twice the annual revenue of 2014.
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Although Netflix’s DVD subscriber base is shrinking, the company enjoys a higher profit margin
from that segment. The contribution margins from DVD subscribers were 48% in 2013 and 2014,
while the margins for domestic streaming customers were only 27% in 2014 and 23% in 2013.
Non-U.S. streamers provided a contribution margin of -12% in 2014, an improvement from the
margin of -39% in 2013 (Netflix, Form 10-K).
In the DVD rental model, the only upfront cost is in the DVD purchase. Netflix buys a few
thousand copies of movie “X” and recuperates costs within a handful of rentals of each DVD. On
the other hand, for digital rights of movies and TV shows Netflix usually pays a fixed fee over a
certain number of years, and these costs are massive. According to The Hollywood Reporter,
Epix made a deal which gave Netflix access to 1,000 films from Paramount, MGM, and Lionsgate
for $200 million per year. This was more than the $175 million Showtime television offered Epix
for their movie package, signaling to the entertainment world that digital rights hold greater
perceived value than TV rights. In addition, Netflix dished out $45 million to Disney for the six
seasons of Lost alone (Bond).
The costs seem even more inflated after considering that Netflix’s licensing deals are NOT for
first-run syndication. Each TV show and movie is a rerun—it’s premiered somewhere else first,
and with the only revenue coming from monthly subscriptions of $7.99, it takes a large inflow of
new customers to cover the annual expenses of a single content license. Despite these costs,
Netflix does not plan to slow down content acquisition and estimates it will spend an additional
$6 billion on content over the next three years. As new competitors like Amazon, Hulu, and HBO
increase their presences in the Video-On-Demand (VOD) marketplace, the demand for digital
licensing rights will go up, bringing prices with them.
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Crowded Competition
At peak periods, Netflix accounts for a staggering 35% of all U.S. downstream traffic on the
Internet. Meanwhile, the leading social media platform in the world, Facebook, receives only
slightly more than 2% of total U.S. downstream traffic (“Global Internet Phenomena Report”).
Netflix’s market penetration is impressive with 40 million domestic subscribers who watch an
average of 93 minutes a day (Spangler, “Netflix Subs”). However, media firms like HBO and
Hulu, as well as retail giant, Amazon, have noticed.
HBO, the world’s most popular subscription service with a customer base of 114 million strong,
has elected to move forward with HBO Now, a standalone version of HBO Go, allowing users to
stream from anywhere and cut the cord (Bachman). The service came out just this April, rolling
out in correspondence with the season 5 premiere of its most popular show, Game of Thrones.
The streaming service offers access to every episode of HBO’s shows, but unlike Netflix, the
library contains more than previously aired seasons. The service works like a broadcast
subscription, for full episodes of current seasons are uploaded to HBO Now on the same day as
the live premiere. HBO Now has been set at a premium price point of $14.99, but HBO’s 14-year
streak as the most Emmy-nominated network in television has solidified its brand reputation as
the frontier of scripted content. HBO Now currently offers 30 day risk-free trails, so the world’s
largest cable subscriber base may only be getting bigger.
Amazon, the largest online store on the planet, has recently expanded its “instant video” service
to include approximately 3,500 unique movies and TV shows at any given time. Amazon instant
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video has been gaining traction and doubled its use of domestic U.S. bandwidth in the past 18
months. However, Amazon has to tackle the challenge of optimizing its online interface because
unlike Netflix or Hulu, the company’s web infrastructure was not built from the ground up for
streaming. The instant video service still doesn’t provide closed captioning for many of its
shows, and the quality of the stream deteriorates on mobile devices. Not one to be deterred,
Amazon has begun an original content division of its own, and it just earned its first Golden
Globe on the quirky comedy series, Transparent. Meanwhile, to enhance the viewer experience
Amazon has announced plans to provide High Dynamic Range (HDR) video by the end of 2015, as
well to add more ultra-HD or 4K quality shows. A serious threat is the potential partnership of
HBO with Amazon. HBO inked a deal in January 2015 with Amazon to offer unlimited streaming
access to previous seasons of award-winning shows like True Blood, Boardwalk Empire, and The
Sopranos (Lieberman). The deal also permits Amazon Fire TV owners to use the HBO Go
streaming app, meaning they can freely watch HBO shows on Fire TVs (as long as they have HBO
subscriptions). This was the first licensing deal HBO has ever done for a streaming service and
may be a sign of joint efforts with Amazon in the future.
Hulu is the smallest but most direct competitor of Netflix. Hulu is the only streaming company
to offer a free version of its service. A user must upgrade to a paid subscription called Hulu Plus
to be granted full access to the video library. The free version simulates an indefinite trial,
permitting viewers to browse without commitment, albeit with limited options. Hulu Plus is only
$7.99 a month, and Hulu doesn’t plan to change that anytime soon since it is the only paid
streaming service to accept advertisers. Advertisements in the side panels of the display, and
even product placements within the show help cover the expenses for Hulu’s licensing fees and
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original content production. While other streaming companies may refuse to give into
sponsorships to avoid disrupting the viewer experience, this additional revenue stream gives
Hulu the flexibility to sustain a very competitive price point.
Target Market
A recent Mintel study found that less than half of all U.S. adults had watched video on a
subscription-based streaming service in a one-month period. However, for 18 to 34-year-olds,
that figure jumped to 71%.
Mintel also uncovered that Netflix had more than triple the domestic subscribers of any other
VOD streaming service, and more than 55% of 18 to 34-year-olds said they watched something
on Netflix at least once in the one-month period. From these results, it appears that millennial
professionals and college students are at the heart of Netflix’s massive market share.
Besides age, there were four demographic traits with noticeable differences in favorability of
streaming services: gender, race, parental status, and household income.
Males were more likely than females to consume video streaming content, and they were more
likely to be frequent users. About 46% of males were medium (3 to 5 TV shows or movies per
week) or heavy (6 or more episodes or movies per week) users of streaming services compared
to 35% of females.
Minority consumers demonstrated a higher average likelihood to utilize streaming services than
their Caucasian counterparts. This coincides with movie theater attendance as well. While the
majority of respondents who identified as Black, Asian or Hispanic consumed streaming video at
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least once in a one-month period, only 42% of Whites said the same. An underlying factor could
be the younger population of minority groups, but minorities have generally shown early
adoption patterns in consumer technology and a heavier usage of entertainment media in the
past few years.
Parents with children under 18 years of age also show a significantly higher chance of being
heavy users of video streaming subscriptions. It could be that parents with younger children find
Netflix and other streaming sites to be a convenient way to entertain their family. A night in
with Netflix is also a cheaper substitute to a night out.
Consumers with mid-tier household incomes, specifically between $75,000 and $99,999, had the
highest subscription rate of paid streaming services at 56% (Hulkower). This particular income
level gives them flexibility to subscribe to multiple streaming services at once, and the low
monthly payment plans for these services have become attractive alternatives to the expensive
costs of a-la-carte models in cable on-demand and digital store rentals and purchases.
Challenges
Original Content
Hollywood’s studios aggregate their leverage to attain every possible dollar in distribution deal,
squeezing operating margins to low profitability levels. In the meantime, video streaming is not
patent-protected, and companies like Crackle who offer completely free content or Paramountbacked Epix who deliver movies straight from the studio are beginning to disrupt the stability of
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streaming distribution channels. These factors have provoked Netflix, Hulu, and Amazon to
transition from content distribution to content creation.
Although content licenses may be expensive, they will never surpass the financial undertaking
and risk involved with original content production. Netflix’s powerhouse political series, House
Of Cards, cost $100 million for the first two seasons at more than $3.8 million per episode
(Greenfield). HBO’s signature series, Game of Thrones, tallies at about $6 million per episode,
and one season’s expenses are similar to a big budget feature length film. In contrast, the most
expensive show ever licensed was Sony Pictures TV Blacklist at $2 million per episode
(Andreeva).
Netflix and its competitors are investing heavily in new content because original series build
brand equity and guarantee exclusivity. Standard licensing deals last for up to 5 years but are
often less, and even in the best case scenario when shows become popular, distribution rights
may have to be shared. Content is king, and the company that controls the content controls the
bargaining process. Unsatisfied with their subordinate role, streaming companies are now
devising their own supply chain of shows to secure stable long-term rights without having to be
at the mercy of Hollywood executives.
Original content isn’t an obvious fiscal choice. A well-received series like House of Cards may
gain additional subscribers, but it may not be enough to offset the immense costs of production.
However, original content is an important step towards sustainable advantage. The medium of
streaming is not a sustainable advantage; a cable or tech company could offer a faster, more
reliable streaming service in the near future. The race is on to build an exclusive library of must-
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see shows so when streaming competition peaks, consumers will have a reason to stay with
Netflix. If Netflix can generate iconic shows, it will anchor itself as a centerpiece of mainstream
culture, and consumers will stop asking if Netflix is worth it and begin wondering how they ever
lived without it.
Genre Divide
National TV audiences have been fracturing since the 1980’s. According to Nielsen
ratings gathered since 1954, the average primetime television broadcast viewership has dropped
steadily over the past two decades for each of the major four networks: NBC, ABC, CBS, and Fox
(The Cancel Bear). Even the most popular broadcast shows of today like the drama musical
Empire and the nerdy sitcom The Big Bang Theory often don’t break 10 millions viewers—a
ratings level that would likely be the lowest acceptable floor for primetime shows of the 70’s
and 80’s (Maglio).
The drop in ratings is not from deterioration in the quality of the TV content but from the
numerous choices now available to the consumer. In a 2015 joint study done by National
Association of Television Program Executives (NATPE) and the Consumer Electronics Association
(CEA), 56% of respondents agreed that there are more quality television programs to choose
from, while 67% of respondents agreed that there is more variety in television programs than
there have been in the past. The number of hours an average American spends watching
television hasn’t changed; what’s changed is the medium. In 2013, Americans watched 147
hours of TV and 4 hours of online video per month, but in 2014, Americans watched 141 hours
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of TV and 11 hours of online video per month (Luckerson). While Americans are locked into a
routine of about five hours of video per day, their eyes will be switching screens.
Not all genres are created equal. In movies, when each genre has to fight a battle royale
for the highest honor of best picture, dramas dominate The Academy Awards, and 89.1% of
Oscars winners from 1928 to 2010 were classified as at least partially dramas. AMC’s Breaking
Bad ushered in an era of prestige drama television that has enraptured audiences with big
budget special effects, complex character narratives, and feature-film style cinematography.
Critics seem to agree, with dramas composing 70% of the top ten annual spots in Metacritic’s
aggregate critic rating system since 2010 (Bettinger). The two most-watched on cable television
are Game of Thrones and The Walking Dead, each averaging tens of millions of viewers.
However, all of this prestige has come at a price—dramas also boost the biggest budgets of any
genre around. With the average drama pilot episode tallying at $5.5 million and headliners like
Game of Thrones tallying between $6 million and $8 million per episode, producing a season for
one of these shows involves expenses roughly equivalent to a Hollywood feature (Nathanson).
A-list talent is noticing the rise of reputation in TV drama, and traditionally exclusively movie
actors like Kevin Spacey, Vince Vaughn, Matthew McConaughey, Kevin Bacon, and Woody
Harrelson have flocked to feature as leads in shows like True Detective, House of Cards, and The
Killing. This newfound star power will give the TV drama lasting appeal, yet it also means
continually rising payrolls.
Comedy isn’t quite as sexy, and it doesn’t pack the same critical wallop. Compared to
dramas, films classified as full or partial comedies are underwhelming performers in the best
picture category, earning just 16.9% of best picture Oscar nods from 1928 to 2010 (Bettinger).
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Recent critical reception of TV comedies hasn’t fared better either, with comedies earning only
about 22% of the top 10 spots in Metacrtic’s annual rankings since 2010. Comedies also seem to
be trending out on network television, as two of the big four networks, NBC and ABC, have cut
the total number of their original running comedy series by nearly half, while the other two, Fox
and CBS have kept this number stagnant (Team TVLine). However, there may be a silver lining
out there—comedies are not dead. Eight of the top ten rated shows on broadcast television
may indeed be dramas, but the very top two, The Big Bang Theory and Modern Family, are both
comedies (Maglio). There is also a production advantage to comedies, for they are short-form,
30 minutes or less, and require less special effects and high-quality set pieces than the typical
drama. In fact, the low production quality of a comedy is often used to amplify its humor like in
the case of Tim and Eric Awesome Show, Great Job! and other sketch shows where the
campiness is part of the joke. These savings can stack up with the average broadcast comedy
pilot episode tallying at about $2 million, almost one-third of the typical drama (Nathanson).
Better yet, there is definitely a demand for humor, as NATPE found that millennials want to
laugh--77% of millennials stated that comedy was a regularly watched TV genre, making comedy
the leading genre over movies, news, reality, and even drama. The same study discovered that
millennials with SVOD subscriptions were still more likely to watch comedy regularly on their
streaming service than any other genre, but only 71% of millennials stated that they watched
comedy on SVOD. As mentioned earlier, video streaming services are most popular amongst 18
to 34 year olds, so original comedy series have noteworthy potential in building attractiveness of
SVOD portfolios in the near future, especially with the decline of the broadcast comedy.
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Operating Margins
The television industry is a tough place to earn money with just content alone, and that’s
why television networks resort to advertising and sponsorship to earn around one-third of total
revenues (Media Partners Asia). Netflix however has taken a resolute stand against advertising
and interfering with the user experience. The lack of this additional revenue stream has hurt
Netflix’s profitability, and the company has struggled to keep its operating margins above 10%
(Netflix, Form 10-K), which is near the bottom when compared to either content-creating studios
or major distributors. Although Netflix’s $8.99 subscriptions have created undeniable value to
millions of consumers, these prices require sales projections to be highly accurate, and they
provide little wiggle room for investments through retained earnings.
Cash flow is also a problem, and Netflix has seen its cash flow growth fall behind net
income growth for the past three years. Noticing this deficit in cash, Netflix issued $1.5 billion in
senior notes in February 2015, with $700 million due in 2022 at 5.5% and $800 million due in
2025 at 5.875% (Financials – Netflix, INC.). This massive financing initiative has made investors
wary; Moody’s has dropped Netflix’s bond rating from “Ba3” to “B1,” while S&P has slashed its
rating from “BB-minus” to “B-plus,” digging deeper into junk bond status (Spangler, Updated).
All of this debt pushed Netflix’s traditionally equity-to-debt ratio of two to one to below one for
the first time in company history. Running on primarily debt will only push interest expenses
higher and squeeze operating margins even thinner, so Netflix must find a way to compensate to
stay afloat.
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A few of Netflix’s original series such as House of Cards and Orange is the New Black have
gained worldwide followings and near universal brand awareness. Yet there are troubling signs
of fiscal efficiency in the average Netflix show. Fixed asset turnover has shot up ever since 2009,
meaning that the plant, property, and equipment (namely Netflix’s headquarters in Burbank and
its DVD distributor centers) have generated revenues more efficiently with every passing year.
On the other hand, the total asset turnover ratio, which for Netflix is mostly non-tangible assets
in the form of content licenses, has gone down steady since 2010, and it was less than one in
2013 and 2014 (Financials – Netflix, INC.). If Netflix is to be a pioneer of home entertainment, it
cannot sustain a business model where the value of its content licenses exceeds its total
revenues. Netflix must either boost subscriptions fees, add advertising revenue or cut expenses
in licensing contracts in order to become profitably viable within the next three years.
Net Neutrality
As the single largest user of bandwidth in the United States, Netflix has been clogging traffic for
Internet Service Providers (ISP’s) at peak times. When the popularity of Netflix soared in 2013,
Comcast let Netflix’s customers suffer the brunt of slowdowns, and other ISP’s followed. Netflix
began rallying public support for net neutrality and tried to find alternate solutions. It began
channeling data through Cogent, an internet network that had indirect access to Comcast’s
customers, and spent $100 million developing open connect appliances (OCA’s) that could
localize up to 90% of Netflix traffic to internet points of presence, effectively reducing streaming
distances to the last, local mile (Seward). Cogent was soon running at capacity, and Comcast
refused to accept the appliances without a per gigabyte fee. Then December brought the
holiday season to U.S. video streaming, clogging playback quality to below standard definition
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for many users. Customers backlashed and condemned Netflix for neglecting its service. With
no victory in sight, Netflix paid an undisclosed amount to Comcast on January 2014 to create a
direct pipeline between Netflix’s content servers and Comcast’s broadband network.
Agreements with Verizon and other ISP’s followed. These payments were labeled as “peering
fees.”
However, Feburuary 2015 saw the FCC vote three to two in favor of strong net neutrality rules.
The ruling squandered the Time Warner and Comcast merger, and until these rules are offically
appealed, any ISP can be condemned for using service speed as leverage for payment (Edwards).
This was a victory for Netflix in future negotiations over Internet speed, but unfortunately,
Netflix must still honor the agreements made with Comcast and other ISP’s until they expire.
International Vision
At 40 million domestic subscriptions, Netflix is approaching the saturation point within the U.S.
market, especially because the multi-screen policy of its plans allows subscriptions to be shared
among households. Netflix considers itself a “global internet TV network” and has announced a
plan to be in 200 countries by the end of 2016. This is a rapid acceleration of Netflix’s previous
target of 200 countries by the end of 2017. Overseas adoption of the service has been faster
than anticipated—the first quarter of 2015 set a personal company record of 2.43 million new
international subscribers.
Initial international expansion was conservative with just Canada in 2010. Since then, Netflix has
been aggressive—but with mixed results. Although Netflix’s first wave of international
markets—Canada, Latin America, Scandinavia, Finland, Sweden, Netherlands, Ireland, and the
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United Kingdom were profitable as a group by the end of 2014, some countries were pulling the
weight for others. Europe in particular has seen quick acceptance because of large bandwidth
availability and a pro net neutrality infrastructure, while Latin America has been sluggish due to
low broadband penetration and scarcer levels of disposable income.
Nonetheless, Netflix intends on being the world’s largest international TV provider and aims for
80% of its revenue to come from non-U.S. subscribers by the end of expansion. There are
unique barriers for each country—for example France has a 36 month minimum delay between
VOD release and theatrical release (Spangler, “Netflix Wants”).
Even as Netflix pushes for a one-size-fits-all pricing at $8.99 per month, not everyone is getting
the same product. Half of Europe isn’t receiving Lost or Mad Men; France subscribers don’t
even have access to Netflix’s signature series, House of Cards, because local channel Canal Plus
has obtained French Rights (Heyman).
Each foreign market is home to local competition and poses a risk in currency exchange
fluctuations. However, the biggest question is how much Netflix must customize their
localization efforts by country. Europe TV viewership is more fragmented than the United
States, and audiences tend to be more nationalistic in their content choices. German and French
audiences in particular are used to consuming American movies and TV shows that are dubbed,
not subtitled, and Netflix must decide if these language adjustment costs are worth paying.
Netflix hopes to launch in China in the coming months, but strict government regulations and
censorship may be difficult to bypass without a local partner. Plans are already in place for
Netflix to enter its first Asian country, Japan, this fall. Japan boasts the largest number of
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broadband connections outside of the U.S. and Germany, but xenophobia and the dominance of
local culture forced competitor Hulu to sell its Japanese headquarters in 2014.
Recommendations:
To help finance the expansion, Netflix must count on the profitability of its established domestic
subscriber base. In order to raise revenues in pace with expenses, Netflix must not only retain
the U.S subscriber base but also continue a stable if unspectacular level of growth. Here are
three strategies to ensure that Netflix’s original content continues to evolve and impress U.S.
viewers.
1. Netflix Independents with Kickstarter
A renaissance movement is underway, for many television shows are no longer conceived within
studios but are extracted directly from consumer preferences. Netflix’s algorithm is currently its
most sustainable advantage—it finds what users want to watch before they even know it.
Netflix records what shows users watch, what they stop watching, even what they scrolled
through, and it builds customized libraries that serve these implicit tastes.
Consumers should also be able to explicitly state what they want to watch, and this can be done
through voting. Amazon Prime Instant Video has been dishing out several pilot episodes in
batches so that users can vote on which ones should be produced into series. Although this has
generated interest in Amazon Prime Instant Video, pilots are typically the most expensive
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episode in a show’s production history, and these show concepts were still created without any
audience consent.
In Netflix Independents, the power to choose is fully transferred to the consumer. Through
talent agencies, guilds, and independent amateurs alike, Netflix finds and receives thousands of
pitches annually. Because of financial constraints, only a select few series are produced each
year, and some unique show concepts never come to fruition. Netflix Independents, a
partnership between Kickstarter, the most popular crowdfunding organization in the world, and
Netflix, will post TV show pitches that don’t make the cut but show exciting potential. These
pitches will be jointly available on Netflix’s website and Kickstarter’s website, and both parties
will be able to accept donations.
Kickstarter is an ideal partner to help Netflix enter the independent filmmaking market because
it attracts close to 1 million unique U.S. users a month and has earned project pledges from
8,453,000 different people. Over its six-year history, Kickstarter has raised over $274 million on
film and video alone (“Stats,” Kickstarter). What Netflix brings in a millennial powerhouse
distribution channel, Kickstarter brings in creativity and legal protection from the crowdfunding
process.
The average comedy pilot averages at around $2 million, and the average drama pilot averages
at around $5.5 million (Nathanson). The combined crowdfunding of Netflix’s 60 million plus
subscriber base and Kickstarter’s devoted supporters can turn these TV pitches into reality.
While Kickstarter infuses its inspirational DIY brand reputation, Netflix will provide the platform
to amplify the voices of these independent filmmakers. A Netflix Independent candidate will
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post his or her TV series pitch on the Netflix and Kickstarter websites and ask for the amount of
money needed to create the first two to five episodes. Pitches will be limited to about three
minutes because Kickstarter analytics have discovered that successful campaign videos averaged
around three minutes and five seconds. Campaigns will be run for 35 days (again, the optimal
length for a Kickstarter campaign), and if the show creator meets his or her goal by the deadline,
he or she will earn a distribution contract from Netflix for that first mini-season. If a campaign is
not successful, all money raised will be returned to the supporters. This contract will also give
Netflix the option for the right of first refusal after the first season.
Independent filmmakers will use funds provided to produce their show for the designated
number of episodes and also to send rewards to the backers based on the amounts donated.
When the show premieres, Netflix will then assess overall viewership, critical reception, and
production quality and decide whether or not to renew the show for a second season and
beyond. If a show is renewed, Netflix will agree to pay a fixed licensing fee that covers the
show’s budget in return for the exclusive right to premiere the show. If a show is not renewed,
the show’s creators are free to take their concept and the rights of season one to any producer
and distributor of their choosing, but Netflix can retain season one in its library for a set number
of years.
This partnership allows Netflix not only direct access to a new pipeline of original content, but it
also gives them the flexibility to avoid the high upfront costs of pilot episodes. As mentioned
earlier, pilot episodes are often the most expensive of a show’s production history, but they also
have a failure rate. Less than half of pilot episodes generally make it onto the first season, and
65% of TV shows are canceled by the end of season one. Netflix will save a substantial amount
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of capital by mitigating the risk of season one’s episodes, and this outsourced financing could
drive the average content licensing costs down. Best of all, Netflix builds its brand reputation
and establishes positive corporate social responsibility with this program, as the average
subscriber will see that Netflix is trying to help aspiring filmmakers achieve their dreams.
2. Laughter is the key for the fountain of youth.
The genre being watched most regularly is comedy. Millennials especially have a taste for it;
74% of Millennials watch comedy regularly, compared to 70% of Gen X and 68% of Baby
boomers. Millennials are also the most likely to look for comedy on streaming sites, and 57%
specifically stated that they go to Netflix for comedy first.
Even though comedy holds such favor with audiences, composition of Netflix’s total portfolio of
original series is 37% dramas, 30% kids shows, 22% comedy, and 11% other. Meanwhile, HBO’s
currently running series has a composition of 66% comedy, 27% drama, and 7% documentary.
Hulu offers 69% comedy, while Amazon offers 44% comedy (aggregated from HBO, Amazon,
Hulu, and Netflix websites).
Netflix does not need to match the extensive level of comedy in HBO’s portfolio, but it must
offer more competitive amounts of original content in this genre. The primary source of
Netflix’s comedy series comes from broadcast networks like NBC, ABC, and CBS. As broadcast
television fades, and streaming competition increases, Netflix cannot rely on rerunning sitcoms
to satiate viewers’ heavy appetites for comedy. Therefore, Netflix should aim for a minimum
23
level of 40% comedy in its portfolio. Comedy does not have to be a mutually exclusive genre,
and it can be fused with drama and sci-fi elements in new and creative ways.
Comedy offers a reduced production cost to drama and often can be shot faster. The shorter
time frames of comedies also allow for relatively sporadic viewing that better suits college
students, parents, and those with mobile lifestyles. Laughter is never out of style, and a
consistent stream of original content within this fundamental genre can help Netflix retain brand
loyalty among its broad subscriber base.
3. Let the viewer look in the mirror
American audiences are diversifying, but Hollywood and TV have lagged behind. The
entertainment industry has been predominately white, but Mintel Oxygen has found that the
average African-American, Hispanic, and Asian consumes more movies and television than the
average Caucasian. In addition, the 2015 Hollywood Diversity report found that TV shows that
casted an accurate 31% to 40% of minorities on screen enjoyed higher aggregate broadcast and
cable ratings when compared to underrepresenting counterparts.
The research shows that diversity sells and buys well, yet minority representation in front of and
behind the camera is scarce. Composing 17.1% of the U.S. population, Hispanics are only
featured in an average of 2% of broadcast speaking roles and 3% of those roles on cable. At the
same time, Asians make up 5.3% of American citizens, yet they’re only landing in 4% of speaking
roles in broadcasting and 3% in cable. When minorities are actually shown on camera, they’re
often shuffled into the background. Minorities are underrepresented in lead roles by a ratio of 6
24
to 1 in broadcast and 2 to 1 in cable (Hunt). Hispanics have proven to be film and TV’s most
loyal demographic, and Asians are the fastest growing minority in America. This
underrepresentation should be fixed, and the content creator that does it first will likely enjoy a
lasting first-mover advantage.
While movies tend to be plot-driven, TV shows tend to be character-driven. Audiences are
drawn to TV characters that are likeable, dynamic, and most of all, relatable. This is shown by
the rise of TV ensemble shows where a large number of characters hold equal importance to the
plot, as opposed to the traditional structure of a one-protagonist narrative. The two most
popular TV shows today, Game of Thrones and The Walking Dead have ensemble casts, and the
principle applies to comedies too, with broadcast leaders Modern Family and The Big Bang
Theory exploiting conflicts in their many character relationships for humor. However, Game of
Thrones doesn’t have any minority representation—all its major characters are white, and the
other three shows reflect significantly less than the accurate 31 to 40% minority ratio on screen.
With so many important roles to fill in ensemble shows, Netflix has an opportunity to cast more
Hispanic and Asian characters to accurately reflect the diversity of its viewership. Popularity of
minority ensemble casts was tested earlier this year when Fox debuted Empire, a show that
featured the members of a hip-hop and entertainment label, and the ratings exploded, beating
out Sunday night NFL games and even dethroning ratings champion The Big Bang Theory a few
times in its first season. The Empire success should serve as assurance for the future of diversity
in television programming. Therefore, Netflix needs Hispanic and Asian consumers to
consistently relate to characters in its original content, and their perceptions of Netflix’s brand
will flourish.
25
Appendices
Appendix A
Total Subscription Base, U.S. and International
Number of Subsribers (in millions)
120
100
80
Domestic
60
International
40
20
0
Netflix
HBO
Hulu
Aggregated from sources from Netflix, Engadget, and Diffen.
Appendix B
Overview of Netflix International Content LIbraries
26
Appendix C:
Pricing
Number
of Titles
Adsupported
Number
of
Countries
2014
awards
4K
Supporte
d
$7.99 per month for $14.99 per month
current users, $8.99
per month for new
users
7200 Titles
2000 titles
$99 per year
$7.99
3500 titles
4150 titles
No
No
No
Yes
Over 50
170
1 (USA)
1 (USA)
31 Emmy
nominations
(primetime)
99 Emmy
nominations
(primetime)
2 Golden Globe
Nominations
3 Daytime Emmy
nominations, 1
Sports Emmy
nomination
7 Golden Globes
Nominations
Yes
15 Golden Globe
nominations
No
Yes
No
Comparison of Streaming Services
Aggregated from sources from UnoTelly, Engadget, Amazon, and Diffen
Appendix D:
Characteristics of Successful Crowdfunding Campaigns
27
Source: Shopify Crowdfunding Guide
Appendix E
Streaming Popularity among Minorities
28
Appendix F
Minority Representation on Screen
29
Source: Hollywood Diversity Report: Flipping the Script
Appendix G
Financial Statements
Income Statement
Balance Sheet
Statement of Cash Flows
30
Source: Netflix 2014 10-K
Appendix H: Key Efficiency Ratios
Source: MorningStar Financials
31
Appendix I Broadcast Viewership History
Source: The Collider
32
Appendix J: Broadcast Ratings Current
Source: TheWrap
33
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