Amazon and Viacom Burn Netflix

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Amazon (NASDAQ: AMZN) and Viacom (NASDAQ: VIA) came to a deal recently that will provide Amazon Prime subscribers exclusive streaming access to a slew of popular programming. The deal came almost immediately after streaming king Netflix (NASDAQ: NFLX) allowed its contract with the media company to lapse at the end of May, and is only the latest effort from Amazon to compete with Netflix in on-demand streaming video.

Let’s take a look at how the deal affects all three companies.

Viacom

Viacom expected to grow its on-demand streaming fees by 10% this year, and with the Amazon deal, the media company has done so. While the exact terms of the agreement were not disclosed, Amazon is said to be paying “hundreds of millions” for the content rights. That would imply at least $200 million, where the company needed just $125 million to $150 million more to achieve its goal.

The company’s total revenue fell 5.8% in the first quarter of 2013 to $3.14 billion. In the last 18 months, two of the company’s key networks, MTV and Nickelodeon, have struggled with lower ratings. That means the company is losing ad revenues.

Part of the blame is placed on content licensing deals like the one it had with Netflix and that it just made with Amazon. Kids don’t mind watching reruns as much as adults, so the streaming platforms have cannibalized Viacom’s children’s programming. That’s why it’s important for Viacom to increase its streaming fees, which it did.

But the question is, how will they continue to grow revenue in the future? Assuming the Amazon deal is a multi-year contract, Amazon’s exclusive rights means Viacom will need to grow through different revenue streams ... something it’s struggling to do currently.

Amazon

It was just over two years ago when Amazon added streaming video to its Amazon Prime service. What was once just a bonus offer of 5,000 free titles has grown into a selling point with over 40,000 TV episodes and movies. The Viacom deal added about 4,000 new episodes to the company’s rapidly expanding library.

One of the most widely watched genres on Amazon Prime is children’s programming. With a rather extensive kids show library already, the Viacom deal adds another 55% to the number of episodes available for kids according to Amazon CEO Jeff Bezos. These are some of the most popular and well recognized shows too - Dora the Explorer, Spongebob Squarepants, Go, Diego, Go!, and more.

Both Amazon and Viacom hope that these lovable characters showing up on Prime Instant Video will behoove parents to order character-branded toys and accessories with their Prime accounts. It’s a win-win for both companies if that proves to be the case, and Amazon could use those data to convince other media companies with a hand in toy sales to choose Prime over the competition.

Netflix

In preparation for the loss of Viacom content, Netflix made a deal with Disney last month to bring several Disney Jr. titles exclusively to Netflix. While these titles aren’t as recognizable as the Viacom titles, they do have the Disney brand behind them, which is the gold standard of quality children’s entertainment.

Still, this Amazon-Viacom deal speaks to a much larger problem I have with Netflix. It can’t outbid the competition for programming. As a stand-alone service, Netflix has just one form of income - subscription revenue - compared to the multiple revenue streams at Amazon. Noticing the heightened bidding activity from competitors such as Amazon and Hulu, Netflix CEO has adopted a new strategy: only pay for top-quality content.

This a la carte strategy practically admits Netflix can’t afford to pay for the rising cost of content with the amount of content obligations it currently has in the pipeline. More importantly, while the strategy looks like a nice solution on paper, it doesn’t actually work.

First, most media companies prefer to bundle their content. Pay-TV operators can’t avoid it; why would streaming video platforms be able to? Netflix management originally planned to keep its Viacom content costs flat by cherry picking the best content. Viacom didn’t like that idea, and was happy to talk to Amazon about licensing its content exclusively.

Second, when media companies do offer exclusive rights to one-off shows, what’s preventing its deep pocketed competition from outbidding it still? Amazon did this with Downton Abbey earlier this year. It did it with a couple TNT dramas and CBS’s forthcoming Under the Dome too. If Amazon wants something, there’s almost nothing stopping it from outbidding Netflix.

Netflix is betting it can be a better curator than the competition. With its loads of data on viewer habits it just might be. But I’m willing to bet Amazon, with its data on consumer habits, can do a pretty good job too.

The bottom line

The Viacom deal is a big win for Amazon, and a minor blow for Netflix. Viacom locks up some growth in its streaming fee revenue stream, but will need to grow its other revenue streams going forward, which it’s struggled to do.

More interesting, however, is what the deal between Amazon and Viacom says about Netflix’s new content acquisition strategy. I’m very skeptical it can work, and believe the deal shows the weakness inherent within the strategy. Amazon’s content library might not match Netflix’s quantity or quality currently, but I think it’s fast approaching a level of parity. When Amazon starts promoting its Instant Video service to outsiders, Netflix might have a harder time holding onto its huge subscriber base.

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Adam Levy owns shares of Amazon.com. The Motley Fool recommends Amazon.com and Netflix. The Motley Fool owns shares of Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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