Can Verizon's Redbox Challenge Netflix?

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

Prior to 2012, Redbox was just a kiosk video-rental outlet, while Verizon Communications (NYSE: VZ) was focused on its core telecommunications business. Both companies had absolutely no presence in the online video-streaming business. However, during 2012, Verizon made an initiative to form a joint venture with Coinstar, in order to offer online streaming services. Verizon’s stake in the business stood at 65%, while Coinstar held the remaining 35%.

The venture has only rolled out recently; hence, its impact on Verizon’s stock price has not been realized yet. However, going forward this segment certainly has the potential to drive Verizon’s earnings.

Growth potential in video streaming

Since Verizon's streaming business is still extremely marginal, we can examine revenue numbers from Netflix (NASDAQ: NFLX) in order to establish the potential of the underlying growth in the streaming business. According to the valuation offered by Trefis, at present, Redbox holds no value in Verizon's stock price.

However let's consider this, by the end of 2012, Netflix's U.S. subscriber base stood at 27 million, which  enabled it to generate a revenue of $2.17 billion. Further, Netflix generates $288 million through international markets and $1.1 billion through U.S. DVD subscriptions. According to a recent press release by Informa Telecoms & Media, the online video market will surpass $37 billion by 2017. With new additions such as Comcast's XFINITY, the market is expected to grow exponentially in the coming years.

Success or failure in the online streaming business predominantly depends on the content offerings. With Verizon's exceptional cash resources ($9.5 billion in cash) it can certainly establish a superior content library than Netflix.

The numbers presented above are indicative of the the growth potential that video streaming offers. I believe it can match Netflix's revenues in the next two years, however, it needs to be receptive and learn from its peers. How can Verizon's Redbox tweak its content library and overall business to match Netflix's numbers will be established later in the article.

What influenced Verizon?

The demand for broadband in the U.S. has grown considerably over the years. Internet penetration in the U.S. is close to 80% with around 245 million Internet users. The rapid growth in demand for online video has increased in proportion with Internet users. Revenues for competitors such as Netflix (NASDAQ: NFLX) have increased exponentially over the past few years.

Such developments have influenced Verizon into entering the rapidly growing online streaming market. The company can augment its product by combining the video-streaming services with its existing pay TV in order to enhance its existing user base.

This will enable Verizon to gain a sustainable competitive edge in the wireless market and bolster its earnings in the future. Further, it can differentiate itself from rivals such as AT&T and Sprint Nextel, as both companies still do not possess any presence in the online video streaming market.

Verizon-Redbox’s business strategy

The online streaming service rolled out by Verizon, called Redbox Instant, differentiates itself through cost leadership, as it charges a mere $6 for its streaming services, which is relatively cheaper than its main competitor Netflix.

The new joint venture offers unlimited video streaming and four one-night credits for DVDs for a nominal $8 per month. By providing cheap monthly subscriptions coupled with some exciting features bundled as one, the new streaming service expects to outdo its competitors. However, it must be noted that its strategy is predominantly price centric and, thus lacks originality.

Where has Verizon gone wrong?

In the online video-streaming business, offering optimum quality and diverse content provides a company sustainable competitive edge in the long run. Online users give much higher preference to high-quality content, unique features, and multiple-device compatibility. Offering only cheap subscriptions will not allow it to penetrate deeper into the market, resulting in Redbox losing more ground to competitors such as Netflix.

In addition, Redbox does not offer TV shows unlike Netflix, which recently revealed that two third of its online viewership is for episodic content. Moreover, Redbox does not offer any original content like HBO Go; nor can the streaming services be accessed on multiple Internet-enabled devices. In contrast, rivals such as Amazon's (NASDAQ: AMZN) Prime service offer a large variety of content that can be streamed on multiple devices.

What can Verizon learn from its peers?

In the streaming business, price leadership is not enough to ensure user engagement. In order to capture market share from its competitors, it is imperative for the company to offer a wider range and better quality content. So far, Redbox does not offer any original programming, in addition, it has access to limited movies and TV shows.

Redbox competes directly with Netflix, which is the largest video streaming service in the U.S., as it holds nearly 30% of online web viewing with 36 million subscribers. It recently signed a deal with Warner Bros and an exclusive content deal with Disney for an unprecedented access to Disney’s titles from 2016 onwards. This is expected to bolster its already large user base.

Amazon has 10 million Prime members that pay an annual fee of around $80 to access books and online videos. The company offers downloadable content that enable users the freedom to view videos offline. It strategically offers a large mix of products and services, which includes movies, TV shows, digital books, and shipping services on a variety of Internet enabled devices.

To further develop and establish its content library, Amazon signed an agreement with A&E after Netflix failed to reach a deal with the company. The new deal will allow Amazon to offer some of the highest rated television shows such as the Pawn Stars and Storage Wars.

Similarly, HBO too clocked an exclusive 10-year deal with Universal for content acquisition until 2022. It is noteworthy that Netflix spends approximately $2 billion on content acquisition. For Redbox in order to compete with HBO and Netflix successfully, it must commit to multiple-year spending on content acquisition. Although this will substantially increase its operating costs, such investments are necessary to report a consistent growth rate in user base.

It is absolutely essential for Redbox to offer content across multiple platforms in order to capitalize on the growing demand of Internet enabled devices such as smartphones and tablets. Furthermore, growing broadband penetration in the emerging markets makes it crucial for Redbox to target growing economies such as Latin America. Its main competitor Netflix already has a strong presence in several international markets.

Key takeaway for Verizon

Verizon has taken an initiative to enter the growing, highly competitive video-streaming market, where its telecom peers have avoided this business so far. This brings a certain degree of diversity to its business, which will allow it to offset for any future bumps in its telecommunication business.

However, its present offering through Redbox lacks in several areas, and needs to add a lot if it expects to challenge Netflix.

It is essential for Verizon to focus on improving its content portfolio and gradually expand internationally in order to enhance its user base. This may involve hefty cash investments in the near term; however, the company will reap benefits going forward.

Presently, video streaming is a very small part of Verizon’s business and may seem insignificant to investors. Then again, I believe this is a highly strategic move, which can gradually turn into a big revenue driver for the company, if it improves and incrementally develops on its current offering.

The television landscape is changing quickly, with new entrants like Netflix and disrupting traditional networks. The Motley Fool's new free report "Who Will Own the Future of Television?" details the risks and opportunities in TV. Click here to read the full report!

Kiran Gulati has no position in any stocks mentioned. The Motley Fool recommends and Netflix. The Motley Fool owns shares of 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!

blog comments powered by Disqus