Netflix and Amazon To Test "Content is King" Adage

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

I do not think Netflix (NASDAQ: NFLX) is the most popular of stocks right now for traders or investors. I think it is quite popular for covered call writers, and that means it does not move. I expect this to continue for at least a year. I have Netflix set to underperform on Motley Fool CAPS for a year. However, I do think it should be on watchlists, and every earnings report and conference call should be scrutinized for the slightest hints of growth. Netflix needs to enter the next stage, and I think it is headed in that direction. The question is whether the steps they take will benefit the share price.

Original Content Could Provide a Solution to Woes

Producing original content has to be the course for Netflix if it is going to differentiate itself in the streaming market. It is curious to see streaming content go from simply providing TV shows and movies on-demand to becoming the Internet version of television channels. I do not want to delve too deep into where the industry will move in the far future, but the lines between streaming and television are becoming blurred. However, keep in mind that you get a lot of content from one service via a cable provider, but a Netflix subscription will only get you what they have license to distribute. Imagine if you had to pay for each individual channel in your television package, it would be a nightmare.

Netflix has decided to bring back Arrested Development. It will be featuring a new season on its service. I applaud the choice. The fans of Arrested Development are a small but focused group. The show was very popular among my peers, and I am sure that when the series premieres there will be a deluge of social media activity about it. Not due to the size of the group but by their nature. It will be viral marketing at its best. If the return of Arrested Development is news to you, I am sure it won't be as we get closer. Fans of the show will let other fans know. Such is the strength of this cult following, that many might subscribe to Netflix just to watch the series, however that remains to be seen.

Proprietary content is a great way to draw in subscribers, and a great way justify greater costs later. Netflix cannot rush the increase in cost, because for now Netflix is about finding specific things that you want to see. It is not about tuning in night after night to watch your favorite shows. You want to see a specific movie you check if it is on instant or if the disc is available. This will remain Netflix's core business, but this new venture will offer people an additional reason to subscribe. The move does open them up to more competition from other exclusive content providers. Netflix will not just be about the size of its collection, but about whether it can compete with the likes of Spartacus.

Key things to look out for regarding proprietary content are the cost of producing the content versus the growth in subscribers. I do not know what kind of monetization strategy Netflix will employ, but for now it seems the normal subscription strategy is being used. Production is expensive, and Netflix would need to lock in lots of subscribers. I expect this to be a losing proposition at first. The question is whether it can become profitable eventually. You would need to see subscriber growth. Retaining subscribers is not going to generate growth, and should lead to a deteriorating balance sheet. If the cost of keeping those customers increases, but the revenue does not it becomes a problem.

Only One Can Dominate Online Streaming Content

I can only think of three major cable program packages that command a premium; HBO, Showtime, and Starz. All three of these produce their own content, and people pay extra for these. They do produce fantastic content, but people tend to pick one of the packages. Any people on the younger side, like myself, get Netflix and wait for the series to come out on disc. I like it because I eventually get to watch content from all three without having to pay each individually. It'd even be cheaper overall to just buy the discs when they come out than pay a monthly fee.

I see the same thing as happening to the streaming market. Everyone wants to jump into the hot new market. This includes content creators, distributors, cable networks, and anybody with a video camera and an Internet connection. In the quest to eliminate the middle man every firm wants to fatten its own pockets. I think the key thing missing from all of this is the effect on the consumer. Perhaps I speak for myself, but I am not going to pay for Netflix, Hulu, Redbox Instant, Comcast On-Demand, Amazon (NASDAQ: AMZN), and individual plans from the studios themselves. I might pick 1 or 2 tops. So when Netflix finally rolls their original content out, watch them carefully. Only jump in if they are low cost with high returns, and if they are better than their competitors. You might see a collapse when the market reaches the point of critical mass, but if you own one of the few companies that will come out of it then you have a winner. Each survivor will take a bigger share of the pie, and one will take the lion's share becoming dominant.

I'd be willing to bet that the dominate player becomes Netflix or Amazon. Amazon is setting out to produce its own content as well. Amazon also offers a streaming service through instant video. They are making many titles available to Amazon Prime customers at no extra charge. Otherwise you can buy or rent content as you like. Amazon has a lot of cash on hand, almost $5 billion, compared to Netflix's $800 million. This gives Amazon a greater ability to get content. It can do bigger deals, almost like wholesale stores. It can pay for more movies at once, while paying less per movie just because of scale. Having more cash on hand is bound to be a good thing, and Amazon has much more. They also have a notable brand like Netflix.

Amazon also uses the iTunes style pay per product method. Not all content is available free to prime members. Netflix uses the standard subscription model. Amazon's model has the potential of bringing in greater revenue's when demand is high. Also it offers flexibility to consumers. They can subscribe to one service, then use Amazon when they want something specific they cannot get. The battle between these two will show, which model will reign supreme. I would not count Netflix out of the battle, but it is in a weaker position. I really do like Amazon's chances of rising to dominance. It remains to be seen if Netflix can take the crown itself, or if it just the second dominant player. Everything stated above about original content applies to Amazon, although they do not have a series with an existing following like Arrested Development. Netflix's edge in that regard will be short-lived though.

Conclusion

Remember I have Netflix as an underperform for at least the next year. After that time I will re-evaluate, not buy. If I think they have a good chance at success, then I might make an investment. At the same time I will be watching Amazon to see how they develop. Netflix has other competitors, but I am most concerned about Amazon right now. Amazon is just a larger company with many more factors to consider. As the global economy improves it should improve Amazon's business, so even if Netflix looks like it will be dominant in streaming content, Amazon should still make a good investment. I have Amazon set to outperform in CAPS.


TheArchivist has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com and Netflix. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.

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