(For part 1 of this series, click here.)
There’s a race underway in the broadcast industry. On one side are Canadian incumbent telcos like Bell and broadcasters like Corus. On the other is so-called “over-the-top” (OTT) provider Netflix, a service that streams film and TV content online. Netflix aims to reach a critical mass of subscribers that creates a kind of positive feedback loop. More subscribers mean more revenues which enable the purchase of more and better content, which in turn attracts more subscribers, which starts the loop all over again. If it works, Netflix may not only cement its market share but materially threaten the viability of some of the telcos’ broadcast and TV subscriber businesses. However, it has to get there before the incumbents can create similar offerings of their own. Given the advance of the on-demand or “TV everywhere” trend, which all parties agree is inexorable and inevitable, this means the telcos have to play in Netflix’s space.
Officially, Netflix likes to insist it isn’t the enemy. But that doesn’t quite square with remarks made by Hastings in a first quarter investor letter where he said, “[We] should be able to use our size and international scale to bring the best original and exclusive content from anywhere in the world to anywhere in the world. This is the real advantage over our regional competitors.”
Certainly, the company has shown flashes of relatively fierce competitiveness. In March 2011, it was widely reported that Netflix outbid Corus and Astral for exclusive 5-year rights to Paramount Pictures film content—a point repeatedly raised by the incumbents before the CRTC during hearings in 2011. (Both Corus and Astral declined to be interviewed for this story.) Around the same time Netflix similarly outbid HBO and AMC for exclusive rights to the highly anticipated original series and Kevin Spacey vehicle House of Cards. And in May 2011 at the annual L.A. Screenings where broadcasters buy studios’ TV content, Netflix for the first time had an executive dedicated to shopping for content for Canada. The company reportedly bought the TV rights to an unnamed show just to get the online rights while locking out broadcasters.
Whether it’s Bell, Rogers, Cogeco or others, the broadcast distribution undertakings (BDUs) and broadcasters seem to harbor a distinct fear of Netflix’s potential spending power and consequent ability to snag exclusive rights for both the subscription video-on-demand (SVOD) and formerly untouchable VOD/pay TV windows (see sidebar: “Release Windows”). Primarily because of heavy secrecy, it’s unclear exactly how aggressive Netflix is being in negotiations with the U.S. studios that supply the majority of content consumed by Canadians.
However, with virtually no exceptions, the BDUs and broadcasters are less sanguine. For the 2011 CRTC “fact-finding” hearings on the state of OTT, Rogers commented that because OTT is unregulated and therefore has a lower cost structure, its providers can pay more for the same studio content. “Licensed Canadian distributors will find it increasingly challenging to retain customers as these customers are enticed to access video content from … OTT services.”
The defined periods of time during which a given piece of content is shown, with a brief period at the window’s start that is typically exclusive. However, different combinations of rights/exclusivity can shift these windows in any number of ways. (What Netflix has been increasingly attempting to do is operate in the video on demand, pay-per-view and pay TV windows.) While TV is simplified, film generally follows a complex order that moves in a three-year+ cycle as follows:
theatrical: from month 0-4
airplane/hotel: mo. 3-10
cable VOD/pay-per-view: mo. 6-7 (primarily straight-to-video, e.g. IFC films)
home video DVD/Blu-ray: mo. 8+
home video discount/kiosk rental: mo. 8-10 (e.g. Netflix DVD, Redbox)
electronic sell through (EST), electronic rental (VOD): mo. 8+ (e.g. iTunes)
SVOD: mo. 8-11 and mo. 24+(e.g. Netflix)
pay TV: mo. 12-24 (e.g. HBO, Showtime)
network TV/cable: mo. 26+
free on demand: mo. 48+
And Peggy Tabet, director, regulatory affairs for Quebecor, which owns cable operator Videotron, wrote: “[The] more competition from companies such as Netflix will be present, the more customers of distributors such as Videotron will be encouraged to unsubscribe. If, for the moment, this threat has not yet reached its full extent, what will happen when, for some 1,100 [titles] currently available in Canada, Netflix will offer 11,000, as is currently the case in the United States?”
To hear Netflix tell it, neither side should consider the other the enemy. Like the convivial peacemaker at a dinner table full of inlaws, Netflix leadership has gone to great effort to portray the company’s business as complementary to existing BDUs and broadcasters, whether in Canada or the U.S. It may have a case—for now.
In September, Ted Sarandon, Netflix’s chief content officer, spoke at the Bank of America/Merrill Lynch 2012 Media, Communications and Entertainment Conference and touted the company’s positive effect on broadcaster AMC and others. “They have a particular programming sensibility that works really well on Netflix and we can take a lot of the risk out of the production of their shows. … I with great confidence will tell you that we brought a million new viewers to AMC for the new season of Mad Men and I’ll tell you we grew the audience for Sons of Anarchy on FX. We will grow the audience for Walking Dead on AMC—that access to the content in a catchup mode on Netflix is nothing but good for them.”
This echoes a similar comment made by Corus Entertainment’s EVP and General Counsel Gary Maavara, who commented to the CRTC that “OTT may actually be creating more demand for video programming.” (Corus owns W, Movie Central and co-owns HBO Canada among other properties and claims it hasn’t seen evidence even of cord shaving.)
It’s perhaps to be expected that the existing industry would sound a note of alarm as soon as anyone tried to horn in on its lunch. But like Maavara some are inclined to agree—in a roundabout way—that Sarandon has a point. CRTC worries aside, David Purdy, SVP, video product management for Rogers, says the great selling point of SVOD is the ability for viewers to engage in “catch-up” viewing for TV shows. This can lead to picking up the current season, which of course remains exclusive to cable.
“Binge viewing is becoming more and more a part of the cable viewing proposition. So House of Lies I watched over one weekend. Basically, I had a cold, I didn’t leave my house and I watched 13 episodes. And now I can hardly wait until the new season comes. So this type of service—whether it be Netflix or Rogers subscription video-on-demand—that allows you to binge view on previous seasons, is complementary and doesn’t hurt the ecosystem.”
All of this may be true, but at what point does Netflix move from complement to competitor? The industry and its observers agree this will happen when the right combination of subscribership and content makes Netflix something that, as Purdy says, is seen as “a replacement technology.” To get there, Netflix is in direct and perhaps increasingly aggressive competition with the incumbents for exclusive access to film and TV content. It has to because at the moment its library doesn’t exactly inspire terror in its opponents.
As Josh Scherba, SVP of distribution for DHX Media, says of himself and others he knows, “We’re content junkies. It would never cross our minds to actually cut our cord because then where am I going to watch my sports? And also, I want to watch the brand new HBO content and [broadcast TV is] the only way I’m going to get it.”
The fact is Netflix’s Canadian library just isn’t that strong. And Netflix seems to know it—or at least it’s possible to read as much into its late 2011 announcement that in 2012 increases in its content spend would make the Canadian service’s offering comparable to its U.S. counterpart. Data compiled for Canadian Business Online by Josh Loewen of iStreamGuide.com shows a total of 10,625 unique titles for U.S. Netflix and 2,647 for Canada (see sidebar: “How much greener is the grass at Netflix USA?”). The genre disparities are similarly wide, with 3,035 film titles in the drama category for the U.S., but only 829 in Canada, for example.
As for quality, consumers will find little in the way of the premium movies they can expect on a pay TV or video on demand (VOD) service. Instead it’s too often a slate of low-rent, straight-to-video unknowns such as 2-Headed Shark Attack and box-office underperformers like After the Sunset. Officially, Netflix says it doesn’t really play in the premium movie market, with TV streaming making up 70% of served content, but even there the selection in Canada significantly underachieves compared to the American library. Only time will tell if this is simply the temporary result of the Canadian library’s younger age. But in a Q3 2011 note, CEO Reed Hastings said the plan was to get content spending to the “population-adjusted equivalent” of the U.S. However, with a population only 10% of the States, that doesn’t seem to bode well for Canada’s content junkies or the company’s ability to grow its market share here.
The battle over content spend
If content is king, then what the ongoing confrontation between the two sides is about is what each can spend for content and when they can get it. As mentioned, Netflix has shown itself willing and able to make serious plays for content it believes will attract subscribers. Getting that content first and on an exclusive basis gives consumers just one more reason not to bother with their traditional cable subscription. To compete, the incumbents have to be prepared to pay a little more and according to the BDUs and other sources prices are indeed going up.
Some distributors say there is more money being paid by buyers as a result of Netflix’s presence. “I can definitely confirm that there is additional money being paid for these [digital] rights now,” says DHX Media’s Scherba. DHX, which recently acquired Cookie Jar Entertainment, produces, licenses and distributes dozens of children’s shows including Battletoads, Caillou and Yo Gabba Gabba. DHX in March 2012 signed a content deal with Netflix.
And from Corus’ Gary Maavara, who specifically identified Netflix in comments to the CRTC: “If Canadian broadcasters are to compete with such players for Canadian rights to popular content, the inevitable result will be a dramatic escalation in the costs of acquired programming and an erosion of operating margins.”
Joris Evers, director of corporate communications for Netflix, insists the company doesn’t “go crazy on pricing.” Of the Paramount deal, he says, “To be able to have Netflix in Canada, and make it an attractive service that people want to subscribe to at that $7.99 a month, we want to have a nice mix of content and some [pay TV] titles, like through Paramount, for example, are a key part of that mix. And we pay fair prices for content. We pay well for content people really love to see.”
Competitors in linear and other pay TV services have now woken up to Netflix’s power. Content providers now appreciate the growing value of digital rights—and the price keeps rising. It’s not a given that the company’s $7.99/month all-in model is sustainable; long term it may not be enough to buy the premium content it needs to attract subscribers or even maintain market share. Global scale might sustain it for a while yet, but for how long?
“That’s the billion dollar question that ultimately everyone is trying to figure out,” muses RBC analyst Drew McReynolds, co-author of a 2011 RBC report, “Pricing in a Potential OTT Inflection Point.” “And I would say from Netflix’s perspective that with their $7.99 model they could certainly afford to dabble in the premium content side of things, but ultimately they’ll need a lot more scale if they’re going to have the pockets to bid for some of the more premium stuff.”
Several years ago in the U.S., Netflix tried changing its price/value offering—to disastrous effect. The company now insists it’s going to stick to its current pricing. Asked if Netflix might consider introducing tiered service with a premium pricing point where subscribers get a better selection, Evers says the company isn’t thinking about that at the moment. “We don’t confuse people with different price points, with the ability to watch pay-per-view titles, with an upsell to now buy a download or something like that.”
So who’s spending what to acquire content? Based on filings with the CRTC, Bell leads the pack at $1.5 billion for 2011 (year ended August 31 and filings are delayed one year). In the middle is Videotron at $527 million and rounding out the bottom is Cogeco at $288 million (see chart: “2011 broadcaster/Netflix content spend”). Netflix doesn’t release its content spend figures, but it’s possible to back out a rough estimate using its financials. For 2011, the company came in at about US$2.4 billion for its consolidated operations.
Figuring out Netflix’s Canadian spend is trickier still, but an April 2011 report by RBC Capital Markets makes some conservative projections for future outlays between 2015-2020, which it says represents a tipping point for OTT in Canada. If we use the same formula, but for its current subscriber level of 1 million, we get a 2011 figure of about $65.2 million. Considering that RBC’s calculations are for a future where Netflix has grown to 2.7 million subs, its projected $176 million content spend at that point would still pale before that of the BDUs (although it would be competitive with broadcasters Corus and Astral). Today’s $65 million figure is even more miniscule. So the question becomes to what degree, if at all, is Netflix using its American muscle to plough its way into the Canadian market? Netflix is already on record as saying it uses its American revenue to fund its international expansions, but it also made a point of noting in its Q2 financials that its Canadian operations have reached “scale,” are now generating a “small contribution profit” and that it plans to “manage … content and marketing expenses to grow more slowly than members and revenue.”
“The company strategy [on Canada] has gone a little dark,” says Dan Cryan, research director, digital media at IHS. “Looking at what they have been doing internationally and the number of users, and given the expansion to [Europe] and so on, it’s not clear to me that Canada is the international priority it once was.”
Peter Miller, author of a report for the CRTC called “Developments in the Canadian Program Rights Market 2011,” says, “There’s really no scenario where Netflix can outbid a Canadian player on a rational basis. The issue is, are there strategic reasons for them ever to do it irrationally? Do they go out and spend a ridiculous amount of money to get exclusive rights to something that Canadians want, thereby driving up their subscriptions because Canadians say we really want that programming and Netflix is the only place to get to it? It won’t make any economic sense out of the gate, but if it grows their business it’s not a completely irrational thing to do.”
RBC’s McReynolds agrees. “There’s nothing I’m aware of that prevents that strategy from unfolding,” he says, although he points out that as a public company Netflix faces constraints. “But you would expect them to ramp up the spend at certain points and each time they would do that it would be incrementally negative impact on the incumbents here.”
But among the possible advantages Netflix has that makes up to some extent for its lower Canada-specific spend are that: it does not currently have to contribute to Canadian production funds such as the Canadian Media Fund; does not have to set aside program time for Canadian programming; and does not have to support any telecom infrastructure beyond its server clouds. Instead Netflix uses the infrastructure built and maintained by the telecoms. All of this naturally makes Netflix a much leaner operation than, say, a Rogers. The telecoms have identified these issues before the CRTC as sources of (unfair) competitive advantage that they would like to see addressed in some manner.
Netflix’s freedom of movement limited
Others say it’s a mistake to attribute too much power to Netflix. Catherine Tait, president of indie film & TV company Duopoly and part owner of recently launched pay channel Hollywood Suite, says Netflix’s freedom of movement is limited. She points out that existing output deals Canadian broadcasters/BDUs have with U.S. studios tend to be long-term and high volume. Paramount-type deals notwithstanding, Netflix is shut out, at least for now. “There’s no black and white here. It’s like the trenches in the First World War—you win 25 yards and then you go back 15. It’s a little bit like that. And Netflix is battling for each of those relationships in the U.S. and in Canada.”
Given that Netflix has been in the country only two years, these are the opening stages of the content wars and Canada’s incumbents have sounded an early alarm. It’s too soon to declare a winner, but a combination of market positioning, resources and even regulatory rulings are likely to play a part in deciding who comes out on top in the future.
In part three of this series, the options facing Canadian incumbents are revealed. Whether it’s Bell, Rogers or Shaw, none of Canada’s big players can be considered easy pickings. They all have considerable resources and other advantages they can bring to bear to fight off—or at least fight to a standstill—the challenge of foreign OTT services. But time may not be on their side.
The world of broadcast and telecommunications is filled with jargon and acronyms. Here are some of the key ones.
BDU: Broadcast distribution undertaking. A cable or satellite provider.
Linear TV: Programming aired at a certain time in a certain order with no ability by the viewer for intervention. In short, network TV.
OTT: Over-the-top. A reference to services like Netflix and Hulu, which serve content over the Internet to a variety of devices and bypass the systems of traditional broadcasters.
Output deal: An agreement by one company, usually a distributor, to sell/distribute a specified amount of content from another company, usually a studio, over a contracted period.
SVOD: Subscription video on demand. The viewer pays a periodic fee in order to access content à la carte, usually online.