Netflix North

The newest online giant enters the Canadian marketplace for video-on-demand and the competition better gird for war.

Netflix’s September launch party celebrating the media company’s arrival in Canada briefly took over a trendy downtown Toronto neighbourhood, complete with costumed performers, booths streaming films and, to the media’s surprise, actors pretending to be enthusiastic bystanders. Netflix CEO Reed Hastings apologized for the stunt, an ill-advised gimmick perhaps telegraphing a hint of desperation at the uphill battle it faces in the home base of giants like Rogers (market cap: $19B) and Bell (market cap: $27B). But is it really the Americans who should be worried?

Netflix (Nasdaq: NFLX) is hardly a bit player. From its origins as a DVD-by-mail service in 1997, it has since added a streaming video component and now boasts 16.9 million U.S. subscribers. Its Q3 net income rose 26% and revenue for the period hit US$553.2 million. Its market cap is nearly US$10 billion and its stock price is up 261% this year. And the New York Times recently quoted a study by broadband equipment maker Sandvine that said Netflix traffic accounted for more than 20% of all Internet download traffic in North America during peak evening hours.

Except for Shaw Communications (TSX: SJR.B), which is demanding the CRTC regulate Netflix, video-on-demand incumbents in Canada profess a studied lack of concern. ‘Let’s just say HBO has never made a single title available to Netflix,’ says David Purdy, Rogers’ VP of video products. (Canadian Business Online is owned by Rogers Media.)

Bell (TSX: BCE) also shrugs off any suggestion Netflix will muscle in on its territory. Bell TV Online recently added titles from Movie Central, Playhouse Disney and YTV to its library, says Heather Tulk, SVP of residential products, Bell Residential Services.

Scott Richards, CEO of Ottawa-based DVD-by-mail company, doesn’t view Netflix as a competitor either. Well, not until the American company starts offering new releases, which is what is pursuing this winter. Richards says the company will make an announcement in early 2011 about its own streaming service, but he hints the new deal will work on a revenue-sharing model, with titles going for $4 to $6 per rental. He scoffs at Netflix’s all-you-can-eat model, saying it merely ‘hoovers in content that is not in high demand.’

For all the bravado, at present the incumbents’ more robust content libraries may be all that’s standing between them and another victory for Netflix. The newcomer offers unlimited streaming for $8 a month but by comparison to its offerings stateside the catalogue is dusty. To its credit it has recently signed deals for content such as Weeds, Saturday Night Live and The Tudors, but because of licensing issues Canadians won’t see much more than that for a while. It isn’t a slam dunk that Canadians will fork over $8 a month to watch ‘new arrivals’ such as Slumdog Millionaire and The Secret Life of Bees.

‘If Netflix makes the content really attractive both in terms of quality and cost, then they would be on their way to building a better business model in Canada, as they indeed have built in the U.S.,’ says Eugene Fiume, a professor of computer science at the University of Toronto. ‘With an improvement in the diversity of content, they may well have a winner.’

Netflix says it’s working on that.

‘We’ll build the Canadian catalogue but for now we just wanted to get the service up and running,’ says Steve Swayze, VP of corporate communications. ‘We’re moving as quickly as we can on all fronts to sign more licensing deals. Don’t worry, we enjoy writing big cheques.’ Of note: Netflix has recently struck deals with Nu Image/Millennium Films ( The Expendables), FilmDistrict ( Drive) and Relativity Media ( The Fighter) to provide its subscribers with online streaming of first-run theatrical movies during the films’ pay-TV window.

Canadian media companies aren’t sitting on their hands. Bell says it has made $6 billion in capital expenditures over the past two years, a large part of which has been devoted to increasing its streaming video capabilities and upgrading its fibre and satellite technology. Adds Tulk, ‘Our acquisition of CTV directly supports our content delivery strategy. Clearly, owning Canada’s No. 1 media company provides Bell with unique content advantages.’

‘We’ve been getting ready for a competitive entertainment space for awhile,’ Rogers’ Purdy says, pointing out that Rogers (TSX: RCI) now offers streaming rentals to PCs, an extension of its existing VOD services. Seven thousand titles are available, Purdy says, and insists Rogers has an advantage over Netflix in the marketplace thanks to its ‘premium content, [rather than] last season’s shows.’

But the telcos have some cause for concern: Subscriptions to digital (cable) TV may be in relative decline. Rogers’ Q3 results reported 16,000 household additions of digital cable for the three months ending September 2010, compared to 32,000 who went digital in the same period in 2009.

In its report Rogers claims the slowdown ‘reflects the timing of annual pricing changes, which took place in March 2009 and July 2010, combined with certain bundling and retention initiatives.’

Bell’s results aren’t much different: for Q3 2010, total TV subscribers increased by 18,538 compared to an increase of 40,665 in the same period last year. In a Globe & Mail report CEO George Cope attributed the 54% drop to Rogers’ aggressive cable TV promotions.

(And as for an outfit like, small and privately held, it’s unclear that it possesses the capital to stand toe-to-toe with the Netflix giant.)

It would be too simplistic and perhaps too early to directly attribute this decline to the presence of online-video companies like Netflix, but their impact has surely affected consumer behavior. An Ipsos Reid survey in October 2010 found 76% of Canadians between 18 and 24 watch online video several times a week. And 68% of Canadians over 55 are tuning in online. Also, a CRTC survey reports video on demand saw 33% growth in 2009 compared to 20% in 2006. Studies in the U.S. show similar trends.

It’s that trend line that positions Netflix to be a serious thorn in established media’s side, whether here or south of the border.

‘Our advantage is we have unlimited movies for a subscription price delivered to multiple devices,’ says Netflix’s Swayze. Netflix content is directly accessible through game consoles, Blu-ray players, streaming hardware such as Apple TV and via smartphone apps.

Some analysts agree it’s this ubiquity that gives Netflix an edge over competitors like Rogers and Bell. ‘It’s genius to offer your content on devices where the incumbents might not be found,’ says Sergio Meza, marketing professor at the Rotman School of Management at the University of Toronto. ‘If you have Rogers, you can get their stuff on your TV but offering content on many devices might appeal to some consumers who don’t have cable.’ (This past fall Rogers launched its Rogers On Demand Online store which does make some content available to non-Rogers cable customers.)

On the other hand, he believes the incumbents are well positioned because they’re entrenched in households with cable/Internet bundles, and premium programming with Rogers and Bell are already attractive to consumers.

If Netflix does have an Achilles heel, runaway success may be it. For example, Dan Rayburn of research firm Frost & Sullivan, believes Netflix is too dependent on studios. ‘Netflix doesn’t own any content or create any hardware, so what happens if studios decide Netflix is too big for them and hold back content to make them squirm?’

And there are increasing signs of unrest on this front: four (Warner Bros, Universal Studios, 20th Century Fox, Sony) of six major studios no longer allow Netflix to offer some of their movies until 28 days after the DVD debut. Time Warner CEO Jeffrey Bewkes is practically trash-talking Netflix. And the latter’s landmark — some say bargain basement — deal with pay-TV channel Starz (handling Disney and Sony) expires next year; the renegotiation of that deal is expected to see Netflix’s payment balloon from about $25 million today to possibly the hundreds of millions. That cost could be passed on to consumers via higher fees.

And that may go a long way toward leveling the playing field.

Note: The original version of this story was corrected to include information about the Rogers On Demand Online store.