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Netflix: Premium cable's worst nightmare

Well established as a mail-order movie-rental service, Netflix is now perfectly placed in the burgeoning business of online delivery.
/ Source: Business Week

Hollywood is having a hard time deciding if Netflix is friend or foe. The fast-growing movie service has already helped drive DVD retailer Blockbuster to the brink of Chapter 11. Now, Netflix is poised to take on premium cable giants like HBO and Showtime. Last month, Netflix bought the rights to stream films from three studios. That will make it the first true Web-based movie channel. It already has 15 million subscribers and an ad-hoc distribution network that includes Web-ready TVs like Sony's Bravia, game consoles like Microsoft's Xbox 360, and even gadgets like Apple's iPad.

( is a joint venture of Microsoft and NBC Universal.)

That makes Netflix's $8.99 a month mail-order and online service a threat to more-expensive premium cable channels. It also poses a quandary for HBO parent Time Warner, whose Warner Bros. studio has become more reliant on Netflix as a source of revenue as overall DVD sales have declined. Netflix "is a customer for our output, and it is a potential competitor to networks like HBO," Time Warner CEO Jeff Bewkes said last month. "So far it has been more of a complementary service to HBO than a competitor."

That's changing. Netflix's most recent deals have moved it from the periphery of the home-entertainment ecosystem into the center of a world in which consumers can watch films and TV shows anytime and anywhere. On Aug. 10 it agreed to pay $900 million for online rights to films from the new Epix pay-TV channel, giving it streaming rights to 3,000 or more films from Viacom's Paramount Pictures, Lions Gate Entertainment, and MGM. That raised Netflix's total to more than 20,000 films and TV shows. (It already had rights to some shows from CBS' Showtime, and movies from Walt Disney and Sony via a deal with the Starz pay channel that expires late next year.)

Three weeks later, Apple Chief Executive Steve Jobs announced that Apple will use Netflix to stream movies through its Apple TV device as well as the iPhone and iPad. Since then, Netflix' shares have jumped 14 percent to about $143 a share. "The value of Netflix continues to grow," BTIG Research analyst Richard Greenfield observed recently. "Adding a premium TV channel to your cable subscription can cost $10 to $15 a month, in contrast to Netflix for as little as $9 a month."

Netflix won't instantly remake the cable landscape. It has more than 15 million subscribers; HBO and its sister channel Cinemax together had 41 million U.S. subscribers at the end of 2009. And it's still no snap to stream shows from the Web to the living room TV. But the explosion of Net-ready gear will help. Already, more than 61 percent of Netflix customers have streamed movies, the company says, up from 37 percent a year ago. As its subscriber base grows—Barclays Capital analyst Anthony DiClemente projects membership will jump 43 percent in 2011, to 26.4 million — so too will its clout.

Chief Content Officer Ted Sarandos says Netflix isn't out to topple the cable incumbents, whose parent companies control the online rights to many of the movies Netflix needs. "We see ourselves as complementary," says Sarandos. "If someone loves Weeds on Showtime, they'll watch it on Showtime and go find the older episodes from us."

Still, the pay channels are taking no chances. They're beefing up original programming, like HBO's Boardwalk Empire and Showtime's The Big C, and keeping much of it in-house. For instance, to give its customers first dibs on its shows, Showtime doesn't release episodes of its comedy Weeds to Netflix for streaming until months after they air. Epix requires Netflix to wait 90 days before streaming its new movies and TV shows.

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HBO, the largest premium cable channel, takes an even harder line: It won't license any of its films or original series, like The Sopranos, for Netflix to stream. HBO also holds the rights for up to eight years to some films from Twentieth Century Fox and Universal Pictures—which could slow Netflix's advance. "There is value in exclusivity," says HBO co-President Eric Kessler. "Consumers are willing to pay a premium for high quality, exclusive content." HBO will battle Netflix on the Internet as well, and by early 2011 expects to make its new HBO Go online service available to its subscribers nationwide. The service, which provides 800 hours of TV shows and movies a month, is available to HBO's subscribers with Comcast and Verizon's FiOS video service.

Netflix can counter with 46 percent of the films released last year, says Sarandos, including independent titles like "The Girl With the Dragon Tatoo." HBO points out that it has seven of last year's 10 best-selling flicks. None of that matters if Sarandos can sign a deal with HBO, which he says he still hopes to do. "We're buyers and they're sellers," he says. "That's what we do."

The bottom line: As more home entertainment gear becomes Web-ready, Netflix is poised to become the first true online rival to cable movie channels.