Hollywood's Broke: How the Netflix Deal Will Forever Change Distribution

There are several takeaways from Netflix's announcement that it will have exclusive streaming rights to movies from Epix, the joint venture between MGM, Lionsgate, and Paramount. While the deal has generated a lot of press, however, I find the impact on us regular viewers and indie filmmakers is more significant than the financial implications for the entities involved.

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We've known for some time that DVD's days were numbered. Eventually, streaming would be the standard, and likely to be the final type of format in which we view content. The importance of the Netflix deal is that it is the equivalent of Gabriel's horns signaling the Rapture. Netflix's most recent earnings report said that 61% of subscribers viewed more than 15 minutes of streaming content. If you have a DVD player in your home, even if it is Blu-Ray, the beginning of the end has begun. It may take five years or ten years, but at some point you will have wireless signals pushing movies through the hallways of your home 24/7.

It also highlights the continued degradation of Hollywood box-office admissions. We've seen 3-D and IMAX take off like a rocket this past year, as every other film seems to get released in these formats. These are just gimmicks to push more people into the theatre and at higher prices.

The Financial Times quotes Brandon Gray, president of Box Office Mojo: "The studios are guilty of short-term thinking,”They all jumped on the 3D bandwagon but they’re avoiding the real issue, which is their bankruptcy regarding storytelling.”

Eventually, films will be streamed directly to a screen. There will be no front projection. Movie theatres will be nothing more than a choice between a large screen and a really large screen (IMAX, which is enjoying an undeserved stock run at the moment, is toast unless they change their business model). The power of transmedia will also grow. I discuss this with Heroes creator Tim Kring, in my book Inside the TV Writer's Room.

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These changes may ultimately lead to the great democratization of theatrical production and exhibition for independent filmmakers. Currently, the distribution structure is such that indie films get hosed if they want to be in theatres. The distributor, most of whom are the studios, take a "distribution fee" as a percentage of box office, often leaving the filmmaker with nothing.

Streaming, however, is going to become commoditized just as DVD players were, and VHS players before that. When streaming becomes something anybody can do -- and that day will come -- exhibitors will be able to broaden their content offerings. Exhibitors may ultimately negotiate directly with indie filmmakers and their agents, while skirting a distribution fee -- permitting indie filmmakers to finally see returns on their investments.

This trajectory is only aided by the studios, which continue to produce content that has resulted in the degradation of box office admissions.

Financial Implications



Is this an attack on the Pay-TV market? That depends if you are Chicken Little or Logical Larry. Edward Woo at Wedbush Morgan Securities claims, "It represents a very big threat to HBO. They aren't serving different markets, they're competing for entertainment dollars on a subscription basis". Rick Aristotle Munarriz, a terrific writer on a crappy website called The Motley Fool, says, "What does this mean for conventional movie channels including Time Warner's HBO? Toast."

What a load of bunk. Netflix streaming and Pay TV are serving totally different markets! For starters, Netflix's streaming deal permits the content to air 90 days after the Pay TV window. So if you really want to see the content that Epix provides, then sure, you can cancel Showtime. But guess what? After Starz moved its content to streaming, it continued to add subscribers.

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Second, people are not going to cancel HBO, which has output deals with Fox, Universal and Time Warner films for the next four years, along with all of its original content. You can't get that content on Netflix streaming (yet).

Financially, the story is more complicated. Netflix is going to shell out $1 billion for this content, dwarfing the $30 million fee it paid for the second-rate content from Liberty Media-owned Starz subsidiary. Netflix is making this bet for several reasons. Primarily, it's a land grab. While there are no real serious streaming threats out there, Netflix wants to extend its brand identity as being The Name in streaming. There just isn't much barrier to entry from a technological standpoint, and we all know Google could just smash its way into this arena (and still may). The only winner in a commodity-based business is the one with the brand name. So Netflix is jumping out front now.

This raises the question of whether the $1 billion price tag is too high. On the one hand, it may be worth it from the branding standpoint. In addition, by allowing new subscribers unlimited streaming for its lowest-tiered monthly subscription rate of $8.99, it plays into the land grab strategy. Scoop up customers for the DVD mailing product with a cheap entry fee, and give them a huge value-add with unlimited streaming. Streaming also saves on postage for Netflix, which will spend $200 million this year on its DVD mailings. The downside is that it may encourage other higher-tiered customers to downgrade as well. I know I did. So in the short-term, this is going to slam Netflix's operating results. I would not be a holder of the stock at this time.

However, by spending the big money now, Netflix assumes its brand will be so dominant, that people will naturally choose its service. Then it will try to recoup its outlays in later years by raising prices for those who want unlimited streaming. If it is the dominant brand, it will also have negotiating leverage over the studios, who want their content to be streamed on Netflix, driving the license fees down over time. So for the long-term, this may pay off for Netflix. Ultimately, however, I just have to believe that streaming will be commoditized and Netflix will just be another name, branded or otherwise.

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