The Worst May Be Yet to Come for Netflix

The Worst May Be Yet to Come for Netflix

  • 7/28/2019

There’s a long road ahead for the streaming giant as new competitors, including your phone company, step up

By any measure, Netflix is a smashing success. Launched in 1997 as a mail-based DVD rental outfit, the company now streams video on demand to 151 million users worldwide every month. Once just a small thorn in the side of traditional cable giants, Netflix currently serves more paying video consumers each month than Comcast, DirecTV, and AT&T, combined.

But things are only going to get tougher on Netflix from here. One of the company’s most significant threats? A telecom sector is quietly laying the groundwork for revenge.

For years, big telecom has viewed Netflix as a mortal enemy because the company has steadily eroded the sector’s biggest cash cow: traditional cable TV revenue. Instead of embracing head-to-head competition, telecom lobbyists often try to undermine Netflix in other ways, like a recent AT&T proposal demanding Netflix be taxed by the FCC — with the resulting money given to internet service providers.

Telecom’s biggest lobbying win came when the sector convinced the government not only to kill net neutrality protections but erode much of the FCC’s authority to police anticompetitive behaviour in the space. Depending on an ongoing lawsuit, this could open the door to telecom giants like AT&T utilising all manner of dirty tricks to undermine competitors like Netflix, from throttling a competitors video quality to imposing arbitrary surcharges if you use a competitor.

But telecom’s lobbying domination of Washington, D.C. is just one small part of Netflix’s newfound worries.

According to Netflix’s latest earnings report, the company lost 130,000 subscribers last quarter, its first subscriber loss in eight years. And while Netflix added 2.7 million paid customers a worldwide previous quarter, that was roughly half of what Wall Street expected.

The news sent Netflix stock plummeting 13% on July 17, obliterating $16 billion in market value in a flash. And while the company’s stock price has edged back up slightly, some investors have since filed suit, angry over Netflix’s growth projections, and worried the $15 billion Netflix is spending on licensed and original content this year isn’t paying off.

The hyperventilation and hand wringing invoked memories of Netflix’s botched 2011 DVD business spin-off and price hikes, which netted no shortage of doomsday declarations at the time. Now, like then, there are indications that much of the media and market hyperventilation is premature.

In a letter to investors, Netflix admitted the subscriber dip was due to an underwhelming second-quarter content catalogue and a $2 price hike imposed on users last May. Netflix says that ongoing international expansion and a stronger looming content lineup (including new seasons of Orange Is the New Black and Stranger Things this month) should soon rekindle growth.

Realistically, losing less than 0.5% of your subscriber base after imposing an 18% price hike isn’t the end of the world. Most consumer surveys suggest Netflix users still find the company’s pricing reasonable, especially compared to traditional cable. The line in the sand for many of these users is ads, something Netflix says they’ll avoid, for now.

That said, there’s still plenty of reasons for Netflix executives to worry.

The most pressing concern is the looming army of deep-pocketed streaming video competitors just over the horizon. Researchers predict that by 2022, every major broadcaster will have launched their streaming service.

Increasingly, many of these companies are pulling their content off streaming services like Netflix, Amazon, and Hulu, and making it exclusive to their platforms. Disney, for example, intends to take its popular Star Wars, Marvel, Pixar, and kids programming off Netflix, making it exclusive to its Disney+ service, which launches in November.

Other media and telecom giants have the same idea. AT&T recently noted it would be pulling Friends from Netflix, making it exclusive to its looming new streaming platform, HBO Max. Comcast has announced it will be pulling The Office from Netflix and making it unique to its new unnamed streaming service, launching next year.

More competition means more options to flee to should users tire of mediocre Netflix content or price hikes. Keeping those users subscribed in a saturated U.S. market will be a significant challenge, and crafting quality originally programming will be essential.

“We see a lot of churn among all these services every month because you’re going to see people jump from one service to another as a series comes out that they’re binge-watching,” Dan Rayburn, an independent streaming industry analyst, tells OneZero.

But the rise in competitors creates more risk than just added competition. As consumers are forced to hunt-and-peck through a laundry list of costly subscriptions to find the exclusives they’re looking for, the industry risks something analysts call “subscription fatigue.” These users, confused and frustrated by price and exclusives, may resort to piracy.

Early data suggests this may already be happening. BitTorrent traffic, long on the decline after teaching some hard lessons to the entertainment industry, has rebounded in recent quarters.

“Most consumers have a limited amount of dollars they can spend on services,” Rayburn says, pointing to four services as the likely max for most users. To ensure they’re one of these four significant choices, companies will attempt to press different tactical advantages, Rayburn says.

For example, Disney’s looming streaming service will likely be successful due to its lower $7 monthly price point and its vast catalogue of hugely popular exclusive kids programming, Rayburn suggested. Users are also likely to remain subscribed to Amazon’s Prime Video because it comes tied to existing Prime subscriptions.

That’s before you even get to the telecom sector, which has perhaps the most significant advantage of all: it owns the tubes all of this content travels over.

The benefits of owning the content and the conduit are numerous. AT&T, for example, offers steep discounts for HBO and its DirecTV Now streaming service if you subscribe to AT&T’s wireless services. If you’re looking for a streaming service to cut from your roster, you may be less inclined to axe the one that’s giving you a discount on your telecom services.

And with net neutrality rules recently killed by the FCC, AT&T has quietly started to take advantage in more subtle ways. It now hits customers with arbitrary bandwidth usage caps and overage fees if they use streaming competitors like Netflix, Hulu, or Amazon, but not if they watch AT&T’s DirecTV Now.

It’s a subtle, anti-competitive tilting of the playing field says Gigi Sohn, a former FCC lawyer that helped craft the agency’s net neutrality rules.

“If Netflix is subject to a data cap and other video streaming services like HBO or Comcast’s new streaming service are not, subscribers will naturally gravitate to the zero-rated service, putting Netflix at a distinct competitive disadvantage,” Sohn says.

Netflix initially complained to the FCC about these kinds of practices (dubbed “zero-rating”), but its defence of net neutrality has grown tepid as the company has become more powerful.

“Weakening of U.S. net neutrality laws, should that occur, is unlikely to materially affect our domestic margins or service quality because we are now popular enough with consumers to keep our relationships with ISPs stable,” the company said in a 2017 letter to shareholders.

In other words, Netflix began thinking that the death of net neutrality wouldn’t harm its business, purely because of the company’s size and success. CEO Reed Hastings has subsequently stated that while Netflix was “disappointed” with the repeal of net neutrality, it wasn’t a big deal.

Should the telecom industry win, ISPs will be free to hamstring competitors like Netflix in a wide variety of creative, new ways.

Sohn disagrees. She tells OneZero that Netflix could soon face ISPs demanding steeper and steeper rates for interconnection to networks, a battle that resulted in widespread Netflix performance issues and immense industry bickering back in 2014. And while Netflix may be powerful enough to manage the threat, smaller companies may not be.

For now, ISPs are on their best behaviour as they wait for the result of a lawsuit against the FCC by 22 state attorneys general, a ruling in which should drop any day now. Should the telecom industry win, ISPs will be free to hamstring competitors like Netflix in a wide variety of creative, new ways, Sohn says.

Rayburn notes that in the streaming wars to come, telecom giants have some distinct disadvantages as well, many of them self-inflicted.

For example, telecom giants aren’t always the most consumer-friendly, adaptive, or innovative companies on the block. That’s been reflected by several early missteps in their streaming efforts, ranging from Verizon’s bungled Go90 service to the numerous initial technical hiccups AT&T saw with DirecTV Now.

Giants like AT&T have another problem: debt. In a bid to dominate the TV space, AT&T spent $67 billion to acquire DirecTV in 2015, and another $89 billion to acquire Time Warner last year.

“They are the most heavily indebted company in the world,” Rayburn notes.

To pay down that debt, AT&T recently imposed streaming price hikes that resulted in a significant recent subscriber departure of its own. While AT&T hoped these megadeals would give it a leg up in the streaming wars, the debt load they created could make AT&T less flexible in the race to craft original, essential content, Rayburn says.

“Consumers care about quality, and Netflix has always worked.”

Like AT&T, many new entrants are going to struggle to make headway in the streaming sector, and Netflix has a notable advantage in showing it can deliver a massive array of high-quality content consistently and at scale, Rayburn says.

“Consumers care about quality, and Netflix has always worked,” Rayburn said. “They rarely have an outage.”

Streaming providers now see significantly higher customer satisfaction ratings than their traditional cable TV counterparts, who still struggle with the basics of customer service. And while it’s always possible that Netflix could bungle its advantage, its recent subscriber's losses are likely a blip, and it remains well-positioned as competitors offer new streaming platforms.

That said, the cutthroat rush to dominate the space using every trick in the book is sure to cause some growing pains for the nascent sector, and there’s no limit of challenges facing Netflix over the next decade. Should telecom giants, dirty tricks, and exclusives come to dominate the space,, the future of television could look remarkably like its bundled, troubled past.

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