Can Amazon push Netflix out of limelight?

Amazon CEO Jeff Bezos

(Credit: CBS)

For years, Amazon appeared to be a big pushover when it came to delivering Web entertainment.

During the early part of the Internet Age, Amazon shipped CDs and DVDs to customers who ordered them via the Web and CEO Jeff Bezos' company was synonymous with Web music and movies. Then Apple's iTunes, and Netflix, laid waste to physical discs by delivering digital downloads or streaming video and Amazon seemed to quietly drift to the back of the pack.

But today Amazon flexed some muscle of its own by announcing it would stream movies for free to people who subscribe to the e-tailer's Prime service. Amazon Prime subscribers will be able to log on to the Web from Internet-connected devices to instantly access a pool of 5,000 films and TV shows. For $79 a year, Amazon Prime subscribers receive unlimited free two-day shipping without being required to meet any minimum-purchase requirements.

Plenty of commentators in the blogosphere are noting that Amazon's video service isn't a Netflix killer yet, and they're right--but this is just the merchant's first volley as it prepares to take on Netflix, Apple, and others in the growing streaming media sector.

The imagination runs wild when one considers what Amazon could do if the Web store throws its considerable retailing and financial girth into marketing a streaming-video service. Consider that Amazon must pay the film studios and TV networks for the rights to offer the streaming video, but so what? Amazon has loads of cash. The company reported $3.7 billion of cash and cash equivalents for the 12 months ended December 31, 2010. With a snap of their fingers, the Amazonians now offer an unbeatable subscription price.
Amazon can keep ads in front of the 65 million online shoppers that visit the company's site each month. The video service could be promoted and bundled with all kinds of other product offerings. Dan Rayburn, an analyst covering Web video for consulting firm Frost and Sullivan, said Amazon could conceivably sweeten its offer by selling deeply discounted set-top boxes that enable Prime subscribers to watch streaming video on their living-room TV sets.

Heck, Amazon's deep pockets might allow the company to give those boxes away.

Another advantage Amazon has over Netflix is that the company has the horsepower to stream its own video to Prime members without having to pay a third party. Netflix can't say this. On the contrary, the company overseeing that chore for Netflix is Amazon's Web Services (AWS). That's right, Netflix is dependent on a rival for some of its back-end operations. But as full of potential intrigue as that sounds, it's doubtful Amazon would ever undermine AWS' reputation by torpedoing Netflix that way.

Wall Street apparently believes Amazon could cause Netflix some hurt. Netflix's stock tumbled more than $13, or 5 percent, in afternoon trading. Netflix shares have risen steadily over the past year and the stock posted an all-time high last week when it topped $247.

Investors should factor in that Amazon is not likely to unseat Netflix anytime in the near future. Netflix has more than 20 million subscribers, a far larger selection of films and TV shows than Amazon, and has already shown that it can outmaneuver larger players. Experts once thought Blockbuster, the brick-and-mortar video-rental chain, would smash Netflix. The opposite happened. While Blockbuster was still charging late fees and engendering a deep well of consumer bitterness, Netflix was delivering videos to customers' doors via the U.S. Postal Service--creating an entirely new delivery model--and telling users to hang on to the DVDs as long as they liked without charge.

"A growing market attracts competitors," said Netflix representative Steve Swasey.

While Amazon has several businesses to distract management's attention, Netflix thinks exclusively about delivering movies and TV shows. The company has posted a team of dealmakers in Hollywood so they can insert the company into the studios' future plans. Netflix has deals with such content suppliers as Warner Bros. Pictures, Relativity, Starz, and Epix, and just today it added TV shows from CBS, parent company of CNET.
And consumers are already streaming video from Netflix via more than 200 different kinds of Internet-connected devices, such as video-game consoles and Web-enabled TVs, which are compatible with the service. Even if Amazon did offer a Roku-like box for free, it would likely take the company a while to cut enough of the deals to make itself as widely available as Netflix.

The real loser could be Hulu, the joint venture operated by Disney, NBC Universal, and News Corp. that has recently suffered from internal strife. Hulu offers some content for free but the service requires users to pay $7.99 to access a growing number of shows. In addition, Hulu's pay service also forces viewers to watch ads. Amazon's new video service is ad free.

Regardless of which company takes over, with all the price cutting and scrambling to add programming, the real winner--for the time being at least--will be consumers.

Netflix rises as studios' DVD money plunges

Not long ago, ambitious young executives at the six major Hollywood film studios maneuvered to get into the home entertainment divisions.

Nowadays, getting assigned to home entertainment is like being sent to the Eastern front. Better to work in theatrical distribution, international, or maybe studio facilities. Recently, I spoke with an executive from one of the big studios who, while discussing the challenges of working in the film industry, noted there was one silver lining: "At least I don't work in home entertainment."

The home-entertainment divisions at the studios typically oversee sales of DVDs and Blu-ray discs as well as Internet distribution. But the DVD has long been synonymous with these units for the simple reason that the discs account for the vast majority of revenues. This week, Sony, Time Warner, Viacom and News Corp., reported earnings and their film divisions continue to see falling DVD sales.

For the quarter ended December 31, Paramount Pictures saw a 44 percent decline in home video revenue from the same period a year ago, according to Viacom, Paramount's parent company (don't people give DVDs as holiday gifts anymore?).

Bad films or dying format?
Time Warner, which owns Warner Bros. Pictures, generated $923 million in revenue from home video and electronic delivery of feature films. That was a 23.5 percent tumble from the $1.23 billion made during the prior-year quarter. Sony and News Corp., which operates 20th Century Fox, don't break out their home video numbers, but they both signaled that DVD sales were ailing. Sony reported that Sony Pictures suffered a 20 percent overall decline in "sales and operating revenue" in the quarter partly due to "lower home entertainment revenues from catalog product."

For two decades, DVDs and before it, VHS tapes, were a huge source of profit for the studios. DVD sales outpaced box office sales between 2002 and 2009. Barry McCarthy, Netflix's former chief financial officer, noted a couple years ago that the DVD was the most successful consumer product launch in history measured by penetration into U.S. households. He said five years after debuting, DVDs could be found in half of all U.S. households. But the garden years appear to be over, as consumers continue to show less and less interest in physical media and turn to the Web for entertainment.

In their earnings report, the studios blamed the poor quarterly performances in home entertainment on the high number of hit films they had during the prior year. The way the studios tell it, they produced a higher number of popular films in 2009 than they did in 2010 and that resulted in lower DVD sales. This explanation, however, doesn't jibe with box-office figures.

Overall ticket sales in 2010 were $10.5 billion, just shy of the record-setting $10.7 billion generated in 2009, according to Boxoffice.com, an online service that tracks theatrical revenue. There was plenty of popular films last year. What this suggests is that in a down economy, people continue to find enough money to go to the movies. What they're apparently cutting back on is DVDs.

Why own movies?
Now, contrast the studios' dismal quarterly numbers with Netflix's performance during the same period. The video-rental service, which mails DVDs to subscribers as well as streams films and TV shows over the Web, added 3 million subscribers in the quarter--largely on the growing popularity of its streaming service, the company said.

It's not an apples-to-apples comparison, but it shows significant numbers of consumers are moving to Netflix, a service that all but eliminates the need to own movies.

Netflix now has 20 million total subscribers, a 60 percent year-over-year increase. If Hollywood wants to know where the DVD money went, this would be a good place to start looking. It shouldn't be hard to figure out that Netflix is thriving because it provides consumers with what they want: convenience, control, and a good price. For $7.99 a month, a Netflix subscriber gets access to all of the service's streaming content. That's just a better deal, when a single DVD often costs twice that amount.

That Netflix offers an alternative to owning movies or paying for cable TV, may explain why Time Warner CEO Jeff Bewkes has criticized Netflix so much lately. Another reason could be that at this early stage, Web-video distribution doesn't appear to be the cash cow that DVD was in its heyday.

The good news is that not everybody at the studios sees Netflix and Web distribution as a threat. A group calling itself DECE--made up of film studios, software, and hardware makers and almost everybody else connected to film and TV--is trying to create a set of standards and specifications designed to make approved digital content playable on a wide range of certified devices. The standards are called UltraViolet.
Supporters say this could help mainstream consumers make the jump to streaming distribution. Critics say this is an attempt to wrest control of digital distribution away from users. Regardless of whether UltraViolet works, it's a sign that some at the studios see the end of the DVD coming and are preparing for that day.