21 June 2011

Netflix on Cable, how could that work?

I was intrigued by a comment about Netflix at the recent Cable Show by Melinda Witmer, Time Warner Cable's Chief Programming Officer:  “Consumers are getting it on every device that’s coming on an IP basis today but not the set top. They look like a programmer to me and it makes me sense that we’d be doing business with them in the home on our equipment, too.”  The intriguing part of this is not that it makes sense, but that it is completely counter to the conventional wisdom that Netflix and cable companies are inherently competitors.

Netflix on cable offers the Netflix the following advantages:
  • Availability on another device is always good.
  • Integration with the mainstream of TV watching probably increases usage of the service similar to how carriage on a more convenient channel increases a channel's viewership.
  • A relationship with the cable operator represents a way of addressing ISP bandwidth caps (e.g., excluding Netflix usage from such caps) and network traffic imbalances (that negotiation gets rolled into the affiliation negotiation).
  • A Netflix app on the cable set-top box might improve the technical quality of Netflix service by storing some of the most requested content (or the starting minutes of a lot of content) at the headend rather than outside the headend (with a CDN).  Presumably this could save Netflix something on its content delivery costs as well.
Netflix on cable offers the cable operator the following advantages:
  • Netflix adds to the functionality of the cable service.  Looking at it the other way, if Netflix is not on the set-top box, the subscriber has a reason to turn on another device (game console, PC, Apple TV, Roku, connected Blu-Ray, etc.) and, once there, will see more value on that device and spend more time using it.
  • Netflix is a popular services and is already being bought by many cable customers.  Offering it is a way to repatriate some of those revenues.
Netflix on a direct streaming basis costs a consumer $7.99 (plus applicable taxes). Presumably the cable operator would like to make some margin on the sale of Netflix. Cable customers could pay extra to get Netflix via the set-top box as it simplifies the home entertainment system by eliminating the need for another box to be connected to the TV (although relatively little of Netflix distribution to the TV is likely via a dedicated box like Roku -- game consoles are probably the biggest one and no one buys a game console primarily to get Netflix). Cable television has always been a premium product and its price reflects that.  After all, about 10% of cable customers buy only the basic broadcast level of service and the primary competitive service to that is free over-the-air television. Cable operators often sell their services for different prices than other providers in the marketplace (e.g., HBO's price on Comcast often has little similarity to its price on Verizon or DirecTV), although few services are available directly from the wholesaler (MLB.TV is such an example as it is a broadband delivered version of the Major League Baseball Extra Innings package sold by multichannel providers).  [Added:  In fact, that might be the biggest issue for a distributor; HBO might, not unreasonably, expect the same rights as Netflix, to be able sell direct to consumers.]

If Netflix expected 70% of retail revenue and it wanted the same $7.99 wholesale than it would get from a direct customer, then the retail price would have to be $11.41. 70-30 is the typical split for content providers in Apple's iTunes store and is a common split in Internet content-distribution relationships. If the retail price would stay at $7.99 and Netflix were to get a 70% split, that would make the wholesale take $5.59.

All things considered, both Netflix and the cable operator could benefit from the arrangement, so perhaps they would split the difference between these scenarios -- that would put the retail price at $9.70 and the wholesale rate at $6.79 -- rounding puts Netflix at $10 retail and $7 wholesale. For those who remember premium television pricing history, that sounds very conventional (and I mean that as a compliment). 

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