Characteristics of original video content for online streaming providers

I have been researching Netflix (NFLX) lately and I ran across a good interview from earlier in the year that described the differences between original content being financed by online streaming providers like Netflix versus traditional television companies. By original content I'm referring to sourcing of content in the first window (i.e. you are the first one to show it).

Although online streaming companies are not financing much original content—Netflix is only allocating around 15% of its content budget to original content and Hulu Plus and YouTube have only spent small amounts on original content—I think it may change over time, if streaming customers are willing to pay for original content. So far, judging by the customer backlash over Netflix raising prices earlier in the year, as well as the lack of sizeable deals by YouTube—YouTube has something like 140 million unique viewers and it still hasn't been able to spend $100+ million on original content—it is probably safe to say that customers are unwilling to pay for original content. But this may change.

The interview was carried out by AllThingsD's Peter Kafka with Netflix's content chief, Ted Sarandos, answering the questions. Netflix had just signed an original content deal to produce David Fincher's House of Cards. Original quality content is expensive and Netflix spent around $100 million for 26 episodes over two seasons (this is very expensive for Netflix).

(As is usual on this blog, I typically bold text in the quotes that are interesting.)

Kafka: You’re not producing the show yourself–Media Rights Capital will do that. Will you cover their costs, or will they deficit finance it?

Sarandos: They’ll deficit finance it. We’re coming in at a percentage of the budget.

Kafka: So where else will can they make their money?

Sarandos: Anywhere in the world. Syndication, DVD. Same as any other show. It’s traditional in the windowing, it’s just that Netflix owns the first window.

Kafka: So what will it cost?

Sarandos: No comment. But I will say this: If the show proves very popular, it won’t be any more expensive than licensing a popular show off of a network. So economically, it’s not a seismic shift, if it’s popular. If it isn’t, then we’ll have paid more for an unpopular show than we normally would have.

The first thing that is interesting about this original content deal is that Netflix is paying a portion of it for the first window but it will be syndicated after that. I'm curious what the long-term impact of such a deal is on Netflix.

As I highlighted with the bolded text, the big difference between financing original content and buying re-runs is that: if the show is popular, it'll be just like any other show. But if it isn't popular, Netflix would have paid way more than another show. Since the show isn't already tested in the marketplace, original content deals are way more risky. However, there are some key differences with online streaming:

Sarandos: The models are radically, radically different. They’re [traditional television and cable] trying to develop a show that will be watched in very big numbers on Wednesday night at 9 pm, so they can sell advertising against it, for that time slot.

I don’t care if people watch it Wednesday night at 9pm. They can watch it anytime in the life of the license, and it’s economically neutral.

This is a major difference between traditional television and online streaming! (The reason I thought of writing this post is to highlight this point.)

Online streaming doesn't have to ensure that viewers watch at a particular time slot. Instead, as long as streaming customers watch during the life of the license, it can enhance the value for the customer. This makes me think that original content economics may work better for streaming than with traditional television. The notion that a streaming provider can extract value from video content at any point in time during the license is something new (at least I think so).

The problem with online streaming and the watch-at-any-time method is that promoting the video is difficult. For the last 50+ years, everyone knew to turn on the TV at a particular time to watch a particular show — this was backed up with big marketing. With streaming services like Netflix, time slots don't exist. Ted Sarandos goes on to talk about how Netflix will attempt to promote the original content:

Sarandos: The fact that we can algorithmically bring an audience to a show, we’ve proved for 11 years, on DVD. So I have very high confidence that the same methods and algorythms[sic] that we’ve used to pre-determine size of audience for a show will work, here. Even if the show doesn’t have a massive external marketing campaign, or even large external awareness.

It'll be interesting to see if companies like Netflix can pull this off. The online world allows you to collect a lot of data about customers and do computing in the background—things that traditional television and cable and satellite couldn't easily do—so will this work? It remains to be seen.

Kafka:You’ve been adamant about saying you’re not interested in getting into the “next-day” window for TV shows, like Hulu does–where a show airs on a Tuesday and you can stream it on a Wednesday. Is that still the case?

Sarandos: Our value proposition to consumers is so much more about completeness than freshness. Having the complete season is so much more valuable, in our business model, than having last night’s episode.

That is demand fulfilment more than demand creation, and demand fulfillment tends to be a much lower-margin busienss [sic]. And I look at the series that we have today: The most watched episode of almost any given series on any given day, is episode one, season one.

So we have new people coming to these shows constantly. So there’s much more value in having the entire series experience, than it is having last night’s episode, or some kind of convoluted, rolling 5-episode model [like Hulu does].

I see a lot of people suggest that online pay-per-view or pay-per-item businesses, such as Apple iTunes or Amazon (not Amazon Prime) or XBox Zune, are somehow better than streaming models. As Sarandos points out, 'demand fulfillment' is a lower-margin business. Almost everyone can cut a deal with major content producers to sell episodes for $3.99 or whatever. There is razor thin margins and everyone will be competing with every single retailer on the same thing. What Sarandos characterizes as 'demand creation' is probably the more lucrative area. Having said that, I have no idea if Netflix will be the one to succeed.

(You may also want to read this article from Knowledge@Wharton about companies like Netflix that are ignoring short-term profitability in order to focus on customer lifetime value. Companies like Amazon have utilized that strategy but it's not clear what the limits of it it are in the online world.)