Amazon And Netflix: An Odd Relationship?

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Includes: AMZN, NFLX
by: Mel Daris

For Netflix (NASDAQ:NFLX), the past two years have been a series of ups and downs. After changing pricing structures for its DVD mail order/online video streaming business in 2011, many subscribers left - never to return. A year later, the company reports growth in membership along with steady increases in downloaded content.

Recently, Netflix CEO Reed Hastings spoke at an Amazon (NASDAQ:AMZN) cloud event mentioning his desire to become the largest business to use Amazon's web hosting platform. Amazon, which owns Amazon Web Services, along with Amazon Prime Video Service, competes directly with Netflix in the online video streaming market. And while this relationship may seem strange, I think the benefits of working together definitely outweigh the negatives.

Cutting Overhead Costs

To keep the company going after steady losses as a result of creating two subscription plans, Reed and his management team decided to expand Netflix into new regions, particularly those experiencing growth in online technology. As a result, Netflix expanded services to countries in Latin America, Eastern Europe and Canada. And while these efforts help the company increase its revenue, expansion hasn't proven profitable enough to offset maintenance and other costs including web hosting.

This is where Amazon comes in. As a hosted company on Amazon Web Services, Netflix, along with many other companies benefit from Amazon's ability to cut hosting costs relative to its competitors (as much as 25%). With this savings, Netflix updated its interface, developed new contracts and licensing deals with movie and television production studios, and plans to continue its expansion efforts.

Building Solid Business Relationships

If Netflix and Amazon can maintain a solid business relationship, customers of both companies may benefit over time. In the future, both companies could work together to create innovative new products and services. Competitor collaboration is not a new concept, especially in the technology realm. Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL) worked together to develop Microsoft Office and other software for Mac (this collaboration actually saved Apple from going under). Through this partnership, both companies increased profits and helped push the information age forward to what it has become today. Google (NASDAQ:GOOG) has formed partnerships with NASA, AOL (NYSE:AOL) (owned by Time Warner), Intel (NASDAQ:INTC), and others to develop Internet technologies.

Companies within the telecom industry constantly work together to manufacture phones and other equipment, enhance wireless connectivity, and provide phone service and Internet access to customers. This industry is a classic example of how all companies involved must work together to co-exist to generate steady profits. Yes, the competition is tough and sometimes it gets nasty; there are patent lawsuits, sales and marketing wars, and pricing conflicts, but at the end of the day, these companies all need each other to survive. As online video streaming becomes more popular, companies like Netflix and Amazon will need to work together and with others including Verizon (NYSE:VZ) and CoinStar (NASDAQ:CSTR) (owner of Redbox), which have partnered to launch an online video streaming service by next year.

Healthy Competition

Remaining competitive also helps fuel innovation and better products and services for consumers. Until a few years ago, Netflix was the only online video streaming company. As a result, the company decided to break its services into two categories in an effort to boost revenue. This mistake almost ran the company into the ground. Had there been additional competition, perhaps the company would have made better choices.

Increased competition also leads to better content that consumers demand. Movie and television production companies now have the opportunity to make licensing deals with multiple companies if they choose. This will increase selection and increase profits for those creating original content and provide more opportunities for consumers to view this content.

Netflix in a Nutshell

I think investors should welcome new relationships with competitors and others as these relationships could help Netflix stay in business. The company has seen slow growth - sales/revenue totaling $3.54 billion, with quarterly revenue growth (year-over-year) of 10.10%. Netflix has a trailing price-to-earnings ratio of 105.43 (the industry average is 72.90).

Increased competition could help Netflix grow by forcing it to concentrate on building the brand, and by forcing management to really consider the risks and costs of business decisions such as altering subscription plans or expanding into new regions. I think increased competition may be what Netflix needs to help it get back on track. Given that quality content may be the only way for companies competing in this market to stand out, perhaps Netflix should concentrate on building relationships with movie and production companies and then expand service over time to new regions.

Building real relationships with competitors may also help Netflix stay in business. Netflix may never regain its number one status in online video streaming, but by building and maintaining positive relationships, it may find some solid ground in this market to become a long-lasting player.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.