DVD rental and online movie streaming company Netflix (NASDAQ:NFLX) reached an agreement with Warner Brothers (NYSE:TWX), one of the biggest Hollywood movie studios, that focused on two important points of negotiation:
(i) Larger and cheaper catalog of Warner Brothers films available online (benefits Netflix)
As a result of the agreement, Netflix will have access to a larger portion of Warner Brothers' movie catalogue in order to stream online. DVDs from the studio will also be available at cheaper prices, which can help Netflix to avoid growing its content acquisition and revenue sharing costs which together currently cost Netflix nearly 30 cents for every $1 of revenue.
(ii) Length of DVD sell-through window (benefits Warner Brothers)
The agreement gives Warner Brothers a 28 day DVD sell-through window before new releases become available to Netflix subscribers, which we believe is positive for Warner Brothers’ DVD sales.
Warner Brothers estimates that about 75% of DVD sales occur in the first four weeks after a release. Over the years, the home entertainment market has declined due to declining DVD sales. As a result, we view this as an attempt by Warner Brothers to obtain more profits from the initial sales period.
Other movie studios like Fox (NASDAQ:NWS) and Universal (NYSE:GE) have attempted a similar approach which signals an industry-wide trend on restricting DVD sales for new releases. Given the shift to more film consumption online, we believe Netflix benefits from the wider online inventory made available as a trade-off in negotiations with studios for a longer DVD sell-through window.
New releases from all studios comprise about 30% of Netflix's DVD shipments and most of the sales occur in the first four weeks after release. Since Netflix offers a subscription service and does not charge per DVD rental, we believe that a negative hit on Netflix revenues is less likely as few subscribers will change their usage as a result of the deal. Furthermore, competitors like Redbox are facing the same situation, thereby reducing incentives for customers to switch their film rental service.
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