Amazon (AMZN) finally threw down the gauntlet in the video subscription war. It is now offering over 5,000 movies and TV shows as part of a paid subscription to Amazon Prime. Amazon has iterated its online video service (from Unbox to AVOD to the Prime bundle) and seems to be committed to the space. Its commitment likely stems from a logical fear that the business of selling physical discs is declining faster than Amazon is gaining market share in video.
Nonetheless, while Amazon has the capability and some of the motivation to compete with Netflix (NFLX), it may not have the financial will or the strategic necessity. Amazon is a very complex business with lots of moving parts and many areas of rapid growth. It doesn't need its online video subscription business to succeed for Amazon as a whole to succeed.
The same cannot be said about Netflix. It will fight hard for leadership in this space, since it is an existential issue for it. Amazon won't need to (and therefore won't want to) sacrifice profitability to do so. In fact, the way that Amazon has structured this new offer implies to me that it is largely about drawing new customers into Amazon Prime. I suspect that many customers will end up like me: Amazon Prime customers and Netflix customers.
Now, even if you assume Amazon will be irrationally aggressive in this space, I still think Netflix will remain the dominant force in U.S. subscription video for quite a long time. My reasons:
- Customer critical mass. Netflix has the second-largest video subscription base of customers, behind Comcast (CMCSA). It can spread the cost of any incremental or exclusive content across a 20+ million user base that is rapidly growing.
- Content negotiation. Netflix has the strongest negotiating leverage with studios of any company, as it is the largest customer of discs and the largest streamer of movies. While Amazon could afford to start a bidding war with Netflix, it would be investing heavily just to try and catch up -- much less surpass -- Netflix. Prime costs $80 a year, but that money will be needed to defray postage costs for Prime Members and content costs. Amazon will quickly find it uneconomical to compete.
- Customer inertia. Customers are lazy; they've got their queues, their ratings and recurring billing already set up. Netflix's recommendations actually work for people -- why give that up?
- Brand awareness. Netflix is everywhere. The mailers are in 20 million homes. Everyone knows what Netflix does. It is simple and easy to get started.
- Ubiquitous product integration. Netflix is integrated into nearly every new TV, Blu-Ray player, game device, and smart phone. Amazon might get there, but it will take time. It will be interesting to see if Amazon can even get its video app onto the Apple (AAPL) TV or the iPhone.
- The slow death of DVDs. Amazingly, DVDs still matter -- and will for a while. People like seeing the latest movies that studios won't stream via Netflix or Amazon's unlimited plan. People also like getting their HBO and other disc-only content for a reasonable cost. Everyone still has a DVD or Blu-Ray player. Heck, most people can play DVDs on their computers. This makes the "dying" part of Netflix's business a competitive asset.
- Netflix just isn't that expensive. One flaw of the Netflix-bashing argument is that it maintains that many users will say, "Hey, Amazon's service is free!" so customers will quit or skip Netflix altogether. If Amazon matched Netflix's content (which it won't) and sent discs of the latest movies and TV shows, then that argument would work for a rational person -- the mythical "economic man." Humans don't act rationally, but they do act out of convenience. Netflix is $10 a month, people love it, it has tremendous brand momentum and is simple to use. Why bother with something else?
As a quick aside for all the Sirius XM (SIRI) fans out there -- I could basically write a similar post about why SIRI will triumph over would-be contenders Pandora and Spotify. A critical mass of paying users allows for the best and most exclusive content, which reinforces the critical mass of paying users.
For a great look at how Netflix came to dominate the video landscape, check out this graphic from The New York Times.
So what could Amazon do to become more competitive with Netflix in the U.S., if it were willing to take the financial hit?
- Expand the offering rapidly by paying for more content. It really needs to notably outdo Netflix.
- Offer 1-3 current hit movies per month free.
- Find content Netflix does not have and lock it up exclusively.
- Integrate with every consumer electronic device imaginable.
- Buy Hulu and lock up long term (ideally exclusive) deals with its current owners. Hulu's CEO, Jason Kilar, worked for Jeff Bezos -- those two should talk!
Internationally, Amazon is a contender with its purchase of Lovefilm and Netflix's minimal efforts to date. In the U.S., while I believe Amazon will only dent Netflix's growth, this was a very savvy move for Amazon. It promotes its Prime service, which was already awesome but likely underpenetrated. If other consumers are anything like me, these new Prime customers will dramatically increase their purchasing from Amazon to the detriment of other online and offline retailers. Amazon has said as much in past earnings calls. Prime makes an already competitive Amazon almost irresistible to savvy online shoppers, and the free streaming option makes an already compelling Prime offering a no-brainer for fence-sitters.
The ultimate winners may well be the content producers who have been looking for a credible threat to reduce Netflix's growing clout. While Amazon and Netflix will both continue their amazing growth, both will likely have lower margins because of Amazon's entry. How will that impact on their super-charged, high octane, high-flying stocks? That is another story for another blog post.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
