SOPA, PIPA, Intellectual Property And Netflix

Jan.24.12 | About: Netflix, Inc. (NFLX)

Tensions boiled over as the internet partially shut down last Wednesday, January 18, in protest over SOPA and PIPA, the Congressional bills intended to crack down on online piracy but viewed by many as being potentially invasive and harmful to internet users and the internet itself. The anti-SOPA/PIPA movement began largely in internet communities like Reddit, but the blackout ended up being supported by Wikipedia, Google (NASDAQ:GOOG) and thousands of other large and small websites.

Following the protest, the authors of the bills agreed to back off - it seemed as though the internet had won. But then, news broke that the proprietors of MegaUpload, a popular video and file sharing site, had been arrested (including pictures of seized luxury vehicles). Legitimate users were upset, as they suddenly lost access to important files, and the group Anonymous fought back, shutting down websites of various government and commercial groups. Since then, some other file sharing websites have voluntarily limited some features.

The eventual results of these bills (or similar ones), government actions, activist reactions and associated activities will be one of the most important external influences on Netflix (NASDAQ:NFLX) in the foreseeable future. Netflix will face unique challenges if it must exist in high piracy/low regulation or low piracy/high regulation environments. Netflix will likely lay low and not support the unpopular bills or outwardly oppose them, but they should be planning for how to do business in any future environment.

An elevated-piracy environment could potentially be a great thing for Netflix. If content owners see their content being distributed without receiving any financial benefits, they will be likelier to negotiate terms favorable to Netflix, who can help them monetize beyond box-office tickets, pay-per-view users or DVD sales. Additionally, Netflix would look like a "good guy" in the eyes of consumers - Netflix is fighting big media, to provide entertainment to consumers at an affordable rate. However, if piracy becomes too prevalent, Netflix will lose savvy customers who can get content (including new releases and popular shows, which Netflix doesn't have anyway) for free.

However, a low-piracy environment could also potentially be good for Netflix, too. If, theoretically, movie studios and TV content creators completely eliminated piracy, they could charge very inflated prices for content. Again, Netflix could benefit from being a low-cost provider - if renting a new release was $10 through iTunes, a lot more people would be attracted to a $10 Netflix all-the-decent-content-you-can-watch package.

But a low-piracy environment could also lead to the death of Netflix. Content owners would have no reason to provide kinder terms to Netflix than to consumers, and Netflix would ultimately have to raise prices and/or decrease content. (This has already begun, though not because of piracy issues - the rising cost of content is widely recognized as one of the biggest threats to Netflix's business.)

Despite developments like SOPA/PIPA and the MegaUpload raid that appear to threaten the freedom of internet users (including the freedom for some to commit illegal acts), I would not expect there to be any serious conclusions in the immediate future. The collective power of internet users was demonstrated during the blackout on the 18th - I cannot recall another time when grassroots organization succeeded in affecting societal institutions (i.e. Wikipedia shutting down) and government policy. The internet seems to do a pretty good job of policing itself, and an excellent job of fighting back when attacked (as Anonymous members demonstrate every time they cripple important government and business websites), so I don't think that a government effort to punish with tougher regulations would come to fruition. Lastly, businesses like Google seem to understand what is in the best interest of the average internet user, and are willing to campaign for those rights, when necessary.

Internet piracy will never completely go away, but the ebb and flow is something that Netflix must keep an eye on. Working with studios to maximize revenue for both entities in the context of whatever current piracy climate will be their best hope at a long-lasting, successful business. However, Netflix cannot be seen as being too cozy with the MPAA and big media without becoming associated with the unfavorable legislation. Netflix has already been victim of public backlash when they raised prices in 2011; hopefully that experience will encourage management to be conscious of acting in the best interest of customers and interested observers in the future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.