Netflix: Open Connect Will Likely Fail

| About: Netflix, Inc. (NFLX)

Hot off the press, Netflix (NASDAQ:NFLX) just announced that it is launching its own content delivery system for its videos. The content delivery network that the company plans to launch is called Open Connect.

This will essentially mean that Netflix will be its own video host. It will no longer have to use and rely on third-party CDNs to host its videos. The third party CDNs would host the videos that would then be delivered to subscribers, via their Internet service providers (ISP) for streaming purposes. At the consumer level, it means that people making use of Netflix will have a faster connection. Netflix says that this is the obvious next step. The other major players in the field, such as YouTube, have hosted its own videos for a long time.

Now that Netflix has grown as much as it has it makes sense that it starts to move toward having its own content delivery system. This is not something that will happen immediately. For now, Netflix will continue its relationship with the CDNs that have served it so far. Over time, it will gradually move more and more of its functioning to Open Connect and in the long run all of its video will be delivered by the new system. At the moment about 5% of Netflix is on Open Connect. Over the next few years this percentage will increase, but at a very gradual rate.

Netflix's plan is not seen as a threat, although initial market reaction implied that people felt this move would have a serious and negative effect on content delivery companies. Shares of Limelight Networks (NASDAQ:LLNW), Akamai Technologies (NASDAQ:AKAM) and Level 3 Communications (NASDAQ:LVLT) dropped after the announcement was made, illustrating the market reaction to the news. As things stand at the moment, it simply seems that there really is nothing for these companies to worry about. These companies will now be able to use the freed up bandwidth to attract higher margin customers. The CDNs were not making a great deal of profit off of Netflix in any case. About 20 to 30% of U.S. internet traffic is due to the service of Netflix. This has allowed the company to drive a very hard bargain and other companies have not succeeded in making much a profit for the deal. In fact, companies like Limelight have made such a small profit from Netflix that it has actually refused to raise the company's volumes. And Akamai says that it is far from surprised by these developments as this is a path that Netflix has been talking about taking for many years now. It also stated that the situation does not affect Akamai in any material way.

In addition, analysts are not entirely convinced that Netflix will be able to create a viable product. Netflix has tried to do something very similar in the past, but failed. This could decrease the company's credibility in this endeavor going forward. The fact that Open Connect can only handle 5% of the traffic at present does nothing to improve my perception of this stock's chances of moving to its own content delivery system. (NASDAQ:AMZN) knows that if it wants to keep up with the increasing demand for e-books it will have to keep on expanding the list of titles that it has available. In line with this knowledge the company recently acquired Avalon Books. This is a publishing company that has been around for 62 years. The actual amount that paid for Avalon is not clear at this point, but the important thing is that this stock now has 3000 additional titles on its site on top of the huge number of titles that it already has the rights to distribute. Amazon continues to grow its selections, and the expansion is felt across each industry it works in.

A company that competes at a similar level to Netflix is Verizon (NYSE:VZ). Recently, this company tried to soften the blow that the price of prices for new tiers of Fios broadband service will go up by stating that consumers will have more flexibility in creating bundles with Verizon Fios video service. What this could mean is that users may in fact end up paying less every month if they know how to make this flexibility work to their advantage. For the sake of the stock, I do hope that this is true. Verizon stands to anger customers with its price change, as new options are increasingly becoming available.

Coinstar (NASDAQ:CSTR) has entered into a deal with Starbucks (NASDAQ:SBUX) to operate thousands of kiosks that will very soon be available in grocery stores, drugstores and mass-market retailers. Starbucks has signed an exclusive deal with Coinstar to roll out the coffee kiosks that it has been testing. By aligning itself with such a popular and universally recognized brand as Starbucks, Coinstar may be on the right track for achieving greatness in its capacity as a tech stock. It is already doing well following the announcement as its rose in extended trading shortly thereafter.

Netflix competitor Best Buy (NYSE:BBY) has selected the consumer tracking service of The NPD Group to keep track of "market sizing, share measurement, and demographic assessment of the consumer electronics, information technology, and mobile phone industries". Essentially this will allow Best Buy to identify key consumer trends which in turn will allow it to focus its marketing strategies on those areas that will yield the highest return. As a strategy, this is obviously a good move to make. This will keep Best Buy ahead of the competition in terms of keeping up with what its target markets want.

Netflix's step is the right one. The independence is a natural progression of its business model. However, it's started small for now and growing pains can be expected. The move is nice for longer term investors but may not do much for the stock price right now.

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

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