With all the non-stop mentions of how popular OTT services are, the one thing no one seems to be talking about is how any of these OTT providers are actually going to make money and become profitable. For years, many said the key to the success of any OTT business was simply to get enough scale and subscribers to cover the costs of licensing and distributing content. But even as we have seen with Netflix (NASDAQ:NFLX), scale doesn't get you to profitability when the cost to license/create content is so high and the price you can charge the consumer each month is so low.
Netflix's subscription rates haven't grown as fast as it needs them to and the company can't raise prices each year the way pay-TV providers do. When content costs go up in the pay-TV world, they pass those costs on to the consumer with higher rates. But when content costs go up for Netflix, Amazon (NASDAQ:AMZN), Hulu, Sling TV, PlayStation Vue, etc., they end up eating those additional costs and rarely raise their monthly rates to consumers. Viewers have become accustomed to OTT packages in the $6-10 range for VOD and it's a sweet spot as we have witnessed. Each time Netflix has raised rates, it has lost subs.
With more competition entering the market, content licensing costs have skyrocketed as more OTT platforms have been bidding up prices. As of last quarter, Netflix has streaming content obligations that total over $13B and its licensing costs have grown by more than 50% from 2010-2015 while its revenue has only grown 26% compounded annually. While breath and depth of catalog used to be how Netflix promoted its offering in the market, now it has so many competitors that original content is the only way to differentiate the service. Netflix is spending nearly $5B in content licensing/creation costs in 2016 alone and extrapolating out the numbers simply doesn't work in Netflix's favor. The company could literally run out of cash before the number of subscribers can support the business.
And it's not just video. Spotify's (Private:MUSIC) revenue grew 81% last year, but royalty fees jumped 85% to nearly $2B, taking up 84% of Spotify's revenue. CBS (NYSE:CBS) said it lost money on its content licensing deal with the NFL last year for eight Thursday night games and that was for pay-TV, not online. And internally, people at Twitter (NYSE:TWTR) who don't want to go on record confirm that they will lose money on their deal with the NFL as well. Content licensing costs aren't just a Netflix problem, or one tied to VOD content, it's a system-wide problem across music, movies, broadcast TV, for VOD and live linear. That's why no standalone company can ever afford to offer live linear services and has to be owned by an ISP, carrier, MSO or large company in the ecosystem like Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Sony (NYSE:SNE), Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), etc. Sling TV would not survive if it weren't owned by DISH Network (NASDAQ:DISH). And DirecTV Now is a service that could not afford to be in the market if AT&T (NYSE:T) didn't own it. These OTT services are loss leaders for other products and services these companies are selling, or enable them to generate revenue from other services tied to it, like Amazon has with its Prime service. But even then, it's no guarantee that OTT will make these companies more money in other ways. Hence why so few of them are willing to break out any actual numbers on their OTT offering or the impact it has on their other lines of the business.
In 2015, Microsoft disclosed how it stopped all plans for live TV service to the Xbox as it said the content licensing costs were so high, it could never create a profitable business from it, at the price point consumers would pay. Hulu's monthly fee of $12 a month with "almost" no commercials isn't enough to offset the cost of licensing content, as the company isn't profitable. Talking to those who saw the term sheet when Hulu was being shopped around last year they say Hulu has had over $1B of cumulative losses since 2008. And then we have guys like Yahoo (YHOO) who lost $42M in 2015 on licensing and original content creation and there are plenty of one-off examples like that to go around.
In any other segment of the industry, we typically judge the success or failure of a company based on their profit and loss statement. Yet when it comes to these OTT services, many want to judge their "success" based on the number of subs they have without looking at profitability. Why are so many giving these OTT services a pass? And even if we do look at the number of subs, if we strip out Netflix and Hulu, none of the other major OTT services even have 2M subs, with many well under 1M. CBS All Access and Showtime each have 1M subs, as they reported in the summer. HBO Now had over 1M subs a couple of months back. Sling TV and PlayStation Vue won't put out numbers, but are without a doubt have under 2M subs, with my bet being that both are under 1M. DirecTV Now is new in the market, but the company's own internal projections are for 1-2M subs by the end of 2017. Hulu reported 12M subs, six months ago, which was up from 9M at the same time period, yet its growth slowed from 2014-2015 when it was growing 50% at the time.
The trickle down effect of what is happening, to everyone in the video food chain, is that Netflix and many of the other OTT services are bidding up prices for content that is so high, that even some cable channels and even studios think they won't be able to compete. So while we have a lot of choices right now as consumers, the business of licensing content has to change if any of these companies want to make it long term. The current way of licensing content and the costs that go with it don't support a profitable business models. As a result, many of these OTT services are going to be impacted and will probably get re-packaged through an aggregator like Amazon, which we are already seeing take place. At some point, profit and loss of the OTT business will matter, for all of these companies.