Tuesday, August 2, 2011

Should Google Buy Netflix?

In a previous entry I described how  I tripped over a question that I found fun to ponder:
Should Google Buy Netflix?
The short answer I give is, yes, Google should buy Netflix.  Here's why:

Background:  Google as my TV provider

Although Google is my phone, my search engine, my address book, and on its way to becoming my email provider, Google is not yet my TV.   Google supplements my TV watching with YouTube.  Netflix supplements my TV watching, but in a very different way.  I watch YouTube in my home office on the computer.  I watch Netflix in my living room.  My YouTube watching is generally solitary.  I watch Netflix DVDs and Internet streams with friends, just like I do with regular TV.  According to an article in The Economist, Changing the Channel, this communal TV watching is one of the reasons for the continued strength of conventional TV in the face of competition from the Internet.

My TV still comes from a cable company, Comcast. With the purchase of NBC by Comcast, there is a vertically integrated monopoly from script writer, to my TV.  Comcast owns a piece of every link in the value chain.  

Internet streaming is a flanking attack on the likes of an NBC/Comcast vertically integrated monopoly of content creation and delivery: perhaps via Hulu, perhaps subscription via Amazon, perhaps through purchases via ABC/Disney/Apple.  Netflix is the stealth-leader, offering a tremendous breadth of content at a low subscription price with a set-top box that is widely available.

Think about Netflix like Android

I see some important similarities between a deal with Reed Hastings for Netflix and the deal with Andy Rubin for Android:
  • Netflix is building up a following in a new and intensely competitive market.
  • This new market, online video delivery, is in a space Google seems to want to inhabit.
  • Reed Hastings is an extremely talented entrepreneur who makes bold moves and makes them work.
  • Netflix has made it easy for people to acquire the hardware needed to access the service.

There are differences, of course:
  • The asking price, and ongoing cash flow to feed Netflix would be dramatically larger than Android.
  • Reed Hastings is not a technologist who fits into the existing Google "numbers and code" mindset.
  • It is unclear that Reed Hastings sees an advantage to selling to Google.
  • It is unclear that Google sees a significant advantage to funding Hastings and Netflix.

What Google gets from buying Netflix

The first thing Google gets is a ubiquitously deployed set-top box.  I expect the value of this aspect is under-appreciated at Google. Every other Google success, search, email, online maps/directions, smart phone market share, came when the new Google version came along and displaced entrenched competitors.

However, Google always took advantage of being crucially different and better than a group of evenly matched competing products. Google became a big player by displacing a group of smaller players. It's never had to displace a single dominant player. For example, when Google search appeared on the scene in 1998, it was a close competition between Lycos, Yahoo, HotBot, Excite, AOL and MSN. They competed with each other until Google differentiated itself from them all. The kind of market staying power, largely inertia from familiarity and existing big share was not a factor for Google here or elsewhere.

With web-based email services, Google gmail entered a market with no clear winner and lots of somewhat un-differentiated competition among Hotmail and the portal email services of Yahoo, Excite, AOL, and others. Again, many small players competing but similar enough to each other to give Google an opportunity to differentiate and dominate.

With maps and directions, Google was on-track to displace Mapquest, and Yahoo Maps on the desktop when it suddenly became the one that worked BOTH on your phone and on your desktop. This simple, direct differentiation lead to domination.

Lastly, with the smart phone market, Android entered and differentiated itself from Palm, Windows Mobile, Symbian, and Blackberry and is now in a two horse race with Apple.  I explored this in greater detail in my blog entry, Apple's "Moat" is its brand not IOS.

In the home video streaming market, there is a stealth leader: Netflix.  Netflix has a widely distributed set top box and an extremely broad range of interesting content at an attractive price.  In the set top box realm, we can say that Netflix has "solved the chicken/egg problem":  Consumers do not want to shell out for a set top box until the service is well established.  The service does not become well established until lots of consumers shell out for the set top box.

Whereas competitors, Google TV, Apple TV, Roku, Boxee, etc sell one set top box to get onto their service, Netflix has its internet streaming service built into BluRay players and other devices people already buy from over 200 vendors.  Google should have done this, but didn't.  Now it will have to negotiate a path Netflix has already traversed. Hulu too is available in some of these devices, but it does not have the breadth of content, and does not have the popularity and market familiarity that Netflix built.

The Reed Hastings Wild Card

Another big value I find in Netflix that may be  under-valued by Google is Reed Hastings himself.  Like Steve Jobs (Apple), John Chambers (Cisco), Larry Ellison (Oracle), and Page and Brin of Google, Reed Hastings is a business builder.  Commentators kept wondering when Netflix would be killed by Blockbuster practically until the day Blockbuster was liquidated to Direct TV.  Hastings has a flare for seeing a key to transforming an emerging market.

An article in Wired, Netflix Everywhere: Sorry Cable, You're History, alerted me to Hastings' cleverness with the deal he cut with Starz in October 2008. It bypassed the "windowing system" that studios have in place controlling who can show what films when.  By treating Netflix as a content aggregator, akin to a cable company like Comcast, Netflix gained the ability to stream a bunch of films over the Internet at the same time they would normally show up on a Starz, rather than waiting for a DVD to be made, or waiting until the end of the "90 day pay window."

That contract created a significant advantage for Netflix that Google TV lacked:  A license to stream 2500 movies much sooner than what the studios would normally permit.  This was a sweet deal that looked like the first step in rewriting the business model for cable companies.  But subsequently it came to be viewed as a one-off mistake by Starz that won't be repeated.  The other deals Netflix subsequently struck with EPIX and Relativity were more costly, involved the standard windowing rules and granted license to less interesting content than the Starz deal did.  Reuters, in Starz talks with Netflix weekly, no rush for new deal, reported how any renewal of the deal between Netflix and Starz will be for a lot more money and for a lot less access, so as to maintain their good relations with the conventional cable companies.  But Reuters also pointed out that a way to trump such a problem would be for Netflix to buy Starz.

Netflix needs to keep itself attractive by maintaining an ever broader range of available content, while confronting providers who want more dollars for less access. How will Netflix balance revenue against content quantity? That question is key to deciding whether or not to buy Netflix stock.  Alan Edwards posted in the blog The Markets Are Open a straightforward analysis of the present situation with speculation about the future and the conclusion that Netflix is on an unsustainable trajectory.

Now Hastings has answered that concern by taking the bold and controversial step of changing the structure and pricing of the service.  Although customers are up in arms, the move comes at a time when again, Netflix is the stealth leader.  When I look at the streaming content services, even at $8 a month, Netflix has the most content at the lowest cost, and is positioned to maintain that lead.  I'll grumble about paying more, but I'll pay it. Hastings is brilliant at making those kinds of business decisions.

If Brin, Page and Eric Schmidt could open their executive committee to one more member, Hastings would be a powerful addition.  But it is unclear that the four of them would want to work together.  I suspect Hastings would want to be the king, but that the other three like their Great Triumvirate just fine.

If Hastings were content to own the TV division of Google the way Andy Rubin owns the Android division, then Google should DEFINITELY sign the paper and do the deal. Google would de-cloak as the instant market leader in licensed content and set top box ubiquity.  If not, then Google will be playing catch up to compete against the NBC/Comcast vertically integrated cable TV monopoly and the Netflix stealth leader in the internet streaming realm.

Would the direction and culture that created Netflix survive the infusion of cash and sheer size that acquisition by Google entails?  Netflix is just big enough right now to be interesting, and to still get reasonable deals with studios and other content providers.  The combined Netflix/Google entity might be too scary for content providers to deal with.

On the other hand, with Comcast NBC preparing to become the 2000 lb. gorilla, might ABC/Apple/Disney want to acquire a stronger dissemination presence?  Perhaps Disney should buy Netflix.  Perhaps Netflix would sell itself to Google to prevent being taken over by Disney?  This space continues to evolve in interesting ways every day.

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