Netflix Raises The Ante for Hollywood

The outcome of the content spending frenzy will shape the TV business for years to come
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Netflix’s disruption of television takes many forms. There’s binge-releasing, which the service pioneered just three years ago. There’s its discovery algorithm, which guides subscribers to more content in its ecosystem without any of the shouty promo spots constantly sprayed at broadcast or cable viewers. There’s its ability to analyze how and what people are watching, with those findings augmenting the gut instincts of its human executives.

But Netflix is forcing the hands of its subscription video on-demand (SVOD) rivals these days with cold, hard cash. In 2016 alone, Netflix will spend $5 billion on programming, an amount almost unthinkable by recent standards. Amazon will come in at $1.7 billion and Hulu $1.5 billion, according to RBC Capital Markets. Because Netflix is favoring originals over off-network fare, FX Networks boss John Landgraf lamented the company’s “shock and awe levels of spending and commitment” during the TCA winter press tour.

Shock is a description for many networks’ state as the SVOD threat has grown. Landgraf and his peers complain that Netflix and its SVOD brethren are not held to the same standards that they are: ratings and profitability. Prestige shows? Fine, they concede, they’re making some of those. But we would kill for the luxury of not having to put up numbers!

Amid all of the grousing, through, rival programmers have mounted a strategy to fight fire with fire, and the results of this orgy of spending will shape the industry of the 2020s and beyond. In just the first quarter of 2016, numbers have come into clearer focus. Time Warner, which owns such properties as HBO, Turner and a half-interest in The CW, plans to spend nearly $5 billion on content this year, $3 billion of it by HBO, which also plans to boost originals on its OTT platform, HBO Now, by 50%. Other programmers are also boosting budgets, with Fox to ante up $3.83 billion; Viacom, $3.82 billion; Disney, $2.88 billion and Discovery $2 billion, according to a MoffettNathanson report released in March.

Netflix, Hulu and Amazon declined to comment, and network brass agreed to discuss strategy only on background.

A Swiftly Tilting Planet

The spending spree is already having ripple effects throughout Hollywood.

For starters, it is accelerating an ultracompetitive environment in which it’s hard to land talent for projects. With so many opportunities, many actors are getting straight-to-series offers, while others are locked into recurring roles. The environment is allowing Hollywood’s hottest talent to call the shots on their contracts, nixing shooting in places other than Los Angeles, declining what used to be typical seven-year series commitments and demanding fewer episodes per year.

What’s also clear is that the SVOD binge model has further strained the networks’ 22-episode orders and protracted series runs. Live-plus-seven-day ratings for two-thirds of returning broadcast shows have declined, inverting the conventional ratio of winners to losers, largely because viewers have grown accustomed to catching up in bulk…or even just skipping the premiere window and waiting until a show hits SVOD.

Creating a content bubble was already a worry—now it’s a certainty. FX said in January that there were 409 new scripted series on the air across distribution platforms over the course of 2015. That number is likely to surge past 500 this year. And how about this stat, courtesy of a report by Redef.com: In 2014, Hollywood cancelled more TV shows than it produced 15 years ago.

If a production company can’t monetize its shows, it will stop producing them, making that pace of production economically impossible to maintain. And if networks can’t get viewers to discover their shows, in a world of skinny bundles, they could end up frozen out.

Netflix is spending the big money for several reasons. The company is pulling back from acquired product. For starters, studios have become wary about selling their shows to SVODs rather than keeping them for themselves, fearing their cash grab (a hard one to resist, given the talent and the money involved) could be helping to create viewer habits that directly harm them.

“We are evaluating whether to retain our rights for a longer period of time and forego or delay certain content licensing,” Time Warner CEO Jeff Bewkes declared during a November 2015 earnings call. “This would effectively push the [SVOD] window for content on our networks to a multi-year period more consistent with traditional syndication.”

Netflix, meanwhile, wants to be able offer its shows in all of the worldwide markets it serves. And it is moving from acquiring the non-exclusive syndication rights for shows that run first on cable and broadcast networks to increasingly acquiring the exclusive rights.

Going Global

In 2015, Sarandos said that Netflix’s priority was to acquire global rights for shows, allowing the service to air those programs in all of the countries to which Netflix was rapidly expanding. Netflix partly accomplished that goal when it bought Warner Bros.’ Gotham, which Warner produces for Fox in the U.S., for an estimated $5 million per episode across many—but not all—of the territories it serves. Between Fox, which probably paid a license fee for the show in the range of $3 million, and Netflix, Warner Bros.’ costs to produce Gotham were more than covered, creating an ideal production scenario.

Still, brokering such deals quickly proved too difficult in most cases. Studios have existing output deals and clients in the various territories, and it’s not so easy to just sell shows to one buyer, cutting out everyone else. By last December, Sarandos was backing down on that stance, admitting to the difficulties.

That’s largely why Netflix has turned to producing its own shows: so it can own the exclusive global rights.

There are some limits to the profligate spending: Netflix has been unwilling to pay top price for shows that had more than five current episodes available at any given time on other platforms. That stance had prevented studios from allowing their network buyers to air full current seasons on their own on-demand platforms, such as Watch ABC and CBS All Access.

That logjam has, in turn, created chaos not only for the networks but for consumers. In some cases, past seasons of shows might be available on SVOD platforms, and the most-current five episodes are available on-demand. But the rest of the current season may not be available, which keeps consumers from being able to fully catch up. (Sometimes the chaos produces odd spectacles, like FX running on-air promos for Amazon Prime as the destination where viewers could catch up with prior seasons of some of its shows as opposed to, say, VOD.)

By agreeing this month to allow ABC to air all current in-season episodes on its on-demand platforms, Warner Bros. solves that problem, but only for shows produced by Warner Bros. and ABC. (As part of that deal, ABC also will air all episodes of shows it produces on its on-demand platforms.) The pact sent a clear signal that networks want to control their destiny as Netflix does, pushing their own vertical OTT destinations—either authenticated TV Everywhere or stand-alone subscription services.

The Consumer Conundrum

For Netflix, or anyone else, for that matter, it’s not clear there will be a big ROI for all the spending on content, in part because picking a hit is like betting in Las Vegas. And consumers can be cheap—and finicky.

Research is increasingly indicating that consumers won’t necessarily be inclined to buy multiple subscriptions to get all the shows they want to see. MoffettNathanson’s report found that Netflix households watched CBS 42% less than nonsubscribers, while they watched Fox 35% less, ABC 32% less and NBC 27% less.

“There’s five shows, maybe six, that people feel they have to watch,” says Rich Greenfield, media and technology analyst at BTIG and a noted Netflix bull. “There’s a huge opportunity to give consumers exactly what they want: ad-free, bingeable content.”

Many wonder how long Netflix can deliver such an overflowing buffet of options for the basic rate of $7.99 monthly—the cheap price is one of the main reasons for its volume of subs.

The median household income in the U.S. before taxes and adjusted for inflation in 2014 was $53,657, according to the U.S. Census Bureau, and average household disposable income was $41,355, according to the Organization for Economic Cooperation and Development. The average monthly cable bill in 2015 was just under $125 ($1,500 annually), with many networks that most subscribers don’t watch.

A Bundle of Challenges

Perhaps the biggest losers in this new bidding war are cable networks. Some basic cable networks, either because they lack ratings or big-brand status, will be deemed unworthy of a skinny bundle—and face a looming existential challenge.

“Netflix is shifting consumer behavior, and the end result will be smaller bundles or cord-cutting,” Greenfield predicts.

The results are already in on that trend, with Wall Street hammering cable company stocks that have had to declare subscriber losses, including Viacom and Disney.

Even ESPN, a network whose dominance was seen as unshakable not so long ago, has seen subs drop by 7 million over the past two years as viewers cut the cord. That’s putting pressure on its business model, which relied on demanding a huge per-sub fee of about $6 monthly and then paying high prices for exclusive rights to sports. Disney chief Bob Iger, after long batting away concerns about ESPN, has recently touted the viability of skinny bundles.

“The rise of high-quality SVOD services reduces the need for as large a range of channels in order to have something to watch,” says Dan Cryan, IHS senior director, broadband media. “The non-premium channels that flourished under the traditional bundle are undoubtedly coming under pressure, and that’s only going to increase.”

Netflix’s disruption of television takes many forms. There’s binge-releasing, which the service pioneered just three years ago. There’s its discovery algorithm, which guides subscribers to more content in its ecosystem without any of the shouty promo spots constantly sprayed at broadcast or cable viewers. There’s its ability to analyze how and what people are watching, with those findings augmenting the gut instincts of its human executives.

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