January 22, 2007

Netflix in 2017?

From The Fool

I'm interested in hearing what others think Netflix will look like in 2017. I'm probably going to hold my shares that long, so the question is an important one for me. Putting on my way-future goggles requires a little looking back first, and a really long post. I apologize in advance for the length, but this was pretty fun to write, so if you don't want to read the reasons, you can skip to the end where I sum up my predictions. I suppose I could use a good editor.

First, I want to talk about Pepsi and Coke. Coke, for years, offered it's unsettlingly addictive drink in a 6oz (yes, it was that small) bottle. They dominated the soda market, their branding rocked, and the trademarked bottle design remains with us today.

Enter Pepsi, and they... Double the size you can buy for the money to 12oz. Advertise to African-Americans in the 40's. Publicize with public taste tests. Hook the youth market with snazzy ads and pop music stars. Pepsi took Coke's old-fashioned market dominance and made itself look new and cool, eventually becoming the clear winner as a company, even as their namesake drink flails in popularity. Netflix has a similar future ahead of it if it moves into digital content and away from DVDs, and they definitely have an edge over unpopular BBI in terms of coolness factor.

Soda is a commodity product. You could probably make it in your basement. These Pepsi and Coke are billion dollar brands and companies because of marketing power and customer satisfaction. Period.

I saw it said by another poster that eventually movie downloads will be commodity products. I beg to differ, but even if you assume this is true, which we must as cautious investors, the two things that Pepsi and Coke have -- brand power and a highly satisfied customer base -- are the keys to maintaining large, powerful, and relevant businesses spanning decades.

So, when I say (and I do) that Blockbuster will go into bankruptcy, I'm very serious about that. However, I do not think that BBI will disappear from the landscape. They will undoubtedly restructure, and I suspect that investors and bond holders will lose out, but BBI is too important to our movie distribution system to go away completely. BBI learned some hard lessons from Netflix about customer satisfaction, and they are executing to make changes. They could be the greatest turn around story since 90's Marvel emerged from bankruptcy.

When they work through their financial troubles, Netflix and BBI will continue to be the Coke and Pepsi of the movie rental marketplace. Why? Because when you want to 'rent' a movie, you think BBI or NFLX. You don't think, "Oh, I'll rent from Apple or Microsoft tonight."

Now back to the present. Remember Microsoft and Apple? They're both engaged in their own wars, both fighting with consumer preconceptions to get their OS's into our living rooms. Really, do you need a DVD player, CD player, video game machine, and DVR lined up next to your TV? Heck no. All you need is one box, discretely hidden next to your 200 watt receiver. MS and Apple (and Sony -- PS3 anyone?) want to own that operating system. They want to own your living room experience. Apple has the styling and convenience edge. Microsoft has the ubiquity and familiarity edge. One or all will succeed in changing customer behavior in the next 2-5 years to make sure that you have a web browser available on your HD flatscreen.

Netflix does not need to develop a box. It would be irrelevant if they did so, in fact. They can (and should) be agnostic about whose box we consumers choose, just as they can remain agnostic in the HD format war. They've got a Flash system for Bob's sake. It runs on Internet Explorer and probably on Firefox and maybe even Opera. It will run on whatever MS or Apple manage to coax in front of the family -- so long as it isn't a video game system with proprietary access such as the XBox Live system. While this kind of exclusive video game box could gain popularity, I doubt they will be the first and best choice for consumers.

Since you have YouTube, Netflix, and probably BBI wanting to be the main rental/immediate gratification providers today, and Apple and other download sellers trying to download to your hard drive, when the masses start to demand this service, they will want a home media box that allows multiple formats to play from any internet connected source company. Users won't want to be restrained by a one-company system if there's a choice.

In 3 years, a cheap computer with a killer graphics and sound card will probably cost $2-300. Will we bother buying a PS3 or Xbox at that time when we can get a great experience from this inexpensive equipment without being bound to Sony or Microsoft licensed content? Most people won't.

This is why people are waiting to buy Xboxes and PS3s and Wiis. They're unsure which will have the best content. With Netflix and other providers sending content, it's a no brainer. Buy a cheap computer and hook it up.

This is where cable companies will fall down, and where Sony and MS will fall down if they try to lock users into a box that restricts their access to content.

So, I think that Netflix's choice to ride a browser window will leverage any popular boxes, should they appear. If they do not, no biggie. Their core DVD rentals will continue for years with it or without it (I suspect disc based media will still comprise at least 50% of revenues in 15 years, even with an internet based box by the TV, since consumer habits are hard to change and our bandwidth limitations in the US).

Next, let's talk about IPTV and VOD. Should the cable companies manage to grab government sponsored monopolies on digital content through IPTV using their considerable bribery (Ahem, I mean lobbying) of government officials, the monopolies will likely create user dissatisfaction and high prices. This would be bad all around, and probably not be a happy place for movie and TV distributors, as the cable companies would have undue holds over them. If the DVD disappears, as we all believe it will, those companies will need to make up their margins somewhere. They will need to squeeze it out of the Netflix's and the Cable providers. Therefore, I believe that Hollywood favors a competitive end-user distribution landscape if they can't keep it to themselves. So, I don't feel that cable can monopolize IPTV in the real world, no matter how hopeful the Verizons and AT&Ts are about their futures.

Should the telecoms and cable companies not gain power to restrict IPTV content to themselves, they will become just one other VOD content provider, just like Netflix and the other competitors.

They will also lack the customer content decisioning system that Netflix already has in place. Netflix moved first in creating a recommendation system for customers, and they have never lost their lead. The lead means that Netflix customers will be the happiest customers, since Netflix will have the most customer data from which to pull relevant recommendations.

BBI will start to frustrate customers once again as it closes more stores and goes through its internal struggles. TA customers are now in the Honeymoon period. They love their free movies. When their local store closes, their satisfaction will plummet. This will be unavoidable. Cable companies also have long histories of poor customer relations, and have no experience in creating a strong customer-based interface tool. They would need to design one, and try to steer clear of Netflix's patent, unless they wish to join Blockbuster as a defendant. Also, they will probably want to puts ads on much of their content, which will continue to differentiate Netflix.

So, what does this mean for the future?

1 year)

BBI will continue TA for as long as they can keep their loan payments going, at break even. Subscriber acquisition numbers will start to drop in a few months as store renters are mostly converted and the well runs dry. Then it will be all advertising, and both Netflix and BBI will fight it out in a battle to rival the Cola Wars. Netflix will allow all users streams on 1000-2000 titles. They will continue to meet their stated subscriber and income goals most quarters.

2 years)

BBI will have to end TA at some point, or close enough stores as to render TA valueless to 50% of their current users. We will reach a store closure tipping point around this time. Netflix will offer streams on 3000-6000 titles. They may have to dig into their Line of credit to do so, but will be easily able to make payments and continue growing income at about 50% per year. Canadians and possibly Mexicans with decent internet connectivity will be able to start streaming meaningful amounts of content from Netflix and possibly BBI (assuming BBI's recent announcement about 'maybe' getting into digital distribution isn't complete bull). This will open up the previously closed Mexican market, as their existing postal service is a joke. It will also allow Canadians to rent despite their lack of local distribution centers.

Netflix will start advertising in video games, and will roll out a beta of their first phone video preview service.

4 years)

IPTV will roll out in major metropolitan areas such as NY, LA, SF, Chicago, Boston, Houston, Miami, and San Antonio. These rollouts will likely serve small (read: affluent) percentages of every zip code, and will not roll fiber to the home, but more cheaply to the curb. Still, IPTV will become a reality for most left-wing blue-state pinkos like myself. The government will take a wait-and-see approach to regulating the cables and telecoms, but by this time will likely have created some unruly regulation system that slightly favors cable companies while keeping competition open on the internet. The regulations will probably make no sense and be in the courts for years as technology and user behaviors outpace the law even as the new president signs it. Netflix will offer 10-20 thousand titles through VOD and 150,000 via hard media, of which about 300-500 will be proprietary content comprised of small independent titles. Some users will experience DVD or higher quality resolutions through their new FOTC networks, others will have to suffer with DVD quality only.

Blockbuster will have worked out its financial woes by now, one way or another. Despite their best marketing, BBI's subscriber base will lag at half of Netflix's. BBI will have closed at least half of their stores by now, and remaining leases will have been modified or shortened. Video games will finally be recognized as art and should have a more episodic feel and come out with smaller modules, more often. Computer supported design will speed delivery to market and a few will even be as compelling as 24 or LOST. Video games and other interactive entertainment (read: porn) will start to cut substantially into consumers' TV time.

10 years)

Fiber optic should run to 60-80% of the US, and most of Europe. Asia will probably institute a huge infrastructure rollout by then that will bring high-speed access to their expanding middle-classes. Netflix will still rent 50-70% of its content via physical media, as more non-tech-savvy individuals realize that online renting is easier than online banking, but are still unable to set the time on their DVD player. Television episodes will expand to be 50% of the rental market, as the sheer quantity of TV shows on DVD will greatly outnumber the number of movies available by then. Studios will not control their end user distribution, but will license content to the major providers, who will be Netflix, its clones, and telecom/cable companies. Most home televisions will support widescreen 1080i or better resolutions, and we'll be debating the next generation of video or holographic imagery and what kind of storage space will be required to deliver near-realistic wall-sized images on these boards. Home projection systems will be commonplace, but considered a luxury item. Wii3 users will have dents in their walls instead of cracked TV displays.

Microsoft will own the living room, to Steve Jobs dismay. The 4 inch iPod will be a quaint antique, like a Walkman tape player.

Realistic HD worlds will exist online, and with motion control, people will immerse themselves in Warcraft type games to keep fit. Interactive neuro-stimulators will allow game players to feel hits and environmental effects without actual harm to your body. This technology will, of course, be embraced by the porn industry first, and will be outlawed by states like South Carolina and Georgia. (You think I'm kidding, but I'm dead serious about this prediction. Ten years.)

15 years) (Okay, what follows is mainly fantasy...) Network speeds will be faster still, with the increased speed of servers and components, but infrastructure rollouts will be expensive and difficult. Cable companies will have had difficulty getting return on their infrastructure capital investments, once again. Medium range WIFI peer networks, which I expect to start out by distributing data to rural areas, should by now cover most of the country as cheaper, upgradable alternatives to upgrading copper from the curb to the home. All data equipment from phones to computers (if such a distinction even exists then) will be wireless and use battery power for extended periods (I already have NIMH batteries that charge in 15 minutes and provide about 30 hours of play time). Cars will still run on gasoline (and Iraq will be the 52nd state, after Israel (Just kidding)). Small robots in swarms will accomplish meaningful tasks such as physical security and perhaps harvesting and planting crops, but still won't be as cost effective as labor in poor countries for textile and detailed equipment manufacturing. Netflix will probably have upward from 30MM subscribers throughout North America. Their recommendation software will decide what to send or download to you next as an option, and it will make better decisions than you would if you did it on your own. They will still have the highest customer satisfaction in the world, and they will never open a Kiosk or a physical store location.

That's my story, and I'm stickin' to it. For this week.


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