The Broadband Dilemma and Netflix

Jonathan A. Knee wrote a short article in the July/August edition of The Atlantic that should be required reading for every businessman “Why Content isn’t King” (http://www.theatlantic.com/magazine/archive/2011/07/why-content-isn-8217-t-king/8551/).  In this article he explains why Netflix has been successful leveraging distribution economies of scale and building loyalty in their customer base despite the predictions of many market analysts.  The Netflix business model runs contrary to the conventional wisdom that consumers are only interested in the content, not in how it is delivered, and that the real profitability in the value chain lies with the content producers.  Knee argues that content producers suffer from two real problems... 1) that there is no long-term loyalty to content producers, particularly to the production houses and that 2) there is no substantial economies of scale in production, despite a hundred years of “industrialization” on movie/TV/music/video production experience.  The only place in the value chain where economies of scale exist are in distribution and that it doesn’t take much to create customer loyalty when competing with the likes of the cable MSO’s.

When I was at Ameritech Services in the 1990’s, I was involved with a lot of study work and network planning around the deployment of broadband networks to the home (ADSL, FTTC, FTTP, etc.)  The Broadband Dilemma as it was expressed then was as follows... how do you build a business case justifying broadband deployment when the vast majority of the investment is required for the distribution network while the customer willingness to pay is associated with the broadband content?  If you can force the bundling of content with the distribution network, as cable companies did, then your business case would work.  If you were forced to unbundle the distribution network and offer it to your competition, then you were stuck with low rates of return on investment and you would never be able to attract capital for this build.  In the mid-1990s, Ameritech concluded that the regulatory environment was the problem and our competitive response to the threat of Cable MSO’s offering broadband data and voice was to become a second cable operator in a few of our most vulnerable markets and compete with the MSO’s on their turf with the same regulatory structure.  Subsequent regulatory change on the telecom side (Telecommunications Act of 1996 and following court decisions) allowed deployments like Verizon’s FIOS to move forward in the last decade.

The Netflix model does a number of interesting things:  first, Netflix leverages existing distribution infrastructure investments (the postal system and broadband deployments), it also relies on existing customer premises equipment (PCs, Blue Ray players and game systems), so Netflix isn’t picking up all the cost of the distribution network, just some pay as they grow costs for servers, processing centers, advertising, etc.  They have bridged customer loyalty built on bettering the Blockbuster business model into the video on demand business... they have not allowed a particular distribution technology to define them, but rather, they have focused on customer satisfaction.

I have been a happy Netflix customer for years and use their instant download services through a Sony Blue Ray system attached to my cable modem via WiFi.  Ironically, Comcast provides the infrastructure for Netflix movies in my house.  What’s your experience with Netflix... how do your view their business model and long-term prospects for growth?