United States – Netflix

Contributed by Amanda D. Lotz

March 2017

 Key Takeaways

• Netflix first established itself as a DVD by-mail business and pivoted to streaming after decimating the video rental business

• Netflix was more willing to innovate than other television and film companies that sought to preserve the legacy practices and revenue streams

• Netflix substantially acculturated viewers to nonlinear viewing protocols

• The corporate history of Netflix is most uncommon both in its evolution of a DVD by-mail, to US, to international streaming service, and in terms of breaking into an industry with very high barriers to entry

Market

Netflix’s US market entry considerably pre-dates its role as an internet distributor. Netflix entered the US market in 1997 as a video rental-by-mail company.[i] Its first foray into television was thus distributing television on DVD—a format of television distribution that appeared in the early 2000s. It performed better than expected, but remained a negligible revenue stream for content owners.[ii] Netflix launched its streaming service in January 2007, first only to PCs, then Macs, TiVo, and Samsung BluRay players in 2008. Streaming was initially free to subscribers of the by-mail service; viewers could stream one hour per month for every dollar spent on the monthly subscription.[iii] By January 2008, it made unlimited streaming available to nearly all subscribers. At the time, Netflix had 7 million subscribers and a library of 6,000 titles (though 90,000 in its DVD library).

Netflix was thus first to market a service offering access to a library of content for a monthly fee. Apple’s iTunes first made internet-distributed television series available for transaction sale in October 2005, but this remained a slight source of revenue (less than one percent of 2014 revenue). Broadcast networks (ABC, CBS, NBC, Fox) offered internet-distributed, advertiser-supported access to some series through proprietary sites beginning in 2006, though none was successful in attracting many viewers. The video available from these sites was mostly promotional content rather than full episodes. Advertiser-supported Hulu launched in beta version in October 2007, and officially in March 2008. Hulu remained insignificant until late 2009, at which point Disney joined NBC and Fox in the collaboration and more content was made available on the service.[iv] Hulu remained ad-supported and primarily functioned as a current season catch-up service or portal to current series until it shifted to a mixed subscription/advertiser-funded revenue model and then offered a pure subscription option.

The most comparable competitor to Netflix at launch was the HBO Go service launched in February 2010, but this was not a stand alone internet-distributed service, it merely offered nonlinear access to the HBO library of content by internet for those who subscribed to its cable/satellite service. In 2010, Netflix launched a streaming-only subscription for $7.99 a month (for HD; a discounted service for SD was available; subscribers could also pay $1 less for a subscription that allowed only one stream at a time). In 2016, the service increased its fee to $9.99 for HD and two simultaneous streams or $11.99 for Ultra HD and 4 simultaneous streams.

A number of similar—though not necessarily competing—services launched throughout 2015 and 2016. Most notably, HBO Now and Showtime Anytime offered subscribers access to a library of licensed theatrical films and original television series for $14.99 and $10.99, respectively. Amazon Video also created original series and more aggressively marketed itself as a competitor. Analysis by ratings service Nielsen in 2016 found Netflix available in 51.2 percent of US homes, Amazon Video in 28.6 percent, and Hulu in 12.7 percent. In terms of use, Netflix accounted for 46 percent of time spent streaming, followed by YouTube at 15 percent, Amazon Video at 8 percent, and Hulu at 4 percent.

Other services followed a similar revenue model (subscriber-funded library access), but offered a narrower and more specific content proposition. In 2016, Parks Associates reported the 10 most watched, subscriber-funded portals as: Netflix, Amazon Video, Hulu, MLB.TV, WWE Network, Sling TV, HBO Now, Crunchyroll, Showtime, and CBS All Access. At the end of 2015, there were nearly 100 portals available, 76 of which relied on subscriber-funding.

It is already possible to identify a number of strategic shifts in the brief history of Netflix’s streaming service. The company initially sought to offer a lot of content to viewers, which it did through licensing from studios. It was able to secure relatively affordable deals early on because its subscriber base was small and there was no sign of viewer demand for the viewing experience Netflix offered. By 2011, Netflix had nearly reached the subscriber base of HBO, and that growth allowed it to begin amassing a trove of use data that helped it craft more strategic licensing deals.

The strategy shifted again by 2013, at which point is was clear that Netflix’s aim was to become the equivalent of the first global video network. A level of stasis occurs in the US market as Netflix establishes an equilibrium that maintains US subscriber levels, but targets more resources to international growth.

Regulation

Netflix was not initially perceived as “television” and not regulated as either a broadcaster or cable channel. The United States lacked substantial internet regulatory policy when the service launched, and the service was frequently discussed in relation to debates about “network neutrality” that were still specialized and uncommon, despite initial regulatory action in 2010 (Open Internet Order) that was overturned in January 2014 after court consideration.[v]

As the Federal Communications Commission (FCC) announced plans to put forth net neutrality policy that would withstand judicial test, Netflix was frequently cited as the need for separate tiers of internet pricing (fast lane), and aided consumers in understanding what net neutrality could mean in daily life. A high profile complaint by Netflix against internet-service provider (ISP) Comcast for “throttling,” or slowing, its content became an illustration of the power ISPs could wield without net neutrality policy. The FCC introduced net neutrality regulation, or Open Internet Rules, in February 2015. But rules from a government agency are not as reliable a form of regulation as Congressional legislation. The FCC chair appointed by President Trump in 2017 immediately signaled plans to roll back the net neutrality rules.

Viewing Habits

Viewing of Netflix has trended toward the living room screen, with different devices used to get it there as these devices have become more common. The first “smart TVs” came to market in 2010, but BluRay DVD players and internet-connected video game systems first dominated in connecting living room screens to internet-distributed content.

By 2016, Apple TV, Roku, and Chromecast augmented, and in some cases replaced these earlier technological intermediaries, while penetration of internet-connected televisions increased as well.

Internet Pricing and Availability

When Netflix’s streaming service began steady adoption in 2010, 66 percent of US adults had home broadband internet access. In its early years, home internet access was commonly priced as all-you-can-use access for a monthly fee that was substantial enough to allow unlimited Netflix use. Some subscribers using mobile devices to access Netflix were constricted by pricing based on packages of data too small to allow significant HD video streaming (unless over wifi networks that did not deplete data). Notably, U. internet service is among the most expensive and slowest when considered among peer countries, likely owing to the fact that there is very limited competition in internet service.

Home broadband service grew minimally after 2010—even declining in some years—to reach 73 percent by 2016. In that year, several ISPs announced changes in billing, establishing 1 terabyte per month as a use cap and required additional fees for homes that exceed it.[vi] “Regular” use of HD streaming video would not surpass this limit, but the ISPs laid the groundwork to charge higher prices if consumer’s data use increased, for example, if transitioning to Ultra HD content. (Estimates place five hours of HD streaming a day at 300 gigabytes of content; the average U.S. household watches five hours of television per day).

Content

Given the roots of the service in DVD-by-mail, Netflix was initially viewed more as a repository of films than television. Initially, much of the streaming library consisted of “library” content from studios. But by 2016, Chief Content Officer Ted Sarandos noted that 70 of the content streamed was television (he did not distinguish whether this was US or worldwide use).

In March 2011, Netflix announced plans for its first original series, House of Cards. This was a high-profile announcement that emphasized a commitment of $100 million for two seasons of episodes—an unprecedented deal in the US marketplace—that also drew attention for having top talents Kevin Spacey and David Fincher attached. The series arrived in 2013 and received a lot of critical attention. Awards nominations and wins for House of Cards and Orange is the New Black quickly established that internet-distributed services were viable content creators.

Netflix did not own a studio and contracted with various studios to make the series it licensed. It initially established conventional licensing deals for US rights only for House of Cards and Orange is the New Black, but began seeking global rights as its distribution footprint expanded. It also licensed series using a cost plus rather than deficit financing scheme in order to gain greater exclusivity.

The development of original series indicated that Netflix was embarking on a pivot away from relying on licensing content to becoming the owner and creator of a sizable component of its library. This corresponds to changing attitudes within the industry and the realization that Netflix was becoming an industrial force, although possibly a complementary one. The licensing fees paid by Netflix were initially an important new revenue stream for legacy conglomerates. By 2015, it was clear that Netflix could compete as a program creator, and the legacy conglomerates developed self-owned internet-distributed services of their own.

Netflix established a reputation of being tight-lipped about the performance of content, a policy that drew ire from the television industry. Netflix did not even share viewing data with show creators. What is known about Netflix viewership is thus very partial and not externally verifiable.

Consumer and Press Reaction

Netflix’s streaming service is beloved, and though some changes in its terms of service have drawn criticism, it can be credited with substantially changing US consumers’ expectations of television viewing and related behaviour. Though available earlier, mainstream cultural awareness of Netflix as a streaming service became pronounced in 2010, when Netflix subscribers grew from 12.2 million to 20 million. The surge continued into September 2011, when the company mishandled plans to separate the DVD-by mail and streaming business. Expiration of some content—particularly that from subscription service Starz—also occurred at this time and led to customer concerns about the service’s on-going value proposition. This discourse quickly turned around as Netflix aggressively pivoted into original series production.

Netflix U.S. Offices
Los Gatos, California
Los Angeles, California

Other Key Sources of Data
Alan Sepinwall, “Ted Talk: State of the Netflix Union Discussion with Chief Content Officer Ted Sarandos,” HitFix, Jan. 26, 2016;

Notes

[i] Gina Keating, Netflixed: The Epic Battle for America’s Eyeballs (New York: Portfolio, 2013).

[ii] By 2005, DVD sales of television shows reached $2.6 billion and accounted for nearly 20 percent of the overall DVD sales market. John Lippman, “New Shows Try Their Hand at Copying Fox Hit 24,” Wall Street Journal, Mar. 24, 2006, W7.

[iii] A common, unlimited access DVD subscription cost $16.99 per month.

[iv] Hulu remains difficult to compare to Netflix. It functions mostly as a catch-up service or source for viewers who don’t subscribe to multichannel service. Its owners remain most focused on legacy industry practices such as licensing content in other windows, which keeps Hulu tethered from meaningfully competing.

[v] Net neutrality policy was not overturned; the FCC had crafted the rule in a way that was beyond its authority. The court found the FCC could not create net neutrality rules unless it first classified the internet as a “common carrier.”

[vi] Prior to 2016, about 25 percent of U.S. internet subscribers had plans that charged extra for heavy usage.