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Netflix shifts its digital course - January 3, 2008

Smart move by Netflix, both financially and strategically, to drop its efforts to develop its own set-top box in favor of licensing its digital service to CE makers and platform providers. Financially, a move into STBs would have been expensive and produced uncertain returns. Everyone and their mother are trying to bring the Internet to the set-top and we're a long way yet from figuring out who's got the best route, not to mention the inevitable shakeout once we do. Strategically, the decision lets Netflix concentrate on what it actually knows how to do: aggregate and distribute content.

The most intriguing aspect of Netflix's deal with LG Electronics, however, may be its structure. Essentially, Netflix has licensed LG the right to bundle its instant-viewing digital functionality into LG devices that attach to the TV. The service will be offered free to existing Netflix subscribers, just as it subscribers now are able to access movies instantly via their PC as part of their subscription plan.

That sort of bundling points the online video business in a similar direction as the music industry has been moving recently: toward licensing its content as a service to be bundled with devices or platforms, rather than insisting on a discreet transaction around each copy or use. Although many content owners are loathe to think of the products they create at such great time and expense as part of a "mere" service, in a networked world it has advantages over per-copy or per-use business models. Not the least of these is that it shifts some of the piracy and consumer-monetization risk to the device maker or platform provider. The studios have been doing something similar for years, moreover, in the pay-TV business by signing output deals with HBO, Showtime and Starz, which are then bundled into consumers' cable service by the system operators.

The pay-TV business, of course, has historically not been as lucrative for the studios as the DVD business; replicating the pay-TV model on the Internet may not seem all that appetizing to some. But fighting endless battles over piracy and DRM in an effort to recreate the DVD business online doesn't seem all that appetizing, either.

The real question for content owners is whether they can come up with a rights structure and licensing scheme flexible enough to let third-party aggregators do their thing online and develop new markets and new business models. The next logical step for Netflix, for instance, would be to extend its digital service to LG customers who are not currently subscribers to Netflix's DVD-by-mail service. It's not clear, however, that Netflix's current revenue-sharing or purchase deals with the studios would permit that.

It wasn't the studios who created the pay-TV business, after all, it was HBO. And the studios were originally none-too-happy about video rental stores developing a business on the backs of "their" movies. But it worked out pretty well for everyone in the end. And it happened because the rights structure and licensing schemes at the time permitted those third-party aggregators to act entrepreneurially and develop new businesses.

UPDATE: As Media Wonk was preparing to post the above item, a press release came in announcing a new bundling deal, between Samsung and Vongo, under which Vongo's subscription movie download service will be included with Samsung's P2 portable media players.
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