This article won't delve much into the technology of the process; instead it will focus on enlightening the reader about the economic issues surrounding the current Netflix / Hulu business models and the long term trends that will affect subscribers to these services.
Overview
There is a direct correlation between the advent of Netflix and the demise of Blockbuster Video. Netflix's business model provides a product on demand and a very attractive price just $7.99 a month. That's less than renting from BlockBuster or Red Box and far more convenient.
How can Netflix do that, you ask? Well, for starters, they have a cost of delivery which is miniscule, they have the advantage of being web based with no "bricks and mortar" facilities or store employee costs. Their delivery cost is the fractional royalty paid to the owner of the media and the monthly cost of a fat internet pipe. That competitive advantage allowed them to undercut Blockbuster and deliver the product much faster and more easily (from a consumer point of view).
But, are the competitive advantages real and sustainable? Consumers got an inkling that something might be going on in "NetFlixLandia" in October, when, without warning, Netflix attempted unbundle DVD delivery from streaming and alter their pricing structure raising prices overall to consumers...Why do you suppose they did that? They lost immediately 800,000 subscribers!
The answer to that question can be found in NetFlix's guidance to shareholders (NFLX) last quarter. In a nutshell, Netflix announced that starting in Q1 of 2012 that it would be "unprofitable on a global basis."
One of the reasons for that projection is that Netflix is having a devastatingly negative impact on the Internet. Currently, Netflix and the other streaming services are consuming 58% of the available bandwidth in the USA. The kicker is, they are not paying a nickel for that bandwidth and therein lies the flaw in their business model. The circuits that transport NetFlix's content are being saturated to their maximum, forcing carriers and ISPs alike to buy larger and larger circuits costing a whole lot more money with no offsetting increase in revenue. So carriers and ISPs will look to those who are responsible for the saturation and seek increased payments from them. Netflix saw this coming and tried to head off the problem by raising prices, but, that move backfired badly. Ultimately, Netflix and the other streaming content providers will have to raise their prices or go under because the transport industry is no longer going to give streaming providers and their customers a "free Ride".
Unsustainable Business Model
The Internet, as we knew it until 2009, was principally used interactively. People browsed to a web page, paused, read, then clicked and browsed to another page, paused, read etc. The downloading that was going on then was short (in comparison to a full length movie) file downloads lasting a few minutes.
The pricing structure of the Internet (including the wholesale costs paid by transnational carriers for really fat fiber circuits and ISPs for not so fat fiber circuits) was translated into a consumer retail price based upon those costs and utilization models. But, with the advent of streaming, the Internet changed from a transactional based network to something more akin to an oil or gas pipeline network, with the flow rate jumping over 300% in less than 12 months.
Evolution of Communications Technology
There isn't a whole lot of difference between the Electrical Grid of the USA, or the Water Systems of the USA and the Internet. When the demand becomes excessive, the flow dries up...Electrical brownouts, water curfews are imposed, and your Internet performance becomes slow. Electrical and Water Utilities came up with ways to tax those who demand more than the average user long ago. Those who demand more and consume pay more. Consumers are very familiar with this pricing model. Take gasoline for the family car; the more you drive, the more fuel you use and the more money that fuel costs you. Or take food for an example; eat more, buy more and pay more. This isn't about greed. It's about paying for what you use so that the providers of what you consume are compensated fairly and adequately, enabling the providers to meet the demands of their consumers. It's Capitalism 101!
Another way of explaining what's happening is that when the Internet was spawned back in the 70's (yes, my friends, the precursor to the Internet called DARPAnet (military) and Vnet (IBM) were being used as early as 1969), the content was text only. Then along came the Macintosh in 1984 which introduced the first commercially successful graphical user interface (GUI). The advent of the GUI changed communications content forever. So, as the Internet evolved and became a consumer accessible network, the pricing models were simple because the content was trivial and miniscule in comparison to what transits the Internet today. So, as the content has evolved, so has the technology and so must the pricing models in order to fund the use of the technology.
Something's Got to Give
Streaming businesses, taken as a class of Internet content providers, are placing a dramatically larger demand on the Internet than any other class of content providers. It follows then, that the carriers who transport streaming traffic must be able to recover the cost of transport by charging the content providers for the right to send their traffic across the carrier circuits which comprise the Internet. If you want to ship something by UPS, you expect to pay for the cost of the transportation and delivery, right? But, the current Internet pricing model doesn't provide a way for this to occur. Hence, there is an inevitable change coming and Netflix is warning the market that these changes may make it unprofitable going forward, unless they can raise their prices to consumers to support their increased costs.
That change is coming at both ends of the streaming pipeline. At the source (Netflix end), the transnational carriers are going to charge Streaming Content providers (like Netflix) a fee for consuming 58% of their bandwidth. In the middle, ISPs who are forced to have to buy significantly larger fiber pipes to carry the traffic being demanded by the consumers who want to engage in real-time streaming movies and videos, will also have to be able to recover those increased costs. And that will affect some consumers, those who create the demand by streaming content in real-time. Since they use a disproportionate amount of the the ISPs available resources and create congestion by doing so all at the same time, these consumers are going to pay more for the amount of bandwidth that they consume, and more than those consumers who either do not stream content or who do so during Off-Peak hours.
The metamorphosis of billing practices has already begun. AT&T and Verizon have put bandwidth caps on the amount of bandwidth that can be consumed, eliminating unlimited data. ISPs all over the nation are doing the same. The caps are generally quite reasonable, and are only exceed by a small percentage of customers, those who stream movies every night or who have their children and the parents all streaming different content at the same time. Once the cap is met, the consumer is charged an additional fee for additional content, somewhere around $2 per each additional 6 gigs (1 movie). Over the course of 2012, most, if not all, ISPs will move to this form of billing.
How Can Consumers Hold Costs Down & Still Enjoy Movies
The root cause of the excessive demand problem is that streaming as we know it from Netflix, Hulu and the like is a Real-Time Event, most of which occurs between 6pm and 11pm daily during the week and most of the time on Saturday and Sunday. That means that from 6pm until 11pm every night, all of the streamers are downloading, all at the same time. But, after 11 or 12pm, the demand on the Internet dries up to less than 1/3 of the demand between 6pm-11pm. Below is a graph of AireBeam's fiber utilization. Notice the peaks and valleys!
So, there is an opportunity here. If consumers were able to download their content between midnight and 7am and store it for later viewing, several major benefits will accrue to all parties concerned:
The peak instantaneous demand on the Internet would drop dramatically meaning smaller fiber pipes (lower cost) could be used to provide the content. Lower costs along the way translate to lower consumer costs in the end.Average demand on the Internet would also drop because a 2 hour movie could be downloaded slower over 6 or 8 hours, significantly reducing the demand level.Consumers could download their content using slower speed (lower cost) connections, 2mbps instead of 4mbps or mbps, saving $10-$20 per monthSince the consumer is downloading during "Off Peak" hours, in most cases the content downloaded would NOT count towards the cap, meaning more movies every month at no additional cost.
How to Download Off PeakLike all forms of technology, multiple solutions for downloading and recording for later viewing exist. They differ in complexity and in cost. We're going to look at the most consumer friendly (and it turns out least costly) solution first.
Ever so quietly, Dish Networks recently bought the assets of BlockBuster Video. Now, when you subscribe to Dish Networks, you also receive a Blockbuster Video Pass FREE! And the pass gives you FREE access to over 100,000 titles. The basic Dish Networks Family Plan with over 55 Top Channels, is now on sale for just $19.95 a month with a one year contract. "But, $19.95 is about $12 more than I'm paying for Netflix", you say! Not so fast, Abernathy!! Take a closer look at your Total Cost!
To view standard definition content without buffering (pauses during viewing), you need a 4-6mbps connection. To view high definition content without buffering, you need at least a 6mbps connection and more is better. So, your 6mbps + connection is currently costing you about $60 a month. But, if you had a Dish Networks subscription, you could schedule your download to occur while you were sleeping on a 2 meg connection costing you only $40 a month. That $20 a month saved on your Internet connection just paid for your Dish Networks subscription! And, right now, Dish will give new customers an HD DVR for free! Here is Dish's current new customer offer:
Additional Benefits
You can say good bye to the tiresome "Buffering" Messages. Your movie is recorded on the hard drive of your HD DVR.And, there are more benefits.You can watch your downloaded movies over and over again, as long as you don't delete the fileOnce cap based billing goes into effect, if you are a Dish Networks customer with a BlockBuster Free Pass, you will be able to download a different movie every night using Off-Peak bandwidth that doesn't count towards the cap. So, over time, you'll save on all those over-cap fees that real-time demand streamers are going to pay!While you are watching your downloaded and stored movie (which you can watch over and over and over again as long as you don't delete it), your Internet connection is idle. So if you have kids who need to do their homework online, that idle 2 meg connection will be lightning fast! Sure, this all takes a little planning but, you can make that a family event, too. On Sunday, sit the family down and start browsing the catalog and pick out your movies for the week.
Slightly Geekier Solution
There are a number of software based Netflix Recorders available. The most popular one is published by Audials. Using this software, you can record almost any source of streaming video or audio. You can view a tutorial about it on YouTube: http://www.youtube.com/watch?v=eKeQB7aGaUw
Summary
The cable and satellite TV industries are not going to sit back and watch NetFlix take away all of their subscribers! Comcast just bought NBC Universal which gives them access to all of Universal's film vault and everything that Disney produces. Dish bought Blockbuster! And the Internet Community has no choice but to put a tax on Netflix (that is going to translate into higher Netflix monthly subscription prices) as well as to impose caps on Real-Time content download quantities (to protect the user experience for all), which will translate to still higher real-time streaming costs.
But, the Off-Peak Model, downloading during off-peak hours, storing content for later viewing, neutralizes those increased costs, translating into more value for the consumer via a community friendly, sustainable model.
Author: Gregory Friedman, Owner, AireBeam
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