Netflix May Dominate The Online Video World, But With What Business Model?

Yesterday, the New York Times Bits blog had a post that rationalizes how Netflix could become the leader in online video content. While I agree that Netflix has made huge strides due to their deals with Xbox, Starz and of course the Roku player, the real question is how they plan to make money from this new distribution strategy?

Each time Netflix streams a movie to your PC, Xbox or Roku, they pay a fee to deliver the bits and pay another fee to the content owner for the rights to distribute the content. Right now, the streaming movie services offered by Netflix costs them money but helps them retain Netflix customers. But over time, as subscriptions to their DVD service slows, how will Netflix translate their online video offering into revenue? Can Netflix convert those who use the DVD service over to a streaming only service? And more importantly, will Netflix offer a streaming only service for those who want to stream movies to the Xbox 360 and Roku but don't want physical DVDs?

Some say that by making the Xbox 360 capable of getting Netflix content, the Xbox 360 console will be more attractive to new users who are deciding on whether to buy an Xbox 360 or PS3. I would agree that for some, it makes the Xbox 360 more attractive. But unless Netflix is getting paid by Microsoft to help sell consoles, which I don't believe they are, Netflix only sees additional revenue today if the user who bought the console is not currently a Netflix subscriber and signs up for the service. And the idea that Netflix can easily tap into the Xbox 360 community around the world is a great idea, but in reality, causes big problems since much of the content from the major studios is typically licensed on a region by region basis.

With Netflix still only having less than 15% of all their DVD inventory available for streaming, the volume of popular content continues to be a major hurdle. If Netflix can get more first-run movies online it will help, but how long will it take to get even 50% of their content online? The problem does not lie with the encoding and hosting of the video but rather the licensing deals with the content owners. Netflix's success with their streaming offering is solely dependent on the major movie studios giving them distribution deals to stream more of their library over time. But the real question is how much inventory will they allow Netflix access to and over what time period?

Netflix is smart to do all of these deals as no one will argue that it makes a Netflix membership much more valuable than it currently is if you could only get physical DVDs. But at some point, Netflix is going to have to make up for the huge amount of money they are spending to stream all of this content to devices. Right now, the Netflix streaming service is a loss leader. That's fine for now, but how quickly is Netflix going to have show how they are going to make money from the service? They may be able to do a streaming only subscription down the road or maybe advertising will creep in over time, but right now, Netflix is burning through money to make all this happen. Exactly how much we don't know, Netflix won't say on record how much their streaming service is costing them. Over time, I think they will get so much pressure from investors that they will have to break out those numbers.

For Netflix, the streaming service is a big gamble that they are betting everything on. They have to turn the streaming service into a real business model down the road or they risk having a cool service, but one that costs them money. If it was anyone else, I'd say they have some bad odds at making it. But so far, Netflix has been very smart at how they operate, doing things like making their platofrm open and providing APIs. I give Netflix about 14 months before they have to start showing investors how they are going to turn their IP based video offering into sustainable business model. I'm rooting for them.