Online VoD is changing the face of film distribution — as seen by the huge growth of Netflix and Amazon’s recent acquisition of LoveFilm. Colin Brown explores the latest moves in the battle for the living room

Pretty much all those iconic Hollywood logos which introduce viewers to big studio films have one visual element in common: swirling clouds. Which is fitting because that is where all film distribution is heading right now. Cloud-based streaming is rapidly replacing physical storage devices as the entertainment world shifts to an on-demand universe made ­possible by broadband delivery mechanisms. What is less clear is whose cloud systems will end up as the film industry’s future rainmakers. It’s cloudy indeed right now, but with a chance perhaps of profits.

“We are about to witness the next chapter in the ongoing fight for the living room,” says Saul Klein, the London angel investor who was the co-founder and original CEO of what became LoveFilm International. He was speaking the same January afternoon that Amazon announced it had acquired full control of LoveFilm, paying about $320m (£200m) with the aim of rocket-fuelling the online consumption of movies across Europe.

“In the next couple of years, you will see Netflix, LoveFilm and of course Apple and Google, all gearing up,” says Klein. “And you can bet the incumbent players from pay-TV, cable, satellite and the telcos will do all they can to protect their turf too. It’s a gathering storm.”

Indeed, in a repeat of the pay-TV dogfights of the past, a rights brawl has already broken out over a subscription TV business that PricewaterhouseCoopers reckons will climb to a global $211bn within three years. In the US alone, digital on-demand viewing of TV shows and movies will generate $10bn by 2014, according to recent figures from In-Stat. Similar sums will surely be spent in overseas markets as more homes get high-speed networks and web-connected TVs and mobile smart devices mushroom around the world.

‘We are about to witness the next chapter in the ongoing fight for the living room. It’s a gathering storm’

Saul Klein, LoveFilm co-founder

It’s anyone’s guess how much of that bonanza will be siphoned off by feature-length films, which have come to rely on pay-TV and pay-per-view for at least 20% of their total expected revenues. But anyone who doubts that movies are a major battlefront should look at the language being used, particularly with regard to Netflix’s movie service being streamed to US and now Canadian monthly subscribers.

Fighting talk

Asked by The New York Times whether he felt Netflix posed a threat, Time Warner’s CEO Jeff Bewkes had this to say: “It’s a little bit like, is the Albanian army going to take over the world? I don’t think so.” A few weeks later, at January’s CES tradeshow in Las Vegas, reporters again asked Bewkes whether he thought Netflix was the entertainment industry’s new 800-pound gorilla. “More like a 200-pound chimp,” came the tart reply, before later characterising Netflix as a “utility” service better suited for secondary content.

If Bewkes’ put-downs sound a tad too dismissive, he has reason to be defensive — particularly with regard to HBO, Time Warner’s pay-TV superpower where he built his career over 23 years. Netflix, which effectively drove Blockbuster into bankruptcy in the US, has been shedding its skin as a mail-order DVD business to become a pay-streaming service that is angling for moving rights in HBO’s jealously guarded premium domain.

A six-month shopping spree has left Netflix with exclusive access to movies in the US pay-TV window from Relativity Media, Film District and Nu Image/Millennium Films for the next several years. A five-year licensing arrangement worth close to $1bn with startup pay-channel Epix gives Netflix exclusive online rights to films from its three equity partners — Paramount, Lionsgate and MGM — just three months after they first air on cable.

Netflix’s sudden ascendancy can be measured on Wall Street, where it has a market capitalisation of about $9.6bn. In other words, despite hefty acquisition costs that will only rise as output deals expire, Netflix is valued at an amount worth more than a quarter of the entire Time Warner colossus — HBO, Warner Bros and all.

Over the course of 2010, Netflix piled on another 7.7 million customers for an accelerating total which has now topped 20 million. “It’s very clear that streaming is energising our growth,” Netflix chief Reed Hastings told analysts on January 26. With each subscriber paying at least $7.99 a month, that 12-month jump alone has added another $738m in annual subscriber revenues to its coffers. Throw in the estimated $500m that Netflix would save each year if it did not have to also deliver DVDs in those distinctive red envelopes, and you can see where Netflix’s acquisition war chest is coming from as it vacuums up pay-streaming rights.

SVoD: the way to go?

Broadly speaking, there are four online movie services up for grabs. Transactional video-on-demand (TVoD), essentially movie rentals chosen a la carte, is the natural outgrowth of the pay-per-view business. Electronic sell-through (EST) refers to the purchase of video content which is then downloaded and stored.

Then there are two kinds of all-you-can-eat movie menus: those which are offered as a monthly subscription package (SVoD) and those which are streamed for free but preceded or surrounded by advertising (AVoD).

Of all these, the Netflix brand of SVoD is seen as having the highest growth potential, but it is also the most disruptive to the carefully orchestrated procession of distribution windows which has come to define film-business economics. The jury is still very much out on whether Netflix, by offering a cheap buffet of movies so soon after their DVD release, is simply undermining cinema’s entire value chain.

“The success of Netflix validates the strong consumer appeal for the subscription model that is the foundation of pay-TV,” observes Bob Leighton, a former top executive at both HBO and Starz Encore, who is now SVP of programming at international cable operator Liberty Global. “Netflix’s success is less about streaming and more about offering the consumer a good product at a low price, all wrapped in a great interface. Netflix is good for the movie business as long as it is accretive, by generating more viewership, and not just cannibalistic.”

‘I understand why many studios and networks want to avoid Netflix but you ignore these platforms at your peril’

Matt Dentler, FilmBuff

Predictably, Netflix sees itself as a net plus and is keen to downplay any antagonism with the status quo for fear of biting the hands that feed its growing popularity. “We can all co-exist and cultivate this online movie addiction together,” seems to be the mantra.

“It’s very difficult for people to understand who we really do compete with,” Netflix chief content officer Ted Sarandos told a recent media con­ference. “We don’t compete with transactional VoD. We’ve been saying that for a long time and nobody really wants to hear it. We would much rather have our service on the Xbox than compete with them on transactional VoD. So it keeps a kind of Switzerland for content across devices.”

The Netflix effect

Neutral or not, Netflix has been partly blamed for the ‘cord-cutting’ phenomenon — those US homes which are disconnecting themselves from their umbilical pay-TV providers in favour of broadband video alone. A recent survey by JP Morgan reported that 47% of all active users of Netflix’s service (people who stream at least one to two videos per month) would consider cancelling their pay-TV service. Sure enough, HBO lost 1.5 million paying subscribers last year, though the reasons for this are not so clear-cut.

“This whole cord-cutting debate is pretty academic. Where it is happening, it is largely a result of recessionary churn,” counters Netflix’s communications chief Steve Swasey. “We believe we are complementary to cable. First, our service is offered at such a low price that it doesn’t supplant your existing TV service, maybe just a latte or two each month. And second, while we offer a lot of great movies, there are no live sports or reality shows or events like the Oscars. For that you still need cable and satellite TV.”

For independent suppliers of movies, such arguments are largely moot anyway since most would consider themselves lucky even to strike decent pay-TV deals. This is particularly true in overseas markets such as the UK which are in the grip of monopoly players that cherry-pick at will. No wonder indies have come to regard Netflix and its upstart equivalents such as LoveFilm and Blinkbox in the UK, Scandinavia’s Voddler and Australia’s BigPond as their new potential financial bedrocks.

“Netflix is an extremely valuable place to make deals for content today, and I think major media companies will be forced to ultimately reconcile their orthodox feelings with the changing trends,” says Matt Dentler, head of content for digital distributor FilmBuff, a sister company to New York’s Cinetic Media. “We’ve done deals for films and TV shows with Netflix, and it’s always worth it. I understand why many studios and networks want to avoid Netflix, but I think a ‘zero tolerance’ policy is a huge mistake.

“You ignore these platforms at your peril. It should be less about ignoring Netflix and more about working it into your overall strategy. The history of film and TV is full of new technologies and services that shake the foundation of how work is consumed and how deals are made. These same cable networks that are competing were the Netflix equivalent of their era.”

Lucrative tie-ups

The tipping point for Netflix was its inclusion on Microsoft’s Xbox game console, which offered a gateway drug into another potential 25 million homes when the deal was done in late 2008. In the case of Europe’s LoveFilm, the watershed moment was a corresponding deal struck last October with Sony’s PlayStation 3.

But the real game-changer may well be Amazon’s return to international film distribution as LoveFilm’s sole owner, bringing with it huge financial and technical resources, unparalleled expertise in e-commerce recommendations and the IMDb database to help steer and stimulate film appetites. All of a sudden, LoveFilm has real negotiating clout as it tries to persuade studios to part with rights in the critical pay-TV window.

Right now the bulk of its recent Hollywood titles are offered as transactional rentals; the online buffet which is served to its 1.5 million monthly subscribers, however, basically comprises Hollywood leftovers and warmed-up seconds, supplemented with independent output deals with the likes of Icon, Momentum and Optimum. As is the case with Net­flix, LoveFilm is only able to stream a 10th of the number of films it can offer its DVD mail-order customers.

Even LoveFilm’s competitors in the Nordic countries where it also operates welcome Amazon’s arrival as a force for prising open the release windows and letting air into the European distribution marketplace. Voddler, the Stockholm-based video-on-demand service which operates across Sweden, Norway, Denmark and Finland, carries films from all the Hollywood majors and key local distributors. But all the most recent titles on offer are TVoD rentals, leaving its ad-supported streaming service reliant on re-run classics and films which have passed through the pay-TV window at some point. Voddler sees monthly subscriptions as the way forward — easy access will not only grow the market, but also kill piracy — but must win over content-holders first. Amazon could accelerate that.

“The LoveFilm deal is great news,” enthuses Voddler’s vice-president of communications, Anders Sjoman. “It will help collapse the windows, make a true subscription model generally more acceptable, and build the VoD market. Which in turn will make this market more important to the content holders, and speed up how quickly they revise their business models.”

‘The LoveFilm deal is great news. It will make a true subscription model more acceptable and build the VoD market’

Anders Sjoman, Voddler

Though this transition is starting to happen in Scandinavia — Inception, for example, came out at the same time on DVD, pay-TV and VoD rental in Dec­ember — Sjoman says he will know the sea-change has occurred for good by the executives with whom Voddler ­negotiates. “An indicator we’re looking for — when will the first Hollywood major re-organise its sales departments from separate TVoD, AVoD and SVoD teams into one combined ‘on-demand’ group?”

Benefits of competition

Like Netflix — and presumably LoveFilm — Voddler is actively eyeing other markets to enter. Sjoman will not identify which, though Voddler’s Wikipedia entry has earmarked western Europe, Russia and the Baltic states as among the targets. EU regulatory initiatives might help speed up this process, including easier cross-border licensing and more transparent rights management collection. So also would a favourable ruling by the UK’s Competition Commission, which is currently investigating whether BSkyB’s exclusive pay-movie deals with the six Hollywood studios needs to be loosened to allow others to share in those rights. Its decision will have a major bearing on how other EU territories deal with their own pay-TV ecosystems.

Sjoman hopes that as soon as more content is made widely available to him and his rivals, the streaming market will stop being held hostage to wallet sizes and bargaining power. “Competition should hopefully turn from a titles race to one of best user experience — who has the easiest exploration, most flexible business models, most personalised service, best explicit/age sensitive filtering systems, best social glue features and so on.”

If true, then the studio conglomerates had better get off their clouds very soon and re-examine their value propositions. They would do well to follow direction from Liberty Global’s Leighton: “An important mantra for us in this regard is, follow the customer, not the cable.”