With Netflix's foray into original, high quality programming today, the streaming TV network wants to turn into the HBO of Internet TV, but can the network afford it? Putting together a big production with famous actors like House of Cards costs a lot of money—$100 million for two 13 episode seasons, to be exact—and Netflix CEO Reid Hastings says he plans on making five new shows like that per year, he told GQ's Nancy Hass. How can that make economic sense for a company makes all of its money off $7.99 per month subscription fees? Netflix doesn't run any ads, nor does it benefit from a relationship with a big media conglomerate like HBO and its parent company Time Warner. But while $100 million sounds jaw-dropping, a little math shows that, if the shows are good — a big if, admittedly — spending that kind of money could be good business for the company.
Breaking Even Won't Be That Hard: With Netflix spending a reported $100 million to produce two 13-episode seasons of House of Cards, they need 520,834 people to sign up for a $7.99 subscription for two years to break even. To do that five times every year, then, the streaming TV site would have to sign up 2.6 million more subscribers than they would have. That sounds daunting, but at the moment, Netflix has 33.3 million subscribers, so this is an increase of less than 10 percent on their current customer base. Of course, looking at Netflix's past growth, that represents pretty reasonable growth for the company that saw 65 percent growth from 20 million to over 33 million world-wide streaming customers. Much of that growth, however, comes from new overseas markets. But, even in the U.S., from one year ago, Netflix saw about 13 percent streaming viewer growth jumping from 24 million to 27 million.
That's Actually a Bit Better Than HBO Does: HBO gets about $7 per month per subscriber from its 30 million or so fans, according to an analyst at SNL Kagain. Although the charge for HBO on your cable bill is something like $15, HBO splits the fee 50-50 or so with your cable company, according to The Economist. That puts it pretty close to Netflix. Those revenues also pay for some of the most expensive TV on cable: True Blood came in at around $5 million per episode. The debut of Boardwalk Empire cost $20 million alone. Then again, HBO is a prosperous outpost in a huge media empire, which helps with marketing and infrastructure costs. Netflix is all on its own. It has built its own infrastructure to stream things to consumers, so it doesn't need cable companies, but then again, it doesn't have those cable providers working on commission to sign up HBO subscribers.
But Is It More Lucrative Than Paying Other Content Makers? Probably. Up until now, Netflix's strategy has involved paying content makers and distributors, like Disney and Epix, for streaming rights to their movies and TV shows. It turns out, however, the company is overpaying on a lot of those deals. As you can see in this chart Seeking Alpha's Cris Frangold shows, these deals cost Netflix billions:
The real problem for Netflix is that their subscription revenue is not growing as fast as their content costs. Michael Pachter, an analyst with Wedbush Securities, told Bloomberg News' Cliff Edwards. "Netflix will continue to generate negative cash flow going forward, driven by the company’s ever-increasing streaming commitments," he said, a sentiment also reflected in this chart from Ferngold:
Basically, subscriptions haven't kept up with high costs for content, like this $200 million one with Epix to lease Paramount, Lionsgate, and MGM hits.
Part of that has to do with the rising cost of content. The going rate for digital rights has increased because the owners of said TV and movie shows know they have leverage over Netflix. For example, back in 2008, Netflix convinced Starz to make a deal for $30 million a year. When it came back to the table in 2011, $300 million wasn't enough for the network. Netflix now pays $100s of millions to Disney and Epix and has deals with individual channels, paying AMC $1 million for exclusive streaming rights for each episode Mad Men, a show viewers can watch on cable television, if they want.
And that brings us to the other reason Netflix hasn't been able to draw enough subscribes...
Exclusive Content Is King: Like HBO, Netflix is moving away from buying content because it would rather draw addicts, who have just one just-for-Netflix show that prevents them from canceling. (To start that addiction, the first episode of House of Cards is available to non-subscribers.) With the HBO model it only takes one really good show to hook one new subscriber. The idea is that at least 520,834 someones will start paying $8 per month because they want to watch House of Cards, because it is that good. HBO already plays a similar game: all of it shows don't have to be monster successes (Girls doesn't draw that many viewers) but they do need to have an answer pop into their customer's head whenever they look at their bill and ask themselves "Why am I still paying $15 a month for HBO?" As of right now, Netflix has a lot of overlap with traditional cable and other streaming services, and they need more answers to "Why am I still paying $8 a month for Netflix?" They've tried to create some of that exclusivity, paying a premium $1 million per episode to be the exclusive streaming home of Mad Men. Others are playing that game, too: Amazon today invested an undisclosed amount to make a similar deal for Downton Abbey. But, in reality, those deals are for re-runs: the people who will sign up for Netflix to watch Mad Men are the ones who missed the boat the first time around and want to catch up. Even better is something truly original. It might cost a little more money per show—Mad Men only costs $1 million to the nearly $4 million for House of Cards—but the pay-off, if the program brings in a ton of people to just Netflix, will be worth it.
It Also Has Other Potential Revenue Opportunities: So, if House of Cards turns out to be the type of thing people will subscribe to Netflix just to watch, it also means Netflix created something of value to others.*
Can Netflix Afford the Gamble? That's Unclear. Unlike HBO, Netflix doesn't have a big rich cable company owner with lots of cash on hand. In fact, the company is scrambling for money to pay for its current investments, according to last quarter's earnings report even though it did report a surprise profit. Basically, House of Cards has to bring in subscribers, it has to be decent enough to get people to pay. Some early reviews suggest that's the case. The Los Angeles Times called the show "deliciously spiteful." We'll defer to resident Atlantic Wire TV expert Richard Lawson for the final verdict. Even if the critics like it, though, the results of this business scheme will be hard to dicipher at first, since no Nielsen for Netflix exists. We'll be watching those subscriber numbers, though.
*This post originally stated that Netflix owned the syndication rights to House of Cards. However, The production company Media Rights Capital own them.