Netflix shifts toward new world orders

Analysts forecast effect of streamer's overseas expansion

Netflix topper Reed Hastings may have better things to do than watch his company’s collection of war movies, but that could be good preparation for facing the minefield of challenges that await him as the domestic streaming content giant puts international expansion firmly in its crosshairs.

The company will initiate an overseas push this calendar year and will need to deal with critical matters such as the deals required to license or acquire programming and to secure the pipes it will use for delivery.

Expanding overseas may not sound as sexy as some of Netflix’s recent moves, such as greenlighting an adaptation of the BBC drama “House of Cards” with Kevin Spacey attached to star. But it’s as bold a strategic shift as any the company has taken in its 13-year history — and one that has serious implications for maintaining its sky-high stock price.

That’s because foreign growth will be essential for Netflix to continue the huge subscriber gains it would be hard-pressed to maintain in the U.S., according to Dan Rayburn, principal analyst at Frost & Sullivan.

“To me, this is make or break for Netflix,” he says. “If they don’t expand quickly enough overseas, investors are going to hammer the stock.”

Last month, Credit Suisse issued projections envisioning Netflix growing its current domestic subscriber base of more than 20 million subscribers to as many as 69 million worldwide by 2016 — provided the company adds at least one major global market every year going forward.

The firm also projects Netflix will have to spend $1 billion in streaming rights overseas over the same period — and double that amount in the U.S.

Netflix, which declined comment for this story, has divulged few specifics about its expansion plans. What little is known was last disclosed during the company’s fourth-quarter earnings call in February: Hastings plans to add a new market in the second half of the year at a cost of $50 million. The way that goes will determine strategy in additional markets.

Netflix may be emboldened by its deployment in Canada, which Hastings has jokingly referred to as “international lite.” Launched last September, a streaming-only subscription service at $7.99 a month will have been lapped up by as many as 900,000 Canucks by the end of the first quarter, Credit Suisse projects.

That success encouraged Netflix to add a streaming-only option to its U.S. business. This points to the likelihood that Netflix’s overseas offerings will not include the discs on which the company built its U.S. business, allowing Netflix to avoid shipping costs and the intricacies of international snail-mail systems.

Netflix nearly entered the U.K. with just such a business back in 2004, only to cancel its plans in order to focus on combatting growing competition back home.

This time around, there’s still plenty that could make Hastings balk before Netflix crosses any borders.

For one thing, it’s not as if the company will just walk into a territory with instant brand recognition, though it may ring a bell among cinephiles.

“Netflix is not a household name out here by any stretch of the imagination,” says U.K.-based Giles Cottle, senior analyst at Informa Telecoms & Media. “But there’s an early-adopter audience that knows the brand.”

What’s more, there is a range of rivals Netflix will have to confront no matter where it goes — though few with the same monthly subscription model. One notable exception is U.K.’s Lovefilm, which was recently acquired by Amazon. (For more on Lovefilm, read “Lovefilm romances indies and more”)

A more immediate concern will be incumbent cable and satellite giants like U.K.’s BSkyB, France’s Canal Plus and Italy’s Mediaset, which already offer a la carte VOD with deep libraries. Though multichannel distributors aren’t as deeply entrenched in Europe as they are in the U.S., there’s a whole other tier of so-called “hybrid” services, which combine satellite or terrestrial TV with broadband VOD, like Spain’s Telefonica. Plus there’s online-only VOD players from Germany’s Maxdome to Switzerland’s Acetrax.

Still, the absence of any one dominant VOD provider could be the very thing that gives Netflix an edge. “There’s not enough comparable product that offers unlimited streaming for a set fee in the European markets,” Cottle says. “It’s a market ripe for expansion for Netflix.”

The ubiquity of piracy in international markets would seem to present competition for Netflix as well. But analysts are divided between those who see lawless markets like South Korea as no man’s lands and those who see them ripe for the kind of cheaply priced, convenient go-to choice Netflix has the potential to be.

Then there’s the matter of licensing content; it’s not as if Netflix can simply take its existing library of programming and funnel it to whichever country it chooses. While there’s a healthy appetite abroad for U.S. product, it’s going to take a lot of dealmaking to secure the rights for content across continents containing dozens of countries.

“You do one set of deals in the U.S, you can reach 300 million people,” says Cottle. “The European Union has 300 million people, but you have to do like 27 sets of deals.”

If that’s not stressful enough, subtitling or dubbing for dozens of different languages requires extensive encoding, which is expensive and difficult. Getting copyright clearances through local collection societies is time-consuming.

Netflix also will have to aggregate locally produced content, given that even countries with the heartiest appetites for Hollywood fare will want to see homegrown product, too. But not all local companies may want to license to Netflix. Conglomerates like Canal Plus and Mediaset own both studios and distribution arms, which means they hold back valuable content for competitive reasons, just like HBO does in the U.S.

As for obtaining the local content available to Netflix, it requires boots on the ground in order to know what titles are worth buying.

“You can’t just run this out of L.A.,” says Michael Aragon, who is in charge of securing content for Sony Network Entertainment, where he’s VP of global digital video distribution and operations. “That was an assumption we quickly blew out of the water.”

Aragon learned the hard way about yet another obstacle: regulatory bodies with content standards that vary country to country. A lawyer warned him Sony would face fines in Germany if they didn’t remove the image of a handgun from key art for the film “Swat.”

The Sony arm, which took 18 months to get into nine countries overseas to date, has taken a pretty selective approach to the markets where it has set up shop. Like other tech giants, it needs to see enough of an installed base to justify return on investment.

Last but not least is the matter of the broadband networks that Netflix uses to stream its content. The company has proved peerless in its ability to gobble bandwidth; in the U.S. alone, Netflix can account for one-fifth of downstream traffic at peak times, according to research firm Sandvine.

Many countries in lesser developed regions of the world will get sidestepped by Netflix simply because they don’t have a reliable enough infrastructure to support its content.

Oddly, the country that has presented the most troublesome connectivity issue is the one where Netflix has gotten its international start. Canadian ISPs like Rogers, in response to Netflix’s presence, have begun instituting aggressive bandwidth caps that have in turn prompted Netflix to intentionally degrade the video quality it provides in order to use fewer gigabytes.

Netflix may also avoid other markets with oppressive caps, such as Australia.

But there may be a twist in this relationship. Kurt Scherf, principal analyst at Parks & Associates, believes ISPs in need of content to make their broadband offerings more marketable could turn Netflix into an ally.

“Netflix’s play in some of these markets is to figure out how to align itself with the broadband provider,” he says.

One important faction Netflix won’t have to worry much about in its international push are consumer electronics companies. Netflix is already available on a plethora of connected devices from major brands like Samsung to Sony. Extending that footprint overseas doesn’t require customizing technical specs for each country — a far cry from the complications of content deals.

Though Hastings has been quoted as saying Europe represents the biggest opportunity, the bandwidth conditions are a big reason why many analysts believe Latin America will be Netflix’s first stop.

Broadband penetration and speeds are higher in many major cities across the Latin world than they are in the U.S., and the population is vast enough to get enough subscribers to maintain Netflix’s rate of growth. Plus, there’s strong demand there for American films and fewer languages that will require subtitling.

For now, Hastings is keeping his passport close to the vest. Even job postings at Netflix’s call center in Hillsboro, Ore., offer few clues as to which region takes priority; the company is looking to hire those fluent in at least eight different languages spoken on three different continents.

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