Network, studio brass on high alert

While royalty rates may be the first thing you think of in the face-off between Hollywood’s major content creators and outlets such as Netflix and YouTube, there’s a much bigger battle brewing under the surface.

Online video, historically, has not been something that compares well with film or television. Production budgets, if they exist at all, are lower — and due to differences in the ad model, there hasn’t been a lot of incentive to create programming that’s on par with what the studios and networks regularly release.

That’s changing, though, with both Netflix and YouTube taking tentative steps into the original content business. And while both are just beginning to explore the field, the moves already have network and studio brass on high alert.

It all started in mid-March, when Netflix commissioned 26 original episodes of the David Fincher-produced thriller “House of Cards,” starring Kevin Spacey, scheduled to air in late 2012. In the blink of an eye, the company transformed from a pipeline for other studios’ content into a competitor.

“Our goal remains to constantly expand our selection of previous seasons of popular TV shows and we may bring more exclusive series to Netflix in the future, if an opportunity arises that has the key elements a show needs to be successful; great storytelling and great storytellers,” wrote Ted Sarandos, Netflix’s chief content officer on the company blog.

YouTube, meanwhile, is reportedly planning to add up to 20 “channels” of original, professionally produced content, filling between five and 10 hours per week. The Google-owned company is said to be planning to spend as much as $100 million on the initiative — a pittance compared to that of studios or major networks, but enough to get content launched. YouTube has declined to comment on the reports.

The company has been dipping its toes in the streaming waters for a while now, letting it determine audience appetites for longer form entertainment. YouTube and Sony’s Crackle.com have been partners for several years, streaming back catalog films and television shows, including “The Da Vinci Code” and “Married With Children.”

There are a few things at stake here. First and foremost are advertising dollars. The television industry takes in roughly $70 billion per year from sponsors. While the ad-supported model doesn’t much interest Netflix, it holds huge appeal for YouTube. With 111 million unique visitors in February, the site could woo ad dollars away from the networks if these original series catch on.

For Netflix, it’s an audience play. Digital video makes up a quarter of all home video volume, according to market research company the NPD Group. And it’s growing fast.

Currently, 23.6 million people subscribe to Netflix. That’s nearly equal to the number of people paying for the far more established HBO — and tops the number of subscribers boasted by Comcast. The company holds a 61% market share in the streaming movie field, per NPD.

But with Apple and Amazon nipping at its heels, Netflix wants to extend its lead in the streaming space. It’s betting that a serialized series, in the same vein as “Lost” or “Dexter,” will help it achieve that goal.

Netflix downplays the theory that it’s becoming a content provider, likening this to a typical licensing deal, with the caveat that it’s purchasing assets that don’t yet exist.

Netflix execs say the company would prefer to redistribute programs from the likes of HBO and Showtime. But with HBO not willing to play ball and Showtime now wanting to wait several seasons to license episodes, it’s keeping its options open.

“It remains my first desire to license great off-network content as much as it is available,” said Sarandos in an interview with Variety. “But if we can’t come to terms with traditional season-after model, that pushes up our appetite to compete with those distributors for that same content.”

Analysts note that if Netflix’s experiment succeeds, it could open several doors.

“If Netflix were to successfully add original programming, it could … enable Netflix to be not just a destination for older content, but also a must-have channel for new, original TV series; (give it) a much stickier subscriber base; (provide) content that can be easily leveraged internationally as the company expands abroad; and help to justify possible higher subscription prices in the future,” said Edward Williams of BMO Capital Markets.

At YouTube, the company has been quietly recruiting some big Hollywood names. A month ago, Paramount’s head of digital distribution — Alex Carloss — jumped ship to join YouTube’s content acquisition team. He’s working alongside Robert Kyncl, who left Netflix for the video streaming service last September.

Carloss brings extensive industry experience to YouTube. Before his six-year stint at Paramount, he put in time at MGM, Buena Vista Home Entertainment and Electronic Arts. Also on the company payroll is Malik Ducard, formerly senior VP of digital distribution for Paramount, who took an unspecified role in content business development at Google last December. Those relationships could help Google as it seeks to make deals with studios.

The timing behind the push for original, professional-quality content from streaming companies is not coincidental. Virtually every major television manufacturer embraced the Web-connected set at this year’s Consumer Electronics Show, opening up a huge new audience for the sites.

A new study from DisplaySearch, in fact, estimates that connected TVs will increase at a compound annual growth rate of 30% in the next three years. By 2014, total shipments on the sets are expected to reach 123 million. Already, connected TVs account for 20% of all TV shipments.

Netflix is gaining the biggest early foothold, with a number of manufacturers having agreed to add a red Netflix-branded button onto new remote controls. That will give viewers access to the streaming service that’s just as convenient as changing the channel.

At the same time, the explosion in high-definition portable devices, such as smart phones and tablets like the iPad, are letting consumers move their program viewing beyond the living room.

Rounding out this perfect storm are the regular increases in the price of cable rates and satellite rates (DirecTV, for instance, hiked fees 4% in February). While the cord-cutting movement isn’t taking off as fast as some proponents like to say it is, consumers are cutting back on some package options — and an increase in content from Netflix, which people seem to put into a separate category mentally, and YouTube, which is free, could be sufficient to give fence-sitters the push to drop a premium channel or two.

The challenge with this sort of programming is standing out from the pack. Netflix hasn’t yet determined how it will air “House of Cards.” And while YouTube can funnel traffic through the use of its home page, it’s unable to do so in a manner that will drive numbers that come close to those the networks post.

There is, in fact, a flood of existing episodic content on the Web that has won acclaim, such as Felicia Day’s “The Guild” or Illeana Douglas’ “Easy to Assemble.” But they haven’t caught the eye of mainstream channel surfers due to the medium — networks still have established program grids working in their favor.

That familiarity is one of the most distinct advantages broadcast has in this fight. Disruption isn’t easily achieved. Breaking people out of their typical viewing habits is difficult. And convincing someone to change formats versus simply changing channels will be doubly so.

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