05 January 2010

Netflix Envoy Pitches Online Films to Wary Studios


Netflix Inc. Chief Content Officer Ted Sarandos bypassed Hollywood to jump-start the company’s online film-rental business last year. Now he has to convince the studios the company is a friend and not a foe.

Chief Executive Officer Reed Hastings is counting on Sarandos to cut deals with studios giving Netflix rights to show more films over the Web. Sarandos, 45, says he is willing to write big checks after Netflix went around Walt Disney Co. and Sony Corp. to gain access to movies from the Starz network.

“We have to fight against their fear that we’ll destroy the ecosystem,” Sarandos, a former video-store clerk, said at a Dec. 16 panel discussion. “We’re not destroying anything. We’re creating a new opportunity.”

Sarandos’s success is critical to Netflix as viewers move to the Web, endangering the mail-order DVD rental business that helped the company upend brick-and-mortar stores such as Blockbuster Inc. His challenge is to persuade studios to provide content as they explore their own digital options, including offering movies online themselves.

“The challenge for Netflix is what to do when the world migrates to digital distribution and whether it can obtain product from all the studios as that’s happening,” said Warren Lieberfarb, the former head of Warner Bros. DVD operations.

Netflix, the largest mail-order film-rental service, offers Web-based movie-viewing that’s used by 42 percent of its 11.1 million subscribers, according to the company. It has an online library of 17,000 films and TV shows.

DVDs Yes, Streaming No?

The studios, coping with a decline in DVD sales, are trying to avoid the fate of newspapers and music labels, which lost sales when their content went online. Hollywood executives view the Internet-based distribution as a threat to the traditional way money is made from movies.

“Everybody views it as a terminal career decision if you get it wrong,” said Frank Biondi, who has led Universal Studios, Time Warner Inc.’s HBO cable network and Viacom Inc., owner of Paramount Pictures.

Acquiring DVDs has rarely been a problem for Netflix, which charges $8.99 a month and up for its mail-order service. The company needs additional rights from the studios to stream films to PCs, game consoles and Web-linked TVs.

Netflix gained streaming rights to Disney and Sony movies including “Ratatouille” and “Spider-Man 3” last year by allying with Starz, the pay-TV network controlled by John Malone’s Liberty Media Corp., based in Englewood, Colorado. In the future, permission will have to come from the studios, Netflix said in its annual report.

Hollywood Breadbasket

The Starz partnership created animosity in Hollywood, according to Tony Wible, an analyst at Janney Montgomery Scott LLC in Philadelphia, who recommends selling Netflix shares. The retailer will probably need to pay studios more or risk losing content, he said.

Paramount, based in Los Angeles, supplies older titles to Netflix for streaming, Thomas Lesinski, head of home entertainment, said in an e-mail. “But not new releases.”

Home entertainment executives at the other major studios declined to be interviewed.

DVDs rank as the most profitable part of Hollywood’s film business, with studios keeping about 80 percent of each purchase, according to Tom Adams, president of Monterey, California-based Adams Media Research. Sales will fall about 10 percent to $13 billion this year, according to Adams, who tracks the market. Rentals will total $8 billion, unchanged from 2008. Studios also will get about $2 billion from premium cable in the U.S. and $1 billion from basic cable and broadcast TV.

Market Share

Sarandos, based in Beverly Hills, California, and Hastings, 49, pledge to pay studios more as online viewing replaces the mail-order business. The company estimates it will spend $600 million next year shipping DVDs.

“We’ll become one of the networks’ and studios’ largest revenue generators,” Hastings said. He expects to be mailing DVDs until 2030.

Netflix’s DVD subscription service is projected by analysts to drive profit of $110.8 million this year on sales of $1.67 billion, a 22 percent gain from 2008. The shares, which have almost doubled this year, fell 36 cents to $56.98 at 4 p.m. New York time in Nasdaq Stock Market trading.

Through the first half of 2009, Netflix accounted for $803 million of the $4.14 billion U.S. rental market, trailing Blockbuster Inc.’s $986 million, according to Janney Montgomery, which cited Adams Media data.

The big studios -- Warner Bros., Disney, News Corp.’s Fox, Paramount, Sony and General Electric Co.’s Universal -- sell films in separate windows and times. Movies go from theaters to stores, for purchase or rental, to cable and satellite pay-per- view, to premium channels like HBO, then basic cable and broadcast, with studios collecting money at every step.

Existing Contracts

Hastings’s aim is to find a niche for streaming.

Netflix’s goal of streaming films to rental customers when DVDs arrive in stores or air on pay TV would violate studio agreements with cable networks, said Biondi who’s now senior managing director of WaterView Advisors LLC, a New York-based private-equity firm.

“Not that those can’t be reset,” Biondi said in an interview. “But you’re going to have big customer sets that are going to be very unhappy.”

Sarandos says Netflix is creating a business that didn’t exist before, partnering with Tokyo-based Sony, Microsoft Corp. and TiVo Inc. to stream films to game consoles and set-top boxes. It is also vying with cable operators such as Comcast Corp., which is introducing an online service, studios including New York-based Time Warner and Burbank, California-based Disney, as well as Apple Inc. and retailer Best Buy Co.

Sale-Only Window

Researcher iSuppli Corp. in El Segundo, California, estimates consumers worldwide will have 376.5 million devices that can receive Web video content by 2013, up from 94.8 million now. Netflix plans to expand internationally with a streaming- only service next year, Hastings said in October.

The studios have seen rental chains buckle under competition from Netflix and Bellevue, Washington-based Coinstar Inc., operator of Redbox kiosks that rent movies for $1 a day. Time Warner is seeking more money from Netflix, whose Web site no longer features the studio’s DVDs -- a possible “sign of strain,” Janney’s Wible said in a Dec. 17 research note.

To alleviate fears that its online service won’t cannibalize existing revenue, Netflix has suggested it may agree to a new sales-only window in which movies can’t be rented.

Sarandos often meets with Hollywood brass over breakfast at the Four Seasons Hotel in Beverly Hills.

‘Trust and Relationships’

“Doing business in Hollywood is very much built on trust and relationships,” Sarandos said in an interview.

In May, Jeffrey Katzenberg, CEO of DreamWorks Animation SKG Inc., hosted Netflix executives for a demonstration of 3-D home movies. At the Video Hall of Fame dinner this month, Sarandos mingled with executives like Lions Gate Entertainment Corp. President Steve Beeks.

“If you could assume anybody’s position in the game right now you’d probably prefer Netflix’s,” said Kevin Landis, the founder of SiVest Group Inc., in Santa Clara, California, which owns 227,000 Netflix shares.

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