Netflix Wants to Be HBO, Not Comcast

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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This is one of the most interesting pieces of news I've seen in a while: Netflix is looking to hook up with cable companies, allowing them to put a Netflix app on their set-top boxes. Talks are in early stages, so it's too soon to flip out about a sea change in telecoms. But if this moves forward, it will represent a dramatic change in Netflix's strategy -- and possibly a blow to the dreams of cord-cutters everywhere.

In the minds of many fans (including, at one point, me), Netflix was supposed to be the cable-killer. I explained why this was folly a few years back, after the brief and tragic life of Qwikster, Netflix Chief Executive Officer Reed Hastings's attempt to separate its DVD business from the streaming:

Quite often, the answer to that exasperated "why don't they just ... ?" is green, and it folds. So in the case of Netflix, where most of the analysts who follow it closely seem to agree that Reed Hastings is not actually dumber than the proverbial bag of hangers, nor crazier than their cousin, the snake's armpit. I'm sure that Reed Hastings is well aware that Ms. Martin, like everyone else, liked things better the way they were. And I'm quite sure that he knew this when he launched Qwikster on its brief and tragic life.

More likely an extremely non-crazy and non-stupid Reed Hastings is casting around for a way out of a very, very tight spot. The DVD business, while less convenient, and more expensive to run, relies on something called "first sale doctrine": once you buy a DVD, you can rent it out as many times as you want. Reed Hastings didn't need much help from content owners to get into that business. Digital streaming rights, on the other hand, have to be negotiated.

Those negotiations were fairly easy when streaming was a marginal business. But now that it's big enough to cut into other revenue streams, like DVD sales and cable television, the content providers are demanding that Netflix make up for that lost revenue by paying them more money.

Netflix understands quite well that its customers would like them to deliver on-demand content at prices much lower than said customers used to pay for cable. The problem is, the owners of that content are not going to let them do that. The most common -- and plausible -- theory of why he tried to split the businesses, even though it was completely obvious that this was really going to upset his customers, is that content owners were demanding a per-user fee for the streaming rights, and that Hastings wanted to get the DVD-only customers off of Netflix so that he wouldn't have to pay for streaming rights they weren't using (or paying for).

That's why they raised prices. That's why they've split the businesses. That's also why there's less content on Netflix. The content providers probably don't care much if Netflix kills cable ... but they're only going to allow Netflix to do it if Netflix replaces that lost revenue, which is to say, if your Netflix streaming account costs about what your cable subscription does. And everyone who says "I'll show them -- I'll go to a better streaming service!" misunderstands the problem. If those streaming services get big enough to substitute Netflix, they will run into the same problem that Netflix has.

That doesn't mean, mind you, that Qwikster was a good idea. I thought it was stupid at the time, and the fact that the company killed it off quickly seems to indicate that Reed Hastings agrees.

Netflix still has this problem: The more people use it to evade the high cost of cable television, the more content providers will demand that it pay cable-like prices for the content they need. It's why it has gotten into the original content business with shows such as "House of Cards" and "Orange is the New Black." What these talks seem to signal is that the folks at Netflix have decided they are never going to beat the cable companies -- so they might as well join them.

That's interesting because it comes not long after Home Box Office's CEO, Richard Plepler, has begun making noises -- albeit vague, uncertain noises -- about possibly selling his web portal, HBO Go, as a standalone product. Are we starting to see some sort of convergence, where content providers settle on a model that's a bit more independent from the cable company than HBO or Showtime, but much more dependent than Netflix or Hulu?

It certainly seems possible. And if that convergence happens, here's what it might look like: cable for people who like their content bundled, and standalone Web products for those who just want a couple of things. HBO or Netflix might cost $8 as an add-on to cable, but $15 or $20 as a separate product. People who only watch three or four shows a year could pay for a couple of networks, while those who watch hours of television every night could get the "all you can eat" package we're used to.

Or perhaps all of this is just vague talk, and things will continue as they are right now, for far longer than you'd think possible. If you think markets just naturally get disrupted when new technologies appear, just ask yourself why you still have to buy a car through a dealer in 2013.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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