Netflix, past and future.

Photographer: Andrew Harrer/Bloomberg

Netflix Wags Its Short Tail

Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
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In the 2006 business bestseller “The Long Tail,” author Chris Anderson depicted DVD-rental service Netflix as the poster child for the idea he was trying (quite successfully) to popularize. Anderson credited Netflix Chief Executive Officer Reed Hastings with giving him the idea for the book, and he quoted Hastings at length describing how Netflix’s users were moving out the long tail of content:

Historically Blockbuster has reported that about 90 percent of the movies they rent are new theatrical releases. Online they’re more niche: about 70 percent of what they rent from their website is new releases and about 30 percent is back catalog. That’s not true for Netflix. About 30 percent of what we rent is new releases and about 70 percent is back catalog and it’s not because we have a different subscriber. It’s because we create demand for content and we help you find great movies that you’ll really like.

So that was going to be the new content industry model. The limits to shelf space -- both physical and metaphorical -- that had long dictated media strategy and marketing were giving way to unlimited digital supply, and the business was changing accordingly. The blockbuster era (and not just the Blockbuster era) was waning, Anderson wrote, and “niches are emerging as the new mass market.”

Funny thing about Netflix, though. It’s doing quite well these days, as one might have expected after reading Anderson’s book. But its success doesn’t have much to do with the long tail. In this week’s gangbusters earnings release, for example, the focus was on Netflix’s handful of original series. Here’s Ted Sarandos, the company’s chief content officer, answering a question during the post-earnings call:

What we're seeing is the dollars invested in our original programming are more efficient in that for every dollar spent, we get more bang for the buck in terms of hours viewed. And hours viewed leads to higher retention, more word of mouth and more brand halo.

Another big driver of viewing hours in the last quarter, Sarandos said, was the arrival of the TV comedy “Friends” on Netflix in January. “Friends” is old, sure, but it’s an utterly mainstream former ratings hit -- quite a distance from the long end of the tail. Today’s Netflix and its “brand halo” seem to have a lot more in common with existing TV channels, most obviously HBO, than the back-catalog specialist that it was back in 2006.

Yes, the company still has that back catalog in the form of a U.S.-only DVD-rental division that made $85 million in profit in the first quarter. “The broad selection of titles … remains appealing to a core user base and means that the tail on this business should be quite long,” the company said in its earnings release. But the DVD business has just 5.5 million subscribers to Netflix’s 62 million streaming customers worldwide, and while it has provided a nice flow of cash to help finance Netflix’s push into streaming, its significance to the company is steadily waning.

So was Anderson all wrong about the long tail? Well, he does seem to have underestimated the resilience of media blockbusters -- although he never said they were going away entirely. But in books, music and lots of other kinds of media, the rise of niches that Anderson celebrated has indeed transpired. It’s even somewhat true in TV, where the number of viewers needed to make a TV show a success has declined dramatically over the decades.

But it’s not entirely true in TV, and it’s even less true for movies. That’s mainly because the makers of movies and television haven’t allowed their business to evolve that way. Farhad Manjoo of the New York Times wrote a column last year lamenting this, and pining for a TV service that resembled music streamers  Spotify and Rdio, which allow you to “pay a monthly fee to listen to whatever you want, whenever you want.” That was Hastings' original streaming plan for Netflix. According to a 2009 Wired article by Daniel Roth, he hoped at the time to “deliver the entire recorded output of Hollywood, instantly and in high definition, to any screen, anywhere.”

From Hollywood’s perspective, though, what happened in music was a disaster -- recorded-music revenue plummeted, and while live-performance revenue rose that’s not really an option for movies and TV. So the industry has stuck with established practices such as “windowing” the release of movies and signing exclusive distribution deals. Maybe this is a rearguard action that’s just delaying the inevitable. But for now it is reality, and Netflix has adjusted to it with remarkable skill.

In the DVD business the “first-sale doctrine,” which allows the buyer of a DVD to do whatever the heck he wants with it, meant that Netflix could rent out movies without permission from the studios. In streaming, that kind of permissionless innovation wasn’t an option; you need to acquire the rights to a movie or show to stream it.

Netflix did make its initial splash in streaming with what you might call a permission-lite move, getting the premium cable channel Starz to license it the rights to stream 2,500 movies and TV shows that nobody had expected to be shown anywhere but on Starz. But since it became clear that this deal wouldn’t be extended when it expired in early 2012, Netflix has had to play the same game as established TV channels.

In 2011 Hastings began to target HBO as his company’s primary competitor, and in the beginning lots of people thought Netflix had no chance in that race. The stock price tanked in 2011 and went nowhere in 2012. Jeff Bewkes, CEO of HBO parent Time Warner, amused himself in interviews by likening lightweight Netflix to the “Albanian army” and a “200-pound chimp,” and saying that Netflix and other streaming services were left with “archival content that nobody would want in Blockbuster.”

So why is Netflix still standing, and apparently thriving? Sure, some of its original series are pretty good. But having your own programming, even if it’s good, is no guarantee that anybody will watch it -- as Yahoo! is apparently discovering.

In this week’s Netflix earnings call, Hastings took a stab at answering the question:

The key thing is that the company is very agile, we're just a learning machine … we're just open-minded, curious, we're learning. And then, frankly, it's that Internet TV is growing around the world at incredible rates. And so, we're really propelled by that big macro trend.

Internet TV isn't the long-tail cornucopia of content that Hastings initially envisioned. But neither is it the same as old-style TV, and as the first mover Netflix has built up some advantages. It developed the first TV streaming box, but at the last minute Hastings decided to spin that off into a company called Roku and push to embed Netflix streaming in existing devices such as TVs, DVD players and gaming consoles (as well as the Roku box). That was a success; Netflix was often the first streaming service to arrive on these devices, and it continues to be featured prominently on just about every streaming device that exists -- because if it wasn’t that device would seem incomplete.

That’s sort of an old-fashioned competitive advantage, like being one of the first few channels on a cable system lineup. More-newfangled plusses include the size of Netflix’s streaming catalog, which is much smaller than the DVD catalog but still includes thousands of movies and shows, and the company’s engineering prowess. Thanks to its brilliant engineers, Netflix streams more reliably than most of its competitors, and it algorithmically optimizes and personalizes its homepage in ways that enable and encourage subscribers to find stuff they like and watch in mighty binges.

Maybe this isn’t as revolutionary as a truly long-tail Netflix might have been. Maybe it’s just revolutionary in a different way. In either case, it does seem to pay the bills.

  1. For younger readers: a now-defunct chain of video-rental stores.

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

To contact the author on this story:
Justin Fox at justinfox@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net