Analysis & Opinion

Netflix rights the ship, but OTT is the real rising tide

Joel Espelien, senior analyst, TDG

Joel Espelien, senior analyst, TDG

Attribution Bias is a cognitive partiality that causes us humans to make systematic errors when evaluating the actions of others and ourselves. In a nutshell, when good things happen to me, it’s skill. When they happen to you, it’s luck. And when bad things happen… I think you get the idea. Attribution bias affects not just individuals, but individual companies and entire markets, as illustrated on Thursday when Netflix announced its Q4 2012 financials.

When Netflix’ stock was soaring between 2009 and 2011 (rising from less than $50/share in October of 2009 to a high of nearly $300/share in the summer of 2011), CEO Reed Hastings and the rest of his team were hailed as geniuses and visionaries. The fawning media was practically throwing rose petals at their feet as they strolled through town.

On July 12, 2011, however, the big brains at Netflix announced the separation of their DVD-by-mail subscription and Internet streaming bundle into two separate services, accompanied by a not-so-veiled significant price increase. The bloggers screamed, more than a few customers said adios, the stock tanked, pundits pilloried them, and suddenly Netflix was the subject of a Saturday Night Live skit – a company run by total bumblers who couldn’t walk and chew gum at the same time. This happened within a matter of just a few months.

Since then Netflix has been fairly quiet, focused (quite rightly) on rebuilding trust and credibility with existing and new customers alike. But yesterday, the stock soared more than 40% in one trading session, all on news that the company had roared back to profitability by adding over two million new US subscribers in the last quarter of 2012.

So the guys from Los Gatos are geniuses again, right? Well, sort of. Certainly their execution in an increasingly competitive market is impressive and should be applauded. But we should not lose sight of the larger industry forces at work behind the Netflix return to fortune.

First, as TDG reported this week, “traditional” TV viewing declined in 2012 and, as we have been forecasting for several years now, is going to keep falling for years to come. Over-the-top broadband video use from companies such as Netflix, however, continues to grow at a rapid rate and will do so for the foreseeable future.

The drivers for this growth include consumer demand for high quality on-demand content, the rapid diffusion of new connected devices (led by tablets but also including smartphones, smart TVs, Internet STBs, etc.) and the huge success of the app ecosystem, which gives consumers a new way to discover and consume video.

Netflix has been a huge beneficiary of all of these factors. First, despite endless harping about the depth of its content catalog, the reality is that Netflix remains the service of choice for consumers seeking high quality on-demand content. Traditional TV is slowly becoming passé, and an increasingly significant segment of consumers turn to the cloud (and not a local DVR) to meet their demand for content on their schedule. This is a significant long-term trend that TDG has covered for years, and there is no doubt that Netflix (as long as it avoids shooting itself in the foot) will continue to be among the industry’s largest beneficiaries.

Second, Netflix was one of the first to support a premium video application on video game consoles (e.g., Microsoft Xbox 360) and other net-to-TV devices, which TDG has recommended as early as 2005 to bring online video services to the television as quickly as possible. No dedicated net TV device required, just use the app on your game console!

Third, Netflix was the first and (along with YouTube) one of the only services to successfully pursue a pre-loaded application strategy on first-generation consumer electronic devices. This was critical in order to get viewers watching broadband video on their TVs now, rather than waiting for mass market TV accessories that support app stores.

Finally, Netflix developed high-quality tablet applications for both iOS and Android, tapping into a wave of growth in consumer use of these devices for both video consumption and second-screen scenarios.

In short, Netflix has several long-term secular trends still going for it. Now that the consumer seems to have largely forgiven (or forgotten) the missteps of 2011, perhaps we should not all be so surprised to see it return to growth (and dramatically so). Without a doubt, the rising tide of broadband video will continue to raise a few boats (and swamp others).

This article was originally posted on The Diffusion Group’s website here.

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