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Netflix to Media World: Gaze Upon Us, Ye Mighty, and Despair

Netflix earnings are worth watching carefully these days, as its subscriber growth -- particularly for its new streaming service -- is upsetting the still fledgling marketplace for online TV. Just ask Hulu.

A Netflix letter to shareholders (it eschewed the typical earnings release) reads like a manifesto from a company that knows it's at the forefront of a revolution. It covered everything from Netflix's financials and subscriber growth to its philosophy regarding TV content to why, despite what Time Warner CEO Jeff Bewkes thinks, it's a good idea for content providers to do business with Netflix. Below, some highlights.

Subscriber growth like a hockey stock

Netflix gained more than three million subscribers in the fourth quarter, a 166 percent gain over the same quarter last year. Forty percent of the more than seven million subscribers the company gained in 2010 came in the final quarter. Streaming, not DVDs, was the key driver; Netflix launched its $7.99/month streaming-only service -- which gives members a deep catalog of TV shows and movies -- in November. All told, Netflix has slightly more than 20 million subscribers spread among its customer base.

Financials are gaining

Netflix had $596 million in revenue in Q4, a 34 percent increase over the year ago period; operating income was up 47 percent to $78 million. But the big thing Netflix told shareholders about the additional revenue from subscriber growth is that it is going to help it pay for the more expensive content deals the company (and its competitors) believe it will be forced to pay for going forward. Here's why:

At $7.99/month (some subscribers pay more), Netflix may have just raked in about $288 million in additional revenue per year with those three million new Q4 subscribers. Its Q1 guidance on subscriber growth is conservative; it's not expecting three million more people to join by the end of March. Nonetheless it's possible that a year from now we could see Netflix having close to $1.5 billion in annual revenues. Netflix also emphasized one area where it is cutting costs: marketing, which it slashed by 10 percent in the quarter. It feels that word-of-mouth is picking up the slack.

When to stream TV content
As we all know, there's been a lot in the news lately about how, when, and whether TV's content owners should release material onto the Web. Netflix stated a very clear philosophy about this which actually counters its recent deals with Saturday Night Live and Disney. It obviously doesn't want people to think those deals are precedent-setting:

Our interest in television shows is high. Our primary strategy is to offer complete previous seasons of shows rather than offering those shows the day of, or a few days after, broadcast, during the critical ratings and revenue window. This is in the best interest of content owners and is consistent with our desire to offer a very low-cost service for consumers.... You will occasionally see us offering shows day after broadcast, as we do with "Saturday Night Live," or 15 days after broadcast, as we do with Disney Channel programs, but it doesn't represent a change in our overall TV strategy.
In other words, if Hulu craters, don't blame us.

On content cannabilization, or, memo to Jeff Bewkes
Netflix holds out Starz -- which it has had a relationship with for more than two years -- as a case in point concerning why content providers should do business with it. This part of the letter came off as a direct reply to Bewkes, and not just because it cited Time Warner's HBO as an example of an entertainment company that has been hurt by not playing ball with Netflix. (Bewkes recently compared Netflix's global influence to that of the Albanian Army.)

The shareholder letter said:

Some content owners fear that licensing to Netflix will undercut other, larger profit streams. The Starz example suggests otherwise. We have carried Starz since October 2008 and we have not licensed HBO. Over that time, Starz' Multichannel Video Programming Distributor (MVPD) subscriber count has grown, and HBO's has not. At a more granular level, the Starz Original "Spartacus" was available at the same time on Netflix as on MVPD, and it was a big success in MVPD viewing, as shown by its Nielsen ratings. ... In other words, the evidence is pretty clear that content that is also licensed to Netflix generates more money for its owners than content that is withheld from Netflix.
Take that, Time Warner!

Seriously, though, the shareholder letter paints the picture of a company that is in as commanding a spot as it can be given it is operating in a marketplace that is changing faster than its players can keep up with it. You can clearly see Netflix using the letter to set the tone for the online video industry, both because of its subscriber momentum and because of the insight into the marketplace that having that many subscribers yields. Of course, the companies that do business with Netflix -- and its rivals -- don't have to pay attention, but if its growth keeps continuing apace, they'd be crazy to ignore it.

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