Beyond Arrested Development: Why we’re so obsessed with Netflix (1)

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Why isn’t this man smiling?… “We are obviously very happy,” said Carl Icahn after his investment in Netflix hit $1.35 billion, a gain of over 400% in less than seven months.

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The month of May saw a flood of discussion about Netflix. Much of the chatter was prompted by the launch of the reborn Arrested Development, with all 15 episodes of the new season going online on May 26.

Americans have treated the launch as an opportunity to be entertained, to conjure with insider jokes, to try out binge viewing, to speculate about where TV is headed (to a new “Platinum Age,” said Wired back in March; and by the way, the Nielsen family is dead).

Then there’s Canada. Our pols and policymakers have long insisted that television is a National Cultural Treasure designed not merely to entertain us but to make us Good. True to form, Canadians have been having worried discussions for the last two years about whether Netflix and its disruptive habits constitute a threat to our way of life.

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Menace or Messiah?

Dwayne Winseck and I have what might be called a philosophical difference over the evolution of TV – or what I like to call the death of TV. I see TV, certainly in this country, as having lived out any useful or interesting cultural function. But as Dwayne often reminds me, you need to follow the money… as he did in a May 1 post entitled Netflix and Canadian TV: Menace or Messiah?

Netflix had an estimated subscriber count of 1.6 million in Canada in 2012, which puts its Canadian revenues last year at about $134 million. That’s peanuts – a mere 1.8% of our broadcasting industry as a whole, which is worth $7.5 billion (not counting the distribution sector). Dwayne therefore questions the claim that Netflix will bring Canada’s four vertically integrated (VI) media conglomerates to their knees (Quebecor, Rogers, Bell and Shaw). “Me, I’m skeptical,” he writes, continuing:

“… I’m afraid that a compendium of disparate press releases will add up to the impression that there are barbarians at the gate and unless we do something fast, they’re gonna tear the place apart – that ‘place’ being the ‘Canadian television system’ as we know it.”

The Chicken Little faction

I agree with Dwayne that the “sky-is-falling” noises about Netflix are overblown, and particularly disingenuous when emanating from our four conglomerates (Telus has always disavowed any serious interest in being a content provider). Unfortunately, as we’ve seen as recently as the May Bell-Astral hearings, Netflix supplies them with an argument nicely tailored to persuading the CRTC to bless major acquisitions: we need to scale up so we can compete in the global marketplace with the Disneys and Time Warners. Whether the emphasis is on the protectionist agenda (let’s regulate Netflix) or the scale agenda (let’s grow our market power), the effect on the public interest is the same: Canada gets more barriers to competitive entry, as well as more barriers to consumer choice.

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Moreover, as Michael Geist notes, industry supplicants looking to bulk up their market power have been trotting out this argument for decades (Why Creators and Consumers Should Welcome the “Netflix Threat”):

“In the 1980s, it was the effort to keep large U.S. specialty channels such as ESPN and MTV out of the market that led to the creation of TSN and MuchMusic. In the 1990s, the U.S. satellite television providers were branded the “death stars” and kept out of the market to allow for Canadian entries. In the 2000s, it was U.S. satellite radio services that were denied entry until acquiescing to minimum Canadian content requirements. In this decade, it is the Internet’s turn as over-the-top video services such as Netflix are viewed as threats to established Canadian broadcasters, broadcast distributors, and content creators.”

ian-greenbergAt the CRTC’s second-round, May hearing on the proposed Bell-Astral merger, Astral CEO Ian Greenberg explained why he needs help saving the old family business from marauding Americans. He said he’s “captivated” by the emergence of OTT competition – and “rightly so because it impacts the very nature of our business.” Greenberg apparently means that any new competition may have the undesirable effect of taking away viewers and revenue. But the use of the calamitous-sounding phrase “the very nature of our business” connotes something more: OTT video operates in a way that puts a legacy media firm like Astral at some kind of life-and-death disadvantage. Greenberg continues:

“At the start of last year, Netflix had just over 1 million Canadian subscribers; one year later, we estimate they have just under 2 million Canadian subscribers. And Netflix is just one prominent example of the kind of scale being brought to bear on Canada’s industry, challenges to our business that we believe we must meet head-on by expanding our own scope and scale” (transcript, vol. 1, para 71).

Here are three good reasons why we shouldn’t buy Greenberg’s Chicken Little scenario.

First, the skyrocketing growth of the Netflix sub base in Canada is meaningless on its own. Is this zero-sum math? Are all these subs going to stick around? Are they finding in Netflix a substitute for Greenberg’s programming? In other words, is Astral actually losing something? As we saw in the financial analysis above, Netflix operates on a revenue scale equivalent to about 1.8% of the annual turnover of the Canadian broadcasting system as a whole. They don’t call that “scale” where I come from.

Second, Greenberg’s suggestion that Astral must meet the OTT tsunami “head-on” is disingenuous. If he meant it, he wouldn’t be sitting before a CRTC panel asking them to allow the change in ownership, while asking us to gloss over the associated risks: more concentration, harm to consumers, undue preference. “Head-on” connotes battling it out with competitors like a good capitalist, not hiding behind the skirts of a tribunal that specializes in managed competition. Astral and Bell want regulatory guarantees for the usual reason: as a hedge against market forces not working in their favor.

And third, Astral may be a small player compared to Netflix, financially speaking, but certainly not Bell. Astral’s market capitalization is $2.8 billion, fairly puny beside Netflix and its market cap of $12.4 billion. More to the point, however, the monster that would swallow Astral – BCE – has got Netflix completely eclipsed with its cap of over $40 billion. Whatever regulatory beneficence towards Astral might seem appropriate, the end result is that Astral gets swallowed and BCE gets even bigger.

Data caps to the rescue in killing off competition

One irony that emerges here is that, on the merits of the way they conduct business, our conglomerates should be worried about innovative upstarts like Netflix. It’s true, as Dwayne points out, that our conglomerates hate Netflix because their lucrative VOD services are coming under pressure from subscriber-VOD (SVOD) services. It’s also true they have to go up against Netflix and other OVDs to secure the distribution rights for popular American content. And among the technical innovations our distinctly uninnovative incumbents should be worried about is the range of end-user choice in streaming devices. Incumbent set-top boxes may be great for locking in customers, but they look mighty shabby compared to the 400-plus devices that can stream Netflix – the Xbox 360, Nintendo Wii, Sony’s PS3, Blu-ray players, Apple TV, etc, etc.

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Except possibly for the issue of access to new titles, Netflix wins hands down over our incumbent TV providers on price, tech support, hardware versatility and video quality. When Netflix says you’re getting a title in hi-def, they aren’t bullshitting you like the cablecos and telcos, which have their customers duped by stamping “HD” on everything that moves.

openmedia-capsThe issue of video quality points to one of the major ways in which the CRTC’s ITMP framework – ostensibly for managing ISP traffic – turned into a betrayal of the public trust. I’m referring to the weapon the CRTC handed the incumbent ISPs three years ago that lets them carry out their own “regulation” of Netflix: data caps. Dwayne alludes to this issue when he points out that Netflix’s Canadian subs “have to endure deliberately downgraded quality (i.e. no HD) to ensure they don’t blow their monthly bandwith caps…”

I’d put a stronger emphasis on the disastrous effects on our TV and video market of having our regulator actually encourage the use of data caps by our incumbent ISPs, which a) control over 90% of the residential access market; b) have an egregious conflict of interest between their role as ISPs and their role as owners of vast TV exhibition and distribution holdings; and c) operate without any regulatory oversight of retail pricing or the use of caps, long after we learned the caps have no legitimate use in real-world traffic management.

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~ Video controls in the Netflix preferences panel ~

What Dwayne refers to as Netflix’s “downgraded quality” came as a defensive move that enables Netflix subscribers to adjust the quality of their video in order to escape financial punishment on their ISP bills. Despite appearances, this preferences panel is not entirely a bad sign. At least it shows Netflix is prepared to offer its subs meaningful control over their viewing. I suspect not many people take advantage of this feature, either because they don’t care that much about quality or because preference settings are too much trouble.

bell-fibeBut if you do want real hi-def, then you have to set the video to “best quality” – and be prepared to live with the consequences. That means data consumption of as much as 2.3 GB per hour, compared to 0.3 GB for okay quality, meaning HD gobbles up seven times as much data as the “good” setting. I’m always in “best,” because image quality matters to my end-user experience. (If you’ve been to this page before, you won’t be startled to learn I get away with this indulgence because my 25-meg service on TekSavvy has a 300-gig cap. That’s 200 gigs a month more than the same tier from Bell, which also costs about $20 a month more than TekSavvy, depending on all the usual fine print pitfalls about temporary discounts, bundling, etc.)

In any case, the use of data caps alone means our incumbents aren’t nearly as “threatened” as they’d like us to believe. That’s exactly why the CRTC should be far more vigilant about the use of caps to promote anti-competitive and anti-consumer behavior, rather than worry about protecting our tired, outmoded broadcasting system from the imagined harm that might come from subscribing to Netflix.

In Part 2, I’m going to add a few more comments about why the Netflix value proposition isn’t just about content, and challenge the idea that it’s going to need “a lot of exclusive shows.”

D.E.