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Apple and Netflix offer different services, but there is the possibility that Apple's service would "cross over" this year and take over from where Netflix is positioned as the leader in online video rental.

Netflix has the upper hand right now because of the extreme popularity of DVD players. There's simply a large group of people with a DVD player plus some kind of internet access that can use the Netflix service, who would not be able to use the Apple service. Netflix will likely continue to grow in popularity as brick-and-mortar stores go away due to their lack of selection. In particular, Blockbuster no longer carries any older movies, and Hollywood video still requires you to drive there, drive back, etc. I have family that lives in remote places, as many Americans do, and they would not be able to rent hardly any videos, were it not for the Netflix service. So I'd expect Netflix to crush Blockbuster this year, and/or Hollywood video in the near future to become almost a monopoly in the physical DVD rental business.

At the minimum, with Apple you're either watching on your computer, or you have an apple TV box and wifi/high speed internet in your house to make their service useful.  Apple will continue to make gains with rentals to adopters of these plus some iPod video/nano users, however their service will remain second to Netflix barring some pretty remarkable adoptions of other Apple and higher-dollar technologies like wifi or high-speed internet access.  

 It is possible that Apple could provide more serious competition to Netflix: should Apple release a cable for watching movies rented from an iPod to a regular TV, then every iPod would become a viable alternative to a DVD player.  There are numerous families with iPods that could take advantage of Apple's movie rentals at that point.  Short of such a cable, though, I just don't see Apple's rentals overtaking nearly the marketshare of Netflix.

I would expect both services to grow slowly over the next year, and for them to be eclipsed by more creative businesses over the next five years if they don't make some major changes.

The fundamental problems are twofold. First, I think that rented and purchased online content is likely to be eclipsed by free, ad-supported content. And second, I think the use of intrusive digital rights management systems will limit the growth of the online video market and leave an opening for more open technologies to fill the gap.

First, on rentals versus ad-supported content: renting made a lot of sense when content came on a physical tape or DVD that had to be picked up at the store, viewed, and returned. Those DVDs cost money and they took up space in peoples' homes, so it made sense for people to share them. But online content comes in as pure 1s and 0s. It costs next to nothing to make a copy. And so it's silly to place the same kinds of restrictions on it that are placed on traditional physical media.

This problem is greatly exacerbated by the studios' insistence on using draconian, proprietary copy-protection schemes. These schemes dramatically limit the growth of video-rental platforms, because only authorized vendors are allowed to build compatible products and services. It also deliberately introduces incompatibilities among hardware devices that would otherwise be perfectly able to talk to one another. See, for example, Netflix's troubles with DRM on Vista.

These trends have become obvious in the music space. Last year, Steve Jobs announced that he wanted to do away with music DRM on iTunes, and since then almost all of the labels have taken the plunge toward DRM-free music sales. Late last year, the labels took the even more dramatic step of legalizing music-sharing in exchange for a cut of ad revenues. Today, you can listen to almost any song ever recorded, for free, with the blessing of the record labels. They've done this because they've discovered that selling or renting content doesn't work—there's so much free content on the Internet (legal and otherwise) that a lot of users just aren't interested in pulling out their credit cards and paying for content.

We've seen the same trend in the news space. The New York Times and the Atlantic both recently dropped their paywalls and made their content freely available, supported by advertising. The Los Angeles Times dropped their paywall in 2005, and a lot of smaller newspapers have made similar moves. The Wall Street Journal has become one of the few newspapers still clinging to a paid content business model, and there's a lot of discussion that Rupert Murdoch is thinking about dropping the paywall there as well.

To anticipate an obvious objection, the iTunes Music Store rode almost entirely on the coattails of the iPod. Apple has sold fewer than 50 tracks—i.e. about 4 CDs—per iPod, suggesting that the vast majority of the music on the iPod is from other sources. The lesson of Apple's dominance of the music purchase market, I think, isn't that iTunes was a roaring success but that their competitors were such dismal failures that Apple won the market by default. Digital download sales have come nowhere close to replacing lost revenues from CDs, and I wouldn't expect that to change. To the contrary, I think we'll start to see iTunes become eclipsed by free, ad-supported music sites like Imeem or others that are just being started now.

With all that said, I would expect Netflix to do better than Apple over the next year or two. Netflix has a large installed base of customers who are already happy with their DVD-swapping service. Adding digital downloads probably won't attract a ton of new users, but it will provide a bit of added value for existing customers. Some customers may even decide they like it better—at least for those customers who aren't tripped up over DRM issues. Moreover, subscription models make more sense than outright purchase or rental, because there's no reason to limit the number of movies that a paying customer is allowed to watch. So if I had to put money on one strategy or the other, I would bet on Netflix.

On the other hand, Steve Jobs is a marketing genius, and he may yet unveil new hardware devices that change the game. Apple TV has yet to catch the public imagination, but Apple is working hard to improve it, and it may yet take off. Moreover, Steve Jobs may be pushing hard behind the scenes, as he did with music, to liberalize the licensing terms for movies. If he convinces Hollywood to license their movies on more liberal terms before Netflix or others do, that could be a big hit.

But my guess is that someone else will come along and blow both of them away. The really ironic thing about the video market is that Hollywood already has a winning business model staring it in the face: television. They've been giving away content and selling ads for 50 years. There's absolutely no reason they couldn't adopt the same strategy online: provide free, DRM-free, ad-supported access to their content. If they did it well, they wouldn't have to worry about "piracy" because piracy would just be increasing interest in their shows. I think that sooner or later, someone will figure out how to do this right (perhaps with non-Hollywood content if Hollywood is too intransigent) and make bundle of money. At which point Hollywood will reverse itself, as the record labels did last year, and become believers in free, ad-supported content. Unless Apple or Netflix position themselves to get out in front of that parade, they're in danger of getting left behind.

Until broadband penetration and download speeds increase, movie downloads will still be a niche market, especially HD movies. Even downloading a standard definition movie can take several days if the download speed isn't more than 100Kbps. People may be paying for multi-megabit connections but the true download speed is rarely close to that. However, this doesn't mean that online movies should compromise on quality. The old version of Apple TV had bad picture quality, displaying compression artifacts and jagged images. Even though HD is the wave of the future, people won't accept anything that is less than standard DVD quality.

Online movie libraries are nowhere near the size of what conventional DVD libaries are. Just comparing Netflix's DVD selection vs. its online selection shows quite a disparity between what's available. Online movies have the potential to offer pretty much every movie ever created but movie companies are hesitant to do that. So right now it's simply easier to find what you want on DVD than try to find it online, especially if it's not a popular title like many documentaries or foreign films.

People are used to the convienience of DVDs. They don't want additional DRM restricting where they can watch movies. A DVD can be used pretty much anywhere; many online movies are restricted to just the computer they are downloaded to. In the case of Apple, the movies are restricted to an Apple TV device. Though people may use the online services, they will still find a way to circumvent DRM so they can get "fair use" from them. Hence, it's better for companies to consider what people actually want rather than try to artifically restrict them.

Similarly, movies need to be accessible to multiple devices. Currently Netflix only offers online movies for Windows users, which effectively eliminates 5-10% of computer users, such as Mac and Linux. This is a bad idea; there is no reason why online movies can't be accessed by pretty much any Internet-aware and video capable device.

One way to really encourage online movies is to allow people to make a DVD copy. DVDs are so universal in people's homes that it will be several decades until stricly online offerings take over. It also means that people can download a movie and take it with them so they aren't tied to a computer or Apple TV. It also means that they can show the movie to friends and family, which means more people may become interested through word-of-mouth.

Apple TV is an interesting idea but it harks of previous set-top box offerings. Even though the Apple TV provides other resources besides just movies, there are other ways for people to accomplish this. Therefore the most important reason to buy one is to rent online movies. But why buy a set-top box to watch movies when you can just as easily rent a DVD and use any DVD player to view them? Set-top boxes are a bad idea for commodity products; it smacks of artifical limitations for consumers. When someone can buy a small-form factor computer and use it to download movies from Bittorrent or play DVDs, why be limited by what Apple wants to include in Apple TV?

In summary, I don't think online movies will move much past the "interesting" stage until they are available on multiple platforms and don't lock people into certain devices. Internet download speeds also need to increase so people don't have to wait more than an hour or two, or at least so streaming doesn't stutter. Streaming movies need to allow people to treat the material just like a DVD rental; if people are watching at home, then real life can intrude at any time. It also makes sense to create a system that lets people use the movies on their home theater system rather than restricting them to a computer, therefore one idea is allow burning of DVDs. Finally, the available online libraries need to be at least as good as what's available on DVD; companies are only restricted by storage space, not physical space, so they can offer nearly every movie in existence which means more potential profit from the "long tail".

Existing attempts to provide downloadable "on-demand" services have foundered in the marketplace, suffering from high prices, overly excessive DRM systems, lack of content, and in general, lack of convenience. Further, most consumers already have access to some form of on-demand service via their existing digital cable/satellite set-top-boxes (STB), making it a three-legged race between competitive offerings.

Or four, if you consider the "pressure" placed on buyers to upgrade to Blu-Ray/HD DVD, or five, if we also toss streaming services like NBC Universal's Hulu into the mix.

So with eveyone attempting to grab market share and with existing competive services already in place, how will relative newcomers like Apple and NetFlix fare? What's their competitive advantage?

First, one has to consider one of the key factors that's hampered Apple's prior foray into this space: content. With only Paramount, Disney, and a few independents to rely on, the iTunes store (and as such, Apple TV), suffered from a paltry selection of films and videos. And consumers responded as such. NetFlix, on the other hand, has realized much of its success by maintaining a library of tens of thousands of titles, a true "long-tail" success story. This despite the fact the by-and-large the process is a pain, requiring days to recieve new disks and to turn them around again.

Obviously, content is key. And both Apple and NetFlix have realized this, signing deals with all of the major studios. Granting users access to thousands of titles will be instrumental in weaning them off their cable on-demand services, with a mere hundred or so available choices. This is so important that "first-mover" advantage may fall to the one that rolls out the most content in the least amount of time, and in all likelyhood lead Jobs to announce that "over a thousand titles will be available when the rental section launches." NetFlix, however, seems to already be in the lead in this regard with over 6,000 movie and TV titles available. Time will tell.

But that leads to another prime set of factors: convenience and comfort. It's pretty easy to sit on the couch and press the "on-demand" button. How much additional work is involved in a digital on-demand service? Here, it would seem that Apple is in front with an existing STB product in the marketplace, the Apple TV. This while NetFlix currently requires its users to curl up on their desks in front of their PCs to watch a movie. (Also a major disadvantage of most streaming services.) Forthcoming upgrades to Apple TV will also let consumers browse titles and rent them right from their televisions. NetFlix is said to be working on their own STB solution with LG, but no timeline has been announced. Delay too long, and they may let Apple increase their already considerable lead.

Download speeds will also be issues in terms of acceptance, but that will be true of both services. And in any case, a couple of hours, at worse, is still better than a three-day DVD turnaround.

Price will also be a factor, but both Apple and NetFlix seem to be competitive in that regard, and so we have the iTunes rental ala-carte model vs. the NetFlix subscription-based service. Ultimately, this may simply come down to consumer taste, and what works best for them. And both have subscriber bases (iTunes/NetFlix) to which they can turn in order to promote their products.

But Apple has two significant advantages up its sleeve. The first is its retail presence, in which potential buyers can see Apple's solution, touch it, play with it, and ask questions and get answers.

The second advantage, and equally significant, lies in the form of its massive army of iPod and iPhone and MacBook owners. All video-ready devices ready to provide their owners with on-the-go entertainment when they're on the road, or in a plane or train, and not just at home sitting on the sofa. And, due to Apple's DRM licensing policies, its an army that NetFlix is simply barred from entertaining.

If you've already ventured into the Apple universe, that's going to be a strong inducement to simply take the next step and, as some detractors put it, "drink more of the Kool-Aid."

As consumers slowly warm to the idea of downloading videos on their broadband connections  key questions for both Apple and Netflix are how much consumers will use their services instead of video stores,  DVDs by mail, or Cable offerings.

Unfortunately for both Netflix and Apple they face an uphill battle on several fronts:

Video stores offer many titles, generally at lower cost than downloads, and offer a simple casual shopping experience.   Habits die hard and it's unlikely many consumers will switch exclusively to online downloads anytime soon. 

Given the current state of download technology and infrastructure,  there is a large natural competitive advantage for  Cable and Satellite Companies who are already wired into millions of customer TVs and integrated into their monthly billing habits.    Charter, Comcast, and others already offer on demand pay per view programming, and are in an excellent position to undercut Apple and Netflix pricing to their own competitive advantage.

Also giving the edge to Cable and Satellite is the fact that TIVO / MOXI / Media Center units are making it increasingly simple to program movie downloads from cable movie networks, special networks, and network TV, reducing the potential total demand for paid video offerings.  

Netflix has been successful with the DVD by mail system, which will likely remain quite viable for some time as broadband and customer habits transition, however Apple loses on that front as well and appears unlikely to get into that market anytime soon.  

Apple Video mini SWOT:

Apple has several potential strengths in the downloadable video market.  First, their movies will be IPOD compatible. With some 150 million IPODS this could be an advantage as users warm to the small format for movies.    Apple has cut pricing and renegotiated with studios to offer films at costs comparable to DVD rentals.    Apple's brand is strong, and enthusiasts may fork over the $200+ for Apple TV adapter units and use Apple as their service out of brand loyalty.

Weaknesses for Apple trump the strengths in my view.   Apple is competing with very established players in the form of Cable Companies, many of which already have set top boxes in the home as well as XBOX360 units and Media Center computers which can also manage content.  Will consumers spend another $200 for an Apple set top box so they can watch movies for pay instead of free cable service movies they've TIVO'd?   Some will, most won't.   The limited number of downloadable film titles appears to be another defect in Apple's strategy.   Also, where Netflix now offers unlimited downloads Apple forces payment for each title, which then must be viewed within 24 hours of starting the title. 

Opportunities for Apple appear to lie largely in the iPOD/iPhone markets over which Apple has substantial control.  For me personally, movies on an iPOD are not a pleasant idea but clearly for many in the youth market this may be a viable approach, encouraging downloads where users can watch on the computer, IPOD, or TV or any combination.     As always, Apple's legendary marketing allows Apple to trump substance with style, so they may be able to push demand via advertising and appeals to their loyal following.   In my view Apple should match Netflix "all you can eat" ASAP although from Job's comments about his battles with studios regarding lowering prices this does not seem to be a way to make them very happy.

Threats for Apple are overwhelming in this market.   Several are mentioned above already including Cable Companies and the potential lack of user interest in downloading videos.   A very direct threat in my view is the likely lower cost of the Netflix / LG set top box.    It's hard to imagine even enthusiastic downloading consumers choosing Apple over Netflix if the latter offers cheaper hardware and cheaper movies.

Netflix Video mini SWOT

Netflix has several significant strong suits going into this market.   First, they have established a loyal customer base who count on them for movies already and thus are likely to use them as they transition/experiment with downloadable movies. Netflix decision to go "all you can eat" is a powerful way to leverage the low costs and highly scalable systems to good advantage.    If Apple does not follow this lead Netflix could emerge as the clear winner very fast, and once customers have subscribed and learned the Netflix routines it's unlikely they'll switch over to Apple even if Apple offers the same services.    Price is a Netflix strength - they offer unlimited downloading for the price of a few store DVDs or a few Apple downloads.    Library size is also impressive with Netflix which has made about 6000 titles downloadable to date.   Netflix is generally considered to have outplayed languishing Blockbuster on several fronts, and wisely has no plans to open brick and mortar stores.   Look for Blockbuster customers to switch to Netflix.

Weaknesses for Netflix are as noted above and primarily come from cable companies that offer similar services and are already in the home.    In my view Apple and Blockbuster offer little threat to Netflix's dominance in this market. 

Opportunities for Netflix.   Continuing to poach Blockbuster subscribers and innovate as they have done for several years.

Threats:  Slowing subscriber growth and market saturation.   Seeking Alpha notes that growth in subscribers and revenue has slowed over the past year, though it's still expected to grow about 16% in 2008.   Netflix should avoid aggressive moves that could threaten their profitability at a time where they are winning so many battles for online video dominance. 

Apple vs Netflix Online Offerings:

Predicting the rate of the growth of *online video downloading* by these two services in the coming year is very problematic for obvious reasons.   Clearly the *rate of growth* could be high because the current use is low.

I'd suggest that even though the rate of increase in downloading will be up for 2008 (due to insignificant current levels), the Apple set top box product will have very limited success and low adoption levels in 2008. In the recent conference call Apple suggested that iTunes was run at about "break even" to facilitate sales of hardware. Without a major push in advertising and sales focus (and perhaps even with that), it seems unlikely set top box and video download revenues will be impressive. I can't even imagine how a salesperson is going to push even savvy customers to buy yet another set top box so they can turn around and pay another media company for content. Look for more of the same from Apple TV despite the improvements to the service - slow adoption and low/no revenues.

I'd suggest Netflix has more potential for success both with PC downloading and the set top box for TV viewing. It seems likely Netflix will see a substantial increase in the number of subscribers who test out the download services since these are bundled with the DVD by mail and offer all you can eat appeal. Whether the set top box is a success may depend in large part on the cost of the LG units. At $200+ I doubt they will be enthusiastically received, especially as the US recession puts a crimp in this type of retail spending. Despite the growth in online video usage by Netflix subscribers, I do not think the increased growth in download services will have much if any affect on Netflix revenue bottom line given their all you can download format. Expect modest subscriber growth of 15-20% as the market slowly expands for Netflix services. The huge "silent majority" of customers who are not enthusiastic about the online download advantages will trump the early adopters, many of whom are already participating in this market.

Relevant links and sources:

Switch reports that Netflix "Instant Watch" saw 450,000 users in November 2007. http://www.switched.com/2007/12/04/netflix-seeing-four-times-as-much-traffic-as- blockbuster/

Netflix vs Apple:
http://www.switched.com/2008/01/15/netflix-pre-empts-apple-with-unlimite d-movie-downloads/

Movie Download Market:
http://electronrun.wordpress.com/2008/01/04/netflix-and-lg-to-enter-cro wded-movie-download-market/

Apple vs. Netflix:
http://www.techconsumer.com/2008/01/15/apple-tv-20-vs-netflix-unlimite d-this-will-be-interesting/

Apple vs. Netflix:
http://www.associatedcontent.com/article/553721/itunes_vs_netflix_vs_b lockbuster.html

http://www.swordplay.tv/2008/01/15/netflixbaby-steps-unlimited-instant-vie wing/

http://www.usatoday.com/tech/products/2008-01-15-apple-movie-downloads_N.h tm

http://seekingalpha.com/article/61865-netflix-2008-outlook?source=yahoo

An Analysis of the Apple and Netflix Online Video Models

It is easy to see how the online video arena is shaping into a hotly contested battleground between several of competitors. Thus far, in a category where an undisputed leader has yet to emerge, there is certainly room for a number of players to rise to the top. As a result, shakeout and consolidation are in the forecast for this space just as they are for other key internet-related categories. A look at Apple and Netflix reveals that each company is uniquely positioned to emerge as an online video leader.

Apple, arrives on the heels of a iPod/iTunes powered run over the past 4 years that has catapulted the company’s market share and brand value in the process of changing the dynamics of personal music consumption. On the other hand, the 10-year old Netflix is looking to make its mark in the online video space by extending leadership from the online movie rental market that it pioneered. Both companies stand at the cusp of a large-scale broadband video revolution that promises to transform the distribution of movies, film and television and result in an estimated 86.6% of the US Internet population watching online video by 2011.

Understanding the online video market today
While Internet video begins to deliver on its promise to provide viewers with the content he or she wants, anywhere, across any screen (TV, PC, portable device) anytime of the day. The key forces driving the growth of online video will play a critical role in shaping its winners and losers. As consumers are provided with more options to watch the content they have also proved willing to pay and revenue derived from internet video has been on the rise as a result. In 2006 online video generated $630 million, an increase of an impressive 273% over 2005 ($302 million). The year-over-year growth rates have been attributed mostly to in-stream advertising and download revenue. Forecasts have placed the figure at over $4 billion in revenue by 2011.

According to a study by the Yankee Group, – 2006 US Digital Home Entertainment Survey – internet users who download or watch streaming video are predominantly young males with considerable disposable income (68%). A finding that points to the fact that online video services which appeal to a male audience will fare far better than those which do not. In effect, the content made available through such services must align with those younger males who are most likely to consume it. Therefore, selection that is representative across different demographics is not entirely essential at this stage in the existence of the online video marketplace, unless these demographics change significantly.

It is important to identify the key factors behind the surge in the online video space as well as their potential affect on players like Apple and Netflix, including:

• The rise of a broadband nation. Nielsen/NetRatings pegged the current number of internet users in the United States in 2007 at 209.7 million. However, as the overall population grows and dialup becomes a relic of the past, by 2011 the number of broadband users will reach 221.3 million, an expected 71% of the US population.
• Internet delivered video really takes off. As more internet users view online videos monthly on average [94 million in 2005, 107 million in 2006 and projected to reach 169 million by 2011], the activity will take a higher priority on the list of most popular online activities.
• High Definition video continues to emerge. The future of online video is high-definition (HD). Just as it has changed the nature of broadcast and cable networks, HD will actually accelerate the market for internet delivered video. The online video services that are best to prepared to respond to this reality will be tomorrow’s leaders. According to Microsoft, eight of the top 10 movies on the Xbox LIVE Marketplace as of January 2008 were in HD.
• Apple’s involvement will drive increased awareness. Apple’s introduction of video downloads in October 2005 and its introduction of movie downloads less than a year later helped raise the awareness of video downloads. As the Cupertino, CA-based company matures as an important player across the digital media landscape its strategic moves will generate even more awareness (and activity) surrounding the online video segment.

One overlooked aspect of the online video market is the naissance of download-to-own (DTO) movies. DTO allows consumers to burn movies downloaded from the net to DVD and until recently, Hollywood, fearing a piracy outbreak, distanced itself from giving its approval. However, at the 2007 Consumer Electronics Show (CES) Sonic Solutions unveiled Qflix, a system for adding a digital lock to DVDs burned on a PC or a retail kiosk using the content scrambling system (CSS), all with the Hollywood studios approval. While it is too early to determine the eventual uptake for Qflix, it is safe to say that the verdict for DTO will affect the entire online video marketplace.

Netflix will be particularly affected by the fate of DTO, especially if Qflix can pick up notable traction in the next 12 to 18 months. The Los Gatos, California-based company might potentially lose a sizable chunk of its leading market share in the online DVD rental market if a reliable option for viewing movies downloaded to PCs as DVDs can emerge. Consumers might opt to subscribe to any one of the increasing array of online video stores and burn DVDs themselves instead of relying on Netflix to provide that service. Conversely, Apple stands to benefit tremendously if Qflix or a similar alternative brings the option of DTO to the mainstream. The main reason being, iTunes is able to pass the savings gained through digital distribution to customers meaning they will offer downloadable movies at a significantly lower price than competitors.

What it takes to win
Developing a cogent analysis of the impact of online video services on Apple and Netflix requires each offering to be evaluated in terms of how well it will meet the needs of online video audiences in 2008 and beyond. The key to success for both Apple and Netflix is found in growing online viewership as the basis for new revenue streams. This entails tailoring offerings to meet the online video needs of consumers where the following criteria must be met in the process:

• Content libraries over limited selections. Larger content libraries do more to encourage viewers to return than almost anything else. An inadequate number of selections can prove an anathema for an online video service. Repackaging of content into shorter clips or offering downloads helps augment video libraries and add variety. Bonus features that extend libraries are also beneficial.
• Simple user experiences. Complexity of use always serves to alienate users and sabotage the online viewing experience. Clunky DRM and unfriendly business rules do more to limit the consumption of online video than anything else.
• TV as a good starter. Viewers have already proven that they are receptive to viewing full linear shows and movies online. In that way the Internet serves as an on-demand access channel to popular content minus the need for a DVR. Viewers gravitate towards shows online because: they missed them in broadcast, want to see a current episode again and/or want re-watch old episodes.
• Support for original content. Despite being in its earlier stages, user generated content (UCG) offers staid advantages over repurposed content that has to be managed according to release windows for other channels such as broadcast airing. On the other hand, UCG aligns with the primary advantage of online video: keeping audiences engaged and coming back for more.

The Apple model: Online video as a gateway to increased hardware sales
Apple's iTunes video experiment of selling TV shows for $1.99 and movies for upwards of $9.99 proved a great service to the 4% of online adults who consistently purchase video on iTunes, but not one that translates easily into mainstream momentum. More realistically, it won’t result in what Apple really desires: increased demand for hardware like the iPod touch and Apple TV. As it stands today, critical mass adoption won’t scale past early adopters unless the company opens its online video model to include experiences that are currently missing. Still Apple’s iTunes boasts a 90% market share amongst paid video sites according to NPD Group and has done an impressive job of translating brand equity and leadership in the digital music domain into a position of strength in the parallel online video space.

Before crowning Apple the de-facto leader based on its success with iTunes, the only digital music store to reach scale, but also the third largest music retailer in the US accounting for at least 20% of all US music sales in 2007. Most of this success is owed to iPod, a simple device that practically reigns over the MP3 player market. On the heels of the “iPod revolution,” Apple hoped that by adding storage and a simple display, the device might be able to do the same in the video world. Yet today, a little more than two years since iTunes made the first episodes of ABC's hits Lost and Desperate Housewives for sale, Apple is still looking to lay claim to the wide open online video territory.

Strengths

• iTunes user base is strong. It’s estimated that over 22% of online users are people who use iTunes to manage their PC-based music. This is the main reason iTunes is such a juggernaut. On top of that, because it's a desktop application instead of a web-based service, people persist in their use of it as an all purpose media manager. All this despite being a latecomer to the desktop music application space in comparison to Real Player and Windows Media Player. According to a December 2006 study by the NPD Group (“VideoWatch Digital”) Apple is the clear leader in the online video arena with a 90% market share, with Vongo and MovieLink ranking second and third at 5% and 3% respectively.

• iTunes isn’t just for kids. Users who spend through iTunes are nearly 20% of online adults and 86% of iTunes users. This means that Apple is successful in converting 1 out of 5 iTunes users into customers, even if, as Steve Jobs himself pointed out, 97% of the content on the average iPod didn't come from iTunes (see his memo, “Thoughts on music,” Feburary 6, 2007). Meaning the 3% that did, on average spent $76 buying music from iTunes, nearly eight albums worth. What does this have to do with video? Well, for one it shows that those who do spend money through iTunes, spend healthily and there is little reason to assume this will differ once Apple expands its video library.

• Non-iPod users still buy video. The assumption is that those most likely to buy video through iTunes are iPod owners. However, even those iTunes users who don’t own an iPod have exhibited demand for digital video. Where close to 45% of that crowd buys iTunes video without anywhere to watch it other than the PC. When coupled with a 90% market share

Weaknesses

• An abundant source of TV shows elsewhere. A look back to when iTunes first sold ABC's shows for $1.99, other than tuning into the live broadcast, the only way to get TV shows on-demand was through a DVR, which a mere 16% of the population had. By the end of 2007, however, this figure jumped to 26% and the 52% of the population with a broadband Internet connection could watch TV shows free-of-charge online from every major network. NBC Direct has even extended the option to let its fans download shows for their offline viewing pleasure (http://nbcumv.com/release_detail.nbc/entertainment-20070919000000-nbc46comtooff er.html).

• Hit movies are M.I.A. After launching its movie store a year after its TV shows went live with heavy hitter Disney in the lineup, iTunes expected that the rest of the major movie studios would follow suite. To the contrary even after all the majors agreed to participate with Wal-Mart's online download store early last year, most are still reluctant to sell new releases through iTunes. Mostly out of fear of creating another Apple monster, or due to exclusive commitments to other partners elsewhere. To date, Disney is the only studio that puts its new releases on iTunes, consistently outselling back catalog movies studios like Lions Gate Entertainment, MGM (Metro-Goldwyn-Mayer Studios), and Paramount Pictures feature there. This results in a lack of fresh content and lack of choice movie content for purchase.

• A closed platform. Even though iTunes makes it easy to get video podcasts into iTunes and onto an iPod or Apple TV, the majority of new content going up on the Internet is not formatted in video podcasts. Meaning none of this content will be easily accessible from the closed iTunes platform and further capping iTunes’ range and variety of easily accessible [free] content.

Opportunities

• The potential for cross-sell from music to video shows promise. 19% of iTunes users purchase video from iTunes. This group is certainly attractive seeing how they’ve spent nearly twice as much at iTunes, $123 on average.

• Independent and international video. Despite publicly claiming that it is revving up its film section, Apple features a meager 28 independent films in the iTunes store. The company must look to make it easier for “indies” to list and sell their work. For a company with tremendous brand equity this should be like shooting fish in a barrel.

• Movie rental option. Apple is in a position to adopt a model Hollywood has embraced: digital pay-per-view a la CinemaNow and Movielink. Rental reduces the costs associated with giving the service a try, while also easing the burden of long-term movie storage since movies don’t permanently remain on hard drives. Thus far the new service still isn’t ready for primetime (see: http://www.mercurynews.com/apple/ci_8126504)

Threats

• N BC. The loser in the unfortunate public spat between Apple and NBC Universal over terminating their distribution agreement is Apple, which relies on NBC Universal to deliver 30% of video download sales. iTunes video lacks the leverage to generate a backlash against NBC especially now that NBC has made its content available, for free, on NBC.com and six other major portals sites, via NBC Direct download, as well as over cable VOD. To top it off, NBC and News Corp. joined forces to launch Hulu.com as an added strike against iTunes (see: http://www.informationweek.com/news/showArticle.jhtml?articleID=202603029). Cu rrently NBC has a decided edge in customer-centric innovation and represents a very real threat to Apple’s position in the marketplace.

• DRM. Amazon Unbox’s and Netflix’s decided to place their bets on Windows-only streaming and downloads which has helped them land deals Apple can’t because it uses its own DRM. While both DRM formats are proprietary QuickTime is not as widely adopted as Windows Media formats and Apple suffers as a result. There are no quick solutions but it has been suggested that the company might benefit from the industry disruption introduced by dropping DRM altogether.

• Increased competition from Netflix. The Los Gatos-based company has proven that it has no problem engaging in “one-upping” Apple in the attempt to capture its share of the online video market. For example, in January 2008, girding for a potential threat from Apple, Netflix lifted limits on how long subscribers can watch movies and television shows over high-speed Internet connections (see: http://www.msnbc.msn.com/id/22636776/).

The Netflix model: Evolving into a digital entertainment distributor
It is old news by now: Netflix does have its own digital distribution plans. The company incurred raised eyebrows from analysts and shareholders alike upon announcing that it would invest $40 million in the launch of a streaming video service, this time last year (see: http://www.nytimes.com/2007/01/16/technology/16netflix.html). So while the company’s DVD rental business appears to be in decent shape in the near term, especially since it appears that the bloody price war between Netflix and Blockbuster (BBI) is finally abating, its moves in the online video space are taking shape as a bridge that will allow Netflix to transition from total dependence on DVD rental just as contemporary forms of physical media creep towards extinction.

The question is how cultivating efforts in the online video and DVD rental arenas can fit within Netflix’s business definition. Obviously there exists scale economies associated with offering both services. Currently the company has committed to tying its streaming service, Watch Now, to its current subscription plans instead of offering the services separately. This allows the services to grow as complementary offerings instead of implicit competitors in the early stages of Netflix’s entry.

Strengths

• Good standing with Hollywood. Netflix has rarely clashed with the powers-that-be in Hollywood, maintaining good relations with movie studios that will help in negotiating better prices for its streaming movies. In this way, the company’s entry into the online video arena shouldn’t be cluttered by tiptoeing around existing bad blood between the current vanguards of established media.

• Categorical overlap. A great deal of Netflix’s existing infrastructure and positioning, including its award winning website, applies well to streaming movies. Meaning users won’t be forced to endure a cycle of perpetual tweaking towards achieving a consistent level of integration between the DVD and streaming video service.

• Unlimited streaming. While the company was able to make a splash by removing restrictions on how long more than 7 million subscribers can use the streaming service each month. As it stands, all Netflix subscribers will be afforded an “all-you-can-stream” option for a library of more than 6,000 titles, with no additional charge for the unlimited access.

Weaknesses

• The inevitability of separation. Eventually Netflix will have to detach the Watch Now service from the traditional DVD subscription as the future of the DVD rental industry remains unclear.

• Providing efficient streaming. Without the option to download, Netflix must tweak its streaming technology to a tee. This is easier said than done even if most customers who opt to stream movies will do so over a broadband connection. Customers will expect the same level of reliability from streaming that is afforded through the slower DVD-by-mail delivery but at their beck-and-call.

• DRM headaches. Obtrusive DRM policies have caused several Netflix customers to cry foul. Currently, access to the Watch Now is tied to restrictive elements that might require the removal of licenses to other content using Microsoft DRM (see: http://www.netflix.com/FAQ?p_faqid=1265). This has had the ill-effect of making it seem as if Netflix is trampling user rights to store legal content from third-parties as a precursor to using Watch Now. This also poses a threat that customers, who subscribe to other online video services that use Microsoft DRM, like Amazon’s Unbox, will boycott Watch Now in an attempt to prevent losing content.

Opportunities

• Partnerships with auxiliary players. Even more than Apple, Netflix stands to benefit from delivering digital movies to appliances other than PCs. However, while AppleTV is a notable effort, Netflix is better off taking similar steps by pursuing partnerships. The partnership between Netflix and LG is an example of making a play on the opportunity presented by the fast closing gap between Internet and TV, one which will produce an LG networked and web-enabled video box to debut in the second half of 2008.

• Blockbuster’s inactivity. Since the apparent end of the price wars between the Blockbuster and Netflix, the former has been notably quiet in light of significant activities by the latter. Last year Blockbuster entered the online video market 6 months after Netflix but closed 2007 on a slide losing members from its program while Netflix exhibited strong momentum heading into 2008. Even after the acquisition of MovieLink, there has been little visibly productive activity that has threatened Netflix.

• Truly personalized online video experiences. Netflix will have the opportunity to leverage an existing database of user preferences in offering a personal viewing experience for online videos. This type of personalization will serve as an invaluable competitive differentiator as the company’s subsequent understanding of its customer base will tremendously aide positioning in the coming future.

Threats

• A reinvigorated Blockbuster. After the acquisition of MovieLink, Blockbuster suffered a rough third quarter of 2007. When Netflix’s fourth quarter 2007 earnings trounced analyst expectations it issued an optimistic outlook for 2008 that reflects management's belief that the threat posed by Blockbuster has faded. However, this stance represents a threat in and of itself especially since it eerily resembles what happened a year ago when Netflix predicted it would add between 1.7 million and 2.1 million new subscribers during 2007. However, amid stiffer competition from Blockbuster the company was only able to add 1.2 million. In essence, if anyone is capable of imitating Netflix’s Watch Now model it is Blockbuster and the MovieLink acquisition positions it to do just that.

• Apple’s movie rental service. This is expected to present its customers with more flexibility, allowing movies to be viewed on a range of devices including the ever-popular iPod and iPhone, as well as on computers. Apple has yet to unveil the service and it will have to work through the growing pains associated with it, but Netflix has taken notice even though it expects that the new offering won’t dent the company’s growth or stall its momentum. Still in conjunction with AppleTV, a movie rental service will pose a threat to Netflix’s plans to address the fact that most people prefer watching movies on their big-screen TVs.

Projected growth rates for 2008

In order to forecast the growth rates for these two online video services it’s important to consider certain quantitative realities that will potentially loom large. At this stage in the life cycle of online video, large scale realities will shape the trajectory of offerings in the space. Therefore, the following should be factored into any forecast:

• Movie clips/trailers accounted for 32% of the type of online video that US online video viewers watched once a week while TV shows/segments accounted for 31%. Source: Online Publishers Association and OTX, “Frames of Reference: Online Video Advertising, Content and Consumer Behavior.” This bodes well for Apple since iTunes aligns well with the delivery of non full-length movies.

• US spending on internet downloads of TV programs, $14 million in 2005 and $82 million in 2006 is projected to reach $938 million by 2010 according to Veronis Suhler Stevenson, PQ Media, iTunes and Lexis Nexis. This also figures positively for Apple as Netflix does not support downloads for its online video service.

• The “2006 Piper Jaffray Online Media Survey” revealed that 19% of adult internet users in the US class themselves as maybe willing to pay to watch their favorite video content.

With these numeric realities in mind, over the remainder of 2008 Netflix’s Watch Now service will demonstrate a strong growth rate since it is being bundled with the company’s traditional DVD-rental subscription service. Watch Now will undoubtedly lead in the online movie rental segment but expect Apple to continue to maintain leadership of the overall online video space. Even if the company’s yet to be revealed movie rental venture does not fare well right out of the gates, it will provide another outlet that competes head-to-head with Watch Now. On the other hand, it isn’t feasible for Netflix to challenge Apple on other grounds by extending its service in a meaningful way over the next eleven months. Most likely Netflix will spend the year refining Watch Now as Apple pushes the envelope and expands its reach across the online video landscape.

• Currently the same weakness plagues both downloadable movie services: there aren't enough movies. I have nearly 200 movies in my NetFlix cue, but only 16 of them can be watched online. Even NetFlix's ads promise just 6,000 movies and TV episodes, while NetFlix's catalog holds over 90,000 movies. And surprisingly, Apple's iTunes store offers even less. Last April, iTunes was bragging that it offered "over 500" feature- length movies. Even Apple's big January announcement only promised that iTunes would offer "over 1,000" movies by the end of February. (And that's with 11 studios participating — an average of just 90 movies apiece.) Amazon's Unbox service offers "thousands" of downloadable movies and TV shows, and even Comcast's "video on demand" only offers 10,000 titles. (And CinemaNow also boasts about 10,000 titles.)

  The problem isn't technological. (It's obviously already possible to encode movies into a digital format.) Apple, NetFlix, and all their competitors can't offers movies until they have movies to offer. So for the near future, everyone's at the mercy of studios. (Who are in turn concerned about rights management and protecting their business model.)

• Here's another minor weakness: NetFlix doesn't have Disney downloads. That can be a differentiator for certain market segments, but it just points back to the larger problem that all the services have a limited number of titles.


• There's another obvious threat: competition. Besides the crowded field of the players mentioned above, it's important to remember that the nature of entertainment is changing. Some TV shows are becoming a lot more like movies, and some of the most popular DVDs are "complete seasons" of popular shows. Yet right now there's at least 56 TV shows that can be watched for free online. Apple and NetFlix aren't offering the only game in town.

  TV advertising only brings in $9 billion. (And last year's figure dropped $100 million from the year before.) Last June there was speculation that movie studios might even stop buying TV ads, because they were too easy to skip with personal video recorders. (Movie ads "have to be day-specific," one buyer told Advertising Age.) But online viewing allows networks to require the viewing of commercials, and some even require the user to click after the advertisement before displaying the next segment of programming. They're definitely considering the possibility of distributing popular programs themselves. (The writer's strike is an implicit recognition of the potential of downloadable video.) All this means that Apple and NetFlix will, yet again, have to reckon with the wishes of the major content producers.

• One interesting detail has haunted this discussion for years. Television viewership has been declining, along with movie attendance, and one of the culprit blamed is internet usage. Networked online games are more interactive, and are suggested as one drain on the movie-watching time of former consumers.


• NetFlix currently doesn't offer a pay-as-you-go option. Its business model requires monthly subscription fees, and they presumably achieve high margins from customers who pay for more movies rentals than they actually use. It's obvious NetFlix doesn't want to offer the pay-as-you-go option, for fear of cannibalizing those margins. But it also means they forfeit some convenience for their customers.



• NetFlix also has another cost that its competitors don't: high overhead. (One profile noted the 40 employees just at one local NetFlix facility, all sitting under a motivational poster urging them to turn around 650 DVDs within one hour...) It's not a crippling cost, but it's there, and it's an expense which is unique to the NetFlix business model.

STRENGTHS

• Apple's advantage is tie-ins to the mobile universe with its popular iPod and iPhone devices.


• On top of that, Apple has a huge installed base. Thursday it was announced that even on PC's, Apple's iTunes software is now used more often than RealPlayer, with 35.7 million users. Meanwhile, NetFlix has only 7.3 million subscribers, and the other competitors aren't really close.


• Also, Apple just has a fanatically loyal user base. Apple will still want to conquer the general consumer market, but they always enter these battles with a core base of Steve Jobs enthusiast who are ready to try Apple's latest offering. Comcast, for example, commands no such loyalty.

Broadband penetration isn't universal. In 2007, broadband finally achieved 50% penetration (jumping by 20% in 2006, according to a study by Parks Associates). Their last figure shows broadband in close to 60 million households, representing 55% penetration. Yes, that's a lot, but there's still a few years last before it's even possible to reach every movie and TV viewer with a broadband download.

Obviously that's also an opportunity.

It's inevitable that there will be mergers and consolidation in this field. This is one situation where mergers make a lot of sense, since it allows more titles to be offered and ultimately creates a better experience for consumers.