Will Netflix Break My Heart?

Netflix is going to break my heart. I fell in love one night when I stopped a movie I was watching to wash dishes in the kitchen before I tiptoed upstairs to make sure the kids were asleep, and then I continued the movie seamlessly from the spinning bike in my bedroom. The future has arrived! Almost any movie or show I want where and when I want it.

Alas, I fear, Netflix will soon break my heart. And it's an American icon that is warning me: American Airlines (AA).

You see, middle men are dying. Last week Sabre, the former AA subsidiary, now an independent "global distribution system" (GDS) which supplies travel agencies and online travel agencies with ticket and pricing information, announced it was raising the rates it charges on AA tickets. This move is an escalation of a battle that has been brewing between airlines and GDSs. Just before the holidays AA pulled its fares from online travel agency Orbitz. Just before New Year, another online travel agency, Expedia, pulled AA flights because of a dispute.

What is provoking the animosity and what does this have to do with Netflix?

Underlying this competitive dynamic is the lowering cost of coordination. Airlines once valued the service GDS provided consolidating fairs in a searchable manner to consumers. It cost less for airlines to allow independent coordinators to do this job than to do it themselves.

Now the calculus has reversed. Technology and online consumer habits have changed to the point that airlines can efficiently sell directly to consumers, and consumers can search across airlines for free (Bing's flight search engine, which pulls fare information often directly from airlines' systems, is a great example of this). Airlines would rather you search on a free service and then click through to their web sites to book your seat. This allows them to up sell you extra luggage, more leg room, and other once-free services that airlines increasingly depend on for profits.

My point is the for-profit middle man, the consolidator and coordinator, is under pressure because every day it grows easier and cheaper for providers to do the job themselves. I bet the private equity firms who bought Sabre wished they had foreseen this dynamic.

A major force that is pushing on Netflix's buttons is the competition that exists from cable and Internet providers. Today there are various viewing options available to consumers. For example, the Window's Cloud, Verizon's FiOS, and Comcast Cable's Xfinity all provide more access to "on-demand" movies, which can be watched from any room in the house. These companies usually provide Internet services as well, which is how Netflix offers its customers instant streaming. However, if people can get the same movies, on any of their TVs and computers, and only have one bill, then how long will it be before they ditch the mail-away movie?

Back on my spinning bike, watching MI-5 (former 24 fans, I highly recommend it), I realize Netflix once served a purpose. It helped Time Warner, Disney and other content owners reach consumers they could not reach before. But Netflix is going to face mounting pressure. The copying cost that once kept studios from wanting to do it on their own is falling while the payoff of competing with Netflix is rising. Starz, a movie content owner, currently has a deal to distribute through Netflix but it will soon expire. The renewed deal, if there is one, will certainly involve a much higher price.

In a recent The New York Times article on Netflix, Time Warner (TWX) CEO Jeff Bewkes slammed Netflix, calling it small time organization with a business model that can't work. Bewkes is quoted as saying, "It's a little bit like, is the Albanian army going to take over the world? I don't think so."

Netflix will continue to have an edge for a while longer, but a new era of competition is emerging. Coordination costs are falling and middle men across the nation need to watch out. Ask yourself the questions below to stay ahead of the curve.

  1. How much would it cost my competitor, supplier, or distributor to copy me?
  2. Is the "copy cost" rising or falling?
  3. What does that tell me about the future?

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