As Netflix makes move to streaming, movie studios remain wary

Published 4:00 am Saturday, January 2, 2010

SAN FRANCISCO — Netflix’s chief content officer, Ted Sarandos, bypassed Hollywood to jump-start the company’s online film-rental business last year. Now, he has to convince the studios the company is a friend and not a foe.

CEO Reed Hastings is counting on Sarandos to cut deals with studios giving Netflix rights to show more films over the Web. Sarandos, 45, says he is willing to write big checks and negotiate directly with studios after Netflix earlier went around Walt Disney Co. and Sony Corp. to gain access to their titles from the Starz cable channel.

“We have to fight against their fear that we’ll destroy the ecosystem,” Sarandos, a former video-store clerk, said at a Dec. 16 panel discussion. “We’re not destroying anything. We’re creating a new opportunity.”

Sarandos’ success is critical to Netflix as viewers move to the Web, endangering the mail-order DVD rental business that helped the company upend brick-and-mortar stores such as Blockbuster. His challenge is to convince studios to provide content as they explore their own digital options, including offering movies online themselves.

“The challenge for Netflix is what to do when the world migrates to digital distribution and whether it can obtain product from all the studios as that’s happening,” said Warren Lieberfarb, the former head of Warner Bros. DVD operations.

Netflix, the largest mail-order film-rental service, offers Web-based movie-viewing that’s used by 42 percent of its 11.1 million subscribers, according to the company. It has an online library of 17,000 films and TV shows.

The studios, coping with a decline in DVD sales, are trying to avoid the fate of newspapers and music labels, which lost sales when their content went online. Hollywood executives view digital distribution as a threat to the traditional way money is made from movies.

“Everybody views it as a terminal career decision if you get it wrong,” said Frank Biondi, who has led Universal Studios, Time Warner Inc.’s HBO cable network and Viacom Inc., owner of Paramount Pictures.

Acquiring DVDs has rarely been a problem for Netflix, which charges $8.99 per month and up for unlimited mail-order service. The company needs additional rights from the studios to stream films to PCs, game consoles and Web-linked TVs.

Netflix gained streaming rights to Disney and Sony movies including “Ratatouille” and “Spider-Man 3” last year by allying with Starz, the pay-TV network controlled by Liberty Media Corp. In the future, permission will have to come from the studios, Netflix said in its annual report.

The Starz partnership created “animosity” in Hollywood, according to Tony Wible, an analyst at Janney Montgomery Scott in Philadelphia, who recommends selling Netflix shares. The retailer will probably need to pay studios more or risk losing content, he said.

Paramount, based in Los Angeles, supplies older titles to Netflix for streaming, Thomas Lesinski, head of home entertainment, said in an e-mail. “But not new releases.”

Home entertainment executives at the other major studios declined to be interviewed.

DVDs rank as the most-profitable part of Hollywood’s film business, with studios keeping about 80 percent of each purchase, according to Tom Adams, president of Monterey, California-based Adams Media Research. Sales will fall about 10 percent to $13 billion this year, according to Adams, who tracks the market. Rentals will total $8 billion, unchanged from 2008. Studios also will get about $2 billion from premium cable in the U.S. and $1 billion from basic cable and broadcast TV.

Sarandos and Hastings pledge to pay studios more as online viewing replaces the mail-order business. The company estimates it will spend $600 million next year shipping DVDs.

“We’ll become one of the networks’ and studios’ largest revenue generators,” Hastings said. He expects to be mailing DVDs until 2030.

Netflix’s goal of streaming films to rental customers when DVDs arrive in stores or air on pay TV would violate studio agreements with cable networks, said Biondi who’s now senior managing director of WaterView Advisors LLC, a New York-based private-equity firm.

“Not that those can’t be reset,” Biondi said in an interview. “But you’re going to have big customer sets that are going to be very unhappy.”

Sarandos says Netflix is creating a business that didn’t exist before, partnering with Tokyo-based Sony, Microsoft Corp. and TiVo Inc. to stream films to game consoles and set-top boxes. It is also vying with cable operators such as Comcast Corp., which is introducing an online service, studios including New York-based Time Warner and Burbank, California-based Disney, as well as Apple Inc. and retailer Best Buy Co.

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