Why Netflix is beating HBO
WASHINGTON — Like most people in the nation's capital, I binge-watched “House of Cards.” In my case, I binged all the way from the beginning.
It's not really a very good show. Despite the superficial indicators of prestige television — David Fincher! Kevin Spacey! Ominous camera angles! — it's no “The Wire” or “The Sopranos.” It is an interesting vehicle for exploring how the American political system works, but only insofar as explaining why its outlandish scenarios couldn't possibly unfold in real life is a useful exercise.
Yet, I keep watching. And there's a lesson in that. Netflix Chief Content Officer Ted Sarandos famously described his company's challenge as “to become HBO before HBO becomes us.” And so far he's winning — not just because Sarandos and Netflix chief executive Reed Hastings are smart, and certainly not because HBO's leadership is stupid. Netflix is winning because the structural nature of technological change often favors new firms over old ones, and turns inbuilt structural advantages into weaknesses.
Netflix is, to use a word that's become annoyingly overused, “disruptive.” Which is to say that, relative to its pay-television competitors, Netflix has certain advantages that supersede the quality of its programming. And its competitors are in important ways trapped in a business logic that prevents them from matching Netflix's strengths.
Most notably, Netflix is dramatically cheaper than HBO. New HBO subscribers can typically get a discount from their cable company, but the basic price of the premium channel is $15 to $20 a month — more than twice the price of Netflix. Except it's worse than that, because HBO is an add-on to a basic cable television package.
Due to the lack of competition in the market, going broadband-only and skipping a cable subscription saves you surprisingly little money, but it's not nothing. More to the point, HBO's ties to a cable subscription don't just increase costs — they decrease flexibility.
Even though many of us would buy a stand-alone, broadband-only version of the HBO Go app, HBO has good reasons for not offering this. HBO's existing business is a really good business. Its $4.9 billion in revenue last year was only slightly higher than Netflix's $4.37 billion, but in terms of operating income, HBO blows Netflix out of the water: $1.7 billion to $228 million.
With fat, cable-derived profits on the line, HBO cannot afford to worry only about losing customers to competitors. If it launched a cord-cutting product, it risks losing customers to itself — replacing high-margin customers with lower, Netflix-style margins.
Customers' main reaction to no-standalone HBO Go product has been to do things like borrow an account password from parents or friends who subscribe. HBO chief executive Richard Plepler says he doesn't really mind if that happens. Vigorous enforcement of a “one household per HBO Go account” rule would inevitably annoy legitimate customers while doing relatively little to gin up new subscriptions. Still, legitimizing misuse of your own product is not a promising long-term strategy.
By holding to a one household-one account-many users model, Netflix has introduced practical features that are useful. My wife and I have separate Netflix personas that track our viewing habits and preferences separately, allowing for the collection of more fine-grained user data and appropriate recommendations. HBO is not only behind in terms of analytics — its entire broadband streaming strategy is at odds with gathering those analytics properly in the first place.
Then there's the binge-watching. Releasing a whole batch of episodes all at once is clearly a smart business strategy. Encouraging a show's biggest fans to gorge on episodes builds buzz and sets off the kind of social cascades that make hits more likely. In other words, all the people talking about binging on Season 2 of “House of Cards” inspired me to finally go back and binge on Season 1.
But a binge-releasing strategy is incompatible with being a good citizen of the larger television industry. HBO is part of the much larger Time Warner, a company that includes conventional television networks and production companies. It's not in the interests of those partners to revolutionize the pacing of television production and distribution, so the pressure on HBO to lag the trend will be intense. By contrast, HBO's innovations — like making its entire library available on demand — are easy for Netflix to copy.
What Netflix doesn't yet have is the depth of experience in creating great shows. But in business, there is more to life than quality. Cost, convenience and flexibility matter, and Netflix wins on all of those.
Meanwhile, quality is in some ways the easiest dimension on which to improve. To an extent, firms learn by doing. “House of Cards” is much better than “Lilyhammer,” and “Orange Is the New Black” is better still. Actually getting better still takes hard work, of course, but there are no vested interests or business-model factors preventing Netflix from taking on that challenge.
What Netflix does well, HBO can't always afford to copy without risking its existing franchise. What HBO does well, Netflix can try to copy. And it's getting better all the time.
• Yglesias writes for Slate about business and economics.