Prepare for TV chaos

A stock analyst once called Reed Hastings’s company, Netflix Inc., “a worthless piece of crap with really nice people.” That was six years ago. Hastings and his agreeable team have since helped kneecap video-rental giant Blockbuster by convincing Americans that it was easier to rent DVDs through Netflix’s website, and then have them delivered (and returned, postage paid) through the mail. Now Netflix is in the process of upending the entire television business by using the Internet to stream movies and TV shows directly to people’s computers and big-screen televisions via Web-connected Blu-ray players, Xboxes and other devices. So much for Mr. Nice Guy.

Netflix has so far signed up more than 24 million customers in the United States, rivalling the subscriber base of cable giant Comcast. Hastings expects to add another one million Canadian subscribers by this summer, with each one paying $7.99 a month for unlimited access to Netflix’s ballooning catalogue of digital titles. And the stock price? It’s far from worthless, having surged more than 800 per cent over the past five years—a better performance than even Apple Inc.’s.

Not surprisingly, cable and satellite TV executives are getting nervous—Comcast’s CEO recently derided Netflix as “reruns TV,” referring to its lack of live content. And Hastings isn’t doing much to soothe fears when he describes Netflix’s potential customer base as one that goes well beyond existing cable or satellite subscribers. “One way to think about the upper limit is the number of people who have a mobile phone,” Hastings told Maclean’s. “That’s because they’re people with enough money, and are of the right age to own a device with a screen.”

But while Netflix has become an early leader in the race to reinvent television, it’s far from the only player seeking a piece of the action. Google and Amazon have already dipped their giant toes in the market, and there are repeated rumours that Apple CEO Steve Jobs is quietly working on some sort of iTV-type device. As a result, Canadian consumers can expect an avalanche of TV alternatives over the next few years—all of them promising to let you watch what you want, when you want it—and for less money.

At the same time, the industry’s incumbents—cable companies and satellite providers—are vowing to do whatever it takes to defend their lucrative turf, while broadcasters and studios aren’t sure whether to welcome Netflix and its ilk as valuable new distribution partners or dangerous competitors. It might be tempting to call it TV’s Napster moment, but the industry has had nearly a decade to prepare for the arrival of Web-based competitors and, in many cases, owns the Internet infrastructure Netflix and others need to reach their customers. The battle for the living room has begun.

Netflix hoped to make a splash when it arrived in Canada last September, closing down a busy Toronto street for a launch event that included a cast of extras hired to pose as curious onlookers. It was later revealed that the actors were given scripts that told them to “look really excited, particularly if asked by media to do any interviews about the prospect of Netflix in Canada,” and some were only too happy to oblige. Netflix was later forced to apologize.

The cringeworthy stumble must have warmed the hearts of cable companies like Shaw Communications Inc. and Rogers Communications Inc. (which owns Maclean’s), as well as telecom and satellite TV providers like Bell Canada Inc. and Telus Corp. But the respite was short-lived. Soon, Netflix was back to selling Canadians on its idea of the future of television—one where the days of rushing home to catch a favourite show are replaced by a world of cheap, on-demand programming that can be viewed on a flat-panel TV, laptop, tablet or smartphone.

The sales pitch took on added significance earlier this year when Netflix revealed that it had signed a big Canadian-content deal with Paramount. In the U.S., it also raised eyebrows by securing the streaming rights for the TV series Mad Men, paying US$1 million per episode. But perhaps most interestingly, Netflix also locked up the rights to its own TV series, House of Cards, which stars Kevin Spacey and will be “aired” only on Netflix. Suddenly, in the eyes of broadcasters and cable companies alike, Netflix went from being “reruns TV” to a bona fide competitor. That, in turn, led some of the industry’s big players to call on Ottawa to regulate Netflix as a “premium” broadcaster—an approach Netflix says would be a mistake because it would discourage innovation.

The Canadian Radio-television and Telecommunications Commission (CRTC) will have to make a decision soon. In addition to Netflix, there’s a stampede of other newcomers hoping to cash in on a US$40-billion business in America (about $2 billion in Canada). Online retail giant Amazon earlier this year introduced a video service for its U.S. Prime subscribers with 5,000 different titles that can be streamed to “Macs, PCs and nearly 200 models of Internet-connected TVs, Blu-ray players and set-top boxes.” Meanwhile, companies such as Roku and Boxee are building dedicated set-top boxes so consumers have an easy way to get video content off their computers and onto their big-screen TVs, including pay sports services such as MLB.TV, NBA League Pass, NHL GameCenter and UFC.

Google, too, is trying to get into the game by capitalizing on its expertise in searching. It launched Google TV in the U.S. last year with a promise to combine “the best of TV and the best of the Web in one seamless experience.” Google is also overhauling YouTube so that it hosts more professional, made-for-TV content, with some reports suggesting it will spend as much as $100 million on the effort. It also has an agreement with the NBA to show basketball games.

And then there’s Apple. The iPhone and iPad maker introduced the first Apple TV in 2007 as a set-top box that allowed users to purchase TV shows and movies on iTunes. Though Apple TV has its fans, it has been nowhere near as successful as Apple’s other endeavours—so much so that Jobs once referred to Apple TV as a mere “hobby.” But that’s unlikely to be the case for long. At least one analyst, Katy Huberty at Morgan Stanley, claims there’s “increasing evidence” that Apple is close to delivering a “Smart TV” prototype that would consolidate streaming TV and gaming with other applications like its FaceTime video messaging service. She estimates that Apple could add as much as $19 billion in annual sales if it grabs just five per cent of the LCD TV market.

Despite all the competition and new technologies, there’s still no clear picture of what the living room of the future will look like, or which companies will be calling the shots. Though their decades-old business models are headed for a shakeup, the industry’s current players have so far managed to withstand the onslaught surprisingly well. In Canada, only one per cent of TV subscribers are expected to cancel their accounts over the next two years—dubbed “cord cutting” by the industry—according to a recent forecast from Convergence Consulting Group. The figure in the U.S., meanwhile, is projected to be only slightly higher, about 2.5 per cent, despite an even greater number of Web-based television alternatives.

One reason for the resilience is that TV access providers have had years to prepare for the arrival of Web-based competitors. After witnessing the near-destruction of the recorded music industry at the hands of the Internet, many have invested heavily in on-demand services—both via cable and online—that allow subscribers to watch movies and TV shows on their own schedule. Meanwhile, others like AT&T in the U.S. and Burnaby, B.C.’s Telus Corp. are pouring money into IPTV (Internet protocol television) with so-called “fibre-to-the-node” strategies that allow them to deliver more bandwidth to subscribers’ homes, paving the way for interactive TV features like search and online shopping. “I think what people are broadly looking for is three things,” says Dave Fuller, chief marketing officer at Telus, which is rolling out its Optik TV service in Western Canada. “At its most basic level, they want a high-quality picture, leading access to on-demand content, and they want access to the right content across multiple screens.” To that end, two of Canada’s biggest TV providers—Shaw Communications and Bell Canada—recently purchased major TV networks in a bid to better control the content they can offer their subscribers.

The incumbents have also benefited from the sheer number of Web-based TV options competing for consumers’ attention—each with a different take on the concept and a hodgepodge of content deals. In Canada, the landscape is further complicated by the fact that most online TV programming from the U.S. is blocked in order to preserve lucrative international licensing deals with Canadian broadcasters. For example, Canadians can’t view TV shows and movies on Hulu.com, the popular online site set up by NBC Universal and Fox parent News Corp. in 2008.

Nor have any of these would-be rivals conclusively proven they can do the job of delivering a comparatively wide array of TV programs for less money. The average Canadian household pays its television provider $61 a month and, collectively, watches 240 hours of TV, which works out to roughly 25 cents per hour in a home with at least two TV watchers, according to Convergence research. By contrast, it costs $2 to $3.50 to download an episode from iTunes, Convergence says. Streaming services like Netflix, meanwhile, are more economical, but aren’t yet a realistic alternative for many because of a relative lack of content—particularly in Canada.

Of course, that could all change as Netflix grows its subscriber base and uses the money to sign more content deals. But Brahm Eiley, the president of Convergence, argues that it’s not yet clear whether Netflix will be able to successfully outbid traditional networks for top shows without dramatically increasing its subscription rates, killing its business model in the process. “The only way to sustain their business model is to buy less content or raise prices,” he says. “They are an important player, but they’re at a real crossroads.” In Canada, for example, Eiley says private broadcasters spent about US$1.5 billion on content last year, while Netflix spent only about US$530 million during the same period in both Canada and the U.S.

Hastings seems unfazed by the challenges. “We’re nowhere near as rich in content as we will be in two to three years,” he promises (analysts have predicted that Netflix will spend US$1billion on content in 2011). He also downplays the notion that Netflix’s ultimate goal is to replace cable or satellite, pointing out that current “subscribers are adding Netflix as an additional channel.” Of course, it’s also possible that Hastings is deliberately toning down the rhetoric to avoid an all-out war with cable and telecom companies, which control the Internet connections that Netflix needs. For example, Netflix has accused Rogers of trying to limit the appeal of its service in Canada by lowering bandwidth caps for some of its Internet customers—a charge that Rogers denies.

Lost in all the jockeying for position is an answer to a fundamental question: are consumers really ready to bring the chaos of the Internet—jerky video streams, missing plug-ins and cryptic error messages—to the relative calm of their TV sets? In preparation for a conference it was hosting on the future of TV, Boston-based marketing agency Hill Holliday recently asked five families to “cut the cord” and go a week without cable, substituting services like Netflix, Google TV and others. By the end, all five families were eager to go back to their cable boxes. The complaints ranged from buggy software to being unable to find favourite shows. One woman said she was upset when her daughter typed in a search for “Dora” (Dora the Explorer) but ended up with a YouTube clip titled “Dora the Murderer” at the top of the results list. “The biggest lesson learned is, audiences are going to rally around those solutions that give them the content they want and expect,” says Mike Proulx, senior vice-president of digital strategy at Hill Holliday. While it may take some time for all the bugs to be ironed out, Proulx says he’s confident that television as we know it is unlikely to be around for much longer. “I would go so far as to say television is being disrupted,” he says, adding that the big beneficiaries will be consumers who will be bombarded with options from a range of billion-dollar companies over the next several years.

The price of all this rapid change may be TV’s long-standing reputation as a relaxing diversion. Perhaps the most illuminating finding of the cord-cutting experiment was that its subjects felt overwhelmed by the need to constantly interact with their TV sets, searching for programs and troubleshooting problems—tasks that aren’t out of the ordinary when you’re surfing the Web on your laptop, but can seem onerous when you’re flopped on the couch with a soda. Many simply gave up and decided not to watch TV at all. “At the end of the day, what makes TV so elegant is that it’s so simple,” says Proulx. “There was a time when you would just turn it on, and that was it.”