This Man Is the Reason Why Netflix Is Going to Be the Next HBO.

This Man Is the Reason Why Netflix Is Going to Be the Next HBO.


Ted Sarandos will spend hundreds of millions to do it.

One of Hollywood’s biggest players isn’t a household name like Steven Spielberg or Harvey Weinstein, but a former video store clerk who knows what people like to watch. That man is Ted Sarandos, chief content officer for Netflix’s expanding empire, and he won’t hesitate to go after any movie or TV series in a quest to push to the top.

Cable and satellite providers are reeling from the advent of high-speed Internet. Rivals stream content, but few have the reach into homes like Netflix — and that’s all because of Sarandos and his wheeling and dealing. He greenlit the push to original content and now snaps up everything he can get his hands on.

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Few executives can match his dedication — he brings a devout fan’s love of entertainment to his job. But he isn’t satisfied with re-runs and so-called “cult classics.” If you cut the cable cord and change how you watch television, he believes the replacement must be as good, if not better.

Sarandos doesn’t come to Hollywood with money, but as a man with a true love of movies. Raised in Arizona with three older sisters and a younger brother, both his parents were high school dropouts. His father became an electrician, and his overwhelmed mother was a housewife who left the television on all day.

“With five kids in the house, it was pretty chaotic, so I took comfort from what I watched on TV,” he told the New York Times. “The structure of TV was the structure of my life. I scheduled myself around when shows were on, because I didn’t have any other kind of scheduling.”

Shortly after enrolling at a community college, he found a job as a clerk at Arizona Video Cassettes West, one of the first rental stores in the state. Before long, he ran all eight branches of the chain. He joked he was the original algorithm, according to the New York Times, because he advised customers what to watch next, much like what Netflix does with views today. Eventually, he jumped to become president of product and merchandising for Video City, another large chain, before Netflix founder Reed Hastings poached him into the company.

When Hastings started Netflix in 1997, after he paid $40 in overdue fines, he launched the Netflix site in 1998. But he followed the traditional pay-per-movie rental model. When Sarandos came aboard in 2000, they shifted to a flat-fee, unlimited structure. Five years later, the company was shipping out a million DVDs each day from its 35,000 title warehouse. Then in 2007, Netflix introduced its video-on-demand service, reflecting a change in consumer viewing habits. Streaming was the future, and the company began to bulk up on online content.

Last year, however, Hastings introduced yet another twist: he split up DVD and streaming services, charging customers nearly twice as much to rent through the mail. They were furious about the revamped pricing, so it relented and switched back to its earlier model with slightly higher prices, luring customers back. But Netflix faces increased competition in streaming. To stay competitive, Sarandos made a critical choice — to move into original content.

If you’re hoping to catch blockbusters like “Prometheus” or “Snow White and the Huntsman” on Netflix — sorry, you’re out of luck.

Despite the rise of online streaming services, the cable industry still holds the edge when it comes to getting new movie releases first. The competition for top movie releases is heated enough that channels often pay eight-figure sums for the first cable broadcast rights of blockbuster movies. Cable outlet FX, for example, spent $22 million for rights to broadcast “Iron Man” on its network, snapping up the comic book-inspired blockbuster before its theatrical run wrapped.

Recently, FX paid top dollar to buy up first TV broadcast rights for current summer releases like “Prometheus,” “Snow White and the Huntsman,” “The Dictator,” “Battleship” and “Madagascar 3″ before their theatrical runs ended. In fact, FX acquired basic cable broadcast rights for 28 of the 50 highest-grossing movies of 2011, guaranteeing their exclusivity to the network for a protracted period.

Cable channels have always spent heavily on premium content, trying to command top rates from advertisers and bring value to the often expensive cable subscriptions consumers pay. But the jaw-dropping sums spent by cablers to ramp up on this advantage come at a point of transition in the basic pay-TV industry, as subscriber rates mature and even stagnate and more consumers “cut the cord,” dropping pricey subscription packages in favor of online streaming services like Netflix and Hulu.

Last year, industry analysis discovered pay-TV television viewing dropped to 69 percent, down from 72 percent in 2009, according to a study by ABI Research, with online TV and video-on-demand services often replacing cable TV subscriptions for subscribers.

In light of flagging cable viewing, channels and networks are pushing to stay competitive. Original shows have been one successful strategy for basic cable channels to stay relevant, with networks like AMC finding great acclaim and success with shows like “Mad Men,” “The Walking Dead” and “Breaking Bad.”

But re-broadcasting movies can fill a valuable role for cable channels looking to round out their content offerings, and as a result, basic pay-TV networks are gobbling up more movies than ever to fill their schedules. Nearly 10,000 unique English-language movies aired last year on basic cable networks, according to consulting firm IHS’s study, accounting for 13.5 percent of total television air time of the 79 basic cable networks included in the study. Instead of older titles, however, cable networks are increasingly jockeying for newer releases that once would’ve gone to premium cable outlets like HBO, and are willing to pay high prices for the advantage.

The figures are eye-popping, but it’s an investment that can pay off for cable channels. FX, for example, has seen income grow from just $280 million in 2006 to $461 million in 2011, fueled by skyrocketing advertising profit.

“When you look at the ramp-up of ad revenue for FX, as they’ve increased their movie content, they’ve also increased their ad revenue,” said Erik Brannon, analyst at consulting firm IHS, to paidContent.

As a result of robust content offerings, cable channels are ensuring that cable packages keep their high value. Many subscribers continue to pay up to more than $100 a month to have access the hottest movies, and advertisers pay high ad rates to reach these premium subscribers. Cable companies win on either end, with subscribers perceiving the high value of their service subscription and ad revenue continuing to roll in.

There’s no shortage of premium movie content coming to basic cable, but with channels and networks willing to pay exorbitant high sums for new releases, they may be pricing it out of reach for streaming services like Amazon and Netflix. That’s something Hollywood would like very much, especially as these services continue to gain ground with consumers.

In the industry’s perspective, Netflix was originally a place where older movies and TV shows went to gather dust. Initially the Los Gatos, Calif.-based service focused on beefing up its library of older content, buying the rights to digitally stream Starz’ entire catalog of movies, for example. Hollywood power players were happy to sell these movies for a relatively low price to Netflix, since they regarded streaming as a low-value outlet for their properties.

But a funny thing happened that studios didn’t expect: online streaming became hugely popular. Netflix kept accruing more subscribers, building its broad base. Surging revenues powered higher-profile content acquisitions, and slowly the smaller upstart emerged as a formidable competitor, especially as more consumers stopped buying DVDs, downloaded movie torrents and shifted to video streaming when possible.

Looking to lessen its dependence on other companies’ content and develop itself as a studio in its own right, the streaming service is now branching off into offering exclusively developed content, such as original series like the well-regarded “Lilyhammer” and future releases like a new season of cult comedy “Arrested Development.”

Now, according to IHS in a study published earlier this month, Netflix is the nation’s leading supplier of movies streamed over the Internet, zooming past Apple in 2011 to take the top spot. Despite recent troubles over splitting its DVD-by-mail and streaming business and alienating its customers, Netflix remains strong enough to compete now for increasingly premium content.

But as cable networks fight even harder to win newer movies, the industry is likely breathing a sigh of relief that pay-TV, long a friendly bedfellow to studios, remains one of the most lucrative outlets for material — and with movies that consumers are actually dying to see on smaller screens, cable remains highly competitive against upstarts like Netflix.

The truth is, cable has been fighting to stay relevant and justify high subscription costs for some time now. Last year, in a move to keep up with increasingly mobile viewers, pay-TV entities ramped up streaming apps, though some hit legal snags over whether they violated digital rights. HBO, for example, offers its own streaming service, HBO Go, for online viewing. These benefits can only be accessed by subscribers, making a monthly cable bill still a necessity for many entertainment fans.

The high prices cable pays for premium content also insures a longer window of exclusivity. “Windowing,” the sequential rollout of movies on various platforms, has long been an important practice in the industry for creating and retaining value for content, despite its latent effects on worldwide piracy. Paying high prices for valuable TV broadcast windows closer to a movie’s theatrical release, when consumers’ interest in a film is highest, likely guarantees a longer period of exclusivity — which means it will stay exclusive to cable longer, and reach streaming services more slowly.

Of course, some studios are altogether refusing to allow material to be streamed on services like Netflix and Hulu. HBO has long disavowed selling the rights to its popular acclaimed shows to outside services, ensuring its own apps and streaming sites keep high interest and value.

Many in the tech industry consider an older business like TV and movies well behind the pace of innovation when it comes to new media developments. Hollywood’s short-sightedness with Netflix and streaming in general still has the industry reeling from the shift in power dynamics, and it has yet to come up with a compelling answer and solution to the rampant piracy that saps it of lost revenue every year.

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But money never goes out of style, and with cable spending more than ever on premium content, the high sums ensure that business will stay as usual, even in the midst of increasingly turbulent changes.

Sarandos decided Netflix should include its own programs. It wants to be the HBO of streaming — and for that, it needs its high-quality, and expensive, original shows. He first secured the rights and commissioned episodes to Fox cult favorite, “Arrested Development.” But his big move was the original series “House of Cards.” The political drama that paired director The Social Network director David Fincher with Kevin Spacey proved to be a real coup, kicking off its plan to capitalize on franchises.

In the few weeks since its release, it’s already Netflix’ most-watched title, and while Sarandos wouldn’t share ratings — because it’s an “apples-to-oranges comparison” to television, he added that Netflix is thrilled with its $100 million two-season investment. The show is paying off not only in advertising, but also increased subscribers and credibility among Hollywood.

You can expect more original shows, like “Hemlock Grove,” produced by Eli Roth and “Orange Is the New Black,” a comedy set in a women’s prison, created by Jenji Kohan, who developed Showtime’s series “Weeds.” Unlike traditional networks, Netflix releases all the episodes of a series at once, so you can binge-watch everything on an idle Saturday, and not wait a week for the next installment. Sarandos also discovered that when you have an all-you-can-eat buffet, you enjoy your favorites more.

He also focuses on the youth audience. Earlier this month, Netflix inked a deal with DreamWorks Animation to create its first children’s series, “Turbo: Fast,” which follows the adventures of a snail who gains speedy powers after an accident. Netflix plans to release all 26 episodes in December, after DreamWorks releases a “Turbo” film in July.

“Netflix boasts one of the largest and fastest-growing audiences in kids’ television,” Jeffrey Katzenberg, DreamWorks Animation’s CEO, said in a statement. “They pioneered a new model for TV dramas with ‘House of Cards’, and now together, we’re doing the same thing with kids’ programming.”

Original content is turning Netflix into a Hollywood rival, and Sarandos has to delicately navigate Tinseltown politics. He’ll need to convince studio big-wigs to trust that Netflix as the ideal partner help transition them to the digital age — no small feat amid Internet piracy.

He’s had setbacks and faced hostility, but he’s also marked a few victories in recent months. Last year, Netflix signed a “game-changing” deal, making it the exclusive distributor for Disney films, including Pixar and Marvel, and classics like “Dumbo” and “Pocahontas,” in the pay TV window.

And he’s looking for more deals with studies, including Warner Bros., to keep the content flowing. Warner’s film rights deal with HBO — also part of the Time Warner umbrella — expires in 2014, and Sarandos added he hopes to outbid for it. But just for good measure, HBO didn’t like animated content, so he snapped up titles like “The Lorax” and “Para Norman” too. The real goal, though, is to show studios proof that “there are other ways” to do business.

Netflix started its transition early, offering an ancillary streaming video service to its subscribers that quickly became the major focus of its business. The company took advantage of the opportunity to scoop up large amounts of content for relatively little cost, since the movie and TV industries regarded streaming as minor league, taking a backseat to cable and broadcast rights. As a result, it built up a substantial library of movies at a time when the few competitors — Hulu and YouTube, generally — were focused on TV or other short-form content.

In this way, Netflix took advantage of a propitious moment: it got an early start in a market just starting to take hold, but before other key players — mainly Hollywood — realized how major it would be. It perfected its streaming technology, working closely with device makers of all stripes to make sure subscribers could get its content smoothly and seamlessly on phones, laptops and even gaming consoles. As a result, it built and then cemented what would become a sizeable lead, even as the list of competitors grew. The result was a golden streak of financial performance, up to the summer 2011.

But eventually, the market caught up with them. Significant rivals like Amazon Prime joined the field, backed by deep pockets and major distribution muscle. Hollywood wised up and began charging higher prices for licensing its content, and Netflix lost some high-profile deals, such as its Epix library of films, to competitors like Amazon Prime.

The company made some uncharacteristic missteps as well, alienating what had been a highly satisfied customer base when it tried to separate its DVD business from its streaming arm in the summer of 2011 and institute a price hike of up to 60 percent. Netflix rectified the mistake after a loud outcry from its subscribers, but it seemed to mark the beginning of a new, more troubled chapter for the company.

Netflix is still inking content deals, and it’s also beginning to push into the relatively untapped global market, with substantial expansions in the ripe Scandinavian market. However, these avenues of growth won’t come cheaply and will likely eat into Netflix’s cash reserves, guaranteeing it won’t be the shining star it once was for a while.

Some industry watchers, on the lookout for deeper-seated reasons why Netflix currently struggles, pinpoint its CEO, Reed Hastings, who began the company after racking up $40 in late fees on a Blockbuster rental of “Apollo 13.” The current book release “Netflixed,” by Gina Keatings, reveals Hastings as a temperamental, stubborn leader with a poor read of consumers, the likely architect behind the botched attempt to raise prices and separate its DVD and streaming businesses, not to mention the graceless apology to subscribers afterwards.

She characterized him as a “data-driven” executive who never lets compassion get in the way of strategy, but also notes his vision and fortitude have steered the company well. And Netflix’s management surrounding Hastings — most notably its chief content office Ted Sarandos — has been in place since nearly the company’s beginnings, so its decline has less to do with any management troubles.

Instead, Netflix’s current bumpy ride is a mark of how fundamental dynamics in the streaming video industry are changing for everyone. And the fallout could change the face of digital entertainment for years to come.

One of the major changes to the market is simple: there are just more providers of the same service. The list of rivals has grown since Netflix’s wild ride, and many of these competitors are linked with major tech companies with deep pockets: Amazon’s Prime service, for instance, and even YouTube, with its connection to Google. Netflix now has to compete even more forcefully for consumers’ dollars against a flurry of services promising the same thing and nearly similar price points.

And it can’t underestimate the ruthlessness of its competition: Amazon, for example, has shown a willingness to lose money in the name of dominating a market with its Kindle devices, and will likely pay whatever it takes to build up the most attractive content library in the future.

Another major factor is that the supply of content to fuel all streaming services is going up in price. Simply put, a wised-up Hollywood — the maker of all these TV shows and movies we’re watching on Netflix, Amazon and other digital outlets — is fully aware of the digital direction we’re headed in and is charging a lot more.

But beyond prices, the movie and TV industry is exhibiting much less willingness to strike exclusive deals anymore. Netflix is no longer the only service in town, and the TV and movie industry is using that to its advantage. Epix, which owns the digital rights to movies from Paramount, Lionsgate and MGM, ended its exclusive agreement with Netflix, opting to go with Amazon instead.

“The decision to do Netflix exclusively was because they were really the only game in town at that point in time,” said Mark Greenberg, Epix CEO, to Hollywood industry publication The Wrap. “We live in a capitalistic society and are here to generate profit for our owners. We are doing that by trying to help reach a larger consumer base, hence the decision to go to Amazon.”

It’s not just Netflix that is losing out on prized exclusivity: News Corp, which owns content from Fox, NBC-Comcast and ABC-Disney, were mulling ending their exclusivity with Hulu, according to Variety, taking away its competitive advantage of exclusive rights to current TV shows.

More deep-pocketed rivals plus higher licensing costs is a Molotov cocktail to shake up any industry, and the result has forced Netflix and its rivals into a new dilemma: how to differentiate itself from the crowd and lessen its dependence on its high-priced Hollywood supplier.

Facing its dilemma of high costs on increasingly similar content, the emerging streaming video industry could take a page from cable and choose to compete on service and offerings, bundling themselves into packages that consumers subscribe to. In a market that’s becoming increasingly fragmented, there’s definitely room for some kind of offering that lets consumers subscribe and pay one fee for an array of channels and service.

Instead, however, most players are taking the path that cable heavyweights like HBO and Showtime took to compete against one another: beef up original offerings in efforts to brand and differentiate themselves.

Similarly, Netflix is embarking on a well-documented spree of original material. It’s already launched its first original series, “Lilyhammer,” and is set to roll out more exclusive, original content next year, such as a season of cult comedy classic “Arrested Development,” the Eli Roth-helmed horror series “Hemlock Grove,” and “Orange is the New Black,” a series from “Weeds” creator Kenji Johan.

Other rivals are embarking on original content as well: Hulu is ramping up its original shows, while YouTube, which remains free but ad-supported, is taking a niche approach, creating hundreds of original content channels devoted to interests like cooking, skateboarding, fashion and more.

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Netflix is focusing now on expanding its market overseas as well as ramping up its content deals to placate restless customers who increasingly demand more current content. As a result, the company will likely begin deflating its cash reserves, narrowing margins of profitability as it continues to weather a market in transition to its next phase. The days of the diva of Wall Street are over, and the company must dig in, learn to play hardball at the negotiating table with Hollywood and outmaneuver rivals like Amazon in getting the best content for its dollars.

But its eyes are on a longer-term prize in the distance. It’s telling that the company regards HBO — and not Amazon, Hulu or other streaming providers — as its chief competitor. HBO, which offers its own streaming service HBO Go to cable subscribers, recently started its own Netflix-like service in northern Europe, bypassing cable companies there altogether to offer its shows directly to consumers.

Given Netflix’s recent push in the same territory, beginning last week, “this will be the first test of our relative strengths in stand-alone subscription video on demand,” said Hastings.

In fact, the company foresees a time when cable powerhouses like HBO and Showtime will eventually break loose and begin offering their own streaming services, free of expensive cable packages. “We think it will make strategic sense eventually for HBO to go direct-to-consumer in the U.S., and become more of a competitor to Netflix; so, that is our operating assumption,” said Hastings in the company’s financial statement.

In this light, moves to bolster its original content now and broaden its territory make sense, laying the groundwork to weather further tumult as entertainment becomes increasingly digital — and position itself prominently when the transition is complete. As the industry overall moves to a “TV everywhere” model — on demand on a variety of devices, free of time and location — the digitization is bound to loosen up old partnerships and structures that have long been in place between studios and broadcasters.

But it will be some time before Netflix’s future of free-floating, standalone streaming channels becomes a reality, especially in the complex, interlocking deals that characterize Hollywood, TV and cable. But recent tension and squabbling between cable providers and channels over streaming rights for apps — not to mention the willingness of providers like Dish to kick off channels like AMC from their rosters because of its streaming deals with Netflix — could indicate future breaking points in the industry that could loosen up decades-long agreements.

But Netflix knows it — like its rivals — will be forced to stand increasingly on the strength of its original content. In this light, Netflix’s current strongest competitor, Amazon, still has some ways to go, despite its Amazon Studios initiative. Amazon can shell out for all the TV and movies now, but in the end, the companies with the visionary content that people want to subscribe to will win out.

If the endgame comes down to original content, then Netflix may have the ultimate trick up its sleeve: its large store of finely-grained data gathered on its audience. Since its inception, its streaming service has accumulated a wealth of data on exactly what its customers are watching, when they watch it and how they watch it.

And they’ve shown a canny ability to use this data as a secret to its success: its recommendations, of course, are a key in keeping its audience hooked. Seventy-five percent of users select movies based on the company’s recommendations, according to its senior data scientist Mohammad Sabah to the Hadoop Summit in June, and Netflix is constantly angling to make that number even higher.

It’s also using this data as it pushes into original content: its next drama series “House of Cards,” for example, Netflix looked at various algorithms to see how its members responded to Kevin Spacey and David Fincher movies. It also was able to calculate the decision to release its first original series Lilyhammer as one entire season, since it knew its viewers overwhelmingly binge-watch TV.

In the end, this store of data will keep Netflix — as well as its digitally-based rivals like Amazon — ahead, especially against an established Hollywood industry that still relies on Nielsen ratings and focus groups.

Hollywood overall has long been criticized for its poor read of its audience. Its declining box office audience numbers reflect not just high ticket prices and the ensuing threat of digital entertainment, but the simple fact that the industry isn’t making movies people want to see. “John Carter,” anyone?

Netflix’s huge store of data — gathered on 25 million subscribers, who amass 30 million plays, 4 million ratings, 3 million searches and at least 2 billion viewing hours per day — is only rivalled by Amazon and other digital competitors. Through insights gathered by this data, it’s able to read its audience much more closely and act on this information in terms of programming choices and decisions, not to mention improving customer experience.

And in the end, its finely tuned-read of its audience may prove to be Netflix’s biggest advantage over its named chief rival HBO, especially as other factors begin to even out. The question is whether Netflix can weather the storm until it gets to that point. But it was able to anticipate where the market was headed before, and will likely continue to do so again.

Netflix bounced back as the “world’s leading Internet TV network,” but the company’s future lies in its ability to successfully produce original programming. Despite the boost in subscribers, it lost about 1 million DVD mail rental customers, for a total revenue of $870 million for the first quarter of 2012, falling short of expectations.

Analysts and the company itself differed on the interpretation and meaning of Netflix’s figures, with many hoping for a larger bounce from earlier quarters.

Hastings says his company will return to “global profitability” by next year as its international expansion gains momentum, and highlights Netflix’s transition into a cable-like network, with a mix of nonexclusive broad content and original programming.

Analysts and investors, however, worry Netflix is facing long-term obstacles that will hinder its future growth. Content acquisitions are becoming more expensive, with Hollywood TV studios, networks and other content providers determined to make Netflix pay dearly for the rights to stream their shows and movies.

The cable industry is also ramping up its streaming efforts to compete against services like Netflix and Hulu. HBO, for example, has beefed up its HBO Go service and is courting new subscribers by streaming episodes of new shows such as “Girls.”

The result is a radically different picture from years past, when Netflix enjoyed tremendous growth, built a massive subscriber base, and announced skyrocketing revenues for quarters on end as the company took advantage of a historical sweet spot: it attracted enthusiastic subscribers by the masses while being consistently underestimated by its competitors. But that moment has passed, and now Netflix is reconfiguring its strategy to move to its next — and much riskier — stage of growth.

Netflix has never hidden its ambitions to phase out its DVD rental business, but it has been more circumspect about its desire to become a HBO-like powerhouse of streaming services. But announcing itself as the “world’s leading Internet TV network” leaves little doubt about where Netflix heads next as it doubles down on an original programming push that will likely make or break the company.

The streamer recently released its first original content offering, “Lilyhammer,” to warm praise and wide press coverage. Its experimental foray into original shows has now become a concerted push, and the site will release the David Fincher-helmed “House of Cards” later this year. Other shows are in the pipeline, like the Eli Roth horror series “Hemlock Grove,” a new series by “Weeds” creator Jenji Kohan “Orange is the New Black,” and the new season of “Arrested Development,” which will likely be the Internet-TV network’s first real hit.

But will it manage to draw in ever-important subscribers? So far, results have been inconclusive, but the company says it is pleased with the overall response to “Lilyhammer,” especially in relation to the amount of money it invested in bankrolling the show.

The company itself is emphasizing that original content is a long-term investment, calling it a “strategic expansion” of the brand, but exactly how long it will be remains unclear.

“We are now treating it as a capability we should build, like international, to achieve our long-term ambitions,” said Hastings. “What is still uncertain is when or whether we will take it beyond five percent of our large content spend.”

Netflix is emulating the strategy of one of its biggest foes in Hollywood: HBO. The cable network, like Netflix, initially began with older “library” content and beefed up on second-run exclusives and broadcast premieres of big Hollywood films. The pay-TV channel didn’t become a true player, however, until it began a serious, years-long push to develop original programming.

Their investment paid off, and shows like “Sex and the City” and “The Sopranos” became vital parts of pop culture. HBO’s reputation for great programming continues today with shows like “Game of Thrones” and “Boardwalk Empire,” and subscribers flock to the channel because of its reputation for gutsy original programming, able to take risks far beyond the safe confines of network television.

However, HBO took years to develop miniseries and shows that were critical successes, drawing in consumers attracted to a strong content brand. “That took HBO nearly a decade to accomplish, so we don’t expect overnight results,” said Hastings.

Netflix is banking on the same strategy in the long run. But reputations are a long-term game, and the rules are changing rapidly in the entertainment industry. It takes years to develop content and build an audience, making Netflix’s original programming push a real risk. The content it develops must simply be good enough to keep subscribers coming, able to convert viewers from the merely interested into the rabidly loyal.

In a sense, the company has no choice but to develop its own offerings, especially as cable channels are increasingly reserving their TV shows for their own streaming services. HBO will only stream its shows on its HBO Go service, and other networks could follow suit, potentially drying up a formerly deep well for Netflix.

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However, Netflix lacks one major advantage that HBO had during its transition from second-run cable channel to content powerhouse — advertising, i.e., the lifeblood of cable industry revenues. Netflix does have its DVD rental business to diversify its revenue streams, but with mailing and inventory costs rising and subscriber growth stalling, that stream will likely dry up as DVDs lose favor among most consumers.

Netflix conspicuously lacks ads on its service, and the company seems committed to its subscriber model, but that could change in the future as DVD mail rentals inevitably become obsolete. The company could also experiment with different pricing models, such as tiered pricing plans.

However, subscribers will likely balk against any changes, much like they did when the company re-engineered its subscription plans. Netflix will have to navigate any alterations to its model delicately, especially since subscribers remain the main source of revenue for the company.

The ultimate fortunes of Netflix will likely mirror the overall struggle of the video streaming industry’s attempt to find a viable, profitable place alongside — or in place of — the more established TV and movie industries. Will streaming services entirely replace cable one day? Or will they remain ancillary services in the eyes of content providers, the place where obscure C-list movies go to die? Netflix is one of the most well-equipped streaming companies to determine an answer, and many will watch to see if and how it can carve its own path in uncharted waters.

Netflix’s original series “House of Cards” is a hit. But that success is just the tip of a more ambitious strategy — to turn the streaming service into a Hollywood powerhouse and take on the likes of HBO.

Released in February as an entire season, the Internet buzzed about the political drama, while critics lavished praise on Kevin Spacey’s oily performance as a conniving, duplicitous Congressman who oscillates between deadpan Southern charm and Machiavellian scheming to get what he wants in the viper pit of D.C. politics.

Oscar-winning Spacey is backed by strong performances from Robin Wright as his seemingly Lady Macbeth-like wife and Kata Mara as a young, ambitious political reporter. Meanwhile, David Fincher, famed for directing “The Social Network” and “The Girl With the Dragon Tattoo,” expertly weaves a taut and analytical drama, which holds its own against rival shows.

In fact, you may think you’re watching HBO. And that, of course, is precisely the point.

“The goal is to become HBO faster than HBO can become us,” Ted Sarandos, Netflix’s chief content officer, told GQ. House of Cards spearheads that strategy and uses the quality and strength of the series to build on its first foray into exclusive content, “Lilyhammer,” its quirky mob dramedy.

By all appearances, House of Cards is a hit. Or is it?

It looks and feels like a quality cable drama, but Netflix’s release goes against industry grain, demanding a new stick to measure success and changing the way you watch TV in the future.

By investing $100 million in House of Cards, Netflix is branching out — from a distribution pipeline to a creator — and taking on HBO, Showtime and others, rivals it once courted as partners to license content to. But even as Netflix becomes more like HBO, it is doing business differently. By releasing all 13 episodes at once, Netflix hooks into the binge-watching habit increasingly common with online viewers.

But the move is risky. It forgoes the buildup of buzz TV networks generate by spreading out the show across the year. And the gamble may cost it valuable brand-building opportunities, a stunted fan base or a lack of engagement on blogs and social media, keeping it from reaching the mainstream of entertainment.

Beyond distribution, House of Cards has another glaring absence: no commercials. Netflix instead follows a subscription model to generate its revenue, though the show does follow a television storytelling structure — act breaks that evolved to splice in commercials. House of Cards is ad-free now, but there’s a place within episodes to naturally slot them in. And whether Netflix or another party will fill them, remains to be seen.

Netflix also lacks industry viewer metrics, so it is tight-lipped on viewer numbers — Nielsen ratings that measure audience patterns and habits. Since Netflix doesn’t serve ads, it doesn’t need Nielsen — but without them, House of Cards remains an entertainment anomaly in the current system.

But that doesn’t mean it’s in the dark. Instead, it uses its own advanced data tracking — where and when viewers click on and off, down to the second — to measure audience response. But by foregoing Nielsen, Netflix is placing itself squarely outside of the traditional entertainment system. And that’s a very powerful position.

One key piece is syndication, which Netflix risks losing without Nielsen and advertising track records. Syndication plays a major role in Hollywood’s cash machine and allows shows to relive multiple lives and reap advertising, again and again.

Netflix doesn’t own the syndication rights to House of Cards. That belongs to the production company, Media Rights Group, which would gain financial benefits from reruns. Netflix is still credited as the original broadcaster, so if House of Cards becomes a zeitgeist show and rebroadcast on another network, syndication will expand its reputation as an imprimatur of quality content.

Netflix is taking a big risk with an original content strategy, but it’s shown a keen understanding of the game, and, if successful, stands to gain significant rewards.

Hollywood likes to throw around phrase “content is king” to differentiate powerhouses from mere players. But content isn’t just shows and movies — it’s franchises, or series with the ability to create community, incite debate and generate buzz to compel audiences year after year.

Those franchises keep you subscribing to HBO despite high cable bills — you can’t cut the cord because you just can’t miss “Game of Thrones” and “Girls.” It’s those franchises that add up to large libraries of assets, which can be sold again and again through DVDs, licensing and syndication.

It takes years to build franchises, but Netflix is catching up fast. Aside from House of Cards, Netflix plans to fund five shows a year, including the last season of “Arrested Development” and “Orange Is the New Black,” a prison drama from Weeds creator Jenji Kohan. According to CEO Reed Hastings, it’s becoming a franchise factory.

However, the franchise strategy has wrinkles — it’s very, very expensive. Analysts expect Netflix’s content costs to outpace subscriber revenue eventually. And its subscriber growth isn’t keeping pace with increasing spending. The company may have to raise prices or find ways to cut costs of its expensive DVD-by-mail rental service — changes that prompted serious customer uproar in the past. But the blowback won’t be as drastic the next time around — physical media is becoming an artifact, giving way to streaming as the mainstream.

We’re in the golden age of television — shows today rival films in storytelling complexity, visual panache and intellectual and emotional substance. And House of Cards’ A-list marquee and fine execution shows Netflix is determined to carve out a place in that space.

Sarandos has a hard road ahead. He needs to convince Hollywood that Netflix isn’t the enemy, and it won’t run them into bankruptcy. Instead, he insists content deals are beneficial for both parties. House of Cards is a sign people are hungry for original shows, but even Sarandos admits, you still join Netflix to watch your favorite movies and television shows — and it doesn’t have enough to challenge the more-powerful networks, like HBO.

In addition, producing original shows is incredibly expensive, so if Netflix can’t bank off the success, it’ll need traditional content to keep viewers around. After all, if there’s nothing to watch, you’ll go elsewhere, even if they don’t have Kevin Spacey as a congressman.


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