Netflix's content chief sees more originals in its future, but what that means for the streaming giant isn't totally clear.
Ted Sarandos, chief content officer at Netflix (NFLX) - Get Report , said at an event this week that the company will rely more on its own original programming, or "created IP," to fuel its success amid growing competition in the streaming market. Shares of Netflix were up 1.88% on Friday to $295.07.
Speaking at the Paley Center International Council Summit, Sarandos acknowledged that its competitors, namely Disney's (DIS) - Get Report newly launched Disney+, have powerful IP and content brands at their disposal. But, per Deadline, he spun it as a positive for Netflix's ability to crank out creative programming.
"I don't know if it's a luxury or a trap, but they have IP. They have established IP, and they kind of keep to within those worlds." Sarandos said, referring to Disney. "All of the IP we have on Netflix that's original is created IP, sometimes out of whole cloth or sometimes from a book or something, but not universes that we feel bound by."
To date, Netflix's programming has been a mix of high-profile original content and licensed shows with perennial appeal, such as The Office and Friends. But with other media giants spinning up their own streaming video on demand (SVOD) services, the dynamic that made that strategy possible is changing.
NBC Universal, which owns the rights to The Office, is pulling the popular sitcom from Netflix in favor of its own SVOD service, Peacock, due to launch next year. AT&T (T) - Get Report WarnerMedia-owned Friends is also leaving Netflix soon, and will instead run on HBO Max. Both programs will disappear from Netflix at the end of next year.
The problem? Those older sitcoms are believed to be among the most-watched shows on Netflix. A recent analysis by the consulting firm Activate found that of the top viewed 10 shows on Netflix, only two (Orange is the New Black and Ozark) were Netflix originals, while the rest were licensed shows. There is some debate over what is the single most-watched show on Netflix is -- the company doesn't typically share quantitative watch metrics with investors -- but it is clear that a certain set of syndicated shows hold lasting appeal for viewers despite the current glut of original SVOD programming. Based on a survey, RBC Capital Markets found that the most popular shows on Netflix were Stranger Things, The Office, Orange is the New Black and Friends.
"We estimate that the shows controlled by AT&T, Comcast and Disney account for 65% of Netflix's viewing hours, so the impact will be considerable," said Wedbush analyst Michael Pachter. "Seinfeld will help them recover 10% of that, and there will undoubtedly be other high profile shows licensed, as well as some traction for their originals. I presume Netflix will come up with sufficient quantity of content to replace most of what they are losing, but that will come at a cost."
In September, Netflix announced that it secured worldwide streaming rights to all 180 episodes of Seinfeld, which will begin airing on the platform in 2021. That five-year deal is estimated to cost Netflix about $600 million. Asked to elaborate on the company's thinking in that licensing deal, Sarandos said on a recent shareholder call that Seinfeld is one of a small number of titles that's still "incredibly relevant" and compelling to viewers long after its original run.
"It's kind of a comfort view comedy that travels around the world and Seinfeld is one of these very elite shows that came available in that timeframe. So we have Friends till the end of the year and then we'll have Office for another year after that. And then Seinfeld will roll out to the world in 2021 on Netflix," he said.
It's hard to pinpoint how much subscribers are drawn by classic syndicated shows, such as Seinfeld, versus original shows. Many analysts speculate that there is a correlation between the buzziness of Netflix's original content and the number of subscribers per quarter. Data points like search trends and trailer views of new shows or seasons serve as a proxy for interest in Netflix's seasonal content slate, and research has shown that there is a relationship between interest in original shows and quarterly subscriber growth.
Original content is expensive, however, and the costs of producing good shows and movies appear to be rising quickly.
Netflix disclosed in its third quarter earnings report that its 2019 content expenditure is $15 billion, a figure that has increased steadily for the past few years: In 2018, its content spend was $12 billion, with roughly 85% allocated to original programming. With Apple, Amazon and other deep-pocketed tech firms throwing their weight around in streaming, production costs are ballooning. Sarandos estimated on Netflix's recent shareholder call that there has been a 30% price escalation since this time last year for a "very competitive show," he said. As one example of rising costs, Ryan Murphy, producer of Netflix's dark comedy The Politician, recently told The New York Times that its budget was equivalent to that of The Crown, which reportedly cost as much as $13 million per episode, making it the second most expensive show ever made (behind $15 million per episode Game of Thrones) when it first aired in 2016.
It isn't just Netflix spending lavishly on original shows. Variety reported recently that Amazon's (AMZN) - Get Report planned Lord of the Rings project is believed to be the most expensive TV project of all time, on top of the $250 million rights to the Tolkien intellectual property. Disney+ flagship original The Mandalorian, a Star Wars spinoff, reportedly cost north of $15 million per episode, according to Variety, while Apple's (AAPL) - Get Report forthcoming Masters of the Air series, a World War II drama produced by Steven Spielberg, could cost as much as $20 million per episode.
Netflix describes its own spending on original content as part of a virtuous cycle of subscriber growth and continued engagement that will make it the sustained leader in streaming entertainment. But investors have shown some skepticism Netflix's high fixed costs and its position as a pure streaming business in an escalating content arms race.
Netflix's stock is down more than 20% since it posted its first-ever drop in domestic subscribers in July; in the third quarter, Netflix grew its U.S. subscriber base again, but overall fell short of its own subscriber forecast and issued weaker-than-expected guidance. Netflix also expects negative $3.5 billion in free cash flow in 2019, which executives pin on its increasingly heavier emphasis on original content.
"We'veallbeentransitioningfromlicensedsecond-runcontentintooriginalprogramming,sothatcreatedsomeofthatworkingcapitalpressure," said CFO Spencer Neumann in October. "Butnowthebulkofourcontentinvestmentisoriginalprogramming,sowe'vemadeitalongwayupthatcurve.Sothecombinationof ourscaleandourbusinessmodeltransitioniswellalongandthat'swhyyou're going tostarttoseethatfreecashflowimprovementnextyearandthenbeyondthat,we'renotgoingto givespecificprojections.We'llcontinuetoscalegraduallytowardsself-fundingwhilewecontinuetokindofgoafterourstrategicpriorities."