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Hollywood needs Netflix, but Netflix is struggling

Netflix disappointed Wall Street with its second-quarter earnings. It's trying to get out of the business of delivering DVDs by mail while it grows in online streaming.
Netflix disappointed Wall Street with its second-quarter earnings. It's trying to get out of the business of delivering DVDs by mail while it grows in online streaming.
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In a world where people watching movies and TV shows online is a trend that's absolutely taking off, you'd expect that the biggest name in the streaming space, Netflix, would be doing quite well. And you'd be justified — but also quite wrong.

First, the streaming part. This is from The Wrap, referencing a recent report from the Digital Entertainment Group and looping in Netflix's major business-model change:

The five-fold spike in subscription streaming is largely due to Netflix’s shift away from CDs. Spending on subscription streaming hit $548.6 million in the first half of 2012, up from $85 million in the first six months of 2011. [my emphasis]

How could Netflix lose with increases of that magnitude being posted? Easy: All that demand for streaming means Netflix is going to have to spend and spend hugely to feed the demand. Wall Street is concerned about this — as well it should be given that the former darling of the Silicon Valley tech world just saw second quarter earnings call by a whopping 91 percent. USAToday does the numbers:

Netflix Inc....faces higher fees to license TV shows and movies for a service that shows an unlimited amount of video over the Internet for $8 a month.

In the latest quarter, Netflix added 1.1 million subscribers to the Internet streaming service worldwide. The increase left Netflix with 27.6 million Internet video subscribers through June, including nearly 24 million in the U.S.

The second-quarter subscriber gains were in line with management prediction, but analysts had hoped for more after Netflix CEO Reed Hastings disclosed that usage of the streaming service had been steadily increasing.

If you peer into that analysis, you can see where the trouble lies for both Netflix — and Hollywood, which has in Netflix a technology company that actually wants to play by the Hollywood rules. Netflix pays for the content it provides to users rather than going the route of much of the more upstart Internet world, which advocates an open Internet where copyright enforcement isn't aggressive.

The better Netflix does, the better Hollywood does, as it strives to monetize the online distribution channel, making it as lucrative (potentially) as the old DVD channel has been for more than a decade. But at the same time, Hollywood doesn't want Netflix to be able to dictate pricing terms, and that means that it may be stingy about providing Netflix with the most popular movies. Meanwhile, Netflix has to strike a tricky balance between how much it charges subscribers to stream content on a monthly basis and how much it costs the company to license that content.

For the time being, Hollywood has a fairly ideal set-up with Netflix. The company wants to phase out the old DVD business and go all-in on streaming. But it doesn't want to alienate users by raising prices too steeply. Nor does it want to cut itself off from Hollywood, given that a future that relies on streaming won't be successful if Hollywood doesn't give Netflix the good content.

The risk here is that Hollywood will overuse its leverage and wreck Netflix's business in the process. Netflix's current vulnerability makes tempting. But this should be a relationship that both Hollywood and Silicon Valley can benefit from.

Follow Matthew DeBord and the DeBord Report on Twitter. And ask Matt questions at Quora.