This is the first of a regular series of blog posts that will pick out the some of the more meaningful news stories and look behind the headlines to identify new developments and trends that could affect the broader market development.

Stories in this issue:

• Netflix put to the content test
• Movies, Games, Music and Books make online advances
• Network consolidation success and failure

Netflix put to the content test

Securing high quality content is top of Netflix’s agenda again as the US Internet integration giant looks to create its own original content and faces a fight to renew its deal with movie partner Starz.

Rumour: Netflix to create original programming?

Netflix is to make its first entry into original programming with a US adaption of the UK political novel “The House Cards” featuring David Fincher (West Wing) and Kevin Spacey, according to reports.

A move into production is a radical change of model for the internet aggregator, but it is not one without precedent as HBO has previously made the transition successfully. However, it will take significant investment. High End Drama in the USA costs US$4mm-$6mm per episode and the rumoured two-series, 26-episode commitment implies total production cost of over US$100m, although Netflix would be able to defray some of the risk if overseas partners come onboard. See this Deadline report for more.

Securing the right content is critical to continued success of Netflix and it is facing on-going battles to make the right deals as challengers, such as Amazon, emerge and existing partners flex their own muscles.

Partner blow leaves Netflix chasing Starz

At a recent analyst event, Netflix’s movie partner Starz fired a shot across the integrator’s bow in the build up to contract renewal negotiations between the two. Starz, which provides Netflix with access to Sony and Walt Disney Pictures content, moved to dispel the myth that Netflix had helped its business calling it a “… a little optimistic and perhaps self-serving.”

Starz has previously said that it looked at digital revenue as gravy on top of the US$1.5bn it receives for TV distributors. More worringly for Netflix, Starz said it is probably not in its interest to rush into a new deal with Netflix and it had been speaking with Amazon, which has recently started an internet streaming service.

The contract is crucial for Netflix as it provides vital content but it will inevitably have to pay significantly more if the deal is to be renewed.  The noise on the jungle grapevine is that Netflix got the streaming rights for US$25m/year compared to a current market value of US$200m. See the Hollywood Reporter for more.

Streaming costs a drop in the ocean

On the positive side, an analysis of Netflix streaming costs implies that its cost to stream a movie has dropped from 5 cents two years ago to 2.5 cents in 2011, primarily due to falling CDN prices. It is estimated that Netflix will spend around US$50m on streaming in 2011, which is a drop in the ocean compared to the cost of content rights and equivalent physical postage expenditure.

Netflix recently released performance data of streaming on various US networks which implies the average user streams around 2Mbps compared to their maximum Netflix encoding of double that. See Blogspot for more details.

Movies, Games, Music and Books make online advances

DirectTV’s premium VoD offer challenges the traditional window structure as it attempts to kick-start online movie distribution growth and Spotify faces reality of building revenue, while it is full steam ahead for online games and e-books.

Premium VoD opens new window for studios

DirectTV will become the first distributor to trial a Premium VoD service when it launches in the middle of 2011. The proposition means consumers will pay US$30 to rent a movie in their homes just 60-days after it opened in theatres and at least 30-days before the movie goes on DVD sale. This represents a brand new window for the movie industry and is much hated by theatre owners. Just talk of opening such a new window highlights how much the movie studios value home entertainment revenues and are looking for ways to improve revenues. Read the full blog on latimes.com.

Meanwhile the battle of the online video formats, which impacts on the potential of paid for business models, has moved to the USA justice department. Google’s attempt to promote WebM, a royalty-free alternative to the MPEG LA royalty bearing H.264 family, was always going to end in acrimony and we expect this battle to continue for many years to come. The Wall Street Journal has the full story.

Gamers rush to get online

The Games Industry is moving forward in its online efforts. Sony announced at the 2011 Games Developer Conference that it had 70m users worldwide of its Playstation network and most significantly 70% of those connect to the network every week.

Vivendi, the main shareholder of Activision, also announced in its financial results that it had more than 12m subscribers to its online franchise, World of Warcraft, at the end of 2010. To put that in context, Black Ops, the latest extension of Activision’s Call of Duty franchise shifted over 20m units for more than US$1bn in retail sales.

Spotify grows but faces US challenge

In the online music world, Spotify announced they had breezed past a million subscribers paying for its services worldwide but all is not plain sailing for the subscription music service. With any freemium business model the ratio of paying to free users is vitally important in terms of financial success, even though free users do bring in some advertising revenues. In Spotify’s case, this is 15%, which implies it has 6.7m active users, which itself is some way short of the registered users which passed 10m in September 2010.

Furthermore, Spotify’s much-talked about venture across the Atlantic is facing competition from Viacom and MTV spin-off Rhapsody even before it launches in the US. It has extended its usual 14-day free trial to 60-days in an attempt to cover Spotify’s launch. Rhapsody has around 750k subscribers in the USA. For more see this Business Insider report.

Momentum grows behind e-books

The appeal of e-books is reaching critical mass amongst publishers and consumers alike.

Publisher, Bloomsbury, declared 2011 the ‘year of the eBook’ and announced that eBooks represent 10% of its total print sales and, even more importantly, that new releases attract much higher online numbers. For example, a fiction blockbuster such as The Finkler Question by Man Booker winner, Howard Jacobson, posted digital sales of 42% of the total in the US in its first six months. See this Bookseller report for more.

Meanwhile, Random House, which had opted out of the original iPad launch amid concerns over the Apple agency pricing agreement has signed up for the iPad2. This means that all of the ‘big six’ publishers, the others being: HarperCollins, Penguin Group, Simon & Schuster, Hachette, and Macmillian, are now supporting the iPad. Furthermore, Apple also announced at its ipad2 launch event that over 100m eBooks had been launched through its iBook store in around 10 months, although it didn’t reveal how many were free downloads. For more on our view of the iPad2, see Tablet Frenzy: Network Poison or Economic Palliative?

Network consolidation success and failure

The highly politicized acquisition by NewsCorp of BSkyB, with its 10m subscribers and annual operating profits of over £1bn, looks like it is going to be given the green light as the UK Secretary of State for Culture, Olympics, Media and Sport  announced that he intends to accept undertakings from News Corporation that will see BSkyB spun off by NewsCorp as a separate Ltd company. A final period of consultation ends on March 21, when a final decision will be made on whether to give the deal the go-ahead or refer it to the Monopolies and Mergers Commission.

If allowed, this together with DTH assets in Italy and Germany will make NewsCorp a truly formidable force in the Euro-PayTV industry. Read the announcement in full here.

Meanwhile, the auction for the 3^rd largest German cable network, Kabel Baden-Wuerttemberg, is off as the company has announced its intention to go to IPO. This took the wind out of the sails of John Malone’s, Liberty Global, who for a long time, looked as if it would be the primary suitor and thereby consolidating further the Euro-Cable industry. See Business Week for the full story.

Finally, Liberty Global looks as if it is in process of exiting Australia. Foxtel, the market leading DTH provider, owned by Telstra, NewsCorp and Consolidated Media, is trying to acquire Austar, Foxtel’s regional counterpart which is controlled by Liberty Global. The Australian has the full story.