Netflix: The Disruptor Becomes the Disruptee? (CSTR, VZ, AAPL, MSFT, NFLX, AMZN, WMT, CMCSA, DIS, T, MSFT)

In retrospect, it was inevitable. Where there's money to be made, a crowd will be drawn; think 'Gold Rush of 1949'. That's part of what's ailing Netflix, Inc. (NASDAQ:NFLX) now. Amazon.com, Inc. (NASDAQ:AMZN) saw the kind of money Netflix was making with its streaming video business back in 2008 and 2009, and started to get into the game too. Apple (NASDAQ:AAPL) saw the same, and has begun to beef up its on-demand video offering through its iTunes site. And most recently, Coinstar (NASDAQ:CSTR) and Verizon (NYSE:VZ) have teamed up to leverage the powerful name behind Coinstar's popular Redbox service to deliver digital content online. Although Netflix is still the undisputed king of on-demand video in terms of market share, all three of those competitors (and more) are also chipping away at Netflix's dominance. Worse, because the film studios recognize the revenue potential of on-demand - now that Netflix has proven the concept works - they're looking to get in on the action too.

So what? The proverbial "so what" is that Netflix may ultimately be doomed if it doesn't recognize why it's losing out to competitors like Amazon, Coinstar (Redbox), the Wal-Mart (NYSE:WMT) digital movie site Vudu, Apple, and Xfinity by Comcast (NASDAQ:CMCSA). And, even if Netflix does recognize why the ground beneath the company is crumbling, there's still been no real hint that it's willing to do anything about it.

To really get a grip on what's going wrong for Netflix, and why there's no easy fix, one has to take a step back and look at the bigger picture.

In the early 90's, Netflix was built as a DVD-by-mail rental business. It wasn't until 2009 or so that its digital-streaming business took off, largely because it had no viable competition. At  the time though, the concept was so new, studios like Paramount or Disney (NYSE:DIS) thought little of it other than Netflix being a way to scrape off a little extra money by letting the website stream some of its otherwise-unused movie and TV-show library.  

By 2010 and into 2011 as negotiations with distributors like Stars and owners of content (like Paramount) were due again, these same studios had seen Netflix's prolific growth not only smash their lucrative DVD business [why buy one DVD for $20 when you can pay $15 per months and access hundred of movies and shows online?] but also turn tidy profits off of their content, these content owners cranked up their content licensing prices, with some of them asking more than Netflix was willing to pay. But, already having a taste of what kind of revenue that on-demand video could produce, these same distributors and studios began to shop around at some of the (now several) other venues for online distribution of that digital content.

That is something most investors recognize, but that's not the only thing holding NFLX back and keeping its stock off-limits to skeptical investors. Here's where it gets heavy.

Kudos to Netflix for continuing to do business as well as it can, shrewdly negotiating content-licensing deals that make sense, and passing on deals that are just not fiscally sound. The fact that it was willing and able to outbid what was certainly a ton of competition for rights to new Disney movies speaks volumes about how serious the company is about the quality of its offering (which attracts and retains customers). But, to maintain adequate margins between content costs and subscription prices is ultimately a losing battle, for one simple reason... none of the entities that Netflix is competing with on the streaming content front has to produce a profit with its on-demand business alone.

Think about it. Comcast offers Xfinity, but primarily as a way to beef up the attractiveness of its telco (phone, cable, internet) bundles or to deliver already-free cable broadcasts online. Amazon offers Prime, but only as part of a package that ultimately encourages sales through its physical goods operation. Wal-Mart manages the DVD-to-digital service (and on-demand service) Vudu, but the end goal is to drive sales of more profitable DVDs (and/or to drive people into Wal-Mart stores). Even the new joint venture between Coinstar and Verizon - Redbox Instant - is said to ultimately be designed to funnel new or existing customers to Redbox kiosks (which sell things other than movies) or to Verizon, which sells things other than movies; how long will it be before Verizon makes a special deal to its wireless customers using Redbox Instant to sweeten the pot? And if that happens, how long will it take AT&T (NYSE:T) to team up with Blockbuster or another venue to prevent the Coinstar/Verizon duo from getting too much traction with telco customers and movie watchers? Eithey way, Verizon will be able to immediatey tap its more than 100 million wireless customers.

Meanwhile, Netflix is adamant about only making money one way.... by taking in more subscription revenue than it pays out in content costs. When other players in the same game are willing to sell essentially the same content at break-even prices or less though (while Netflix's content costs continue to soar), how long will Netflix remain viable.

The bottom line is, on-demand content is rapidly turning into a commodity. Netflix is still the king of the hill in terms of its content library and membership, but competitors are gaining. The solution? Netflix may seriously want to consider a partner that doesn't really need the Netflix operation to be profitable, because the many of the entities Netflix is competing against have all teamed up against it (the disruptor has become the disruptee), and many of those partnerships have the studios' blessings. And just to be clear, Netflix needs to think "partnership" rather than "riding coat-tails", as seemed to be the case earlier in the year when NFLX CEO Reed Hastings made zero headway when looking to partner with cable operators as resellers of the Netflix service. The buzz is that Netflix simply wasn't offering enough value compared to what the cable companies could do on their own.

Microsoft (NASDAQ:MSFT) has been named as one potential suitor, which makes a little sense, though even Microsoft's reach with the average technology consumer is a little tepid at this point. Something's got to give though, sooner or later.

Just food for thought.