Netflix has hits, Emmys and subscribers. But can it survive its fight with cable?


Netflix CEO Reed Hastings talks about his company's collaboration with LG televisions during the 2014 Consumer Electronics Show in this January file photo. Hastings is on a mission: to turn his company into the Internet’s first-ever television network. (Julie Jacobson/AP)

Reed Hastings, the lanky and goateed chief executive of Netflix, is on a mission: to turn his company into the Internet’s first television network.

On Thursday, Netflix collected 31 Emmy nominations for its shows, more than double its haul last year, for hit programs such as “Orange Is the New Black” and “House of Cards.” Last month, the company surprised the TV industry by signing comedian Chelsea Handler for a talk show that will be exclusive to Netflix subscribers, the latest move by the company to prove that it can create high-quality programs.

“We are defining the way consumer entertainment ought to work,” Hastings said in an interview at Netflix’s headquarters.

The company that took down Blockbuster and transformed how people watch movies — even as analysts predicted its demise a number of times along the way — now has its eyes set on television. And Hastings sees the future of video entertainment as being largely written by HBO and Netflix, companies that offer must-see series such as “Game of Thrones” and “House of Cards” on mobile apps that are highly personalized and constantly recommend more entertainment from vast libraries of content.

But there’s one major threat to its long-term survival. Netflix, which makes up nearly one-third of all Internet traffic, relies on the Internet pipes ruled by such companies as Comcast and Verizon. Stream to viewers a “House of Cards” episode whose connection fades in and out, and watch subscribers walk out the door.

This year’s Emmy Award nominations are full of the expected honorees, but they also include a few dark horses. The Post's Emily Yahr has four things you should know about in this pack of nominees. (Nicki DeMarco, Tom LeGro and Emily Yahr/The Washington Post)

Already this year, Netflix has grudgingly cut deals with Comcast and Verizon to guarantee faster streaming.

The world of television is dominated by big, entrenched players: broadcasters such as ABC and CBS, and cable companies such as Comcast that run the piping of the Internet and hope to get even bigger.

Standing in the middle is Netflix, which has begun to flex its muscles in Washington, challenging the same cable companies that control those pipes that the company needs to survive, waging a high-stakes bet on government regulators to act as a referee over the fast-evolving tech and telecom industries.

Whether Netflix can survive will help determine how consumers watch television for years to come. Do they continue to pay Comcast for a big package of channels? Or do they abandon the bundle and subscribe to a mix of streaming video services such as Netflix and Amazon Prime, streamed through their Apple TV or Google’s Android TV?

Already, Netflix’s drumbeat of complaints to Washington has sparked a recent federal probe into how Internet service providers such as Comcast and Verizon charge Netflix and other Web firms for more direct — and therefore faster — delivery of their sites to users. Netflix has also urged regulators to reject Comcast’s proposed $45 billion merger with Time Warner Cable, saying the combined company would have too much power with more than 40 percent of all U.S. high-speed Internet subscriptions.

“We think the right principle is that they shouldn’t be impeding, favoring or charging for data,” Hastings said. The Comcast merger is troubling, he added, because “the idea that one company, if the merger goes through, will control half of U.S. residential broadband, not including DSL, isn’t in the interest of the Internet, public and our society.”

Netflix’s opponents, though, say that the company needs to pay for the sheer amount of broadband its content eats up.

“Netflix’s argument is a House of Cards,” Jennifer Khoury, Comcast’s senior vice president for communications, wrote this spring, arguing that the company is simply trying to make all Internet users pay for the cost of supporting its broadband-gobbling business. “The company should at least be honest about its cost-shifting strategy.”

For years, Netflix has navigated a paradoxical relationship with the cable industry, challenging its existence yet depending on it for survival.

“It’s like skating on a razor blade,” remarked a former Netflix executive who said the friend-and-foe relationship with cable companies has long been a source of great concern for Hastings.

Building a better HBO

Hastings, 53, co-founded the company 17 years ago and has transformed it at least three times to fit with changing technology.

Hastings, who nearly named the company DVDbymail.com, began Netflix as a mail-order DVD business that quickly built a loyal customer following. After Hastings saw DSL Internet begin to take off, Netflix began streaming videos in 2007.

In 2010, as some analysts predicted the company’s demise, Hastings began plotting the company’s next big move: building original content. Its first foray would be gangster comedy “Lilyhammer” and then political drama series “House of Cards,” starring Kevin Spacey.

Hastings likes to say that he needs to turn Netflix into HBO before HBO becomes more like Netflix — meaning he wants to create a company that has the same level of quality and variety as the famed network but isn’t tied to the cable bundle.

Today Netflix has 1,300 employees, with a staff of more than 300 in Beverly Hills creating original shows and forming exclusive licensing deals.

Netflix sees this kind of original content — and its technology — as its competitive edge. An army of engineers uses deep data analysis and experimentation on users to make sure at least five good recommended videos are served up each time a user opens Netflix apps.

The heart of that effort takes place in a comfy corner of Netflix’s Mediterranean-style corporate campus. There, product innovation vice president Chris Jaffe is sunk into a tan sofa in front of three huge 4K television screens positioned exactly 10 feet away. With a red area rug, floor lamps and maple coffee table, the space is designed to look like a typical living room for watching TV.

Jaffe is constantly testing changes to its recommendation engine, menus and widgets on the users. Successful tweaks to the app are measured by how many subscribers keep coming back for more videos, click on recommendations and actually finish films.

The challenge is to pay for all the new content without having to increase prices too much. The company raised streaming subscription rates by $1, to $8.99, for new customers this year and didn’t lose many subscribers.

But costs for Netflix could quickly skyrocket as it tries to secure faster service for its content from the cable companies. Last February, Netflix agreed to pay an undisclosed amount to directly connect its servers to Comcast’s network into American homes. Netflix reached a similar deal with Verizon in April.

Taking battle to Washington

These deals may have hurt Netflix’s credibility in an increasingly heated lobbying dispute over fees to direct traffic over the Internet.

Netflix believes it should be able to connect directly to the Internet networks for free, pointing to a long tradition of the free exchange of traffic between the many companies that deliver data over the Web. The company has complained to the Federal Communications Commission that new charges for the delivery of Web traffic is anticompetitive and could harm consumers and small businesses that aren’t able to pay tolls on the Internet.

Cable and phone companies argue that a company gobbling up as much as one-third of all Internet bandwidth should bear some of the costs to delivery content.

Regulators are divided on how to handle the issue, which is separate from the review of “net neutrality” rules now under way. Net neutrality deals with the last mile of Internet pipe before content reaches consumers; Netflix’s issue goes beyond that to other stretches of Internet connection earlier in the chain.

How the government handles these questions, experts say, will help determine how consumers experience media in the future.

Some regulators note that Netflix has led a charge to online video that benefits consumers.

“Services like Netflix not only make us want more broadband, they make our broadband connections more personal — by giving us the power to watch what we want, when we want it, where we want it,” said FCC Commissioner Jessica Rosenworcel.

In the absence of rulemaking by the government, Netflix has tried to educate users on how their broadband service works by holding the companies accountable on speeds and performance — so that if and when a video doesn’t stream smoothly, customers are more likely to blame their Internet service provider.

In June, some Verizon Internet customers saw an error message when trying to load Netflix videos: “The Verizon network is crowded right now.”

Verizon responded with a cease-and-desist demand that Netflix take down its message to subscribers. It called the maneuver a “PR stunt.”

“As Netflix knows, there are many different factors that can affect traffic on the Internet,” Randal Milch, Verizon’s head of public policy, wrote in a cease-and-desist letter to Netflix. He said such factors include “choices by Netflix in how to connect to its customers and deliver content to them, interconnection between multiple networks, and consumer in-home issues such as in-home wiring, Wi-Fi, and device settings and capabilities.”

Netflix, which has two full-time lobbyists, has poured more money into bulking up its political influence, spending $1.2 million in 2013 on lobbying, more than double its total three years earlier.

The money spent on lobbying Congress and the FCC still pales in comparison to cable firms; Comcast, for instance, spent $18.8 million last year on lobbyists who include high-level former staffers from the FCC.

“We are arguing for everyone that no one gets charged,” Hastings said. “That will help Amazon, Hulu and others.”

But Netflix’s founder is careful with how he characterizes his bigger industry bedfellows. And he concedes that the status quo could be difficult to dislodge.

“The cable television bundle is very powerful,” Hastings said. “People have speculated on breaking the bundle for decades and when it’s speculated that much and the number of subscribers hasn’t really gone down, you know its a pretty stable business model.”

Cecilia Kang is a staff writer covering the business of media and entertainment.
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