Should Netflix Inc. and Amazon.com Be Making Movies?

By Markets Fool.com

Netflix and Amazon.com both recently unveiled big movie-making plans. Netflix is producing a Crouching Tiger, Hidden Dragon sequel and four Adam Sandler films, and Amazon announced plans to launch a dozen original movies starting this year.

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While movies may seem like a natural next step for Amazon and Netflix, which produced critically acclaimed TV shows like Transparent and House of Cards, respectively, they also represent a major financial leap which could backfire and hurt both companies.

Netflix's House of Cards. Source: Netflix.

The business of original streaming content
To understand why Netflix and Amazon are investing in films, let's first examine how they started producing original TV shows.

Netflix's streaming content obligations (the amount Netflix promises to pay studios to license future titles)rose from $7.3 billion to $9.5 billion between the fourth quarters of 2013 and 2014. Amazon's streaming content obligations are likely lower, estimated to be between $1.5 billion and $4.2 billion,due to the smaller size of its media library. However, that licensed ecosystem is growing -- right after Netflix andViacom'sprevious partnership expired in 2013, Amazon swooped in and signed a two-year deal which granted it access to 4,000 shows for $200 million.

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So to offset the high cost of licensing content from TV and film studios, Amazon and Netflix have begun producing original TV shows.The first two seasons of Netflix's House of Cards, consisting of 13 episodes each, reportedly cost $100 million to make. Netflix claims that it recouped those costs with subscriber growth and has heavily invested in original content since then. It reportedly spent $90 million on the first ten episodes of its new show, Marco Polo. While the budget for Amazon Prime's Golden Globe-winning show, Transparency, is unclear, it was reportedly higher than some indie films.

From TV shows to movies
Despite the buzz surrounding these popular shows, it's been difficult to measure the subscriber growth generated by such high budget showsbecause their real ratings remain unknown. Ratings for Amazon or Netflix's shows are different from network TV -- which calculates ad revenue per show based on ratings -- and premium cable channels like Time Warner's HBO, which can correlate ratings to subscriber retention and growth.

But Netflix and Amazon's secretive ratings could soon be exposed by Nielsen Media, whichannounced plans last November to crunch those numbers for clients and media companies. When that happens, investors will know if House of Cards' hefty price tag was really justified by subsequent subscriber growth.

With that in mind, Netflix and Amazon are exploring themovie makingbusiness to remain competitive by countering on-demand filmsfrom cable companies and the upcoming launchof HBO's rival streaming service in April.

But will this new effort pay off?
Personally, I believe the money Netflix and Amazon intend to spend on films would be better spent on new TV shows instead. With a TV show, the company can invest in a pilot, gauge its reception, then decide whether or not to order a full season. With movies, a full investment must be made upfront. Netflix's upcoming Crouching Tiger, Hidden Dragon sequel reportedly has a budget over $20 million -- a bigger investment than Marco Polo, which averages out to $9 million per hour.

And Netflix's budget could swell by producing Adam Sandler films.Sandler's last film, Blended, cost $40 million to make, and his new Netflix feature, The Ridiculous 6, was reportedly dropped by Warner Bros. due to budget concerns. Amazon is producing cheaper indie films instead of blockbusters, but they could still cost considerably more than its TV shows.

Is Adam Sandler the future of Netflix? Source: Wikimedia Commons, AngelaGeorge.

Netflix and Amazon are also targeting their films for both on-demand and theatrical releases, and theaters have already staunchly opposed same-day releases -- as Netflix proposed with Crouching Tiger, Hidden Dragon 2 -- since they could disrupt the traditional model of delayed home releases.

Not a good return on investment
Great TV shows can last for years, but even successful films can burn out after one or two sequels. Investing $50 million per year on a drama with 13 hours of Kevin Spacey is a good idea. Spending $40 million for 90 minutes of Adam Sandler probably isn't.

Netflix and Amazon should stick with high quality TV shows instead of big films. The former is cheaper, lasts longer, and can keep subscribers hooked. The latter is expensive, tough to franchise, and does little to convince subscribers to stay.

The article Should Netflix Inc. and Amazon.com Be Making Movies? originally appeared on Fool.com.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Netflix. The Motley Fool owns shares of Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.