Do Netflix Inc.'s Shocking Expansion Plans Make Sense?

By Markets Fool.com

Source: Netflix.

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Netflix recently gave its international expansion plans a huge boost. The digital video giant now plans to cover the entire planet in Netflix-branded streaming video services by the end of 2016.

That's most certainly an ambitious goal. And CEO Reed Hastings wants to keep the company profitable whilegrowing Netflix's list of nations served from less than 50 to about 200.

Is this global market even achievable, or is Netflix setting itself up for failure with this bold prediction?

The basic platform is important
To get this worldwide expansion going, Netflix absolutely must build a decent basic library of global content licenses.

By that, I mean a bucket of content that's ready to deploy in any market, anytime, with no further studio negotiations necessary. That's a big change from how Netflix has been landing most of its content deals so far, with separate licenses for each and every market.

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Some Netflix Originals aren't exclusive. Orange Is the New Black, starring Laura Prepon, has been broadcast Down Under for years. Source: Netflix.

For example, the flagship of all Netflix original shows, House of Cards, is not available in the French Netflix service. French broadcasting giant Canal Plus bought those rights from House of Cards producer Media Rights Capitallong before Netflix entered the French market. Media Rights is perfectly within its rights to monetize its productions elsewhere, since Netflix only has a non-exclusive distribution contract for the politically charged Kevin Spacey vehicle.

The situation is similar in Australia and New Zealand, where local broadcasters already hold the rights for several key Netflix titles. The announcement of the next Netflix grand openings conspicuously avoided mentioning Orange Is the New Black. Lionsgate has doled this Netflix original series out to local broadcasters Down Under, and I'm not at all sure the title will be available from Netflix at launch.

But investors needn't worry. Netflix is already working on this.

Time Warner's production Gotham was an early example. When Netflix announced its distribution contract for the crime-themed Batman prequel, the company made a big deal of its global rights. It's not exactly a Netflix original, since a traditional broadcaster gets first bids on the series, and Netflix users have to wait about a year before digging in. But the agreement does cover digital streaming rights in every conceivable market, giving Netflix an attractive ace up its sleeve wherever it goes.

Gotham is just a start, and Netflix is likely to insist on global rights for anything that might work in multiple markets. This standard-issue content portfolio will make it easy to build a turnkey service that's ready for action anywhere, at any time. And then Netflix looks at what people actually like to watch in Japan, Russia, Nigeria, or Saudi Arabia so it can tweak each product as needed.

I'm not just guessing, either. Hastings has been very clear on this. "If we see that Germans like films with motorcycles in them, then we need more of those," he told German weekly magazine Der Spiegel.

So the basic catalog isn't the final solution for everything, but it's a darn strong starting point for any new market. Without this fundamental collection, I don't see how Netflix could cover the world with a two-year deadline.

That's not the whole story
With a global content portfolio, no matter how small and weak, Netflix will be able to cover a lot of ground very quickly. But is that enough to push Netflix over its self-set goal line?

Not quite. Content is a crucial part of the Netflix service equation, but it's not the whole story.

The company must make sure it can operate in each new market, which can be tricky for political reasons. Hastings already admitted that the launch in China will be small and tentative, because it's not easy for foreigners to rush in and run an online service there. I'm not sure the U.S. government will let Netflix set up shop in embargoed markets like North Korea or Sudan, or that the political climate in such places would let Netflix create a serious business there. If there's one detail that might stop Netflix from going entirely global, political sculduggery would be it.

Netflix CEO Reed Hastings. Source: Netflix.

Beyond that, Netflix must also install digital distribution centers and hook them up to reasonable broadband networks. That's hard enough in America, and the costs might become prohibitive in other places.

I will say that the proven success in Latin America has prepared Netflix for technically difficult markets. Broadband is kind of a luxury in economically challenged nations like Honduras and Nicaragua. Netflix has admitted to difficulties with credit and debit card payments in Latin America, adding to the dearth of broadband options.

And yet, Netflix is making it work even in Latin America. That's why I think it can happen in Pakistan and Madagascar, too. It'll be slow going, and Netflix may have to settle for a bare-bones standard catalog in the tough spots, but there will be something there. The required computing hardware is cheap, and the service can be managed by a skeleton local crew with almost everything done remotely. There's no reason why the Netflix model with global licenses shouldn't be able to turn a profit eventually, even in Burkina Faso and Bhutan.

The final verdict
Unless Netflix runs afoul of political limits somewhere -- which is entirely possible -- I do expect the service to cover the Earth by the end of 2016.

The company may have to launch minimal services in a few spots along the way, just to be able to claim it has a presence everywhere. So the end result might be only a technical victory with lots of work left to do before making it a real business in some difficult markets.

But yeah, Reed Hastings is not making promises he can't keep. Short of the political wild card, I fully expect Netflix to succeed here.

Then it'll be time to start retuning the business model for maximum profit rather than peak growth, and it'll be a whole 'nother ballgame. Right now, you're watching Netflix growing into its digital breeches -- the tentative first steps of a future media powerhouse. And you just ain't seen nothing yet.

The article Do Netflix Inc.'s Shocking Expansion Plans Make Sense? originally appeared on Fool.com.

Anders Bylund owns shares of Netflix. Also a longtime Netflix customer, he canceled his DVD plan in 2011 but keeps a spare red mailer around for sentimental reasons. The Motley Fool recommends Lions Gate Entertainment and Netflix. The Motley Fool also owns shares of Lions Gate Entertainment 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.