Food Network stars Giada de Laurentiis and Bobby Flay. Image source: Scripps Networks Interactive.
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Media companies have long complained about the impact of Netflix (NASDAQ: NFLX) on their ratings and revenue. But on an individual basis, they're each caught in a prisoner's dilemma. If one doesn't license content to Netflix, but others do, the first one misses out on valuable licensing revenue and still takes a hit on ratings.
Now, Scripps Networks (NASDAQ: SNI) is taking the first steps to cut off Netflix. On the company's third-quarter earnings call, COO Burton Jablin told anlaysts that Scripps "made the strategic decision not to extend our SVOD [subscription video on demand] agreement with Netflix past the end of this year." Other networks, such as Time Warner (NYSE: TWX), have discussed extending the window between first airing a show and licensing it, but never cutting off Netflix entirely.
While Netflix has been more selective in what it licenses, a decline in its options could negatively affect its product.
The reasoning behind Scripps' decision
Jablin was short on an explanation, other than saying it wasn't the best way to monetize its content in the long term. CEO Ken Lowe, however, expanded on Jablin's comments later in the call.
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"We have such compelling content for advertisers," Lowe told analysts, "that we just don't want to really cut ourselves off from any opportunity." Scripps' networks include Food Network, HGTV, Travel Channel, and DIY Network.
That comment makes it sound as if Netflix wanted an exclusive contract with Scripps. That's something it's been pushing for with most media companies it deals with. That ultimately led it to lose out on EPIX's content, which is now available on both Hulu and Amazon.com's Prime. Scripps may be looking to forge similar non-exclusive licensing deals to maximize revenue.
Additionally, Lowe noted, "We gained a lot of internal knowledge on the digital side and on the best way to monetize this content, including the further expansion and development of our digital sales team." That indicates that Scripps may look to improve the monetization of its own streaming content as well.
The loss of Netflix revenue will negatively impact distribution revenue, which accounted for about 28% of Scripps' total last quarter. Scripps' distribution revenue declined in the third quarter as the result of average rate declines caused by consolidation in the pay-TV industry, coupled with declines in subscribers. Going forward, management expects its distribution rates to climb at mid- to high-single-digit rates, but is still factoring in 1% to 2% in subscriber losses.
Will Netflix see more dropouts?
Netflix is pushing out more and more of its own original content to draw in new subscribers, but it's still heavily reliant on licensed content to provide value to its 86 million members. Netflix doesn't disclose how much it spends on original content, but it ultimately wants to move toward a 50/50 split in original content and licensed deals. (It's unclear if that's in spending or hours of content available.)
Netflix's licensing deals are focused on brands and content that provide differentiation. But that's exactly the kind of content that's in the best position to stop licensing to Netflix and search for better monetization opportunities.
Time Warner has some of the most differentiated content in the market, which enabled it to sell HBO as a stand-alone service and sell older HBO content to Amazon. It's also considering extending the exclusivity window for its other cable networks before licensing to SVOD services. And if it falls under the control of a traditional pay-TV distributor, it could cut off Netflix altogether, especially considering its 10% stake in Hulu.
If more networks follow the trend -- refusing Netflix exclusivity, or refusing Netflix's deals altogether -- it could result in higher churn rates for Netflix, as the value of its content library is heavily reliant on licensed content. Scripps could be just the first of many. The good news is that Netflix seems capable of producing extremely compelling originals and could ramp up more productions if need be.
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Adam Levy owns shares of AMZN. The Motley Fool owns shares of and recommends AMZN and NFLX. The Motley Fool recommends SNI and TWX. 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.