Netflix Doesn't Want to Stream Most Movies

Image source: Netflix.

It might be time to take the "flix" out of Netflix (NASDAQ: NFLX). The number of top-rated films on the streaming service has steadily declined over the years as it drops licensing deals. As of September, Netflix's U.S. library contained just 31 of the top 250 films rated by IMDB.

But Chief Content Officer Ted Sarandos isn't worried. At a recent conference hosted by UBS, he said about one-third of subscriber viewing is movies, regardless of how many different movies are in its library. So, Netflix can spend money on the movies that drive the most repeat viewing -- like Disney (NYSE: DIS) movies -- and drop licenses for other studios. That could enable it to save money compared to competitors like Time Warner's (NYSE: TWX) HBO.

Similar markets, different libraries, same results

In his talk, Sarandos compared Netflix viewer habits in Canada to Netflix viewer habits in the United States. In Canada, Netflix has deals with five major studios -- that's more than HBO has in the United States. In the U.S., Netflix just started licensing Disney films. In both markets, about one-third of viewer watch time is movies.

Sarandos explains this behavior by pointing out passionate movie watchers will find a way to see a movie they're interested in before it's available for syndication through a service like Netflix or HBO.

HBO has licensing agreements in place with four major studios, the majority of which run through 2021. In its 10-K from last year, HBO boasts those deals covered half of the top 40 films released theatrically in 2015. The irony that Sarandos points out is that if they were high-grossing in the box office, most HBO subscribers have already seen those films by the time they hit HBO. HBO's film licenses account for about half of its content budget.

Differentiating factors

If passionate movie viewers have already seen a film by the time it reaches Netflix or HBO, the audience watching movies on these services is therefore more dispassionate. In other words, it doesn't really matter which films are available for them to watch; they're just looking to watch a movie. Importantly, that kind of viewing doesn't differentiate Netflix's product from any other video-on-demand product.

Sarandos believes Disney is a big exception to that rule. Disney produces very rewatchable content from its kids movies to its big Marvel and Star Wars franchises. The Disney deal is valuable to Netflix because it differentiates the product. It's the only place to stream popular titles like Zootopia or Captain America: Civil War.

What to expect from Netflix

Netflix telegraphed its plans to pursue a more curated selection of content about four years ago when it neglected to renew some of its biggest contracts for both television and movies and signed the megadeal with Disney. It's now clear that curated content didn't mean the best content. If it was the best, people would find a way to see it before it hit Netflix. Curated content is the content that will produce the most watch time per dollar from its subscribers -- differentiated content.

Sarandos didn't go beyond the example of Disney movies as differentiated content, but another example would be Netflix's original movies. Even the Adam Sandler films that premiered on Netflix -- the ones critics absolutely hated -- got a ton of views. Being the exclusive place to watch a really bad movie is still a win in Netflix's book.

The other takeaway is that Netflix will primarily invest in series -- both original and licensed. Considering two-thirds of watch time comes from television series, it's a more efficient use of its content budget. With its content budget ballooning to $6 billion on a profit-loss basis and net profit margin a minuscule 1.9%, Netflix needs to make the most of every dollar.

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Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Netflix and Walt Disney. The Motley Fool recommends Time Warner. 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.