I first met Netflix co-founder Reed Hastings in 2001 at a Maxtor event where I was the dinner speaker. He explained then that the company had always intended to deliver movies over the Internet (hence the name Netflix) but was starting with DVDs because the network infrastructure simply wasn’t ready for digital delivery. They’d eventually drop the DVD deliveries, though I think his estimate of when that would happen was around 2007, not 2011 as the company announced this week. That wasn’t his only underestimation, of course. Hastings also underestimated consumer and Wall Street reaction to the boneheaded way Netflix handled a recent pricing change.

Day traders have to love this, but unless you have your retirement tied-up in Netflix stock and were hoping to stop working this week it doesn’t actually matter much. Still, there’s some value in looking at how Netflix handled the recent changes and how they might have handled them better.

Am I the only person who didn’t see the recent Netflix price change as a price change at all?  We have a streaming-only subscription so nothing changed for us.  As a family with young children, Netflix DVDs would disappear and we’d end up having to pay for them, so it wasn’t a functional service.  We mainly use DVDs while traveling in any case, having finally learned that you can return Red Box videos to any kiosk. No cinephiles here unless you count a morbid fascination with Shark Boy and Lava Girl.

Rather than increase the cost for those who want to stream and continue with DVDs, Netflix probably should have announced the Quikster DVD service, offered current users a choice to stay with streaming-only Netflix or move to DVD-only Quikster, then thrown-in a streaming option strictly for Quikster. This would have been clearer and cleaner messaging but you can see how Netflix might have seen that path as being even riskier than simply adding a surcharge for DVDs on the way to an eventual spin-off.

Wall Street is keyed to total subscriber numbers and anything that causes those to stop growing would hurt Netflix shares. So for Hastings the real question was which move would hurt the company and its subscribers less?

Some level of pain was inevitable, because subscribers don’t like change (unless it involves lower prices) and day traders love market uncertainty exacerbated by throngs of angry torch-wielding peasants upset about...DVDs?

Reed Hastings took his best shot and maybe it was the wrong one. To compensate he threw himself under the bus in a blog post which also means nothing.  Netflix is continuing to follow a path laid out more than a decade ago. And three months from now none of this will even matter, the peasants and their torches having moved on to the next source of upset.

A third of the readers of this column are not in the USA and I can’t claim anymore that America is on the cutting-edge of all things Internet so I’ll just fall back on the argument that this is happening here and could just as easily be happening in your country, too. Which brings us to today’s story of Charlie Ergen’s plan to dominate the distribution of TV content to America in an all-IP, post-broadcast, post-satellite future. John Malone and Reed Hastings beware!

Echostar owns Dish Network, America’s second-largest satellite TV provider. Charlie Ergen is Echostar’s iconoclastic founder, CEO, and largest shareholder. Just as John Malone does with DirecTV, Charlie runs Dish any old way he wants to, which is why his grand plan has taken awhile to come together in my mind.

Charlie — like Steve Jobs — doesn’t do very much explaining.

Echostar has been putting together a digital strategy for the all-IP future where competitors like Netflix and Hulu may replace DirecTV and Comcast. This strategy can’t bet the bank because Charlie knows he can’t predict everything with total assurance (neither can I). But it is possible at this point for him to acquire or deploy enough assets at a low enough price to guarantee Echostar a solid place in that IP future almost any way the future plays out.

I believe Echostar has all but one component in place for this flexible strategy and no significant barriers to acquiring the last part (if it is even needed at all — more on this below). If there’s a question of critical mass it has already been answered. Charlie just has to pull the trigger. When he’ll do that is anybody’s guess.

Here are the tools at Charlie’s disposal — the Dish Network and its subscribers, Sling Media and its customers, Blockbuster Video and its customers, services and locations, Move Networks content distribution network (bought earlier this year by EchoStar), Echostar’s IP cross-licensing agreement with TiVO, and finally what’s behind Door Number Five.

The Dish Network has access to hundreds of video channels and the ability to place that content in tens of millions of homes in real time. Many of those satellite receivers have Digital Video Recorder capability with all of the DVR models having Ethernet ports and running the Linux operating system.

Sling Media developed the first mass market device specifically for streaming your own video content over the Internet. With a Slingbox you can watch your home video library, your nannycam, or even broadcast, cable, or satellite TV halfway around the world if you have a good Internet connection. I am unimpressed generally with Sling video quality but I don’t think that has to matter for this strategy to succeed. Just as there are millions of Dish DVRs installed, there are also more than a million Slingboxes, all of which also run Linux.

Under Echostar, Sling also markets a video streaming service offering movies and TV shows.

Blockbuster has a streaming video service, too, along with extensive license deals with the major film and TV studios — artifacts from when Blockbuster was the Big Kahuna of video rental and Netflix was a lot smaller than it is today. Blockbuster also has 4000+ rental locations, half of which the company is closing, but half are staying open, too.

Echostar’s TiVO license — the expensive outcome of a long legal battle — is something of a mystery here but I count it as an asset not just because it removed TiVO as an obstruction but also because it grants to Echostar a blanket license to TiVO IP, which no doubt includes some tech we haven’t seen before or have forgotten about. Remember all those video patents held by Burst.com? Well TiVO owns them now.

Charlie’s goal is clear. He wants to be a major distributor of professional video content for the rest of this century. He’s that right now, primarily with the Dish Network, but he wants to be at least as successful when IP video comes to dominate over the next 5-10 years.

In order to achieve this success Charlie needs a cheap supply of content, the right to distribute it, and a cheap, reliable, and pervasive method of video distribution. We’re not talking about 100, 1000, or 10,000 channels here. We’re talking about 50,000 movies and 150,000 TV shows — up to 200,000 channels in all and tens of millions of simultaneous connections.

I think Charlie is already there.

He has tens of millions of captive Dish, Sling, and Blockbuster customers, so Charlie’s marketing barrier is lower than it might be if he had to start from scratch. Netflix is in a similar position, which is why I feel this is a market segment where incumbents have a significant advantage over startups.

With only a licensing change Dish Network can be used to inject video content as-needed into millions of points on what will eventually become the Echostar (or Dish or Blockbuster) Virtual Video Network (VVN) — the successor to today’s satellite and cable systems. Every DVR becomes a repository or video cache on that network. All Charlie has to grab is a couple gigs per DVR to hold all the professional video ever watched.

The same will be true for Sling boxes, which can serve this distribution function whether or not there is a co-located satellite receiver.

And same for those 2000 Blockbuster locations that are not slated to close. That’s 2000 neighborhoods in up to 2000 cities that could each hold a copy of all 200,000 shows and films. That’s only 200 terabytes per library, by the way. I’m not sure why this is actually needed, but there has to be some reason for keeping open those Blockbuster locations.

Echostar and Sling already have streaming deals with the studios but my guess is that Blockbuster’s legacy deal is better. That’s the initial key to content, at least for awhile. And if you’ll look in your terms of service for Dish, Sling, or Blockbuster you’ll see nothing that keeps Charlie from leveraging behind your back that device you think you own.

The part behind Door Number Five, if I were Charlie, would be a peer-to-peer streaming client like Veetle. That’s a client for real-time streaming, not downloading — a client that caches only small bits of code on the network making it much more studio-friendly. More important, Veetle or a Veetle clone makes vastly more efficient use of network bandwidth to deliver an HD signal at little or no cost — a distinct advantage over Netflix, YouTube, etc.

A system like Veetle can aggregate smaller data streams from many sources into a full HD signal, making it immaterial that one-to-one Sling video isn’t really that great. Get enough peers together and many-to-one can run at any bandwidth your Internet connection can support while still costing Charlie nothing.

This distribution cost advantage is small but what’s important is it drops all the way to the bottom line, giving Charlie a decided profit advantage over the other guys, but it only works if you already have tens of millions of Linux machines connected to televisions all over America.

Only Charlie Ergen has that.



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The Intertubes are alight this week with old news — that Netflix is the largest user of U.S. Internet bandwidth. Most stories cite a Sandvine report I won’t link to because you’d have to subscribe and I like you too much for that. Better still, look at the very interesting graphic above, courtesy of Arbor Networks. This chart has been floating around the net for a couple of months and shows the result of an Arbor study of several U.S. ISPs illustrating how we Americans spend our Internet bandwidth. There are three lessons I think we can learn from this chart: 1) that BitTorrent is no longer (or perhaps never was) the threat were were told by ISPs; 2) that video is by far the Big Kahuna of bandwidth, and: 3) that Netflix may be approaching the point where it is too big to fail.

First a look at BitTorrent, which ISPs love to complain about. Torrents are down to only eight percent of Internet traffic, but much more important is the fact that torrents have always been more polite than video streams. Here are two more graphs courtesy of Arbor Networks. First take a look at how web traffic varies over a typical 24 hour period: Now look at p2p traffic over the same period:The two are reciprocals of each other. This is by design, not coincidence. The nature of BitTorrent is to grab bandwidth not utilized by other services. So when web surfing declines in the late night and early morning hours BitTorrent increases.

Using only eight percent of Internet bandwidth and substantially less than that during peak hours, I think BitTorrent’s day as the Internet bogeyman are past, though I doubt the MPAA will see it that way.

Even more interesting is the rise of Internet video. Back in 2005 when iTunes users were downloading seven million three-minute music videos, readers of this column were downloading 2.5 million hours of NerdTV. I remember those downloads cost me $0.25 per gigabyte — ouch! In 2010 Netflix spent about $0.015 per gigabyte with an average 1.8-gigabyte movie download costing 2.7 cents to stream. Compare this to the average $1.00 Netflix spends to ship and receive every DVD and you can see their current business transformation from DVDs to streaming will lead to dramatically lower costs, freeing-up capital to buy more content.  It’s a virtuous cycle that Netflix (and all it’s competitors to be sure) will attempt to leverage into its own form of too big to fail.

None of this is big news, I suppose, but think for a moment about the implications it has for both future services and for the commercial value of the Internet. Streaming costs are going down, not up, so what’s cheap today will be cheaper still tomorrow. These lower costs will allow higher quality (1080p video, for example) and they’ll shortly reach the point where stream costs will be lower than over-the-air broadcast costs on a per-viewer basis, which in the longer run is an inevitable prescription for the death of broadcast TV. It’s not a matter of if but when this will happen.

Even Luddites will be sucked into the Internet age if they want to communicate.

Despite having spent billions to help along the recent digital TV conversion, I’m sure the Federal Communications Commission will be happy to see broadcast TV disappear since it will do so with a flurry of spectrum auctions bringing-in many more billions to the Treasury. And that freed-up spectrum will go into more data services as we move toward the all-IP all the time future for carriers I have long predicted.

As for Netflix, it is hard to bet against the company. Hollywood studios glower and hint that Netflix will be deprived of content as current content deals — specifically Starz — expire, but that won’t happen. Dropping DVDs completely would transfer $2 billion straight to Netflix’s content acquisition budget through a combination of an increased subscriber base at lower prices and no more postal fees.

That $2 billion will buy a heck of a lot of crow in Hollywood, where cash is king.

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These boys need bikes!

New York Magazine wrote recently that YouTube was planning to throw large sums of money at celebrities who would then make short form (three minute) videos for the site. The numbers mentioned were staggering (up to $5 million per celebrity channel) but the business model is crazy. It’s the three minute thing that makes no sense. I’m sure if YouTube is planning something like this it is specifically for videos that are not three minutes long.
Youtube already owns the Internet market for three minute videos. While there are probably instances where YouTube might throw some significant money into getting the odd celebrity to do something in this space, it is traditional TV-length videos and movies where Youtube actually needs help.
Looking at total video views, Youtube is the clear winner, but when it comes to longer-form videos, both Netflix and Hulu have more viewers than does Youtube. And Youtube can’t really afford to lose this battle, hence the emerging strategy.
Now let me tell you exactly where this is going, because if you are a couch potato it is important.
The big risk (or big opportunity depending how you look at it) has always been that Apple would spend $1 billion optioning TV pilots and by doing so effectively grab control of television. I’ve written about that right here. But somehow Steve Jobs was too cheap or didn’t have the confidence to know which pilots to choose (I suggested buying online rights to ALL of them, solving that problem). Only now it’s YouTube, not Apple, and it’s Netflix and maybe Hulu because once one does it they’ll all have to do it — even including Apple.
And the one to dominate in this land grab will be the one that spends the most money, with the key being to grab control of longer formats. YouTube already controls the three-minute video. It’s Netflix- and Hulu-length videos they’ll want next.
New York Magazine says Youtube is putting $100 million into such productions, but I can’t believe it will be that little, especially if other players choose to compete. We’ll easily hit that $1 billion number.

If that happens, the TV industry in the United States will be thrown on its head, because producers will be selling online rights first, denying those to the traditional networks. That opens the possibility that TV series may succeed online while never even making it to TV. Or they could succeed online and only later make it to TV.
In one sense it is the beginning of the end for traditional broadcast and cable TV, though visionaries might see it more as the end of the beginning. That’s how I see it.
The result will be an even more fragmented video market that will see lots more hits of all sizes from little vertical shows aimed at specialty audiences right through to Glee-sized hits that will work well because they have global reach over the Internet and can aggregate huge audiences without having to be a hit everywhere.
Some see emerging ISP bandwidth caps working against this but I don’t. AT&T is the first to impose such a cap in the USA for hard-wired customers but I am sure we’ll see exceptions for AT&T-provided content. Just as Comcast has bought NBC-Universal, AT&T will get in the content distribution business, too, if only to better compete.
Netflix is already rumored to be commissioning a TV series from Kevin Spacey. I’m sure we’ll see a lot of this happening and I think it is all good. After all, more video outlets probably means more Cringely, and all three of my kids need new bikes.

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What an irony if the “relatively simple and straightforward” treatment for Steve Jobs’ hormone imbalance revealed this week is for the lifelong vegetarian to eat meat. I have no way of knowing that’s his treatment, of course – the idea just sprang into my head.

But given the press and stock market reaction to details of Jobs’ health problems, I’d say he’ll make a cameo appearance at Macworld a few hours from now even if he has to send his good twin to do so.

I further predict that Apple will make a substantial product announcement or two. This won’t be the minimalist Macworld that people had feared. If Jobs won’t be doing the heavy lifting this time he’ll at least leave Phil Schiller with a product or two to announce.

And speaking of products to announce, readers have been wondering whatever happened to the disk drive I was working on with stainless foil media? It’s still coming along nicely, thanks, but startups without money tend to take longer to succeed OR fail than startups with money.

The recording media is more or less perfected, which was harder to achieve than any of us expected, and we should see prototype drives within the next couple months. They’ll be comparable in capacity to similar size conventional drives but less expensive to make, more shock-resistant, and require vastly less energy to run.

For an example of how much energy savings is possible with Metal Foil Drives, consider the duty cycle of a traditional glass platter drive inside a media player like an iPod. The way such media players work is they read data from the hard drive into buffer memory then play from that buffer. First the drive spins-up, which takes about five seconds. Then the data is read from the drive, which takes about a tenth of a second. Finally the drive is turned-off until the buffer memory is depleted and the cycle starts all over again. Each cycle, then, involves powering the drive for 5.1 seconds.

The Metal Foil Drive (MFD), however, has a LOT less mass to spin up than the heavy glass platter it replaces. Hard drives moved a few years ago from primarily aluminum to glass platters because glass can be polished smoother allowing lower flying height for the read-write heads and resulting higher arreal densities. But glass platters are also more expensive than aluminum and heavier. They are a LOT more expensive and heavier than metal foil. As a result, an MFD of comparable capacity spins-up in a tenth of a second and reads the data in another tenth of a second. Not only is 0.2 seconds a lot less time (and energy) than 5.1 seconds, but the lower mass of the MFD platter allows the use of a smaller, cheaper, and lower-power motor to do the work – yet another win.

But why even bother with hard drives with flash memory prices dropping so quickly? Because the more storage capacity we have available the more stuff we’ll want to store. I see MFD’s carrying HD movies around for years to come.  Maybe your Nano doesn’t need one, but video will keep us buying drive-based media players, too.

There will always be people who don’t want to carry all their movies around with them, of course, and to keep those folks happy Netflix seems determined to stream its B movies to as many consumer electronic devices as possible. This week we hear about Netflix streaming direct to certain LG HDTVs, which is cool. But a financial analysis of the product as it will be initially offered is cool only for LG – certainly not for LG customers.

The Netflix-capable LG TV’s, we’re told, will cost about $300 more than LG sets that can’t do such streaming. The difference between the two TV families is that the streamers have a System-On-Chip to run a minimal operating system and handle H.264 decoding, an Ethernet adapter chip to connect to your home network, and some buffer memory. That’s three extra chips costing at most $20 extra plus a little software, giving LG a gross profit margin of around 1500 percent for this particular improvement!

If consumers will actually pay $300 more for a TV with Netflix streaming built-in then I predict that EVERY HDTV manufacturer will install Netflix on every set by the end of this year. They won’t even care if people actually watch Netflix content as long as they just buy the more expensive sets.

The jury is still out, I’d say, on whether people will actually pay this price difference when, for $99, they can simply plug in a cheap media streaming box like the one from Roku and achieve the same result.  Still it’s worth a shot, the folks at LG must be thinking.

It’s what Steve Jobs would do.