NFLX Stock Is Surrounded by a Fortress
As competitors grow more desperate to dethrone Netflix, Inc. (NASDAQ:NFLX), some investors are doubtful that NFLX stock can survive the onslaught. However, I’m here to quell those fears. Netflix stock is more than adequately protected from its rivals.
In his book Zero to One, billionaire Peter Thiel says that the best businesses are always seeking a monopoly. Government agencies are obviously trying to preserve the state of competition, but the best-performing companies should grab market share and defend it vigorously, argues Thiel. (Source: Thiel, P., Zero to One: Notes on Startups, or How to Build the Future, published September 16, 2014.)
That’s why he thinks that restaurants are such terrible investments. The number of diners, cafes, bars, and steakhouses is beyond count, making it a real-life model of perfect competition. Why would anyone enter a business where there are so many participants?
In business, it’s far better to climb a ladder and pull it up behind you. That’s exactly what Netflix has done to keep its rivals at bay.
Netflix, Rivals, and Content Acquisition
Financial analysts have a different metaphor for Thiel’s principle, called “the moat.”
The moat is a reference to how medieval castles used to fortify their defenses. Historically, they dug a wide ditch around the castle and filled it with water so that an attacking army would be unable to mount ladders or siege towers against the wall.
Similarly, great businesses can build a metaphorical moat to protect their market share. Netflix CEO Reed Hastings knew that sooner or later competitors would start competing for online streaming rights, thus bidding up the price per TV show.
The cost of acquiring content from TV networks was already Netflix’s biggest expense, not to mention that keeping a wide variety of shows is something customers expect. If rival streaming services picked up shows with a dedicated fan base, those customers could migrate away from Netflix.
So Reed Hastings started an original content strategy to give Netflix a moat. By developing shows that can’t be watched anywhere else, Netflix could lock customers into their Netflix subscriptions. Where else can you watch House of Cards or Narcos? (Source: “How Long Can Netflix Keep Climbing?” Fortune, December 7, 2015.)
Netflix borrowed a page from HBO’s playbook by giving content makers the freedom to produce something of quality, rather than curtailing the shows to specific demographics. Making the shows takes huge upfront investments and risk, but the model has proved successful. Netflix stock is up 150% since the start of 2015.
Where Is NFLX Stock Headed in 2016?
A lot of Netflix bears argue that higher costs for content acquisition will kill NFLX stock. The reasoning goes something like this: as Hulu LLC and Amazon.com, Inc. spend more on acquiring content, Netflix won’t be able to afford a satisfactory catalogue of shows. Customers will get irritated and leave, causing the NFLX stock bubble to burst. (Source: Ibid.)
But if the cost of acquisition goes up for Netflix, wouldn’t it also rise for Hulu and Amazon? After all, they are bidding against each other in an auction, so their fate is shared. Higher expenses for one means higher expenses for all.
Obviously, Hulu and Amazon can win some battles, so Reed Hastings added another layer of protection; Netflix’s original content strategy should compensate for the loss of some shows, while also building loyalty to the Netflix brand.
In other words, Netflix has achieved exactly what Peter Thiel was talking about. It may not have a full monopoly over its business, but the company has clearly figured out a way to keep its market share intact by building a “moat” of original content.