Why a streaming movie service from Verizon & Redbox is bad news for Netflix

A Verizon streaming service has the potential to ruin Netflix’s domestic and international business aspirations — and quite possibly destroy the entire company.

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On its own, Verizon doesn’t seem like a threat to other streaming video services. But now the cable company’s rumored streaming strategy includes a partnership with video-rental kiosk company Redbox, and the possible acquisition of an existing streaming video service.

When rumors of Verizon starting its own streaming movie service surfaced earlier this week, I dismissed the idea that it could compete with market leader Netflix in any meaningful capacity. I reasoned that Verizon’s motivation for creating this type of service is financial opportunity, while Netflix is focused on creating a better product. And even if Verizon’s streaming product turned out to be superior, consumers are comfortable with Netflix and many would likely stay with the leading service.

I’ve changed my mind. By combining forces with Redbox, Verizon could conceivably crush Netflix. The partnership will create a credit-based video service with options to rent physical (DVD, Blu-ray) or streaming media, according to a TechCrunch report yesterday. A beta version of the service is said to launch in April 2012, followed by a full launch in late May.

Arguably, neither Verizon nor Redbox has much experience operating a streaming service, which is why Verizon is interested in purchasing a pre-existing streaming media service. At the UBS Global Media and Communications Conference in New York Wednesday, Verizon chairman Lowell McAdam told attendees that the company strongly considered buying popular streaming service Hulu earlier this year. McAdam also said Verizon could still acquire a streaming service in the future, which would presumably lay the groundwork for the Verizon and Redbox streaming service.

Why should these recent developments scare the bejesus out of Netflix? Essentially, it comes down to these three main points.

Access to Money

Netflix has a cash problem. Last month, Standard & Poor’s lowered Netflix’s credit rating from BB to BB- due to higher than expected costs from its international expansion, combined with expensive content agreements with media companies. To pay for those content deals, Netflix sold nearly 2.9 million shares at a discount and issued debt that can be converted into stock, which should raise about $400 million. Additionally, the company revealed it will lose money next year for the first time in a decade. If you combine that with customer backlash from increased subscription fees and a failed attempt to spin-off its DVD-by-mail rental service, its easy to see why the company’s stock is plunging.

Unfortunately, Netflix doesn’t really have much of a choice at this point. Expensive streaming content deals are essential for Netflix to retain current subscribers and draw in new customers. The problem with this strategy is that more streaming video services are entering the market to meet consumer demand, meaning Netflix competitors will eventually have a near-identical library of content. Additionally, Netflix’s exclusive content agreements, such as its deal with Epix, are set to expire over the next two years. With more competition from other streaming services and a smaller pile of cash, it’s unlikely that Netflix will be able to renegotiate those exclusive contracts. At a certain point, Netflix is going to run out of cash.

Verizon, on the other hand, does not have a money problem. The company has several lucrative businesses, including its wireless carrier and FiOS cable TV & broadband Internet service. That means that, unlike Netflix, Verizon has plenty of money to spend on content agreements. The company can simply buy its way into the streaming video rental business through content deals and acquisitions, then sustain itself long enough for Netflix to lose the lead.

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Relationships with Media Companies

As I previously mentioned, part of Verizon’s motivation for jumping into the streaming media service market is the potential for financial gain. The company already has several content deals with major television networks, and renegotiating those deals to gain streaming licensing would be easier and (possibly) less costly. If you combine those relationships with Redbox’s major movie studio relationships, you have enough reach to rival Netflix.

This means the Verizon and Redbox video service will be in a position to negotiate content deals that give it an edge over Netflix. The edge could take the form of exclusive streaming rights, or faster availability of new DVD and Blu-ray releases. The point is, the combined might of Redbox and Verizon is able to compete more directly with Netflix on both streaming and physical media rentals.

Evolve or Die

It’s pretty easy to understand why Redbox wants to expand into the streaming-video side of the business. The company’s rental kiosks are losing revenue because a growing number of people prefer to watch video on the Internet via a computer, set-top box, smart TV, tablet or smartphone. To remain competitive, Redbox must evolve into a physical and streaming rental service. If news of Redbox’s partnership with Verizon is true, then that necessary evolution will be much easier.

Verizon is also struggling to evolve. Companies like Comcast and AT&T are expanding their presence in the wireless network market, which is currently dominated by Verizon. This rumored Verizon streaming service would allow the company to grow its presence as a content provider. It’s also worth noting that both Comcast and AT&T have streaming media options that will probably grow more prominent in the future. With Netflix showing its weaknesses, now is the perfect time to launch a streaming video service.

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A partnership between Verizon and Redbox would be mutually beneficial and help both companies evolve for the purpose of staying competitive.

Conclusion

The short-term consequences of Netflix’s missteps over the last few months were customers getting angry and critics calling the executive management team incompetent. Reasonably, the long-term implications could be a new Verizon video rental competitor.

Even if Verizon decides against launching a Netflix competitor, eventually another giant company with deep pockets will.