Still Buffering…

Amazon's foray into online video streaming

After spending several years and almost a billion dollars developing a video on demand (VOD) service, Amazon, the unquestioned leader of e-commerce, is scrambling to hide the black sheep of its otherwise successful business. Tom Szkutak, Amazon’s CFO, remains vague in reporting detailed results stating, “I can’t give you specifics for attach rates, but Prime Video is making good progress on the video content side.”

The current Amazon Prime package includes free two-day shipping and Kindle e-book rentals for $79/year, with the VOD service included on the house. VOD services allow users to watch video content whenever they want, instead of according to an airing schedule. Unfortunately, Amazon only views Prime as a marketing tool, missing the enormous opportunity to offer Prime Video as a standalone service. As a result, Prime Video is experiencing low customer adoption, and is proving to be a failure. With adequate content (roughly 40,000 titles compared to Netflix’s 60,000), Amazon is wasting its tremendous potential to develop and cultivate a new type of user. Amazon’s stakeholders are now eagerly watching to see whether Prime Video is able to deliver an offering that can rival Netflix and support Amazon’s opportunity to offer the world’s strongest media content ecosystem.

The Chess Board

The most successful player in the online streaming industry thus far has been Netflix. Sandvine Inc. reports that 33% of primetime Internet traffic is directly attributable to Netflix. In the past, Netflix used its first mover advantage and strong content base to capture a large share of the market. Interestingly enough, Netflix has now shifted its offering to include exclusive and original content. House of Cards was released as an entire TV series in February 2013, signaling the beginning of a strategic plan for Netflix to use unique content to garner increasing demand. Netflix has now become synonymous with VOD, capturing the consumer mindshare and funneling new users to their service.2

Although Amazon is outmatched on a content basis, their massive server infrastructure and deep pockets allow the company to still compete effectively. Amazon’s focus has been centered on becoming the world’s largest online retailer, using superior operational logistics, convenient user experience, and customer management systems to offer the lowest prices. Pursuing the “lowest price around” strategy has more than doubled their sales over the last three years to $48B and has built over $8B in cash on hand. Their user base consists of 100 million customers and their servers host roughly one-third of all internet content. With extraordinary reach and financial capabilities, Amazon is well-equipped to develop Prime Video’s content base and thrive in the VOD industry.

Consumer spending on online video services has increased by over 400% in just one year showing a shift to digitized media

Consumer spending on online video services has increased by over 400% in just one year showing a shift to digitized media

VOD subscribers grew across the board for Amazon, Hulu, and Netflix by an average of 193% from 2011 to 2012, signaling that growth in the industry does not necessarily come at the expense of competitors. Subscribers demand a convenient and easy experience featuring the best quantity and quality of content at competitive prices. However, the complexity and closed-door nature of content acquisition and distribution, makes offering the best content a difficult task.

These issues are compounded in global markets. Complex regulations and a vastly different licensing and content acquisition process make it difficult for foreign corporations to operate successfully in the VOD space. The most feasible option has been through corporate acquisition, as Amazon showed with their 2011 purchase of LoveFilm (a European Netflix equivalent). Despite the international growth in streaming, US streaming services have justifiably focused most of their attention on the enormous potential in the local market.

Possible Maneuvers

Amazon has several strategic avenues they could pursue. First, the tough competition and poor performance of this business segment make a divestiture possible. However, the low valuation and significant potential of the industry makes staying the course in search of long-term value creation worthwhile. Second, organic expansion abroad may be tempting as emerging markets show rapid absorption. Unfortunately, international expansion fails to tap into the lucrative local market, and has a high risk factor due to the different and more complex business environment. Netflix’s premature Canadian expansion illustrates how suffocating regulations can hinder its content libraries, which results in dissatisfied customers and a damaged reputation. Third, the financial resources and relative size of Amazon make acquiring Netflix an attractive proposition. Unfortunately, as long as Reed Hastings, Netflix’s passionate founder and CEO, is in the picture, it will be next to impossible to complete a deal. Lastly, incorporating advertisements into their streaming business could be a promising way to generate revenues in lieu of subscription fees. Amazon, however, must be wary of jeopardizing the user experience through irritating ads. The adverse effects to user convenience could hinder Amazon’s ability to attract and retain customers during a time when growth is critical.

The Road to Success

Unleashing Amazon’s True Potential

Unbundling the video streaming service from Prime and offering it for free will allow Amazon to generate large user adoption and mindshare quickly. With a limitless free period, instead of the one month free trial offered by Netflix, convenience is also created for those who wish to try the service. Amazon’s current members already have their personal information in Amazon’s system and will not have to deal with the headache of signing up for, and cancelling, their service. For non-Amazon members, not having to deal with online payments makes trying the service very easy as well.

Amazon can generate immediate value from Prime Video by cross-selling Amazon products and developing consumer insights. By referring customers to merchandise that is related to content being viewed, Amazon can induce greater spending in their user base. Imagine watching the newest episode of How I Met Your Mother and being presented with a direct link to purchase a copy of The Bro Code on Amazon’s website. Amazon can enhance the convenience of the sale through their 1Click technology, user-generated ratings system, and consumer information forums to enhance the cross-selling initiative. This new value will compensate the lost revenues from Prime subscriptions, as an estimated 90% of Prime users would retain membership for its original features like free shipping. As usage for the standalone video service increases, Amazon will extract consumer behavior insights that will aid in further cross-selling initiatives. The valuable data generated from observing user’s viewing habits can be fed into Amazon’s recommendation algorithms, increasing the accuracy and usefulness of their consumer marketing.

Amazon must focus on three phases: unbundling their current video service, generating content, and eventually monetization through tiered services

Amazon must focus on three phases: unbundling their current video service, generating content, and eventually monetization through tiered services

Building the Next Big Thing

Over the next few years, Amazon will need to invest heavily in acquiring new content. In February 2013, Amazon struck a deal to bring FX Networks’ Justified and The Shield exclusively to their streaming service. Still, Amazon would be better served to focus on acquiring exclusive and original content as this is what consumers are growing to demand from VOD providers. This stockpiling of content should culminate in the eventual launch of a premium library offered at a relatively low price (say $4.99/month compared to Netflix’s $7.99/month). This final step will allow Amazon to appeal to customers from both a pricing and content perspective. Considering the importance of content to consumers and Amazon’s vast financial resources, investing in original content is the best path to sustainable success. In planning, Amazon should use the free service to generate consumer feedback to build the premium library. Offering consumer demanded original content will lead to long-term profitability and the creation of a new revenue stream that is directly attributable to the video streaming business.

Turning Free Into Real Returns

The cost of content acquisition is skyrocketing in the VOD arena; Netflix just recently signed a deal with Disney estimated at $300M. Cross-selling and a premium video service cannot justify this massive investment alone. Where Amazon can truly unlock the value of the video service is in the mobile content space, with the Kindle Fire.

In the long term, Kindle Fire users should be given free access to the Prime Video premium library. These devices are already sold at a loss to drive widespread adoption, and bundling VOD services alongside hardware will present consumers with an appealing purchase opportunity. This will accelerate further adoption and create a value proposition combining hardware and free content, something that is unmatched by Apple, Samsung, and Google.5

Establishing a large user base will allow Amazon to expand on its strategy of creating a broader content ecosystem. With the introduction of Amazon MP3 in 2007, and a shifting focus to e-books over traditional written mediums, Amazon is moving from physical content to digital content. The Kindle Fire’s release brought this effort to tablets where Amazon is battling the likes of Apple and Google for mobile content ecosystem dominance. With the introduction of VOD services into the power struggle, Amazon will have a differentiated offering capable of securing a large portion of end users. Amazon’s massive investment will be done in the pursuit of converting users into life long customers. The resulting increased exposure and market share that is brought about by expanding their digital offering positions Amazon to create a profitable hardware and software ecosystem in the future.

Amazon’s Fate

Amazon’s corporate strategy has been built on the idea of “spend now, earn later.” This mentality helped Amazon scale its retail business in the late 1990s and early 2000s. It’s time for the same aggressive approach to be used in building Prime Video as a core component of the Amazon ecosystem. Combining Amazon’s digital ecosystem with its e-commerce business will lead the most comprehensive and diverse service ecosystem in the world