Amazon's Prime Streaming Will Disrupt Netflix, Here's How

Dan Rayburn submits:

Over the past 24 hours, I've read a lot of blog posts about Amazon's ( AMZN ) new Instant Video streaming offering available to Amazon Prime subscribers, yet there are a bunch of really important aspects about the service no one seems to be discussing. When detailed it is clear that over time, Amazon will absolutely compete with Netflix ( NFLX ) for the delivery of movies and TV shows and become a dominant force in the market.

For starters, I don't see anyone talking numbers when it comes to Amazon Prime subscribers or the potential revenue Amazon generates from it. While Amazon has not publicly said how many Prime members they have, analysts on Wall Street all seem to agree that there are about 10M Prime members. Of those, it is estimated that 60% are paying members. If that's true, and it sounds rational, Amazon brings in $474M a year in revenue from Prime subscriptions.

If Amazon could add 5M paying Prime members this year, they would generate nearly a billion dollars in revenue from about 10M Prime members. That's a lot of money they can then use to license content and Amazon would very quickly be at half of Netflix's subscriber count. While some of the money from Prime would have to go to offset the cost of shipping physical goods, numbers I have heard suggest that Amazon's Prime members buy more than 4x more goods than non Prime members. As a long time Prime member myself, I can say that definitely rings true since I always check Amazon first knowing I get free shipping.

While there seems to be a lot of talk around Amazon Prime being cheaper than Netflix's streaming only option, that's really not a big deal. The bigger point is that anyone who signs up for Amazon Prime immediately sees it as a way for them to save money. To date, that's the only reason why someone would become a member. Spending $79 means you will end up saving more than that in shipping each year. Very simply, Prime has always been all about a way to save money.

Of course, for a small percentage of Netflix customers that is the same reasoning since some members use Netflix streaming in place of other more expensive video services. But with Prime members, that's the case for all of them. It's a very easy sell. Add in the fact that you now get free streaming of movies and TV shows and Prime has a lot more value than Netflix. When compared to Netflix, the selection of content in Amazon's Instant Video streaming service is about 25% of what Netflix has today. The quality of video with Amazon's service is not as good and Amazon's Instant Video offering is not yet on a lot of devices. But the fact is, these were all of the same shortcomings Netflix had in the market when they first started their streaming offering.

Amazon can and will get on devices very quickly and one has to remember that Amazon is not starting from scratch. They have had their Amazon Video On Demand application on devices like the Roku and TiVo for years and Amazon does not lack the technical expertise or resources to get Prime streaming to more platforms. It won't happen overnight, but it won't take years like it took Netflix when the broadband-enabled device market was still just starting out. And with the success Netflix has had in the industry, there are plenty of device manufacturers and platform providers who are going to be very eager to work with Amazon to add more content choices to their devices.

When it comes to the argument that Amazon's video quality is not as good as Netflix, that's a valid one, but one that will be short lived. I don't know if anyone has noticed yet but Amazon is not using their own CloudFront CDN to deliver the Prime videos. So far, of all the videos I have traced they are all coming back to Limelight Networks. I know Limelight was doing a large majority of the delivery for Amazon Video On Demand, and it's clear they are also delivering videos for Prime. This is relevant because Limelight is one of the same CDNs that Netflix uses. So when it comes to the quality of videos being delivered, the difference between Amazon and Netflix simply boils down to the encoding specs.

While I have seen some folks like CNET say that Amazon's streaming is " comparable to Netflix HD ," that's factually not accurate. There is something to be said for one's own interpretation of what defines quality, but Amazon has given out the specs on their encoding for Prime streaming and it maxes out at 1.3Mbps, far lower than what Netflix encodes for. Amazon does offer higher quality streaming at 720p, but not for free videos via Prime as of yet.

As most folks already know, Netflix uses Amazon's Web Services for a substantial portion of their web-hosting and video transcoding infrastructure. In a recent filing, Netflix warned that any disruption of Amazon's service would have an impact on the company. In the filing Netflix said, " While the retail side of Amazon may compete with us, we do not believe that Amazon will use the AWS operation in such a manner as to gain competitive advantage against our service ."

That's an interesting statement from Netflix and while they are talking about a technical advantage, Amazon already has a competitive advantage over Netflix when it comes to cost since Amazon owns the infrastructure that Netflix is leasing from them. And at some point, Amazon will most definitely use CloudFront to deliver their videos and move away from using third party CDNs. That's another cost advantage Amazon will have over Netflix, which is estimated to spend more than $50M this year just in video delivery across third party CDNs.

Amazon has a big advantage over Netflix of being able to allow their core business to drive the growth of their streaming service without having to worry about how many members they sign up each quarter, which is exactly what Netflix is so dependant on. The company has the ability to essentially subsidize the streaming service for quite some time, allowing Amazon to spend money on licensing more content and quickly expanding their inventory. Anyone who thinks Amazon won't spend the kind of money Netflix does to license more content is seriously underestimating the company.

Another big advantage Amazon has over Netflix that no one seems to be discussing is the fact that Amazon also sells and rents digital copies of movies and TV shows. Adding a subscription service now gives Amazon three different ways to get in front of the consumer and multiple ways to generate revenue. More importantly, the multiple distribution models are something the content studios love and want to see more of.

Studios I speak to say all the time that they wish Netflix would also offer a pay-to-own download service for newer content, as the studios want to leverage the audience base Netflix has built. For Amazon, they have already got this business model in place and one would expect that their free streaming of content will absolutely drive the sale of more digital content for the studios, especially considering how easy Amazon's 1-Click option makes it to purchase content.

And just imagine the disruption Amazon would create in the market if they released a Kindle capable of playing video or subsidized the cost of getting Prime members a broadband-enabled device? The thing about Amazon that I think most people miss is that they own the entire ecosystem of distribution for video, something Netflix can't do. Amazon still has a long way to go before their Instant Video streaming offering is considered on par with Netflix, but anyone who thinks it is going to take Amazon years to compete with Netflix is truly underestimating the company.

Disclosure: No position

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