The acquisition of Lovefilm by Amazon has really got me interested in this business of online DVD rentals and video streaming. It’s fair to say that Lovefilm’s key metrics are completely gazumped by Netflix’ numbers, its US competitor: 1.6m European subscribers (Lovefilm) vs.19.7m US subscribers (Netflix).

But even a successful business like Netflix is not without key challenges to its core business model. Its core shift in focus from posting DVDs to customers to online streaming to computers and tablet devices does imply some tough hurdles.

These are the two key challenges I learnt about:

1. The introduction of “usage based costing” – Internet Service Providers (ISPs) are increasingly thinking of charging users on the basis of their actual Internet usage. Confronted with a great increase in traffic due to online video downloads, ISPs are looking to recoup the increase of their cost through content providers such as Netflix and Lovefilm.
2. Content is becoming more expensive – Netflix’ rapid growth could potentially form its own downfall now that content owners (e.g. the big film studios) are demanding a bigger cut of Netflix’ growing profits.

The effects of these challenges are twofold. Firstly, the introduction of “usage based costing” could well limit the growth of online video. Secondly, the growing cost of content could limit Netflix in the number of titles it can afford.

Main learning point: one can see the likes of Netflix and Lovefilm eventually overtaking traditional TV. These companies seem perfectly positioned to do so; access to quality content and ability to reach a large audience across a number of channels. However, more expensive content and paying for Internet usage could throw a significant spanner in the works. It will be interesting to see how the business models of these digital content providers will cope with such challenges in the future.

Related links for further learning:

Financial Times “Netflix on a roll as its switch in focus to streaming catches on with customers”

Financial Times “Netflix challenge to traditional TV”