Competing With Free

“We cannot compete with free.”  That is one of the justifications the movie and music industry uses to lobby for the controversial PROTECT IP Act (S. 968) and the Stopping Online Piracy Act (HR 3261).  In a recent hearing before the House Judiciary Committee, the Motion Picture Association of America’s Michael O’Leary argued:

“legitimate companies that want to invest in and develop new and innovative business models centered around high-quality online content and greater consumer choice have a limited potential for growth when they are forced to compete with entities that are distributing the exact same content through illicit means. “

Unfortunately for the MPAA, this is simply incorrect.  Companies like Netflix, Hulu, and Spotify have shown that it is completely possible to “compete with free,” either through an advertising-based business model, a fee-based model or a hybrid model. These companies demonstrate that millions of consumers will pay for content that is otherwise available illegally (and easily) for free.

Though it has been around since the late 1990s, Netflix began to offer unlimited streaming in the mid-2000s, and currently offers a streaming-only plan for $7.99, as well as DVD plus streaming options. Although the company has had some public relations hiccups recently, it is still incredibly profitable: in the quarter ending on September 30th, it made $62.46 million dollars profit, from a total revenue of $821.84 million. In 2010, Netflix took in over $2 billion and made $160 million in profit (guess which industry made out with the rest of that money?). Going forward, Neflix predicts that it will make between $19 and $37 million in the fourth quarter of 2011.  Today, it announced that it may lose money next year, but that can be attributed to a plan to expand into the United Kingdom and Ireland. The company also faces increased future competition from services like Amazon Prime and Blockbuster (who are also chomping at the bit to compete with free) but clearly, contrary to what Mr. O’Leary believes, consumers will pay reasonable prices for content they can get for free, particularly when it is provided reliably and in high quality. 

While Netflix is the leader in the fee-based online video content distribution landscape, other firms have been successful by selling premium features to compliment ad-supported offerings. In this model, all users hear and see advertisements, but those who choose to do so can pay a premium for additional features and content. Like Netflix, Hulu and Spotify have had success offering content that Internet users could access “through illicit means,” and their success confirms that, with an “innovative business model,” it is possible to find paying customers online.Hulu, owned by NBCUniversal, Fox, Disney, and Providence Equity Partners, offers viewers access to hundreds of different television shows from a wide variety of networks, a vast selection of movies, and original content. Content is made available after it airs, on a schedule determined by the studios responsible for its production. All viewers see advertisements, but those that subscribe to the $7.99 per month Hulu Plus service can view content earlier than free users, and have exclusive access to Hulu’s content on mobile platforms. This service has proven itself to be popular: the company recently announced that Hulu Plus has crossed the one million-subscriber mark. The growth to one million has been both rapid and consistent, and, if maintained, the current Hulu Plus subscribership will net the company $95.88 million over the next 12 months. Hulu has also been successful in bringing in advertising revenue, earning $263 million in 2010, up 143% from $108 million in 2009. Company CEO Jason Kilar predicts that Hulu will pull in more that $500 million this year, which would be a 90% increase over last year.

Online content delivery services other than video providers have shown clear paths to profitability as well. Spotify, a popular Swedish ad and subscription-supported online streaming service, has just entered the American market. In June, just before its American launch, the company raised $100 million from three venture capital firms, which valued it at $1 billion. In Europe, it has 1 million paid and 6 million free subscribers, numbers certain to increase. Spotify has yet to turn a profit, but its revenues reveal that the moment it does is not far off: its revenues grew 458% between 2009 and 2010, and losses as a percentage of revenue fell from 147% to 42%. The company pulled in $99 million in total revenues in 2010, and will almost certainly make more this year. Like Netflix and Hulu, Spotify’s rapid growth clearly shows that consumers will, when given, the option, pay for legal content. 

While these are only three of the content distribution companies operating online (I haven’t even mentioned iTunes, which controls over 30% of the U.S. music market, or three times more than Wal-Mart), their success clearly invalidates the claim made by SOPA’s advocates that it is impossible to compete with piracy. Clearly, consumers will pay for, or watch ads to support, their favorite music, TV shows, and movies. Mr. O’Leary and the MPAA would like Congress to believe that Internet piracy has totally eliminated their ability to make a profit online, and that the disastrous Stop Online Piracy Act is the only remedy. Internet users will and do pay for the right to watch and listen to what they want, and firms with business models that allow them to provide high-quality streaming content at a reasonable price can become very successful. Congress should reject the MPAA’s claims along with SOPA and PROTECT IP. 

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