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Amazon makes money in other ways. They are well diversified. They can afford to sell certain products at or below cost in order to dominate a market.
Amazon offers free streaming video to their Prime subscribers. The Amazon Prime service also offers free two-day shipping on millions of items and access to 350,000 e-books — all for the low price of $79/year. That’s less than $7 a month. It is unclear whether Amazon Prime subscriptions are sold below cost. Given that an Amazon Prime subscription offers much more than streaming video, they are competing with Netflix and offering services that can’t be matched.
The other problem for Netflix is that they aren’t vertically integrated. The move to produce their own content is a step in this direction. Netflix, however, does not run their own data center. Netflix streaming services are hosted by Amazon. This reminds me of the tactic Leyland Stanford used to acquire land from farmers. He owned the railroads and priced crop transportation at a level that bankrupted farmers. Then he purchased their land for much less than it was worth.
In today’s modern, regulated economy, it’s much more difficult to be a robber baron. Still, the fact that Netflix depends on Amazon for their most essential services puts them in an awkward position. It’s not illegal to raise prices for such services. Eventually, Amazon could put a strangle-hold on Netflix, making it difficult for the streaming video provider to increase profitability.
I wouldn’t write Netflix’s obituary just yet. Netflix has some amazing original content, and developing these products can differentiate them from their competitors. Amazon is also developing their own original content, but so far without as much success as Netflix.
Data center operations are a major concern for Netflix. The company needs to improve on vertical integration. As it stands, one of their biggest competitors is in a position where they could damage Netflix. With Netflix gradually phasing out DVD-by-mail rentals and moving to streaming exclusively, hosting their own data center only makes sense. Economies of scale have made Amazon hosting more cost-effective than running their own data center. As data center demands increase, it may be a logical step for Netflix to host their own content. After all, 4K video is going to take up a lot of bandwidth!
There’s another way to look at this. Perhaps there is a symbiosis. Amazon makes money by hosting Netflix. Wiping them out could impact their profitability. No one is sure how this will play out, however, Amazon has a history of dominating markets by selling products at or below cost. The market still loves Netflix, however, the new pricing tiers indicate that Netflix is revising its strategy for an increasingly competitive streaming video market.