Amazon Challenges Netflix With A New Pricing Model

AMZN: Amazon logo

Amazon‘s (NASDAQ:AMZN) Prime Instant Video primarily competes with market leader Netflix (NASDAQ:NFLX) in the U.S. video streaming market. Over the past year, the company has set up deals with NBC Universal, News Corp’s Fox and ABC in addition to several other players for content. It recently expanded its video collection with a performance-based pricing deal with Epix – a partnership between Hollywood studios Paramount Pictures, Metro-Goldwyn-Mayer, and Lionsgate. After the deal, the service now has a video library of almost 25,000 titles, which is still about half of Netflix’s. The other competitor products include Barnes and Noble’s Nook Video and Hulu’s Hulu Plus. Though the service is parceled for free along with the $79 a year Amazon Prime subscription, the rapid growth in its collection signals the company’s intent to seriously challenge Netflix’s dominance.

Check out our complete analysis of Amazon

The company is shaking up its pricing model for its licensing deal with Epix. The deal has an earn-out provision if the number of subscribers to Amazon Prime Instant Video increases beyond a certain point. This will be in addition to the usual fixed upfront fee. The studios thus get a share of the additional revenues that result from the popularity of their titles. Amazon hopes to leverage the deal to attract other studios, particularly those that may have been deterred by its reputation of driving down the prices. The new model has helped the company lure away Epix from its agreement with Netflix, which cost the latter a fixed amount of $200 million a year. [1]

Netflix has close to 25 million subscribers in the United States while the Amazon Prime Instant Video subscriber base is expected to be around 3-4 million. Based on the subscriber base size, we expect the Epix agreement to have cost Amazon less than the $200 million per year it cost Netflix. Barclays analyst Anthony DiClemente estimates that Amazon spends about $1 billion a year on content for its streaming service while Netflix spends close to $2 billion a year. [2]

We believe the growing popularity of the revamped
Kindle devices will shore up the use of Prime Instant Video which could result in substantial content-related costs for the company. The additional costs coupled with very low Kindle margins would negatively impact the company’s overall margins, which are already bogged down by the costs associated with the expansion of its warehousing capacities.
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We have a $222 estimate for Amazon which is 10% below the current market price.

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  1. Amazon and Epix strike movie deal, Reuters, September 2012 []
  2. Frugal Amazon opens checkbook for streaming videos, Reuters, October 2012 []