Netflix Fights the Power

It was only five years ago that Netflix moved away from its DVD delivery service as the core of its business and started streaming video. Today it is producing high quality original content and distributing it in an interesting way.

With “Orange is the New Black,” “House of Cards,” and other programming, it releases the entire series at once, so the user is in charge. You can watch one episode per month, if you want, or binge watch the entire season in one day. This is a fundamental challenge to the way we’ve consumed series content before.

Netflix’s decision to produce and release original content came in response to metrics showing that growth of the subscription service had plateaued based on existing content. New material, well marketed, could bring in a flurry of new members. It was a good bet, and worked out well for the company.

But note something extremely interesting about this approach. The same company controls the making of the content and the venue in which it is shown. It’s a kind of vertical integration, as if Pixar owned theaters that mainly showed films by Pixar. It makes sense. The company that makes the content has the strongest investment in the end-user experience. What’s not to like? Netflix here is only following up on a model experimented with some 15 years ago by HBO but with the difference that it was leaving the television model completely.

Incredibly, this is not a new model but the revival of a system that the government had previously destroyed. Indeed, it was the original Hollywood model from the 1930s. Even today many towns have Fox Theaters in the downtown area — beautiful museum pieces of a time gone by. They were owned by 20th Century Fox, but MGM and RKO also owned theaters. The competition was not only about what movies we watched but also about the physical locations, owned mostly by the production companies, that made them.

By 1945, the large studios owned or partially owned only 17% of the theaters but these theaters themselves accounted for 45% of the revenue generated by the industry. This is not exactly “dominance” of the theater industry but there is no question that the studios were the big kids on the block.

This was the “golden age” of Hollywood. It seemed to work. It also made the movies less dependent on enforcing copyright on its movies because it could fully control access to the physical reels themselves. It also gave birth to some of the most spectacular theaters ever imagined – monuments to the beautiful way in which American culture reinvented the old-world European opera house but for a completely different form of art.

In a 21st century way, Netflix has revived this vertically integrated model, except that the theater in which it is shown is your own home via the Internet. Their ownership stake over the content is controlled by the subscription service itself. This is why many observers are predicting a new “golden age” based on the results so far. It has been spectacular to see this whole system in thrive in a high-tech age.

How did this old Hollywood system come to an end? The Roosevelt administration envied Hollywood’s independence and access to the minds and hearts of the American people. It had to be controlled. The administration had ordered harassment all through the 1930s. But once it was clear that Hollywood would weather the Great Depression and be more wonderful than ever, FDR brought out his big guns.

In 1938 when the U.S. Justice Department began investigating the studios for violating antitrust laws. How were they in violation? Well, according to the law, you can’t vertically integrate in a way that diminished competition in the industry, because, according to the old view, only Washington and its elite intellectuals and jurists knew how to configure an industry to be truly competitive.

If you have ever wondered how it is that Hollywood came to be so enlisted in World War II, seemingly happy to lend its time and property to making egregiously embarrassing war propaganda films from 1939 to 1945 — very strange stuff considering the sophistication of its product all through the 1930s — consider that the entire industry had a gun to its head in the form of this antitrust trust that threatened to destroy everything.

As the head of the Office of War Information observed “The motion picture industry could be the most powerful instrument of propaganda in the world, whether it tries to be or not.”

The harassment continued until after the war with the landmark case U.S. vs. Paramount Pictures (1948). The court said that studios couldn’t both make movies and own the venue in which they were shown. This was anticompetitive.

Never mind that consumers were completely happy, that the industry was profitable, that no one and nothing was being harmed. The government was pursuing a vendetta, and weighing in on behalf of the kvetching upstart theaters who wanted access — completely unjustly — to the great movies to show in their theaters. It would be like Yahoo suing Netflix for the right to show “House of Cards.”

The Supreme Court said that prevailing form of vertical integration by the studios had to stop. Studios were expropriated by being forced to sell their property and/or breaking up into units. This decision smashed a great industry and brought the Golden Age to an end. The film industry of the 1950s and 1960s reveals what happened. The incredible outpouring of the two previous decades slowed to a crawl and the quality declined dramatically. It took decades for the effects to shake themselves out.

But now let’s fast forward to March 2011 when Netflix decided to make its own content and show it exclusively on a venue that had previously been used mainly to show movies licensed to them by others. This was taking a model already innovated by HBO and Showtime but going a step further by leaving the system of cable distribution and using the Internet as its home theater. This amounts to a reinvention of the old studio model but in a completely different form.

So far as I know, absolutely no one has drawn attention to how Netflix is effectively shredding the spirit of the ridiculous Supreme Court decision of 1948. If anyone did suggest that, the result would surely be laughter and dismissal.

Obviously there is nothing anticompetitive about what Netflix is doing — just as there was nothing anticompetitive about what the old studios were doing in the 1930s. The difference is that it is more obvious today than it was then, owing to incredible advances in technology. No one could possibly suggest that competition for filmed entertainment is not vigorous and wonderful.

Netflix, completely unknowingly and only through following its internal profitability signals, plus using risky forms of entrepreneurship, is making an end run around hyper-destructive government decrees from the past. It is doing this not by changing the law or the court precedent but rather through marvelously innovative technological means. The regulators, whose driving ethos is necessarily reactionary and anachronistic, can’t keep up.

This is a beautiful example of how increasingly irrelevant the central plans and regulatory statutes of the past truly are in a digital age. It also illustrates how progress is possible despite every attempt by courts, politicians, and regulators to stop it.

The regime-imposed legacies of the past, backed by bad economists and the threat of force by politically controlled bureaucracies, are being swept away, one by one, year after year, in a time when the markets and technologies are changing too fast for the planners to control them.

Netflix is only trying its best to serve consumers, but this also means it is fighting the power, even if not consciously. It’s worth noting, too, that the content itself has a revolutionary bent: “House of Cards” portrays the institutions of government as more corrupt and ghastly than even the worst nightmares of the worst cynic. Bravo!

This is a lovely trend to watch. It’s a model for all lovers of freedom and free markets to follow. Government is the house of cards.