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In Australia, Netflix is the new black

Orange Is The New Black is a smash hit Netflix series.

The signs Australia was primed for the arrival of Netflix were clear.

We were the pirate nation, global leaders in illegal downloads. And there was demand for Netflix existing, but in a murkey legal perspective: by some estimates, some 200,000 or more Australians were using VPNs (virtual private networks) in order to circumvent geo-blocking systems and access products like Netflix before its local arrival.

While the company hasn’t released its Australian subscriber numbers, Roy Morgan Research estimated Netflix’s June subscriptions were up by 151,000 homes to 559,000, giving the US giant an estimated 1.42 million viewers just three months after launch.

It’s disrupting both free-to-air and pay TV models and with the growth of video-on-demand, a new prime time viewing spot is emerging between 9pm and midnight. There’s also a trend of viewers switching on streaming services after they’ve watched traditional news programs on free-to-air.

Foxtel sought to protect its pay TV business by cutting prices to compete. The cost of subscriptions were halved ahead of Netflix’s arrival and the on-demand BoxSet channel was introduced to cater for the modern trend of binge-watching shows like Game of Thrones.

The inevitable entrance of Netflix resulted in some unlikely partnerships between media companies. Stan is a deal between Nine and Fairfax, and while Presto is the brainchild of Seven and Foxtel.

Credit Suisse recently said the rise of Netflix, Stan and Presto wouldn’t kill free-to-air or pay TV. The platforms will be, however, competing for viewers.

“Assuming half of all [Australian] subscribers take more than one service, this implies net penetration of 40% of broadband households; 36% of total households,” Credit Suisse analyst Fraser McLeish said.

They’re the kinds of numbers that make investment bank analysts go weak at the knees.

Over the longer term, Credit Suisse forecasts Netflix will have a slightly higher market share with 40%. Stan will be the second largest player with 33% and Presto 27%. Meanwhile, local player Quickflix is fighting for survival (more of that later).

Citi media analyst Justin Diddams expects by 2018, 3 million Australian homes will use some form of video-on-demand service. He estimates Foxtel currently has 2.7 million subscribers.

“It doesn’t mean the death of Foxtel but it means an explosion in content consumption in Australia in the 70 per cent of households that don’t pay anything today,” he wrote in a note.

“For free-to-air broadcasters, increasing penetration of SVOD could place further downward pressure on audiences but this doesn’t mean [free-to-air television] is dying, but likely to limit earnings growth as focus on differentiated content is needed.”

TV viewership is dropping across all age demographics, especially as online video offerings improve. This chart, for the US market, shows a trend similar to what’s happening in Australia.

This chart shows how linear TV viewership – watching whatever’s on the box on normal scheduling – is also falling, as on-demand options grow.

A recent Citi report estimates about 3 million households are consuming an average of 1 hour per day, per person, of on-demand streaming content. It estimates this could see free-to-air consumption drop by 10%. Here’s Citi:

“Interestingly, across 2015 we have seen FTA [free-to-air] TV audiences decline in absolute terms by c.9% yoy, yet the TV advertising market was flat (reporting 0.2% growth in six months to June 2015), implying both a larger impact on FTA viewing relative to the penetration of SVOD but also that advertisers are still investing dollars in TV despite the audience declines. The key question is how much longer can FTA TV broadcasters sustain this level of CPM increases on advertising dollars, as real audiences continue to decline.”

There’s also a creative side to the equation, with shows such as Orange is the New Black, now in its third season, giving Netflix a distinct audience of fans for the cult show in the way Games of Thrones boosted HBO’s power and prestige. It’s revived the value of original material after TV drama had came precariously close to a “valley of death” as stations sought to cut costs and served up low-risk, low-cost reality shows.

“The launch of SVOD platforms has refocused consumers on the quality of content, not just the quantity. We believe the FTA TV broadcasters can adopt and respond to the shifting audience consumption by reinvesting back into quality content that engages audiences,” Citi says.

The shift even has implications for the federal budget.

The federal government currently receives around $160 million in licence fees from TV networks. Communications minister Malcolm Turnbull said recently he doesn’t foresee television licenses disappearing in the next three years, but arguments from TV networks that license fees are high, especially at a time when the internet is eating their lunch, are increasingly valid.

“The digital transformation of the media industry has been profound,” he said.

“License fees were originally imposed – bear in mind they’ve been halved in recent years – but they were originally imposed in effect as a super profits tax because free to air television licenses were a licence to print money because that was the only way you could see audio-visual content.

“Now, what used to be a monopoly or an oligopoly is anything but. Increasingly people are watching audio-visual material movies, TV shows etcetera online and you only have to look at the growth of the streaming platforms, particularly Netflix recently, to see that.”

Seven, Nine and Ten networks pay 4.5% of gross revenues in licence fees. Culling the levy could lift all three broadcasters’ combined earnings by around $170 million, based on reported revenues for FY14.

But it’s not just TV networks which are feeling the Netflix pinch. Local video streaming player Quickflix has been losing 5000 customers a month since Netflix launched in Australia.

CEO Stephen Langsford says the loss of business was because of an unprecedented level of free trial promotions by competitors, including Netflix.

“Pent-up demand for Netflix generated through media and other publicity ahead of its launch resulted in a spate of customers churning in April and May and a challenging quarter overall,” says Langsford.

The rise of Netflix is also putting pressure on bandwidth around the country. Recently iiNet boss David Buckingham said Netflix’s popularity is making the NBN’s broadband plans unsustainable and pricing would need to be addressed. He estimated data usage in the six weeks after Netflix launched in March increased to a level expected in six months to a year’s time.

“Nobody can forecast that. This is an unprecedented shift in the market that no-one anticipated,” Buckingham argued.

Telcos in Australia are reporting peak bandwidth demands are exceeding 50% in “prime time” at night, with the average at 25% of total bandwidth now trapped by streaming video services. Citi says most of the traffic started when Netflix launched in the Australian market. iiNet also recently reported that 25% of traffic was Netflix.

Netflix has ripped open a debate on how Australia sells bandwidth, putting the telcos themselves under pressure. The company believes data shouldn’t count as a usage metric, but internet should be sold as speed tiers. Newer NBN fixed line plans are starting to include speed tiers.

“There’s no reason for data caps. We want to make the internet unmetered. Period. The capped model is antiquated: we want to make it about speed. 10Mbps will cost more than 1Mbps and 50Mbps will cost more than 10Mbps and that makes sense. Historically, there was so little content in Australia that many users went over the international links and those are pretty expensive, but now there’s more and more content and content caching in Australia,” Netflix CEO Reed Hastings told Gizmodo’s Luke Hopewell recently.

Netflix doesn’t rank Australia’s internet speeds very highly. In April it released its ISP Speed Index which ranked Australia 18th out of 29 countries. New Zealand came in 14th spot.

Hastings explained the development of the NBN in Australia was a “big factor” behind its decision to launch in Australia. “NBN was a big factor [for launching in Australia]. NBN’s what got us to think ‘let’s get in there and go now’, and it’s really viable from a technology standpoint.” He continued:

“With NBN, Australia has jumped to be one of the leaders in the world in internet infrastructure and the idea that the fundamental fibre backbone is going to get — knock on wood — 97% of people to at least the neighbourhood is unlike anything that has ever been done in the history of the world. That really got our attention.

“It’s been harder with the NBN than has been thought. It’s been pretty predictable and the new government doesn’t like the old government plans as much — just typical stuff right? Still, the fundamental idea of fibre for all is very powerful and will make Australia one of the digital meccas of the world.”

The other debate Netflix has brought to Australia is the idea of Net Neutrality – where all internet traffic is treated equally, no matter what it is. Netflix has been fighting US ISPs over the right to a flat and open internet for a while now, but it wishes it hadn’t got involved in the fight in Australia which it was drawn into after it signed unmetered deals with Optus and iiNet.

This is what Netflix recently said in a note to investors:

Data caps inhibit Internet innovation and are bad for consumers. In Australia, we recently sought to protect our new members from data caps by participating in ISP programs that, while common in Australia, effectively condone discrimination among video services (some capped, some not). We should have avoided that and will avoid it going forward. Fortunately, most fixed-line ISPs are raising or eliminating data caps in line with our belief that ISPs should provide great video for all services in a market and let consumers do the choosing.

As a mark of just how influential Netflix’s landing has been, it even has a potential tax nicknamed after it.

Before the federal budget was delivered in May, the Abbott government floated charging GST on online purchases below the current $1,000 threshold. Treasurer Joe Hockey recently said the threshold would be eliminated , which means international companies like Netflix will have to charge its Australian customers GST.

Its single streaming plans start from $8.99 a month, a full buck cheaper than local competitors.

Citi analyst Diddams estimates Netflix’s Australian market penetration is already five times higher than its next competitors. He estimates Stan’s had 332,000 sign ups and 153,000 paying users, and that Presto has had 193,000 sign ups and 90,000 paying subscribers, Citi estimates. Quickflix didn’t even rate a mention in the recent note.

“The market is well and truly gripped by the SVOD revolution, everyone is talking about it and, more importantly, everyone is now watching something “on-demand” in the Australian market,” Diddams said.

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