While reviews have been generally positive for both House of Cards and Arrested Development, reviews don’t pay the bills and have many people asking, “Why is Netflix, Inc. (NASDAQ:NFLX) producing its own content?”

netflix logo

In a well written and thoughtful analysis of this question, Felix Salmon in an opinion piece published by Reuters today, went a long ways towards answering this question.

He began with an an economic analysis by Matthew Ball who recently wrote:

I’d argue that it is unlikely that Arrested Development will convince millions of users to stay an extra month in 2014 and 2015. If this is the case, the show would need to achieve its return in the immediate future. Therefore, if we don’t see Netflix adding four to five million new subscribers during the quarter, one of two things are true. One, the show was a poor investment whose draw was a fraction of those anticipated, or two, the show is instead intended to convince many of the million subscribers currently churning away each month to defer their cancellation. This would be telling.

While Wall Street analysts are assessing the success of original content in terms of new customers, I believe Netflix’s primary goal is on imminent service cancellations.

Netflix Producing Original Content: Mr. Ball

I won’t call this examination shortsighted, because Mr. Ball’s writings didn’t stop there. Rather, I would prefer to summarize his conclusions that ultimately explain Netflix, Inc. (NASDAQ:NFLX)’s economically quixotic endeavors if you are looking at short-term gains.

Mr. Ball points out that not only is Netflix, Inc. (NASDAQ:NFLX) producing original content in the hopes that subscribers will stay on for an additional month or two, that original content will allow Netflix to raise its prices down the line, but the fact is that the increasing cost of licensing agreements make it almost necessary for Netflix to produce its own content.

Netflix’s Licensing Costs

Netflix’s licensing costs have risen over 700% in the last two years. While licensing costs for a single show will never reach the cost of producing your own content, on a differential basis it makes sense for Netflix, Inc. (NASDAQ:NFLX) to continue to invest in programming that it has already begun producing.

Ball continues by pointing out that the more original content it produces the less it will need to license. This is obvious, but Ball makes a better point in my opinion—Netflix, if it continues or ramps-up its own productions will be less over the barrel when it comes to negotiating licensing rights. Additionally and rightfully, Ball points out that as Netflix’s profit margins increase, studios will simply rein this in appropriately.

While Salmon largely agrees with Ball, it’s here that he points out that Ball is speaking in “the now.”

Think Robert Redford in The Sting. Redford abandons the “short con” in which he excelled in order to join Newman in the “long con.” A film, by the way, available to all Netflix subscribers.

Netflix, Inc. (NASDAQ:NFLX) wants “to become HBO faster than HBO can become Netflix,” in the words of its chief content officer Ted Sarandos.

HBO is a perfect example, but it wasn’t that many years ago that HBO became a production house. It’s going to take Netflix, Inc. (NASDAQ:NFLX) time and billions of dollars but if they make it there as HBO has, they will be the ones printing money and licensing their own products to companies in areas where the company doesn’t view it as viable to compete.

Space allowances don’t allow me to further comment on the piece written by Mr. Salmon, but I would suggest you have a read using the link at the top of this piece.