Every Video Site Wants to Be the TV Network of the Internet Age. Netflix Shows What That Takes

Video sites want to become TV networks that carry everything. Here is what Netflix, the furthest along, has run into.

Your relationship with video sites is quietly changing.

Two or three years ago, you opened Youku, iQIYI or Sohu Video to catch the variety show you missed at the weekend, or to keep up with an American, Korean or Chinese drama. All of it came from other people's TV networks. The video site was just the "pipe" that led to them.

By 2015, self-produced series were what video sites pushed again and again in their recommendation boxes and through the media. When you waited each week for new episodes of Surprise and U Can U Bibi, or bought a VIP membership to watch The Lost Tomb, the video site had stopped being a pipe and become a producer, just like a TV network.

These sites are also burning more and more money on their own content. iQIYI, which has just announced it will go private, dragged down Baidu's share price precisely because it spent so much.

Youku Tudou put 600 million yuan into self-produced series in 2015, double the 300 million it budgeted the year before. It wants more hits like Surprise and Luogic Show.

Tencent Video announced a plan for "8 top-quality web series" this year and predicted that "paid memberships across the industry will reach 1 billion" this year. Its biggest bet of 2015 was We Are 15, a reality show modeled on The Truman Show.

Internet content has even started to flow back to TV networks. In 2016, dozens of major satellite channels have a combined 92 dramas lined up for broadcast, and 25% of the production companies behind them were founded in the past three years. They include the major video sites mentioned above, as well as Alibaba Pictures and Penguin Pictures.

Gu Yongqiang, CEO of Youku Tudou, has a bigger plan still: to overtake Netflix and YouTube within five years.

Whether or not that can happen, the "TV of the future" that video sites want to build is indeed following the path Netflix has already taken.

Take payment. Netflix charges users a fixed monthly fee to watch as many films and TV shows as they like. Take licensing. Netflix pays for rights, and its content costs rise every year. Then there is exclusive content it makes itself, which also ties users to the service, such as the third season of House of Cards, which you may have watched and grumbled about.

Ahead of Netflix stands HBO, the network built on producing its own films and series. Netflix's chief content officer, Ted Sarandos, once said: "The goal is to become HBO faster than HBO can become us."

For an internet company that wants to become a TV network, the key question is how much content it has that suits viewers' tastes and, above all, gets them to pay.

In December 2015, Netflix said it would produce 31 original TV series in 2016, twice as many as in 2015. The plan also includes 10 films, 30 children's series, 12 documentaries and 12 talk shows.

How did Netflix get here?

Netflix tells a version of its founding story that was made up for publicity:

In 1997, after paying a 40-dollar late fee to Blockbuster, America's largest video rental chain, 37-year-old Reed Hastings wanted to test a way of renting films online without paying for late returns.

The online store called Netflix opened in 1997 and began operating in 1999. For 10 dollars a month, you got unlimited movie discs. You built a queue, and as soon as you returned the last disc, Netflix mailed you the next one in a red envelope.

In fact, this plausible path is just a story Netflix invented. Mailing DVDs was never the business it wanted. From the start, the idea was to let users watch video online. But after trying various online video models, Hastings and his two co-founders decided that bandwidth was still too expensive and that the internet had not yet reached every household.

Only in 2008 did they decide to offer online video free as part of the DVD service. By 2011, as the market and the technology matured, Netflix moved fully to online video. The DVD business was first spun off, then shut down for good.

In 2013, the year the first season of its original series House of Cards went online, Netflix founder Reed Hastings said that his company would sooner or later replace cable TV.

By audience size, Netflix can already match a TV network. It is worth more than 50 billion dollars and has 69 million users, 40 million of them in the United States. It is the largest streaming service in the US, with a 36% market share. Every day, its users watch 100 million hours of programming.

Remember that two years ago, Netflix carried only other people's films, TV series and entertainment shows.

"The world's leading Internet television network." That is how Netflix's website describes itself.

Why does Netflix make its own content?

Over the past two years, Netflix has fallen into an uneasy relationship with the content providers it depends on: it is both their partner and a competitor they cannot ignore.

In the US, more and more people are switching to streaming. According to 2014 data from the market research firm NPD, the number of households subscribing to pay-TV services such as HBO, Showtime and Starz fell 6% over 18 months. Over the same period, households subscribing to streaming services led by Netflix and Hulu Plus rose 4%.

As more people watch films and TV online, the companies that own the rights keep demanding higher licensing fees. As a result, Netflix's profits have dropped sharply, and some films and shows have become unaffordable when their contracts come up for renewal.

In 2008, for example, Netflix signed a deal with Starz to get Sony Pictures and Disney films for 30 million dollars a year. When the contract came up for renewal in 2011, Starz wanted 300 million dollars. Talks broke down, and those films vanished from Netflix's library.

Such crises have never stopped. In May 2013, when its agreements with MGM, Warner Bros. and Universal Pictures expired, Netflix lost 1,794 titles.

Meanwhile, over the past three years, Netflix's spending on content has grown 20% a year.

Since subscription fees are its only revenue, Netflix's most direct goal is to keep users growing by any means. The problem is that as the choice of films shrinks, why should viewers in front of the TV stay with Netflix?

Original series are one answer. They air only on Netflix and carry its DNA, and as long as they are good enough, they win more and more devoted fans. The first season of House of Cards seemed to prove the point: in the third quarter of 2013, Netflix's US users grew 7% over the previous quarter, against only 2% the quarter before.

Self-produced series look like the best way to lock in users, and Chinese video sites see this just as clearly.

Whether you paid for VIP to finish The Lost Tomb or sat through long ads and waited a week for each episode, iQIYI got what it wanted.

The next challenge is whether it can come up with another show that grabs you before the next time you cancel your subscription.

Good content costs money

With House of Cards, Hastings resolved to spare no expense on original series.

House of Cards cost 100 million dollars, or 4 million dollars an episode.

It was directed by David Fincher (who had made The Social Network) and starred Kevin Spacey, the 1999 Best Actor Oscar winner.

The studio Media Rights Capital had shopped the show to several networks, including HBO and Showtime. Netflix outbid them all.

Analysts predict that original content will cost Netflix more than 450 million dollars next year, and that, counting licensed content, it will spend more than 5 billion dollars on content in total. That is more than most cable networks spend, second only to the sports network ESPN.

The money goes on partners, including well-known directors, screenwriters and actors.

In 2013, Marvel teamed up with Netflix on five series built around The Defenders. The first two, Daredevil and Jessica Jones, both aired in 2015 to strong reviews.

In September, Netflix also snatched the latest season of the hit miniseries Black Mirror from the BBC.

This spending will only keep rising.

By 2016, Netflix's spending on original series is expected to equal 14% of its spending on licensed content, up from 4% in 2013.

And the money will not go to TV series alone.

• At the end of 2014, Netflix announced a four-film deal with Adam Sandler (star of Pixels). One of the films already has a trailer.
• In March 2015, it announced it would make an environmental documentary with Leonardo DiCaprio and Appian Way, DiCaprio's own company.
• In July 2015, it announced release dates for four original films, including Crouching Tiger, Hidden Dragon 2.

Even variety shows and sports programming are in the plan. Netflix has reportedly set up a studio in Hollywood, renting about 19,000 square meters of space and possibly adding a soundstage of about 11,000 square meters later. These facilities will first be used for an original late-night talk show hosted by the well-known TV host Chelsea Handler.

At Chinese video sites, content budgets can reach even further upstream. Last year Tencent Video launched the "Jingzhe Plan" (Awakening of Insects), promising to sign and give priority support to 100 high-quality PGC (professionally generated content) projects within a year and to build the largest original video platform on the web.

Youku Tudou and Sohu Video have their own PGC support programs. Youku Tudou calls its program the "Photosynthesis Plan," while Sohu Video simply says it will put up 200 million yuan to back independent online creators.

The video sites' ambitions are big. But judging by Netflix, the one that has gone furthest, these huge investments have brought more users without bringing much profit growth.

In 2015, original series drove Netflix's spending up and its net profit kept falling. Results missed analysts' expectations, cash flow turned negative, and net profit fell more than 50% from a year earlier. Even user growth is slowing.

Meanwhile, not a single Chinese video site has managed to turn a profit.

Big data cannot keep the content good

"This series looks set for a bright future, a perfect storm of material and inspiration."

When the first season of House of Cards had just aired, Netflix said it had used big data to work out what viewers like, and then chose what to make.

Netflix tracks not only users' tastes and habits but also how long they take to finish an episode and how many episodes of a season they watch in one night.

Netflix has done this since it was founded. In the early days it was a rating system called Cinematch, used to recommend discs to each user. In 2006, 70% of subscriptions came from its recommendations.

Now Netflix describes the system as a guide to choosing scripts. But although House of Cards succeeded, that success clearly had little to do with so-called big data. Netflix claims all its original series are "calculated" by big data, yet their quality is uneven, some good and some bad.

One expensive failure is Marco Polo. The series cost 90 million dollars, was shot in Italy, Kazakhstan and Malaysia, and had a cast of several hundred international actors. Netflix hoped it would draw audiences around the world.

But Marco Polo was panned as soon as it premiered. Viewers found the plot clichéd and muddled, and its exotic touches showy. On Rotten Tomatoes it scores only 24%.

James Poniewozik, TV critic at Time magazine, gave this verdict: "Marco Polo is a total jumble of chaos and absurdity... its heavy nudity and sex make it look like an 'R-rated adult video game.'"

He also dismissed the big-data algorithm Netflix prides itself on: "In Marco Polo, the algorithm shows up as a crude mash-up of things viewers like, historical drama, kung fu and so on, all dumped on the audience at once."

Even its breakout hit House of Cards could not hold on to its reputation in the third season. Tim Goodman, chief TV critic of The Hollywood Reporter, said the show had turned into a soap opera with no way back.

Some shows have won praise, such as BoJack Horseman. This bleak comedy, full of misanthropic home truths, scored a perfect 100% on Rotten Tomatoes by its second season. Its absurd American humor skewers politics and human nature with precision.

Sense8, directed by the Wachowskis of Cloud Atlas and The Matrix, Daredevil, made with Marvel, and the long-running Orange Is the New Black also earned good reviews this year.

In the end, whether a show is good has little to do with big data. Analyzing data better than film studios still cannot guarantee that Netflix's bets on new shows will always pay off.

How HBO, ahead of Netflix, makes its own series

Netflix talks of overthrowing the cable network HBO, yet 30 years ago HBO was in almost exactly Netflix's position and made almost exactly the same choices.

"We want to prove that we can make successful commercial films. Quality films are very scarce, a luxury we can no longer afford."

Michael Fuchs, then HBO's president, said this in 1984. That year HBO began producing its own films and shows to rein in swelling licensing costs, much as Netflix did in 2013.

Until then, its lukewarm original variety and sports programs had not been enough. The New York Times, reporting on the move at the time, was full of doubt: "Can HBO succeed in attracting 13.5 million subscribers and keeping them satisfied?"

The answer is now obvious. HBO has 138 million users worldwide and 13 sub-channels. It has 46 million subscribers in the US, making it the country's largest cable network.

Many of the hit American series you can name come from HBO: The Sopranos, Game of Thrones, Sex and the City, The Newsroom, Silicon Valley, Rome, Band of Brothers...

In 2015 HBO was still the Emmys' biggest winner, taking 14 of the 26 awards presented. Never before in Emmy history had a single network taken more than half the awards.

So how did HBO do it?

How HBO makes its own series

• 1972: HBO goes on air
• 1977: Begins producing original entertainment and sports programs
• 1983: Its first original film, The Terry Fox Story, airs
• 1989: Merges into Time Warner
• 1997: Its first original TV series, Oz, airs
• 1998: The Sopranos earns HBO 111 Emmy nominations and 21 Emmy wins
• 2001: Band of Brothers, executive produced by Spielberg, launches at a cost of 125 million dollars; film-quality television becomes the norm at HBO
• 2002: The Wire cements HBO's reputation for high-quality drama
• 2011: Game of Thrones airs

HBO has also spent heavily on polished production. Band of Brothers, which aired in 2001, had an initial budget of 110 million dollars, but the final cost reached 125 million dollars, or 12 million per episode, not counting 15 million spent on marketing. The Pacific in 2010 cost 250 million dollars in total, and its production in Australia brought the country 4,000 jobs and 18,000 Australian dollars in tax revenue.

So big budgets and lavish spending became a model other networks copied, Netflix included. But Netflix faces harder problems.

They promise to replace TV networks, but internet companies face a much harder task

To become the TV network of the internet age, copying HBO is certainly not enough.

After HBO began broadcasting around the clock in the 1980s, it could fill its daily schedule with its own films. Since then it has produced more than 200 TV series and miniseries without pause.

For Netflix it is not so simple. In an age when you click a button to watch whatever you want online, filling 365 x 24 is not enough.

In 2013, when Netflix put a whole season of House of Cards online at once, the timing of "watching TV" changed.

Traditional networks release one episode a week and take a winter break. A Netflix series, with no more than 13 episodes a season, is released more like a Hollywood film, or a complete novel rather than a serialized one.

More important, HBO's pressure lies in filling every hour of 24/7 with its own content, so that viewers would rather stay on its channels. For Netflix, that "time" is infinite.

If a TV network is a supermarket with limited shelf space, a streaming service is an online mall. It has unlimited storage, which means it needs an unlimited number of products and unlimited production spending.

In other words, to keep users' attention and draw more of them in, Netflix has to add new content harder and faster, as if filling a bottomless pit.

And Netflix is not alone. Other players in the US streaming market are doing the same hard work.

Amazon set up its own film and TV studio, Amazon Studios, in 2010, and has courted big-name writers and producers, such as Jill Soloway, one of the creative team behind Six Feet Under. Soloway made Transparent for Amazon. It was Amazon's first original series and earned a 2015 Golden Globe nomination for best series.

In 2015, The Man in the High Castle not only scored 95% with professional critics on Rotten Tomatoes but also became a mainstream hit after Amazon covered subway cars in Nazi and Rising Sun flags.

Hulu, third in the streaming market, launched its first original series, the political drama Battleground, in 2012. Most Hulu originals have been middling, but Casual, an edgy series launched in 2015, has started to turn things around, earning several Golden Globe nominations.

Even Apple plans to launch a streaming service and is said to be working with Hollywood on original films and series. HBO has also launched HBO Now, a fully standalone internet streaming service that costs 15 dollars a month and is already available on set-top boxes from Apple, Amazon and others.

Competition in China is fiercer still, and no single company dominates the way Netflix does.

Over the next few years, the video site business may become a money-burning game among three companies: Baidu, Alibaba and Tencent.

And no one knows how much money it will take to build an internet TV network that cannot be filled even with 365 x 24.