Amazon Strategy Highlights Arms Race for Original Content

In its earnings call last week, Amazon announced it will be doubling its spending on new content in the second half of 2016 and tripling the number of original shows offered compared with the same time last year. This is likely driven by the investment in original programming by rivals HBO and Netflix, and the fact that Amazon has found that original content helps convert free trials into subscriptions, driving usage of a wider set of Amazon Prime services.

Also like Netflix Inc. (Nasdaq: NFLX), Amazon.com Inc. (Nasdaq: AMZN) is expanding internationally and will be launching in India with a combination of local and global content.

Amazon beat analyst expectations, with revenue growing 31% in 2Q 2016 to $30.4 billion and a net profit of $857 million, the largest ever in the company's history. But the company did acknowledge that content costs will increase through the second half of the year due to the company's aggressive content development plans.

This strategy hasn't entirely worked out for its main competitor: Netflix disappointed with its Q2 earnings, adding 1.7 million subscribers, well below its forecasts of 2.5 million and down from 3.3 million in the same quarter last year. While the company blamed the "un-grandfathering" of older pricing models for higher churn, the fact is that raising prices will cost you subscribers. And yet, greater investment in original content is expensive, and also essential to drive subscriptions. So as an OTT provider, you are stuck between a rock and a hard place. (See Does Netflix Need a New Business Model?)

Still, Home Box Office Inc. (HBO) announced last year that it would be increasing production of its original content by 50% in 2016, and Netflix is apparently cutting down on its third-party acquisitions to pay for investment in more original content. So Amazon is also following that route.

According to analysis from research company Ampere Analysis, investment in original programming by Netflix and Amazon together was $1.02 billion in 2015, compared with $4.70 billion spent on acquiring third-party titles. But in 2020, Ampere forecasts that the two companies will spend a combined $4.45 billion on original programming and $4.85 billion on acquired content.

Ampere also found that "Amazon Prime customers have an increased propensity to spend" and that video is an effective driver for converting users into Prime subscribers. Consequently, Ampere estimates Amazon would be willing to offer an effective subsidy of $130 for every new Amazon Prime subscriber. That means Amazon would be willing to spend more on video content than would otherwise be economically viable for a standalone service. This has to be bad news for Netflix in the long run.

And if the industry heavyweights are wrestling with their economics, what does that mean for others? Few providers can find that perfect balance between content costs and subscription growth over the long term, and keep up in this arms race. If Watchever, a German OTT service owned by media giant Vivendi , has not been able to make a go of it, what chance do smaller players without rich parents and established brands have? (See Does Watchever's Demise Highlight a Looming Challenge for OTT? and Era of OTT Aggregation Beginning, Says New Study .)

As I've stated before, this is all good for pay-TV providers. (See Growth of Netflix Competitors Could be Positive for Pay-TV Providers.)

It's true that the big winners in an arms race are the arms dealers. But those who just bide their time, letting the competition beat the living daylights out of each other, usually end up doing pretty well too.

— Aditya Kishore, Practice Leader, Video Transformation, Telco Transformation