In one sense, the move is an incremental advance. Facebook did little more than offer its technology platform, for which developers regularly build apps like personality tests and casual games like Farmville. But in another sense, Warner Brother's strategy may presage something huge: Streaming online movie rentals could become a big business on Facebook, so much so that the company's entry into the market could trigger a round of mergers among its new competitors.
Shares of Netflix (NFLX), the current leader in online video streaming, fell 6% to $195.45 on the news Tuesday. Facebook is only 7 years old, but this is how scary it has become to older technology companies: It can threaten to disrupt established markets without lifting a finger.
Giving Facebook a Lot of Credits
Of course, it's way too early to do anything more than speculate about Facebook's plans for online video. But the logic of it making such a move is so compelling it's hard not to speculate. Facebook members could pay for rentals with "credits," Facebook's virtual currency. Facebook gets a 30% take on all credits used -- that's a lot of potential money to pay for the increased bandwidth needed to stream movies.
Many Facebook users have shied away from using credits, but streaming video could be the kind of killer app that wins over these reluctant customers. After all, word of mouth has always provided powerful viral marketing for movies, and a rave from a trusted friend on Facebook could be a better marketing tool than movie reviews, TV commercials or recommendation algorithms.
For movie studios like Warner Brothers, this is a worthwhile experiment. It gives them instant access to 600 million Facebook members, and it doesn't look like they'll have to negotiate with Facebook on pricing as they would with Netflix's Watch Instantly, Amazon's (AMZN) digital rentals or Apple's (AAPL) iTunes.
Warner is charging 30 Facebook credits, or $3, for two-day access to The Dark Knight. But if this idea catches on, it could start to charge more. And more important, Warner and others could use a successful Facebook entry into online videos as a powerful bit of leverage in negotiating higher licensing fees from Netflix, Amazon, Apple or Google (GOOG).
Prime Merger Targets: Netflix and Hulu
All of these companies are pinning some, if not all of their success on the future of online video. Movies and TV shows streamed from the cloud are gradually supplanting broadcast and cable TV. But there isn't room for everyone: In addition to the above four companies and Facebook, cable giants like Comcast (CMCSA) are angling for a piece of the Internet-TV pie. A shakeout is inevitable over time.
Or we might see Amazon or Apple pick up Netflix or Hulu to strengthen their negotiating clout with Hollywood. Amazon has been seen as an ideal buyer of Netflix for years. The obstacle has been state taxes: Buying Netflix would mean Amazon has to charge its customers sales taxes in most states. Amazon has bitterly fought to avoid those taxes, but revenue-strapped states are fighting back, and Amazon might not be able to hold out much longer.
Also likely to be bought early is Hulu, which in December ditched its plans for an IPO. Netflix will be a more difficult target as long as its stock remains so richly valued: It's trading at 45 times its estimated 2011 earnings. Netflix's relatively large catalog and its $7.99 subscription model might help it stay competitive, but a decline in its stock price could amp up interest in a buyout.
I concede this is all rather speculative. But the many pieces are in place, and it's easy to imagine any of it happening. Facebook benefits from renting streaming videos through its site, and movie studios benefit, too. The more successful Facebook becomes in this area, the more pressure other online-video companies will feel. And the pressure of competition often leads to consolidation.