After Morgan Stanley analysts downgraded Netflix stock last week, citing increased competition from Hulu and Amazon.com's Prime Instant Video, bulls came rushing to Netflix's defense. Yet bulls' pro-Netflix arguments take too much comfort from the company's current success and misunderstand what Netflix needs to do to keep growing.

Can Amazon compete with Netflix for the next wave of streaming video growth?

Put simply, Netflix has become a household name in the U.S. by appealing to young adults and, to a lesser extent, to parents. Its content library reflects this focus. By contrast, Amazon's content selection appears to be designed to please an older demographic, with shows like Downton Abbey, The Good Wife, The Closer, and even Under the Dome.

The problem for Netflix is that it is already starting to saturate the younger part of the market. Amazon is in a better position to compete with Netflix for the 49 and up age group, which is where much of the remaining growth of streaming video will occur.


It's not just about the youth crowd
In recent weeks, Netflix's defenders have highlighted the service's appeal to young adults. One claimed that most young adults don't have cable, so the growth of Hulu and Prime should not be worrisome; cord-cutters could potentially subscribe to all three! (My Fool colleague Sam Mattera recently made a similar argument.)

Another commenter noted that tweets about Netflix vastly outnumber tweets about Hulu Plus and Amazon Prime. But not surprisingly, Twitter users skew very young. It's no secret that Netflix has "won" among young adults. A recent study by Harris Interactive found that 43% of people ages 18 to 36 in the U.S. subscribe to Netflix. It seems likely that even more people in that age range use Netflix, either through friends' or parents' accounts.

That's a blessing and a curse for Netflix. On one hand, it's great that it has been so successful in its core demographic market. On the other hand, since it's unrealistic to expect Netflix to ever reach 100% market share, the company appears close to saturating the young-adult market.

But while 31% of those ages 37 to 48 also subscribe to Netflix, only 21% of adults 49 to 67 and 13% of those 68 and older are subscribers. For Netflix to hit its long-term target of 60 million to 90 million domestic subscribers, the company will need to make serious headway in that older demographic.

A different focus
Amazon Prime will be a more serious competitor in this next stage of the streaming-video race. First, it's important to remember that Amazon was late to the game and has only compiled a competitive content library in the last year or two. So while Amazon lost the first round (i.e., young adults) by default, it is getting in near the ground floor for the race to sign up baby boomers and even senior citizens.

Second, Amazon has built a content library that is much more targeted toward older viewers than Netflix's catalog. This makes a lot of sense. Netflix has effectively appealed to cord-cutters who can't afford cable TV -- although it's worth noting that most Netflix users also have a pay-TV package.

Amazon, by contrast, is in the streaming business to attract consumers to the Prime service. It hopes that these new Prime members will increase their Amazon spending by hundreds or even thousands of dollars. In other words, it wants to attract people with discretionary income.

Appealing to different demographics
To see how Netflix and Amazon differ in their content choices, let's take a look at some of the top items of content on each service. A third-party analysis of Netflix viewing for 2013 found that the two most-watched shows were Breaking Bad and Family Guy. Three of Amazon's top titles are Downton Abbey, Under the Dome, and The Good Wife.

The demographics for the original broadcasts of Amazon's shows skew much older. For example, on Sept. 29, 2013, the season premieres of Family Guy and The Good Wife aired, as did the series finale of Breaking Bad. Breaking Bad drew 10.3 million viewers, with a 5.2 rating among adults 18 to 49. Family Guy was about half as popular overall and among adults 18 to 49, with 5.23 million viewers and a 2.6 rating.

By contrast, The Good Wife drew 9.15 million viewers, but only scored a 1.5 rating among adults 18 to 49. In other words, it had significantly more total viewers, but significantly fewer viewers ages 18 to 49 than Family Guy, and less than a third the 18-to-49 viewership of Breaking Bad, despite a similar-size audience.

Similarly, Under the Dome's season finale hit a 2.8 rating among adults 18 to 49 despite drawing more than 12 million viewers (i.e., half of the Breaking Bad finale's 18 to 49 audience despite more total viewers). Downton Abbey does not get traditional ratings because it airs on PBS, but its audience also skews older. The show's top sponsor, Viking River Cruises, has described its target demographic as "affluent baby-boomers, 55-plus." Enough said!

Foolish wrap
Netflix certainly has plenty of content that could appeal to older viewers. House of Cards, its first major foray into original content, was primarily targeted at that demographic, although it ultimately attracted more young viewers than Netflix expected. But most of the top shows on Netflix are geared toward the younger audience that represents its core subscriber base.

By contrast, Amazon Prime's catalog is much more focused on the 49-and-up crowd. Amazon's "signature" content deals include Downton Abbey, Under the Dome, The Good Wife, and The Closer -- all shows with large audiences but relatively low 18-to-49 ratings.

With the under-36 market becoming increasingly saturated and the 37-to-48 market not far behind, much of the remaining growth in streaming video will come from adults 49 and up. In this new frontier, Amazon Prime could be a much more fearsome competitor for Netflix.

3 companies that will dominate the living room
You know cable's going away, but do you know how to profit from that? There's $2.2 trillion out there to be had! Currently, cable grabs a big piece of it, but that won't last. And when cable falters, three companies are poised to benefit. Click here for their names! (Hint: they're not Netflix, Google, and Apple.)

The article Amazon's Threat to Netflix Is Bigger Than You Might Think originally appeared on Fool.com.

Fool contributor Adam Levine-Weinberg is short shares of Amazon.com and Netflix. The Motley Fool recommends Amazon.com, Netflix, and Twitter. The Motley Fool owns shares of Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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