What the New Facebook Rental Service is Really All About

In early February, Netflix was sitting pretty, signing up plenty of new subscribers every day, raking in the revenue, and watching its stock prices go through the roof. It was the undisputed king of streaming media, with no real competitors in sight. Now, hardly a month later, it seems like everyone is muscling in on the online movie rental market, and investors are running scared. Netflix stock dropped nearly six percent yesterday, on the news that Facebook has launched a movie rental service, and inked a deal with Warner Brothers for their content. It joins Amazon Prime, Redbox, Hulu Plus, iTunes, Comcast XFINITY, Vudu, Best Buy CinemaNow, and Google TV, who are all ready to take a bite out of Netflix's bottom line. Full disclosure - I'm a Netflix shareholder and I do have a financial interest in what's going on here.

But that said, I have no idea how Facebook's proposed rental service really poses any threat to Netflix. Facebook rolled out "The Dark Knight" yesterday, available to rent at thirty Facebook credits, or $3. More Warner Brothers titles are sure to follow. However, renting digital copies of individual films is what Amazon and iTunes are already doing, and for essentially the same prices. And Warner Brothers keeping its content off of Netflix's streaming service is old news. The real question is whether other studios are going to follow suit, and whether this is the first step in Facebook launching a subscription-based service, which would be be more significant challenges to Netflix's business. The most immediate innovations Facebook offers are the ability to rent films using Facebook credits, and being able to "like" and "friend" a film, a move toward integrating the movie watching experience into the social networking experience.

However, the really interesting story here is not that Facebook is renting movies, but that Warner Brothers is continuing to do its best to undermine the new media consumption models that Netflix and Redbox have created. The big studios have not been happy with these two lately, blaming them for plummeting DVD sales and rental revenues. Earlier in the year, Warners got both companies to agree to a 28-delay after new Warner Brothers titles like "Harry Potter" and "Due Date" hit DVD before they could be offered rental. Netflix and Redbox have similar agreements with several other studios, like Sony and Twentieth Century Fox. These tactics don't seem to have helped DVD sales. However, what drives the studios particularly crazy is the pricing that Redbox and Netflix offer to their customers. Redbox rentals are $1 a night for most titles. Netflix's monthly plans start at $7.99 a month for its unlimited streaming-only service, and $9.99 if you'd also like to rent DVDs by-mail.

Netflix and Redbox prices are far too low, as for as the studios are concerned. Just look at what Warner Brothers is doing with the new Facebook rentals. Warners still thinks that $3 is a fair price to rent a digital copy of "The Dark Knight" for two nights, a film that is nearly three years old, and had its basic cable premiere on TNT a month ago. By this point, even brick-and-mortar video stores are renting it for a dollar a night. Warner Brothers receives $2.10 for every $3 digital rental of "The Dark Knight" on Facebook, according to the Wall Street Journal. They only get a fraction of that for a Redbox or Netflix rental, because the unit pricing is so much lower, though the volume of rentals is almost certainly be higher. I can see the price of Facebook rentals coming down to encourage first-time users, the way Hulu's subscription plan pricing did, but not by much and not for long.

Warners' real interest here is ensuring that viewers believe that $3 is what they should be paying to rent a movie, not $1 a night from Redbox and not the $.50 per film I average with Netflix ($1.25 if you only count the physical DVDs). I suspect that the goal is ultimately to get us to treat online digital streams of Warners' films like pay-per-view or cable video-on-demand (VOD) content, which is traditionally pricier than rentals. Will Warners and Facebook be successful? I have no idea. It's not in my best interests as a consumer if they do, but we're talking about gigantic media companies with armies of marketers and financiers behind them, billing this as the Next Big Thing. The fuss was loud enough to make Wall Street panic yesterday. And who knows? Maybe Facebook will do something brilliant and innovative with their new movie rental app. Maybe they'll join forces with one of the other rental services. Maybe they'll digitize the DVD extras. Maybe they'll offer exclusive content. I know better than to underestimate Facebook.

And yet I wonder why the inaugural Facebook rental title was "The Dark Knight" instead of last summer's Warner Brothers blockbuster, "Inception." It's already been on DVD for three months, and is enjoying some new buzz thanks to its recent Oscar wins. A copy of "Inception" is even a pre-loaded app on the new Android Galaxy 4G phone. Could Warners still be worried that digital rentals of the film might eat into their profits on those shrinking DVD sales? Let's see how far that attitude is going to get them in the online streaming business.