The third season of Orange Is the New Black, Netflix's most critically acclaimed original series, has released on Netflix several hours early. It marks a long weekend of binge-watching the 13 newest episodes of the show for its many fans.
Perhaps surprisingly, the show is also released on DVD (why, you can buy the second season right now) and for digital download (you can buy the second season that way, too). This might seem antithetical to Netflix's overall strategy, where you have to buy a subscription if you want to stream the service's shows, but what many Netflix subscribers don't realize is that the service has essentially no say in the matter.
See, Netflix doesn't actually own the hit shows it airs. They are, instead, owned by other companies that make most of the money off those shows. And while that makes business sense for Netflix right now, this is also the greatest weakness in the company's strategy.
For right now, Netflix likely doesn't much care about this. It's in a stage of its life where it just needs to gobble up as much programming as it can. But it almost certainly will care at some point, and figuring out how to manage that change will be its next big evolution.
Netflix doesn't own its most successful shows
The relationship that produces your favorite TV shows is a complicated one, involving two major entities.
The show is actually made by the studio, which incurs production expenses in the course of making that show. It then sells the show to a network (or, in the case of Netflix, a streaming service), which pays a licensing fee to the studio for the content. Sometimes, that licensing fee is large enough to cover the studio's production costs; other times, the studio operates at a loss in hopes of recovering its money further down the line. (You can read more about this in my piece on why shows get canceled.)
Studios do everything involved in the production of these shows. They get the licensing fee, sure, but that's capped at a certain rate per season (and usually negotiated for multiple seasons at a time). If, say, an episode of House of Cards is going to go way over budget, the studio has to either eat those costs or figure out a way to cut the budgets of future episodes. Now imagine doing this with multiple shows at a time, and you'll see why running a studio can be so expensive. TV shows aren't cheap; almost all scripted shows have per-episode budgets that run well into the seven figures.
The network makes money from ads, subscriptions, or some combination of the two. In the case of Netflix, it makes all of its money from the subscription fees you pay for it, as it doesn't have traditional advertising (though its shows aren't above a spot of product placement, as you'll see from House of Cards). The company, however, is highly profitable, so even if it's paying large enough licensing fees to cover production expenses on all of the shows it puts on the air, it's doing just fine.
However, that really works primarily in the short term. Every other form of revenue these shows pull in goes to the studio — Media Rights Capital for House of Cards and Lionsgate for Orange Is the New Black. That includes syndication, DVD sales, foreign sales, and digital download and rental sales. There's a theoretically possible world in which Netflix's options on its programs expire and they go to some other streaming service (though that world is many years away and hard to imagine existing). And all of these streams of revenue are much more lucrative than first-run airings, because they theoretically will last as long as people want to watch TV shows.
It's possible Netflix has negotiated to receive some cut of the additional revenues, possibly in exchange for directly covering some production expenses up front. (Since we'll never see the service's deals with the studios, we can never know.) But even if that's the case, it's working on a playing field set by the studio, where it has to beg for scraps.
Acquiring content from other studios is a good move for new networks
Netflix probably doesn't care too much about this right now. The service is by far the hottest content provider going right now, making deals for everything from a Full House sequel to a new Brad Pitt movie. It's very much in the growth phase of its life, and owning a giant production studio would almost certainly be too expensive and cumbersome right now.
Netflix's main goal at present is to convince you that you need Netflix forever and ever and ever. And that means scooping up as much content as it possibly can, whether it gets that content from overseas, studio vaults, or production companies that have new shows they want to put on the air. So long as there's always something new to watch, you're that much more likely to keep subscribing to Netflix.
This is, incidentally, fairly similar to the growth strategies employed by many of the best TV networks out there right now. HBO, for instance, licensed most of its original breakout programs from other studios, which means that, say, the seminal Larry Sanders Show isn't on HBO Go, even though the network originally aired the backstage satire. This move makes sense for networks just getting into the programming game.
But it doesn't make sense for networks that are older and looking to fund more and more expensive programming. It's one of the reasons the blockbuster mentality so prevalent in the film world is taking over TV slowly but surely. Game of Thrones might be the most expensive show HBO produces, but it's also the biggest hit in the network's history, and the money it rakes in from now into infinity is going into HBO's coffers.
Netflix will probably bring more production in-house in the future
It's possible Netflix will never set up its own production arm. It may discover that it can live quite healthily entirely through programs it acquires elsewhere. But the nature of TV networks in this era is to start out buying programming from other providers, then slowly but surely building up their own production capabilities.
As the world increasingly shifts to one where streaming is the dominant model for providing content — a world Netflix has largely invented, mind — and more and more companies set up their own streaming services, making deals with Netflix may come to seem less and less of a good idea. And in that world, Netflix will probably have to build up "Netflix Studios" or something similar into a major player.
It's, obviously, something that's in the future, and Netflix, so far, has been remarkably smart about navigating the changing media landscape. But the pitfalls are many. Move too early, and the company could kill all of its growth by sinking its money into an expensive studio. Move too late, and it risks being choked out by the very studios it has such great relationships with right now.
Correction: An earlier version of this piece said season three will have 14 episodes. It only has 13.
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