Amazon is contemplating a move towards recasting its online video service, now a feature of Amazon Prime, as a stand-alone, subscription-based service that would compete more directly with Netflix.

Netflix, for its part, seems to think that is probable. Most observers would tend to agree that, ultimately, Netflix is likely to face more direct competition from the likes of Hulu and Amazon, at least in part, in Amazon’s case, because the business logic behind products such as the Kindle Fire is to create a massive consumer base that is predisposed to purchasing more content that Amazon sells.

But Netflix executives think tablets and smart phones represent distinct and different use cases, for reasons directly related to the bandwidth charging model.

“Tablets are very successful, and people are watching Netflix on lots of tablets,” says Netflix CEO Reed Hastings. But that doesn’t necessarily mean tablets are a new and distinct customer acquisition channel, though tablets are a growing and important consumption channel.

The reason is the difference in venues where each device is used, as well as the bandwidth charging model. Tablets are used in settings where a Wi-Fi connection is available, such as in the house or at the office.

That means users are on the fixed line consumption plans that feature 150-Gbyte a month allotments, rather than the 2 Gbytes to 5 Gbytes that are the norm for smart phones.

The challenging bandwidth caps for mobile devices mean smart phone consumers quickly discover that watching lots of video on a mobile, using the mobile data plan, is exceptionally expensive, with the exception of users who do have a grandfathered “unlimited use” plan.

Netflix also believes it makes a difference “how” online video is paid for. Netflix executives do not appear to believe the company has any particular advantages in the “on demand” business, for example, arguing that its simple one fee, all you can watch model is where its own advantage lies.

Nor, obviously, does Netflix believe the economics of online distribution and DVD by mail distribution can be determined strictly by a comparison of profit margins, an argument that should provoke some puzzlement.

Netflix financial for the first quarter of 2012 indicates that a DVD subscriber is contributing about six times more to profits than a streaming subscriber, or around $15 per DVD customer but only $2.50 for a streaming customer.

But Netflix CFO David Wells says the issue is marginal contribution, not overall contribution.
“A marginal streaming subscriber is almost pure contribution margin,” he argues. In other words, the profit margin on the incremental new subscriber is “almost twice what it is for a DVD subscriber.”

In principle, that should shift even further in the direction of streaming as the subscriber base shifts to online, meaning more of the fixed costs of the DVD by mail business are attributed to a smaller number of customers, and as the incremental cost of mailing, for example, climbs.

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Gary Kim is a contributing editor for TechZone360. To read more of Gary’s articles, please visit his columnist page.

Edited by Jennifer Russell