Personal Finance

Netflix Wants to Steal a Play Out of Disney's Book

Couple lying in bed watching Netflix on TV.

Over the last few years, Netflix (NASDAQ: NFLX) has grown into a content-producing powerhouse. While it's no Time Warner (NYSE: TWX) or Disney (NYSE: DIS) , Netflix's original content budget is swelling, and some of its shows have permeated pop culture. To capitalize on that trend, Netflix is reportedly exploring licensing its intellectual property for merchandising, according to Bloomberg .

Both Disney and Time Warner have had a ton of success with licensing and merchandising. Disney's consumer products segment generated $1.5 billion last quarter alone, roughly equal to 60% of Netflix's total revenue. Video games and other licensing opportunities accounted for 13% of Warner Bros.' revenue through the first nine months of 2016.

Merchandising provides the dual benefit of a new revenue stream plus another marketing angle for Netflix.

Couple lying in bed watching Netflix on TV.

Image source: Netflix.

Producing shows in-house is the key

Last year, Netflix started producing more of its original shows itself instead of contracting a production studio. "Over the long run, we believe self-producing is less expensive (including cost of capital) than licensing a series or film, as we work directly with the creative community and eliminate additional overhead and fees," management wrote in its third-quarter letter to shareholders. "In addition, we own the underlying intellectual property, providing us with global rights and more business and creative control."

Man wearing Stranger Things t-shirt.

Image source: Hot Topic.

That last line is a key part of the value of spending more up-front for shows like StrangerThings . Last year, Netflix conducted a test by licensing Stranger Things to Hot Topic for tee shirts, mugs, hats, and jewelry. Producing more shows in-house opens up more revenue-generating opportunities like that.

On the company's third-quarter earnings call, Chief Content Officer Ted Sarandos said, "Our financial preference, of course, is to produce it through our studios. And when that opportunity will continue to present itself, we're going to increasingly do that as well."

That's not always possible, though, since Netflix is primarily focused on providing the best viewing experience for its users whether it can own the intellectual property or not. In fact, several of Netflix's most popular original series license IP from Disney's Marvel.

Free marketing

As Netflix produces a growing number of originals in-house, its licensing opportunities expand as well. It could provide a small revenue boost for the company, but it largely defrays the additional up-front costs of producing the shows in-house. More valuable to Netflix is the additional marketing merchandising can provide.

Disney has become a well-oiled machine when it comes to using merchandise as a marketing tool. Leading up to the release of The Jungle Book last year, it made special sections in its theme park stores for Jungle Book -themed merchandise well before the film's release date. Combined with its other marketing efforts, The Jungle Book went on to gross nearly $1 billion at the box office.

While Netflix doesn't have the existing infrastructure of an entertainment giant with its own theme parks and stores like Disney, or even Time Warner, it can still enjoy a marketing boost from merchandise. Successful merchandise sales provide social proof that a series is worth signing up to Netflix and spending the time watching the show. It's a bit different and likely more effective than the traditional brand advertising Netflix currently uses.

Marketing costs reached nearly $1 billion last year, up 20% from 2015. If Netflix can curb some of the net costs of advertising with merchandising, that could help it grow net income at a faster clip -- not through a significant increase in revenue, but by a reduction in costs.

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Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Netflix and Walt Disney. The Motley Fool recommends Time Warner. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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