Why Starz Made a Big Mistake

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By now, you've probably heard that plans to stop distributing content through Netflix's (NAS: NFLX) streaming service after the companies' current agreement ends early next year. I don't think losing Starz will hurt Netflix in the long run, but I do believe the falling out has revealed subscription TV as the next industry to fail to adapt to the Internet.

We like the money, but ...

According to TheLos Angeles Times, Netflix offered Starz $300 million -- more than 10 times the current deal's annual payout -- to renew the contract. Unfortunately, Starz also wanted Netflix to create a new subscription tier for users who wanted to access the cable channel's content. This would bring pricing more in line with the $15 most satellite and cable subscribers pay each month for Starz. At the moment, the channel's content accounts for only 8% of U.S. subscribers' viewing, so Netflix refused.

You vs. the cable companies
You can blame cord-cutting -- canceling cable in favor of watching TV online -- for the dispute. According to SNL Kagan, 4% of TV households will drop cable this year, and by 2015, that number will grow to 10%. Many subscription TV providers have already begun to see declines. In the last quarter, Comcast (NAS: CMCSA) , Time Warner Cable (NYS: TWC) , Cablevision (NYS: CVC) , and DISH Network (NAS: DISH) all lost customers.

You can't blame Internet video for all of these losses. Continued high unemployment could force consumers who would just usually keep HBO to cancel. Additionally, years of terrible service and high prices may have driven some customers to new providers such as Verizon's (NYS: VZ) FiOS TV -- which managed to add 184,000 subscribers last quarter.

However, over the long term, Internet video poses the greatest threat to the cable providers. Nielsen said in June that viewers who watched the most online video watched less TV. Worse yet, that trend became more exacerbated in the key 18-34 age group. Fearing that users will abandon traditional live TV and content providers, cable companies have begun to play defensively. Fox -- a subsidiary of News Corp (NAS: NWS) -- has already announced that unless viewers have subscribed to either Hulu Plus or DISH Network, they will have to wait eight days before they can watch new episodes from its FOX broadcast network online.

I'm afraid that the traditional media players are about to learn that fighting the movement to online TV won't work. As Fool editor Jim Royal has previously noted, "the consumerist movement of the past century has been trending toward doing what you want when you want." Currently, the best medium to meet consumer demand is the Internet. We've already watched it disrupt print media and music. Television is just the latest victim, and there's really nothing the traditional companies can do to stop it.

Yarrrrr!
If providers restrict their offerings, people will turn to piracy. After Fox began delaying streams of new episodes, illegal downloads of Hell's Kitchen increased 114%, and bootlegging of MasterChef rose 189%. These numbers don't include the hoards of illegal streaming sites that have popped up around the web in recent years; the increase in pirating is likely even higher.

 It's simply too easy to pirate media. Moreover, the record industry has shown us it's nearly impossible to prevent people from stealing it. Content providers can only protect their property by making the legal option so painless and affordable that the average law-abiding citizen doesn't feel justified going the digital buccaneer route.

Time to adapt

Although I don't believe the Internet will kill subscription TV entirely, I do think it will reduce the demand. Instead of trying to cripple online video, the cable companies should focus on catering to Internet TV viewers. For example, cable companies could offer their Internet subscribers streaming services that don't require a subscription to premium cable.

Sadly, it appears that the old media guard aren't prepared to change yet. They will probably continue to defend subscription TV until long after it's too late for them to claim a share of the Internet video market.

In the meantime, if you'd like to learn about a company that is prepared to profit as we consume more content online, you should check out this special report, "The Motley Fool's Top Stock for 2011." It's absolutely free, so click here to download it today!

At the time this article was published Fool contributor Patrick Martin owns shares of Netflix. You can follow him on twitter @TMFpcmart03. 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 adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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