Netflix reported a second-quarter profit last week as customer demand continues to drive a transition in the company’s primary delivery model from DVD-by-mail to Internet streaming. According to The New York Times, “[t]he company’s net losses among DVD-by-mail subscriptions outpaced its gains in net streaming subscriptions in the United States, reflecting the continued challenge of converting from a physical disc business to one predominately online.” The company, of which I am a longtime subscriber and fan, has famously struggled with the business implications of this transition since it began offering streaming service in 2007. (Remember the Qwickster debacle?) Those business implications derive in some interesting ways from copyright law.
The DVD-by-mail model, on which Netflix built its success, was enabled by the first sale doctrine, which cuts off a copyright owner’s distribution right with respect to a particular copy of a copyrighted work when that copy is first sold. Because of the first sale doctrine, Netflix was not required to get permission from movie studios to set up its business. In the early days, Netflix simply bought DVDs—lots of them—from whatever retailers were selling them and then rented those DVDs to its customers. If the movie studios didn’t like that, well, too bad.
Over time, as its customer base grew, Netflix did enter into direct purchasing and revenue sharing agreements with studios, but it wasn’t copyright law that required it to do so—at least not directly. Netflix agreed to play ball with the studios in part to get more reliable access to larger numbers of DVDs. If Netflix could have lawfully acquired enough DVDs to supply customer demand without bargaining with the studios, it would have had the right under copyright law to rent every last one, forever, without remitting a dime in copyright licensing fees. Eventually, though, it became clear to both Netflix and the studios that streaming was the wave of the future. And delivering movies by stream to remote customers is not covered by the first sale doctrine.
Unlike the DVD-by-mail model, Netflix streaming implicates the movie studios’ public performance right in their copyrighted works. The law right now is a little unclear on this point, the question being under what circumstances streaming to the home is a transmission “to the public” within the meaning of the Copyright Act. (James Grimmelmann has a great rundown of the cases and their tortured logic here.) So Netflix is transitioning from an operating model that is clearly covered by an exception to copyright law to one that (very probably) requires permission for every content delivery. Whether the customer is watching a DVD or streaming, the customer’s experience is the same (assuming a good broadband connection), but the copyright calculus for the business delivering the content is different depending on the delivery medium. Under the streaming delivery model, Netflix has been negotiating licensing agreements to secure public performance rights, which it never had to do under the DVD-by-mail model. Sooner or later, the legal issues around the definition of public performance in the context of streaming-to-the-home will get worked out. In the meantime, Netflix has become a licensee, and the payments to copyright owners are flowing.