SECTION 5

A service like Netflix faces a fundamental chicken-and-egg problem. You can’t get an established base of users unless you have a fairly complete library—users aren’t going to be very interested in a service that only has half the movies they want to watch. But if you don’t have a large user base, you don’t have much leverage against major content providers, who are going to hold back their best content as leverage to get terms favorable to themselves.

Luckily, the classic, DVD-based version of Netflix had an ace in the hole: copyright’s First Sale Doctrine. If a studio wasn’t willing to license its content to Netflix directly, Netflix simply went out and purchased copies of DVDs at retail. Renting out your legally-purchased copy of a DVD isn’t copyright infringement, so there was nothing the studios could do to stop this. And this strengthened Netflix’s position at the bargaining table, because they could credibly threaten to walk away from the table if the studios made unreasonable demands.

This became crucially important as Netflix moved into the streaming era. There is no equivalent to the First Sale doctrine for online streaming. If you want to run a streaming service, you have to cut a deal with each copyright holder whose content you want to stream. And Hollywood, fearful of losing control and undermining its existing revenue streams, has been cagey about allowing Netflix to stream its best content.

The DVD-rental option gave Netflix a crucial fallback position at the negotiating table. Because Netflix has a complete catalog of movies available for rent by DVD, they don’t need any specific title in streaming format. So they could cut deals with the content creators that offered them reasonable terms, and stick with DVD rentals for the rest. That’s a little bit inconvenient for customers, but it’s better than agreeing to terms that would force Netflix to jack up its prices.