At first glance, it seems that Amazon would struggle in this battle.

It may seem a trivial point, but Amazon must consider setting up a dedicated portal and independent domain for videos, complete with relevant analytics such as viewing history. Consumers today have little patience and prize instant gratification particularly when it comes to casual entertainment

Secondly, Amazon’s Videos on Demand (VOD) is still 720p at best as opposed to Netflix’s 780p or 1080p depending on which devices you are using. On top of that its “Watch Now” feature is rumored to stream at 480p at least in the initial stages.

This might be a problem in the short-term, though I imagine Amazon will work to enhance the video quality of its movie collection. Additionally, it could definitely leverage its AWS (Amazon Web Services) infrastructure to enhance the quality of streaming over time. As consumers increasingly switch from renting physical DVD’s to watching streamed movies online, quality of streaming becomes critical. Netflix is believed to consume 25% of US’s internet data consumption, with only 20 million subscribers and limited movies available for streaming. It’s not difficult to imagine that in the near future, the internet will be increasingly clogged with video, and therefore it’s imperative that Amazon plans for that future.

Thirdly, Amazon’s VOD user base pales in comparison to Netflix’s 20m users. A mitigating factor here is that Amazon as a brand has a larger user base, and thus has the potential to scale its consumer base rapidly. The bigger problem for Amazon might be that Netflix has collected significant data such as movie history and recommendations over the years that serves as sticky features for its existing users and increases the switching cost.

Fourthly, Amazon does not offer DVD rental by mail service. That could make Netflix more attractive for those who do not have broadband or Netflix/Amazon capable devices. Netflix streaming combined with DVD rental by mail is a unique offering that lets people watch literally unlimited movies from a very large collection for a fixed price. This is indeed hard to match.

While you might think that Amazon with its marketing muscle and distribution power could match the business model, there are at least two reasons why it won’t. First, it might not make business sense for Amazon to mail rental DVD’s, since doing so will cannibalize its core DVD sales business. Being able to sell DVDs is crititcal to Amazon but no so much to Netflix whose primary business model is centered around rental. Second, while Amazon has exercised immense power in distributing books — it slashed book prices on Kindle to gain market share despite invoking anger from content developers — Netflix already has strong deals with studios that might not be easy to circumvent. As an example, Netflix intends to bid against HBO for Time Warner movies once its contract expires in 2013!

However, Netflix should not grow too complacent. Amazon will not go away quietly into the dark given the factors working in its favor.

Firstly, Amazon’s existing VOD (instant buy, instant rent) combined with “Watch Now” (free for Amazon Prime subscribers) could potentially offer a much larger library than Netflix’s Instant library: since Netflix’s model relies on fixed fees, it can’t stream all movies in its library for the same low fees, i.e., it has to compromise on the collection of movies to stream. Amazon on the other hand can offer a much larger collection overall because for the movies it can’t get “Watch Now” deal, it can still offer on demand via its existing model. Amazon thus has versatility in its distribution models that would allow it to cater to a wider set of tastes.

You might wonder why Netflix doesn’t offer a similar model: that is for the movies it can’t stream, it could offer them per user basis. I think it could make Netflix’s offering a lot more attractive, and move many consumer dollars spent elsewhere on internet TV’s (Apple TV, XBox Marketplace, Samsung and several others) to Netflix. However, I imagine that such an offering would complicate Netflix’s business model, cannibalize revenue from its monthly subscriptions, and making deals with studios more tricky.

Secondly, Amazon can potentially afford to offer similar services for lower price because it is “bundling” its streaming service with other benefits such as Amazon Prime. This puts Amazon in a much stronger position: It’s a no-brainer for existing prime subscribers to stream using Amazon. Moreover, it might entice more users to sign up for Amazon Prime because they could get two benefits for the price of one! This allows Amazon to actually underprice Netflix which it will indeed do if the rumors are correct.

Thirdly, Amazon’s marketing and distribution muscle is not to be ignored. It can easily tap into its existing customers to cross-sell its DVD streaming service. Moreover, with Kindle Amazon has proven that it is willing to go beyond its traditional business of selling content in order to sell more content: That is, by introducing Kindle, Amazon has further solidified its position as a prime content seller. By launching an Amazon set-top box or TV, it could potentially increase its footprint in the video streaming market (whether it succeeds in a tough home entertainment set-top box market is yet to be seen).

So there you have it, the perfect setting for a battle royale between two behemoths of the media world. Like any great technology bout, both players bring distinct strengths and handicaps to the table. Given the rate of evolution in video products, a fair case could be made that both could carve fairly independent niches in the market. In any case, the biggest winners will be consumers who will continue to be spoiled for choice in their quest to be entertained anytime, anywhere.