Netflix — Not Yet Broken
Netflix’s subscriber loss and corresponding plummeting stock price recently made headlines in the finance community. As of this writing the stock is down ~35%, a thud so loud it knocked off over $50 billion of market capitalization.
Rivaling the stock’s crash, however, is the speed at which Netflix critics pumped out their articles. The streaming pioneer that has lead the industry for the past two decades is now a “broken growth story”. Analysts and bloggers who previous worshipped the management team for delivering consistent 20% YOY growth and deemed that the company could do no wrong are now screaming for its demise.
How fickle are the words of pundits, swaying with the wind and rushing into the safety of herd mentality when the popular opinion turns.
Now I have never cared much about Netflix. Over the years I watched its stock soar with curious bemusement, keeping it on my radar as a typical growth company while focusing on other opportunities.
When famed investor Bill Ackman took a $1 billion stake earlier this year, I decided to stop being lazy and actually dive into the company. What I found was a world class team delivering a world class product at a premium price I was unwilling to pay. With the stock price back to the early 2018 levels, I suddenly realized that the herd following pundits might be wrong, and that contrary to mainstream sentiments, Netflix’s future might be brighter than we think.
On announcing earnings, Co-CEO Reid Hastings cited two key initiatives to reignite growth:
- An ad supported lower price tier
- Cracking down on password sharing
Many were not impressed; for a company that has steadfastly resisted advertising, this certainly feels like a desperate hail Mary rather than a long term business plan. Let’s look a little deeper to see if there is any merit to the strategy.
By Netflix’s account, there are 100M shared accounts around the world, 30M of which are in the US and Canada. This means there are at least 100M people out there who enjoy Netflix’s content, but are not willing to pay the current price.
Now here is where I indulge my inner economist, but bare with me I promise I will keep it short. Given that the company generated $7.87B in revenue from 221.6M subscriptions in Q1, we can estimate the standard subscriber to be paying $11.83/month. Suppose that the average account sharer only derives 50% as much enjoyment from Netflix as the standard paying subscriber, that means the most he or she is willing to pay would be $5.92/month, far below the current lowest tier of $9.99/month.
If an ad supported $5.99/month tier was made available, and password sharing was more strictly enforced, a lot of these folks might decide to keep enjoying Netflix at a price they find much more reasonable.
Admittedly, I am one of those people.
I never enjoyed the company’s massive hits such as Stranger Things or Squid Game (oh the shock, oh the horror!), but I do love their amazing documentaries covering everything from neuroscience to Michelin star cuisine, all of which are perfectly produced and simply wonderful. Since I only enjoy a limited portion of their catalogue, I have always found the standard $15.49/month pricing too expensive, and even the $9.99/month option a little excessive. Yet I have always longed for a cheaper option. While the $5.99/month price is a hypothetical I threw out based on back of the napkin math, personally I would not hesitate to subscribe if it was made reality.
The art of pricing is all about balancing price paid verses value received. Currently at least 100M people value their enjoyment of Netflix below $9.99/month but somewhere above zero, so why not try and welcome them at a price point they find more reasonable?
“But wouldn’t Netflix need to spend more to satisfy the new influx of subscribers?”
Well, probably not. Remember, Netflix is a business with largely fixed costs.
Let’s assume that:
- Netflix’s monthly revenue is $10B
- The average viewer demands 10 pieces of quality content per month
- It costs Netflix $10B a month in content creation to meet that demand
In this scenario Netflix plows all its revenue into satisfying customer demand for content and has zero dollars left over each month. Suppose, however, the subscription base suddenly increased by 50%. That is not going to push up the amount of content demanded as the average viewer will still want 10 pieces of quality content per month, which means Netflix’s content creation spending stays constant at $10B. However, monthly revenue just rose to $15B, creating $5B of excess revenue.
So far Netflix has been reinvesting billions of such excess revenue back into content creation.
Why?
Because when a smash hit like “Squid Game” gains worldwide fame, it generates huge amounts of publicity that drive additional subscribers to the service while delivering an amazing piece of content to keep existing subscribers happy. When your marketing strategy is literally viral marketing and customer satisfaction rolled into one, it would be foolish to spend money anywhere else.
So what happens when Netflix decides to increase subscription base further through offering a lower priced plan AND scale back content creation spending? Hmmm… cha-ching?
After all that, does that mean Netflix is guaranteed a bright future?
Of course not.
The case I described makes a lot of assumptions (blame my economic schooling), many of which are not certain; it’s possible that when the cheaper ad-supported pricing is announced, so many existing subscribers currently paying $15.49/month or $9.99/month will decide to switch over as to actually lower total revenue. It is also possible that the 100M account sharers value their enjoyment from Netflix so little that any pricing that is acceptable to the company is unpalatable to these users.
This article grew more out of my frustration with the herd following pundits than anything else. These professional bullsh*tters with no skin in the game simply conform to whatever is the popular opinion with no conviction or integrity behind their mumbling.
I bought several thousand dollars of Netflix stock as I sat down to write this article, right as the WSJ app notified the world that Bill Ackman has sold his stake at a massive loss. Am I making the investment because I am so confident that I’m right? No. I’m doing so because words without conviction are cheaper than a liar’s promise.
Whether I turn out to be right or wrong in the end, I hope I was able to provide an interesting contrarian perspective to the readers, especially when popular opinion is overwhelmingly supporting a single narrative.
“Where all thinks alike, no one thinks very much” — Walter Lippmann
