The Future of Netflix

Netflix- Less Red Dawn, more Soylent Green

Netflix… what started as a DVD rental service, competing with the likes of Blockbuster, became a pop culture idiom recognized both on and offline. While it’s easy to find tons of inspiring articles that describe Netflix as a success story, one can’t help but wonder if the service really is all it claims to be and whether it can really achieve what it proposes to do?

Analysts don’t think so and I, for once, agree with them. While plans for global expansion and original content productions sound great, Netflix’s main challenge consists in growing value per customer, whilst being able to deliver content that is more appealing and unique than their competitors.

Same business model…but different

While Netflix’s business model (paid streaming content) is quite similar to the remaining players in the field, there are inherent differences when it comes to content production and monetization strategy

1. Original Content- A season for a new TV show (which comprises between 10–13 episodes) can cost Netflix, between $40M (House of Cards) and $90M (Marco Polo), and that’s excluding advertising costs. The goal is then to offset these costs via an increase in paying subscribers.

With these expensive price tags it becomes necessary to analyze Netflix’s content-creation strategy. It has adopted a push-strategy; putting the content out there and expecting that audiences eat it up. The results have been mixed: hits like Orange is the New Black and Narcos have triumphed while the expensive Game of Thrones copy,Marco Polo has tanked.

Amazon, on the other hand, has chosen a pull-strategy. By creating a pilot season, the content producer relies on audience reviews and comments to indicate which shows should receive a full season order. A practice that has translated into high viewership numbers (The Man in the High Castle) as well as positive reviews and awards (Transparent, Mozart In The Jungle). In addition they spend, roughly, half of what Netflix does.

2. Ad-based model: An idea that has been rumoured around and toyed with focuses on Netflix changing its monetization model into an ad-based model. I think this is rumour makes sense when you consider that there’s a certain limit beyond which Netflix can’t increase their subscriber base.

Current estimates point out that, based on average viewing habits, users are consuming a smaller amount of ads per year (but certainly not the 160 hours mentioned in recent articles), which suggests that there’s potential money being left on the table by Netflix.

Although the company has repeatedly commented that it is not considering a two tariff model (a more expensive but ad free subscription and a standard one with ads), the opportunity to use an ad-based model as opposed to forced price hikes seems too good to pass. The cost associated with this model is the potential risk of alienating the viewer base with the introduction of such a system.

Competition

Defining the competitive landscape for this particular industry is quite tricky. For simplification purposes let’s ignore the free streaming alternatives that exist out there and focus on direct competitors: Hulu, Amazon Prime, HBO Now, etc. While Netflix is currently winning the “User Base” battle, it is relevant to see how the players differentiate themselves:

1. Netflix vs. Amazon: Content-wise Netflix appears to win based solely on the amount of output released. However with a closer look at Amazon’s library we see something unique: the option to buy or rent new and exclusive content — sort of an add-on the user can choose from. Netflix lacks this choice. Amazon also wins when it comes to offline access. The real upper hand that Netflix has is in price: while Netflix’s $96 yearly subscription cost vs. Amazon’s $99 seems irrelevant, the fact is that Amazon requires an upfront payment for the Amazon Prime subscription, which certainly undermines the freedom and flexibility users tend to value.
2. Netflix vs. Hulu: Hulu offers a wide variety of content in its library, including access to shows aired by the major broadcasting networks, trumping Netflix when it comes to content. However, the platform has an ad-based monetization strategy that can put off users, giving the edge to Netflix. Still, while Netflix couldn’t possibly switch to a two tariff model without jeopardizing future growth, Hulu has plenty of space to do so with less risk. Price-wise, both players are on the same level.
3. Netflix vs. HBO Now: Netflix has the upper hand on HBO,for now. With a higher monthly cost ($15) and a very limited library, HBO’s streaming service has very little going for it. Still, if you use “original content” as a metric, HBO’s output definitely surpasses its rival; with recent hits like “Vinyl” and “Game of Thrones” and classics like “The Sopranos”, HBO’s quality seal is an industry benchmark and could, to some users, be enough to justify the price premium they would have to pay.

The key takeaway from this is that no player has it all and that Netflix is certainly facing fierce competition from its current rivals.

The previous comparisons are restricted when it comes to geographical scope (mainly US-focused). However, as video streaming takes off around the globe, new contenders will rise to compete with the incumbent, like iflix and HOOQ in Asia.

And of course, let’s not forget the potential risk of vertical integration; traditional broadcasters starting to find their feet in the digital streaming world. The outcome: less content available to be licensed, as broadcasters no longer need to use a third party platform, and a very fragmented offer.

Quality and diversity of the content

Picking up on the previously-addressed topic of content I, as a movie buff, feel that the platform leaves a lot to be desired (especially considering that during my 1 free month trial I watched this, a movie that made me rethink how I spend my spare time).

In the streaming business content is king and Netflix operates a hybrid library comprised of both original content and licensing. With the total costs of content escalating from $3 B to $6 B in just one year, the stakes keep getting higher.

However, the average quality of both original and licensed content presented on the Netflix library tends to fluctuate…a lot. You could argue that Netflix could just simply spend more money enriching its library or even buy fewer but more popular titles. The big question is: Would the major studios be willing to sell?

Studios make money by selling the content across multiple platforms, both physical and digital. Why would a studio want to restrict the revenue it can make from this year’s summer blockbuster by licensing it to an exclusive partner (in this case Netflix)? It wouldn’t, making streaming services dependent on both what studios are willing to sell and the quality and appeal of the content they are willing to produce.

Content may be king, but the decision to sign an exclusive four movie deal with Adam Sandler is far from a royalty move. How can a company justify signing up a multi picture contract with a star that, on top of rubbing critics the wrong way (his movies have 16% approval average on Rotten Tomatoes), has been box office poison for the last 6 years (with the last 7 movies failing to make a profit)?

Well, it could be argued that he will increase Netflix’s global awareness. But will viewers rush to subscribe in order to see Adam Sandler? Only time will tell, but considering that, on average, less than half of Mr. Sandler’s total box office revenues are generated outside of the US, I wouldn’t bet on it.

Another common point made about Netflix’s content is how it changes from country to country. While the usage of a VPN exponentially increases your library and Netflix is not actively against their use, it’s only a matter of time until traditional cable providers are against it.

A good example comes straight from my home country: Netflix doesn’t own the distribution rights for “House of Cards” in Portugal having sold them to a traditional cable channel. Assuming this happens often in other markets, it’s highly unlikely that cable operators will sit still while their customers access the content via VPN.

To conclude the discussion on content, I would like to point out that as Netflix evolves in its international expansion it will eventually start producing more and more local content. Yet another additional cost that will increasingly become relevant on the company’s balance sheet. Regarding the return, let’s assume that content creator will grow its ability to better understand local tastes and preference (Marseille, a French Netflix production shows that they still have a long way to go).

User Base Evolution

A constant in all articles praising Netflix is the subscriber evolution. Monthly, quarterly and yearly growth appear to be quite impressive, but besides questioning their sustainability after the major expansion that took place between 2014 and 2016, additional analysis is required.

While some sources point that Netflix has over 75 million subscribers worldwide, the fact is that this number refers to total memberships, as opposed to paying memberships (which according to the company’s annual reports are just over 70 million).

The international segment is becoming increasingly important in the company’s portfolio and is undoubtedly growing faster. With less dependence on a stagnating domestic market, the company’s future is now heavily reliant on an uncertain international market. Still, overall growth on year on year (YoY) basis has been slowing down since 2014.

(Source: Netflix Annual Reports)

When it comes to churn Netflix has been relatively low (when compared to its competitors), at around 9%. This doesn’t take into consideration the price hike that most subscribers encountered last month and that could potentially impact this indicator.

Enforcing anti-piracy regulation

With the sole exception of a few countries, like Germany, very few other markets have enforced any law that actively pursues users who use “grey area” or illegal streaming services (like Popcorn Time). Unless a radical shift occurs this poses a serious threat to further expansion.

While shows like “Narcos” and the latest season of “House of Cards” have dominated the recent TV-related conversations I had with a sizeable and diverse audience, not a single person has used Netflix (ie. paid the platform subscription) to watch any of the shows.

Considering that in the last year Netflix has expanded into more than half of the countries with the highest piracy rate in the world, it will struggle to justify its price unless it offers a degree of differentiation that is valued by the users. Failure to do so, will seriously undermine the player’s ability to grow.

The future of Netflix

With a 100% increase in costs associated with content, a subscriber growth rate that has been slowing down for two years and competition from both similar platforms and controversial streaming services, Netflix certainly has a tough challenge in meeting its “global domination” objective. With China being the only untapped market, the opportunity to expand by delivering the same service grows thin. Like in “Soylent Green”, Netflix is made out of people; paying users who want more bang for their buck when it comes to entertainment. Is Netflix the player that will be able to deliver this?

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Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any other party