How Much are You Worth to Netflix?
And What It Means For How Much Netflix Can Spend on Content
As I wrote about in a previous piece, Netflix’s strategy with content is basically to produce original content which will bring in new subscribers and engage their existing subscribers (which leads to better retention ).
But how much they can afford to spend is dependent on the economics of how much customers are worth to them and how efficiently they can add new customers, which is what this piece is about.
The Value of a Netflix Subscriber
Netflix makes money by directly charging consumers a subscription fee for its service. Therefore, the value of a subscriber is fairly straight forward to calculate and depends on a few key things:
- How much they charge (ARPU/user)
- How much it costs on average to provide the service (Cost of Revenue/per user)
- How long on average a subscriber continues to pay for Netflix
The formula for the value of a subscriber over their lifetime is essentially
where churn rate is the inverse of the average lifetime of a subscriber.
Fortunately, most of these are data points are available publicly for Netflix, and so we can use it estimate how much a subscriber is worth to them. A couple of things to keep in mind:
- Customer lifetime value is dynamic and changes with variations in gross margins and churn, and so they can increase or decrease over time.
- When calculating customer lifetime value, we only consider the direct costs to provide the service (which for Netflix also includes all the content costs) but not G&A and marketing costs.
I’ve calculated it below using both the financial data from 2017 and based on the first quarter of 2018, and as you can see it comes out to ~$400 or ~$500 depending on the time period we use.
So roughly a subscriber is worth ~$450 or so to Netflix over their lifetime.¹
The Cost to Acquire Customers
A customer is worth ~$450 to Netflix once they subscribe.
But customers don’t subscribe for free — even aside from the costs to produce content, there are some other costs (marketing) involved in trying to get someone to subscribe.
We can estimate this again from Netflix’s financials, based on how much they spent on marketing in a given period and how many gross customers they added in any given period.
The marketing cost to acquire a customer is just the total marketing cost spent / total number of customers acquired. Note that the real customer acquisition cost also includes some content costs, but since they’re already fully included in the lifetime value we won’t include it here, but more on this later.
I’ve calculated it below, and as you can see it varies a bit based on the period we consider but it costs Netflix roughly $45 to acquire a customer.
Bringing it Together
So Netflix spends ~$45 to acquire a customer that is worth ~$450 to it meaning that their ratio of subscriber value to acquisition cost is 10. This is a pretty remarkable number, with a ratio of even 5 usually considered excellent.²
Netflix also has breaks up its streaming business into individual segments, which allows us to look at the above in a more granular fashion.³
A couple of things to point out here:
- The acquisition cost in the US is a lot higher, which makes sense since the business is more mature and advertising CPMs tend to be higher and so Netflix needs to spend more to acquire each additional customer.
- The value per subscriber internationally is lower, which might be expected given lower ARPUs but is growing quickly. The value of an international subscriber based on Q1 2018 ($340) was 85% higher than the same quarter the previous year, while the value of a domestic subscriber ($725) was only 15% higher.
What This Means for Content Spend
As I mentioned earlier, the actual costs for content are currently included in Netflix’s cost of revenue, and so in some sense, they’re being completely accounted as a cost to serve/engage/retain existing users, and not how at least a portion of it is actually helping in terms of bringing new users onto the service (i.e., as customer acquisition cost).
In other words, even though any spend on content has two benefits — to retain existing users and to acquire new users, currently they’re all being counted as a spend to “retain existing users”.
For simplicity, one way to correct this is to assume that say 25% of Netflix’s content spend is exclusively used on acquiring new users.⁴
This means that Netflix’s cost of revenue is actually 25% lower per user, meaning their Lifetime Value is ~40% higher at around $625.
Now, say Netflix is trying to maintain a LTV/CAC ratio between 4 and 5. This means that they can spend roughly ~$125–145 on acquiring a customer. We know that ~$45 is spent on marketing costs, meaning that on the upper end, they have $80–100 to spend per acquired customer on the content to acquire them.
This allows us to approximate Netflix’s “spending power” when it comes to content.
For example, say they are creating a new niche show to grow their subscriber base. Because on the upper end, they would want to spend about $100 per customer they expect to acquire from it, if they think a niche show can bring in 250K subscribers, they can spend up to $25M on it.
Alternatively, if they’re spending $8M per episode (a higher end for content spend) on a high quality 13-episode TV series, they need to believe it can bring in 1M subscribers for it to be worth it from an efficiency perspective for them.
¹ To keep things simple I didn’t discount future earnings from a customer. With a 7% discount rate, the number drops to ~$250.
² The ratio is closer to 6 when discounting the future earnings in lifetime value.
³ The figures are based on financials for the full year of 2017.
⁴ In reality, every piece of content has both a benefit in terms of retaining existing subscribers, which can be modeled as a churn reduction for some portion of the user base and a benefit of bringing in new subscribers, which can be modeled as a customer acquisition cost for those set of subscribers. In that way, the content costs is split between both cost of revenue and customer acquisition costs.