Netflix Business Model & Economics

Bobby, can you share some context to your role and responsibilities at Netflix?

I was fortunate to work for Netflix from 2013 to 2017, so four years with the company as it was expanding globally. It was in 30 countries when I got there and 180 by the time I left. I was fortunate to be part of that expansion and saw what went well and what didn't. The other big initiative, during that time, was the Originals initiative. Today it just seems that's what the company is, but during my tenure it was licensing heavily. During my first week they had just launched House of Cards, whereas now they launch an Original every day. My role largely focused on those two big company initiatives – how you sequence the countries and allocate capital into those markets to acquire subscribers, which shows perform best and how to market those shows. I had to think about pricing and everything in between just to grow the service. I was in a proper planning group working to allocate capital across those regions.

How did you look at modeling subscriber growth in the US?

Netflix looked at it in a couple of ways. When folks want to think about it, the addressable market is broadly households. Just because you have a TV doesn't make it enough to get Netflix; we know you need a broadband or at least a high-speed connection of some sort. In the US there's about 80 to 90 million broadband households. They look at that as their ceiling. For several years they put out the long-term view, when they were much earlier in the investment piece, saying we think in the US we can get 60 to 90 million, where cable and satellite packages of 50 to 100 channels went; we're much lower priced and more convenient, so why can't we do that? They've already passed the 60 million mark, domestically. Can they get to that 90 million to match where cable and satellite bundles have been? It's a little harder to imagine with the product now, having no live news or live sports, that it's a full replacement for cable television. Will they get to 90? It seems further away. I believe their question around forecasting the subscriber growth; it will be lower in the US and they're very explicit about most of the growth being international.

That is looked at similarly. How many homes had a pay TV package and are willing to pay $50 to $100? Now we pay $15 for a Netflix subscription which gives you a comparable amount of content, a better personalization, recommendation on demand across any device. Still not that live viewing, still not maybe as much local content as you might have expected, although they're getting better at that. I think they look at those penetration rates of where cable packages got to, where broadband is in a country, as a pre-cursor to them, which in some developing nations is harder. As they move into developing nations like India and others, they might even forego those proxies and look at a little more mobile penetration. India never had widespread 100-package cable channels for $50 a month. They never really even had broadband adoption at scale, moving straight to a mobile infrastructure instead. They'll think about it very differently with lower price points, but the key value is that they believe entertainment of TV and movies is a universal value proposition. This will, in many ways, replace the existing channels, just like smart phones replaced land lines. It is only a matter of time before streaming video services replace linear television packages. Whether that takes two services or three services or one, Netflix helps to be part of the mix. You're talking about a very big market that has been built over a century of TV infrastructure, which is now shifting to a digital infrastructure. This is merely a replacement versus a new category that exists on top of it.

Given Netflix are at 73 million subscribers in the US, it could be likely that they might be moving into news and sports relatively sooner than expected, if they want to get to that 90 to 100 million mark?

I'll take the other side of it. I don't think they want to move into it, nor do they need to for growth. I think to further saturate the US, they would probably move into news and sports more aggressively. They are growing just fine in the US and are growing even better internationally, so I don't think they have to. I think they would do that as a distraction tax for a few reasons. If they were to move into news and sports, live is largely supported by advertising. Advertisers pay a premium and people don't skip the commercials as much. Do they want to go out and build an ads sales force of hundreds and thousands of employees, insertion of dynamic ads, data which Facebook and Google have been collecting for years to do this at scale? It is beyond their focus right now, especially when they have this massive opportunity to take what they've already done and port that over to new countries with different content. They're dabbling with news and sports and reality and other categories and they'll push those. But you'll see non-scripted, the reality competition shows they're doing, before news and sports. Sports is extremely challenged and maybe that will shake out over the next three years, but I don't see it as a near term focus.

Can't they bundle sports into a premium plan, rather than ads and have a premium tier, for example?

Certainly, I think Disney does that very well with Disney and then you add Hulu and then you add ESPN and it costs $5, $15; it's cheaper when you get all three. They could, and that would be a strategy to raise price, which they're doing effectively. They just did a $2 price increase a year. They're talking about great retention, they're growing the US base, despite being saturated, which means retention is in play, and they're able to move price up across the globe over time. Why add more content that requires more cost and all of that? Secondarily, the sports rights are locked up for a longer time, so they don't come up. Every time they do come up, the conversation with Netflix comes up. Will they bid? Will it happen? One of these days it will be true, but I don't think in the next 18 to 24 months any of those rights are pending. Netflix would not have the technology to go there. There will be a point where Netflix's growth slows and they have to look at those spaces, to see if it makes sense for them, just not in the near term.

In the early days, you were modeling subscriber growth on number of households in the US, plus the broadband or smart phone penetration or iPads, for example, to get distribution. As we do get to saturated markets in that sense, does it shift more towards content and new content driving growth?

I think there's still an underlying seasonality that exists, just like in most industries. Summer has always been a big movie season, minus this year. People went to the Summer box office, theaters put their best movies in that disproportionally. Retailers disproportionally benefit in the holiday season, to make most of their sales or back to school. There is a natural seasonality to streaming video and, for the last decade, that has largely been around Q4 and Q1 where people buy devices, device manufacturers launch new TV and home electronics, and then they sign up for Netflix, because that's what those smart devices do very well. You'll always see a disproportionate sign up period around Q4 and Q1, but that's what any analyst can predict.

When you can outperform and underperform, maybe it's because you have some content that helps lift the quarter. You were going to get a million subscribers in Q4 anyway, just because that's when Apple and Samsung release their new devices and, all of a sudden, Netflix reports at 1.5 million. They might have just had a surprise success with one of their new Originals or a second season, so Originals can bend it. It doesn't usually take that million to 2 million, but 1 to 1.2, and it's usually not a single Original. They're now putting together a series of things like Tiger King, an action movie and a returning season of The Crown, all in one quarter. They launch it together which helps it improve. Content can increasingly overperform or underperform, but there is still an existing adoption cycle that is going to happen. If Netflix did no marketing or new content, a user would say this is a superior product compared to my linear television package which is three times as expensive, half as convenient and half the selection, with commercials. That will naturally happen as people say this is a better product, and it will happen even faster as the content is excellent.

How does Netflix look at pricing in the US?

They just commented on their last two earnings calls that they're not looking at a price increase. They have taken $1 each of the last two years, and then $2, if my history serves me correctly. Each time when they do that, they produce a little bump in churn, existing customers get a little frustrated, new customers maybe a little less apt to go. Then they have a slower growth quarter and the doomsayers come out and say this is the end. Further quarters down the line, you will see it come back. They take their time and they usually talk about the fact that they've earned the right to increase the price. They're spending significantly more in content, the product is significantly better, with better recommendations, better marketing, better customer service and customers are, essentially, retaining better than they ever have. For that product, they say they're going to charge you a little more.

Netflix are now spending $15 billion in content versus $10 billion, which means the number of shows and movies that can be produced at the actual level are there and, therefore, they think they can charge you a little more. They think very actively about price, but in the US, they are smart and sensitive to the time the world is in right now – where we are in a severe recession, potentially depression – and there is a lot of scrutiny around internet companies and their power. I think they are going to be very careful there. The real question, if you look at more of a five-year view, is do they have pricing power domestically? I absolutely believe they do. They're going to continue to accelerate their spend, the number of shows and categories such as unscripted theatrical movies they are investing in. I think that will, eventually, result in what Disney is now doing. Disney is experimenting with bringing a $30 super premium movie, like Mulan, which was supposed to go to theaters, and bringing it onto Disney Plus and expecting consumers to pay a regular subscription fee, plus $30 on top. Netflix would take that same movie, that is maybe on a par with Mulan or The Irishman, and give it to users for free.

Eventually, they are going to say, you are getting these movies at Disney – who are charging you $20 to $30 – so we are going to increase our price from $13 to $15. They are still not the price leader, as they are behind HBO Max which is $15. Netflix has a $15 price but its average user is not there, as they are on a lower tier. They have a chance to move people up those price tiers, but I don't foresee that happening in the near term. They have that option when they choose to exercise it and I expect them to exercise it very diligently and thoughtfully.

In terms of exercising that pricing power, is that determined mainly by content spending or do they look at viewing hours or other variables to determine that?

I think it is about content viewing and, more directly, retention. I don't think they have a material view; if you used to watch 10 hours and you retained but now you only watch five hours and you retained, it's still a retention. Obviously, they would like it to be 10 and retained, but I think they are less focused on total hours of consumption. They used to release reports showing a billion hours over the holiday, Amazon streaming, representing X percentage of all internet traffic. Although impressive, do I think they would rather you watched 2.5 hours of The Irishman than 10 hours of re-runs of Friends? They're probably indifferent, but The Irishman represents something they will have forever. It is an IP associated with them that will never go away. Friends is going to leave and go to Warner or a different service in future, so all hours are not created equal. Certainly, we know if you watch more, you retain more.

Retention is a signal that I am willing to pay you $13 to $14 a month and I'm so willing to do it that I might even pay more, because I've been with you for three years. That is the first factor, but will this turn off the 190 million subscribers they currently have and create churn, like the scar they have from the DVD Qwikster days, when they had the service? They separated and did an ill-timed pricing increase which resulted in massive churn. Ever since then, they have been more thoughtful about it. They will ask their users for permission. They have implemented grandfathering in the past, so they will do it as thoughtfully as they can, but it will be driven a little less, so that it can sign up the next 10 million members without alienating the existing 200.

It is an interesting strategy from them, because they are obviously priced very low and it is a great offer for what you get. That was a conscious effort in using the price to almost subsidize or fund the growth, in effect, by giving such value to the users, but I guess the big challenge now is moving that up to make that free cash flow from Netflix?

I don't think it's a march from whatever that 13, 15, to 50, back to the cable bundle. Maybe, for a user, they put together Netflix plus Disney plus Warner and you're at 45 to 50 bucks on your own, but I don't think Netflix sees themselves as a $50 service in the foreseeable future. Is it a $15 to $20 service? They have ambitions to get there but that won't result in free cash flow. The free cash flow is already coming in with their latest earnings at $15 being the price plan ceiling. They do have a path to it and they think about it over the long term. Each year, free cash flow will expand or losses will expand and then it will become profitable in '21 or '22. They believe scale is a more important factor than ARPU. ARPU is relevant, but if Netflix can get a bigger base of 200 to 300 million subscribers each paying $15, versus what cable had, 90 million each paying $50, they will be able to have comparable if not better margins than the cable and channel ecosystem ever had. Netflix has scale and synergy across content with people in India and America watching each other’s content

You mentioned their content is global in nature, but what percentage of viewing in international regions is local content versus Hollywood produced stuff?

I do not have specifics that I can share on that. You should think of local content as an important acquisition strategy, rather than a retention one. I mentioned that framework how everything about price is thinking about the existing 200 million users and it doesn't matter how many new users you get; if those guys are going to go away then you are just wasting it. Those users, increasingly, have a library and the recommendations are well understood. To get a new user in a country, you might want the local star or franchise which resonates more and, therefore, it doesn't feel like this American invader. India is a classic strategy where they are investing heavily in Bollywood, by bringing in the top content, directors and actors, because that is what will get the first 10 to 20 million subscribers.

They can license the old stuff, bring in their international domestic US and European products, and see what works. As the recommendation algorithm gets better, they can figure out all the money they are spending. This is better than that, therefore cut that. In order to get to some scale, I think new acquisition is what drives that initial user base. It also drives the 61st millionth customer in the US, but it's much more critical to get that. Yes, there is no doubt that content is critical.

Netflix have a content budget over the next few years, which I assume they allocate to certain regions. Taking India as an example, if they spend one billion over the next year to attract X amount of new subscribers, but simultaneously want to retain their existing ones, how do you look at that?

Think of each of these countries or geographies of having their own P&L. When you make a show like Stranger Things, you allocate that cost across all regions. It has a higher cost in the US, because it is watched more there. It also has custom native language in the US making it more popular than in India, but India will absorb some of that cost. When they, similarly, take Bollywood's top talent and make a Bollywood show, some of that cost comes back to the US because you spread that cost.

The revenue needs to exceed that cost to be a profitable business, which is a pure function of local subscribers. In the US, they have 60 million plus subscribers each paying 13 to 15 bucks. That is their cap on what they can spend on content. They should not spend more than 60 million times 15 per month, in the US, or they are running a non-profitable segment. They can do that in India where they have five million subscribers, but spend as if they have 10 or 20 million because they have to forward buy. Subscribers will stay and help train the algorithms, but at some point, they will look at their long-term steady state growth in India. Once they pass the investment phase, they expand margins. This is what they are doing in Europe and Latin America and that dictates the spend. In Europe, where they are approaching 50 to 60 million subscribers, they will try to spend less revenue to get that market profitable. Is Spain different than France and Germany? Yes, they all have different inter plays but at a portfolio level, Europe needs to be profitable and it needs to increase every period. They need to add more subscribers than content and operating cost. That is how the budget gets sent, with some leeway for forward acquiring subscribers.

Using India, again, as an example, with a possible 100 million households, they say, we can get to 40 million and therefore spend this budget, but have a long-term view and work back from that to try acquire those customers?

They do not expect to get to 40 million tomorrow, nor do they expect to spend at the 40 million level, but something between. They are at two million now, so they earn their rights, start spending as if they have five or 10 million customers, then once they get there, start spending as if they have 10 or 20 million. Once they reach 20 million, they can spend accordingly. That is not an exact framework but that is how to think about it.

How do you look at different distribution channels, internationally, versus the US and how does that feed through unit economics?

I'm assuming that by distribution, you mean carriage through iTunes or even through a Samsung hardware provider? Distribution is a challenge everywhere. You can ride on existing platforms like iOS and Android, which exist globally. When Netflix launches in a new country, it doesn't have to strike a deal with Android or iTunes. They have a global deal, for the most part, and users know how to download apps on their smart phones and tablets. When you get to TV it's a little harder as you have to work with the TV provider, like Samsung, to get in the store, whether it be Vizio or another provider. They have been doing that for decades and are very good at thinking about global deals. When they make an app for Sony TVs, they not only put it on in the US but also in Japan, because they've negotiated those deals globally. Those are largely comparable – there may be some regional nuances – but they're set up very structurally.

The newest amount of distribution emerging, is with traditional distributors of content like Comcast or even newer distributors like T-Mobile and Verizon. With Verizon, you now get Disney Plus for a year for free and then Netflix shares some revenue back to Verizon, as does Disney. That is a really great boon for new users or those laggards who are not in a position to go to a website and enter a credit card, and are very used to sticking with their cable bundle and adding one more channel, the way they used to at HBO. It reaches a different segment of the population that is a little less apt to be a direct consumer, but it's still a very small percentage of their overall growth. They rely on their primary acquisition to still be the organic channel, where you go to their website and sign up because you have heard about the great content which they are marketing. You have heard about the great simplicity of the service and you go and do that. They do not want to limit themselves from an older or international demographic, who may never have heard of them.

These deals may be more critical when you enter India, to be on India's largest mobile provider. It is only a short-term boost, because over the long term, users are going to get these services. The vast majority are going to find ways so you want to make it as easy as possible. It is not like they will not find their favorite show because of the website; that user is probably only a few of them. Netflix has been leading this industry for years on how you think about distribution with hardware devices, cable providers and mobile providers. They are in sync with the market. India has a lower price point at 3.99 or 4.99 for a plan. The revenue share on distribution is going to be a percentage of that, not a percentage of 15.99 in the US, so it balances both ways.

If we say, for example, there are two million subscribers in India and Netflix want to spend four billion next year there, hypothetically. Modelling out or assuming new customers, taking into account the lower ARPU in that market plus the lower contribution margin from paying distributors, how does Netflix look at amortizing the content cost over all of its subscribers, if it's only local? I'm trying to work out how you look at allocating that capital to new regions.

There's probably a lot of work going into it. I'll give you a more simple framework and I do think, for all the science and data that Netflix brings, they represent a very simple view, that this is going to happen. Adoption of streaming video is going to happen. It went from zero to 60 million in the US. It went from zero to 50 million in Europe and it's going to happen in India. We can debate the time frame but not the if. They may be wrong in that view but that is their view. If India has a potential market of 40 million, high speed, affluent customers that can afford to pay a plan and put in a type of billing that works with Netflix, it will happen. We can debate whether that is over two years, five years, or 10 years, and who is going to get that share.

It is the same way that everybody is going to get a smart phone and we can debate Android versus iPhone's share versus somebody else, but India is now going to have an in streaming video. Is it anomalous to the rest of the world because it has happened in Latin America and it has happened in Europe? How do you attack the Indian market? Do you have some Excel jockey figure out every dollar and dime and case of this? They do the best of that that they can, but really, it is a learning ecosystem. We're going to try some original local content, and if it doesn't work, we are going to try some different one and then we're going to try licensed content. When we do a marketing through Facebook and Google's traditional advertising channels, we get a lot of sign up. If we do not, we are going to expand the partnerships. There is no single playbook that you should have more distribution partnerships than you should have paid advertising. This category is going to come and Netflix figures it out.

The same question could be asked; how much should Netflix spend in the US on premium television versus unscripted? They're going to spend a billion dollars on unscripted and if users continue to sign up and they get great revenues, they're going to go from a billion to a billion and a half. If it's not working, they're going to take that billion down to 500 million and take the extra money and try movies or documentaries or move it to a different country. This is all about pushing it out, testing it and then seeing if it works. They then have a very long time to iterate and move it across the globe, on a thesis that it will happen. If you are consumer friendly and consumer focused, you will iterate to this thing.

What they know, having done 180 countries is that there is a taste for local content. In Europe, there is a taste. Maybe it is 20% there because they have always had a closer tie to America than other regions. In India, they enter with a prior hypothesis that India has one of the strongest content preferences for Bollywood and is not as large an importer of Hollywood content. When they started that catalog, they started with 50% instead of the 20% which they would start in Europe. Maybe the final mix will be 70% local. They will spend and test their way into that and so long as they're growing, they have a very clear signal on what is working and what is not. When your viewers watch, it's the clearest signal.

One question around Netflix is the amortization of content. You can spend $15 billion because you have 200 million users and everyone gets access to this. Conversely, if Netflix is spending $2 billion to $3 billion dollars producing local Indian content which is not relevant to a large portion of the users, you can't really amortize that cost across all the users?

That is correct; local content has to pay for itself in that country. It is very hard to believe that a small country of 10 million will have heavy investment. The reason Netflix says Indian or Japanese local content have bigger budgets than Norwegian, is because the base is never there. That has always existed. Norway probably imports more BBC and US content. but they do have some of their own. If the prize in India is 100 million, the prize in Norway is not, it is just not that big a country but they can invest more in local content.

The last part of it that also represents the investment in local content is that Netflix are saying they are truly a first and one of the global services where India content is playing elsewhere. There is an Indian population in Europe and there is an American population in India which cross over. Different nationalities are watching different content. That doesn't happen with every show; but they talk about several Latin American shows that are very popular in Europe, and some Korean shows that are very popular in America. Is that the rule? No. Do they do it better than anybody else? Yes. Local content will have its cost and the 60 million American subscribers do subsidize early countries, in building their local catalog, but not in a detrimental way where it becomes perverse.

Arguably, the return on the incremental dollars spent on Indian content is actually not as high as it was in the US, because that US material could then be used by myself in the UK or someone in Norway or a more global content slate, rather than India, which is not as global?

The ideal portfolio is that they produce something in Hollywood which works in all 180 countries and they amortize the cost perfectly. Netflix started with this thesis; as they expanded House of Cards and Stranger Things would work globally so do we need local content that much? They've been learning, in Latin America, that Telenovas are very popular. You can't bring in American soap operas, and Telenovas are not as an expensive production as a $100 million movie, so they invested there. Could they do a signature show in Europe? They have, and there are several reasons they did. America's prestige around the world is not exactly at its peak, so to avoid feeling like an American invader, a good PR move is to have local content. This does work, otherwise they would not be investing further into it.

On a government regulation perspective, this is very important, particularly in Europe where American regulation of tech companies is probably not a matter of if, but when. Netflix have been saying, we are producing now and employing thousands of people on thousands of productions across the globe, employing local talent here. The government is then heavily incentivized to have these jobs exist and appreciates Netflix bringing that community there. It serves a public function, as well, which is perhaps less well understood. In the end, I do think it is incrementally positive or they would not be doing it.

That is part of the uniqueness or innovative model that Netflix has, where it operates at such scale. They can amortize it over all subscribers and everyone might not watch the content, but it has redefined the entire media space. It remains quite interesting to understand how to look at allocating capital and incremental returns on that capital.

The most interesting part about this unique model is that a lot of people are trying to copy the domestic model. I don't see as many getting nearly as close in copying this international model, with local content. The plan for Warner is to aggregate all its US brands and they probably talk about some international. Disney probably has the best shot at its content traveling internationally, but it will produce most of it locally and then hope its animation works globally. Netflix truly is a global brand, where content hubs flow across regions. How they spread those costs and how they allocate them – should they produce another Japanese show or an Indian show – is very complicated but also very unique. This gives them the competitive advantage.

How did you look at the return on a show?

It is often thought of a show P&L. The framework may have changed and I'm sure it always evolves a little bit. Spend $100 million on a show and nobody watches, then that show is canceled. They don't go, this show was 100 and then over the next three years it earned this many views and we do some IRR on that. It really is a portfolio of, we're spending $5 billion in the US on content and is this the right $5 billion to spend? What is working? What is not? Let's cancel it. The market, in many ways, dictates the price. There are more bidders and now is a great time, minus the COVID pandemic. But prior to that, I should say, it was a great time to be a content creator. Apple, Amazon, AT&T, HBO and Netflix were all bidding up prices to extreme levels, for the best content in the world, because the best content outperforms. That will continue where Netflix spends a large amount on content.

If $5 billion is spent in the US, do you try to work out. $4.5 billion is retention and then maybe you test with new genres to drive new growth, or is it simply that the market dictates the quality of the genres and shows?

I'm thinking through this because it's a breathing, living organization that learns all the time, but if I were to try and give listeners a sense of how they attack it, it is far less spreadsheet. I did do plenty of spreadsheets and there are many folks that do it well. A little more of crawl, walk, run, so to Originals, they did House of Cards. They put their best foot, outbid HBO two seasons, $100 million, set a mark in the industry, but they did not commit to 100 shows in that first year. They committed to one a quarter, then they did Orange is the New Black, and saw the success. Then they said, we're going to double this. Then they saw more success and then they said, we're going to double that again. Then they said, the last double of having more premium HBO serialized dramas, is not working. We added Orange is the New Black and went from 30 to 40 nominations in Emmys, but we really haven't expanded our universe. We did that from the first doubling, but the second doubling we're only getting our users more hooked but not expanding new users. They are not joining Netflix because we do not have a half-hour sitcom that is just a tune-out.

We're not going to double again because we see this. What we'd rather take is the amount we're spending on those serialized dramas and fine-tune it. Of course, it will grow but it will not grow at 100%, it will be 10% or 20%, in line with overall content spending. Maybe it will lag content spending because we're growing at 100%. It will still grow, as every category there is probably growing. We're not seeing marginal acquisition, awards or prestige coming out of this. Let's do the new category, unscripted and documentaries. Let's do comedy specials and movies. They enter movies and they spend $150 million on The Irishman. They've done a lot more efforts before that, and they say this is working, now let's do another one, or this didn't work. It was a great bio-epic, it was great, it got a lot of Oscars but frankly, we're going to do a lot of action movies now. We're going to get the Michael Bays of the world. If the Michael Bay movie did well, we're going to do two more of those. They are trying to launch their own James Bond franchise. If that works, great, if not, they'll say, what are we doing wrong with movies? Let's do something different or let's scale it back.

It's an iterative approach and the data comes because it's tested with hundreds of millions of subscribers across the globe. Do franchises work, do sequels work? They learn along the way and, while it's still a very much creative process, the content has to be good. Whether you say you're going to spend this money, if the content doesn't turn out the way you want, it doesn't matter, you can't put that into your formula. You spent the 100 million and you got that output. You need to re-spend it and get a greater output. When they enter a category, their bias is to work with the best. To work with the Scorseses or with the David Finches, because they want to remove that variable of the content not being the best, and focus on where they're deficient. Is it distribution, is it the release model, all episodes, is it the marketing? They tweak those variables and isolate as much as possible, where the content was great.

Eventually there's going to be some kind of maintenance content spend to serve the user base? If the 70 million US users chugs along at five to seven million new adds over the next five years, what do you think is a maintenance run rate of content to serve or retain those users?

I don't think we're approaching it anywhere now, so we don't know. I think, for the series investor, they laid out a few previews right now. They are not spending as much as they would like in a way, because content is frozen and it is hard to restart productions. They are still giving them a lot of fresh content because all that content was made a year ago. We know what they're spending now has best-in-class retention. They are continuing to grow subscribers even at the 60 million base, which is pretty challenging. Whatever content they're spending in the US right now, appears to be enough to give them both growth and strong retention. I don't know where the steady state stops. They certainly are not signaling it, but you have a preview of the content spend and the profits and margins which they can produce if they were to turn it all off tomorrow. Users can take that as a comfort that, if you wanted to go steady state, you would probably lower the growth. You could be like a traditional media company where there are users who have been with you for five years and who are not likely to cancel, so you can keep your content budget flattish. When an old show runs, you bring in a new show, and that would work for users.

They will continue to invest in content because it's not about the amount of content but maybe about the pricing that they could charge. We can talk about this throughout the interview but adding movies is adding, theoretically, less content. When you produce a 2.5-hour movie, it's less than the 10 hours of content that you get from a TV show. But a user is willing to pay $30 for a movie, which is what Disney believes, or $20 a ticket times four users, in a major metropolitan area, so $80. If Netflix is bringing those type of quality movies to the service, can it charge $20 or $25? I don't know where the ceiling is but they should not stop investing. I do not think they have any plans to, because it's not only about more users, it's also about higher prices. I think you'll continue to see great content added in great categories, that will expand the user base and also give them pricing power as well.

How do you look at retention at Netflix?

It is thought about in a lot of ways, but the most simple one is, if they have 190 million users today, how many of those 190 million are going to subscribe in August and September? If out of all 190, only 1% cancel, that will be great. If 10% cancel they have to think about something. How do you peel back that onion? They know a few things. They know the longer you've been with them, the more likely you are to stay with them. Users who just sign up for one month have a higher cancellation rate than those who have been with them for five years. That's pretty intuitive and that's true in all subscription services. Therefore, in that thesis, users in the US, where the service has been around for a long time, are much stickier than users in India. They've been operating at scale in India for one or two years. The recommendation algorithm and knowing your user's preference over time just gets better and better. The content gets better and better, as they learn the right mix of movies and local content.

Retention should improve or steady-state, over time. The most correlated metric with retention is viewing. If you are viewing, you will probably say Netflix is worth it and I'm going to stick with you next month. That's not always true. They had users that had not viewed in two years, still playing their $12 just because it is such a low price. They recently put out a press release that they are canceling those users to be consumer friendly. It is a mix of those two things.

Do you think viewing is based on new content, as well?

Viewing is based on content, new or old, but how many times does a user log in and watch a Netflix show? If there's too many days or months where that goes by, somebody is going to get that user. Either that user is going to cancel or that user is going to say, I should go to Disney or somebody else who has the content I want. Netflix almost has a more clear model than anybody else because it's on a monthly cancellation policy. There are no annual contracts, or very few I should say. Sometimes when you sign up with a distributor like T-Mobile, it is bundled in. They get very clear signals that the users are not happy and they don't try to lock them in to these annual packages, because it is a clear data signal of what is failing. They can see that the cohorts who joined in January 2020 are way worse than those from 2018, so what is going on? Or if 2018 is better, was it the content that we on-boarded or was it the product? Other media companies that lock users in for a year don't get that signal quite as robustly and are not as nimble in moving to understand where the user dissatisfaction is. Netflix is learning about that every day.

If, in three to five years, Netflix has 80 to 90 million subscribers in the US, and they reduced their content spend to serve that user base, do you think that will that result in huge churn? How do you look at the kind of steady-state rate of the business serving those 90 million users?

I think your question is framed a little that they were to lower content spend. It is more appropriate that they will plateau on content spend. That point is several years away where they have 80 million subscribers in the US and they spend X billion dollars. That has happened in the cable industry, and I don't know if it is a perfect analogy, but every year they added a new channel. There was ESPN, ESPN 2, AMC, HBO Max, and then each one of those channels was adding more content. We are now at a stage where we are not adding more channels. Most of the channels are not adding more content and it has become a steady-state business. They then try to sell additional businesses on top, which is triple play for those guys or high-speed internet. They are all evolving in their own way. Catalog and content spend go up because every content provider charges a higher price for the same content. NFL want more for the rights than it wanted five years ago and you will have to figure that out with users.

One advantage for Netflix is that, when it gets there, it will own a large amount of content. Its whole library is paid and owned for, which is not the case today, where one of its most popular shows, Friends or The Office, can go away. As Netflix approaches this plateau, it will own its catalog and it will own the ability to introduce those shows to several users that feel new, in the same way that my son is watching Winnie the Pooh and Wall-E, which are new to him. Disney has signed up 60 million subscribers with essentially just an archive catalog. They are introducing some new content, but their production is largely frozen and they are not releasing their newest theatrical content. That archive can become very powerful. Netflix will have to build that, in order to level out their content spend. They need more evergreen lasting content.

As the content spend plateaus, it might be a less dollar spend per US subscriber, but you still have the whole back catalog adding value, people can search and you have the recommendation engine serving fresh content that may seem new for the user?

That is correct and, of course, they are still paying for that content. They amortize this content over years but it still feels new to the user. It still feels fresh and, hopefully, you have built some franchises that you will build sequels and new character universes on top of. That also gives you advantages because everybody who watches Spider-Man 2 likes Spider-Man 1, your marketing cost is a little lower and the users know what to expect. We are many years away from that, as Netflix is still in the innovation stage in a lot of categories such as theatrical movies, non-scripted and competition. Their serialized dramas are different. I bet you a lot of people are discovering things which they released three or four years ago, as much as they are releasing their newer shows. That is a powerful lever for them, as they approach steady-state.

What is it that you think people misunderstand about Netflix? There are some views out there such as, Netflix is not even profitable this quarter; Netflix doesn't have any cashflow, they're just burning cash, etc. What do you think people misunderstand about the economics of their model?

People are beginning to understand, particularly post COVID, how powerful this would be. There has been incredible investor appetite, both from the retail side and institutional investors, putting out positive reports that the economics are there. There are very few bears that understand it or that are making a great counter-view, that perhaps a few years ago, it was the cash flow. The one part I always heard was competition; they were Netflix killers. Disney Plus now has 60 million subscribers and Netflix has grown during the same time. Thinking of this as zero sum is wrong and that view has been out there. I don't know if it is still out there as much, but people likely have more than one or two streaming packages put together, for their entertainment choice.

The area that strikes me as the least-appreciated part of the Netflix strategy and advantage, is its product engineering, product development, talent and lead. To enter this space, we probably have all pegged Disney as one of the best, because their content catalog is arguably better than Netflix. Their marketing might even be better, and everything they can do with their theme parks and cruises, it certainly is going to be a fun competition to watch these two players. I'm a big fan of Disney and their service, and although they are ahead in marketing and content, they are, in my opinion, behind in the technology of their product. It is very underappreciated what Netflix has put together on its recommendation algorithm and product interface, where the cover image art that you see is tested differently than what I see, and you may be more likely to select an episode based on that type of testing.

They can sub and dub in 30 languages and they have invested the best technical capabilities in doing that, where there is no buffering while you wait for your show, because they've embedded local servers in every country and co-embedded with local ISP providers. This is not built overnight. Disney spent $3 billion to acquire MLB streaming which was more for a live platform. They don't have, at least in my interface that I use, a profile, so that the content I watch for Disney could be different than my son. I might like The Mandalorian and he might like more children's shows. Netflix introduced that feature five years ago. I'm not saying you have got to hire the most expensive engineers in the world, but think about what Netflix will do over the next five years in its product development, while Disney or Warner or anybody else is only catching up to the table stakes features of recommendations, profiles and downloading of videos for offline view back. This is all incredibly well done, AB tested and thought out. There are thousands of engineers in Netflix's Los Gatos headquarters, working on every one of these problems.

Most times, when Amazon enters a space, they crush the competitor. Amazon entered into this space almost a decade ago and Netflix has thrived and spent and out-innovated Amazon because it is so focused on that. It probably has more engineers working on it than Amazon does and that is one of the few focuses it does on its product, to make sure it remains best-in-class.

Do you think Netflix has a competitive advantage in creating local content and then globalizing it, versus an HBO, Amazon or Apple trying to do the same?

I don't know if Netflix has an advantage, per se, in getting better scripts than HBO has. The script comes to everybody and then you bid. Do I think they are better at giving notes or running production sets because of their production control using technology? Maybe, I don't know. Where I think they have an advantage is their model, from day one, has been global rights. When they film a show, not since day one as House of Cards was not available and then they had to go acquire the rights, but since they have invested into Originals, when they make their latest episode, they usually acquire it for all 180 plus countries. They have those rights.

I don't know the specifics of every content provider but my understanding is that HBO will have Game of Thrones here on the HBO brand, on Sky brand in Europe and on a third brand in India. Six months later, it releases in Australia. I am drawing a purposely archaic one. I know these competitors are working on and have a lot of streamlined rights, but a lot of their deals are locked up in rights that are very complicated, distributed, windows that are hard to unwind and it is not even their DNA philosophy. When Netflix makes a show, they can have a global conversation because, traditionally, everybody gets it at the same time on the same day at the same point. We are watching that show and having a global conversation in a global world that gives them a distribution advantage. If I want to tell my friend in France about this show, I can say hey, do you have Netflix, watch it.

Did you see the percentage of non-US content viewed, increase in the US during your time over the years, as they started producing more local content in countries outside the US?

I don't remember specifically on that, but has it grown? I'm quite certain it has because they were producing very little of it. Now that they have, many of those shows are working. I watched Latin American Original; I'm sure everybody has done one or two. Do I think it's meaningful where the US is going to have 30% to 40% of its viewing coming from international countries? I doubt it, not in the short term. But those short-term numbers can call me and I can call them, and the opposite is when Disney makes something that might have global resonance. They can't distribute it globally, so I can't call my friend in France and say, do you have Disney Plus? It's not even available. Can I call my friend in Toronto and say, can you get it? They may be launching in Toronto, but the rights are different, so yes, they have Game of Thrones here in the US on HBO Max but in Canada it's on a different provider. I can't tell my friend to go get XYZ service and Netflix doesn't do that. HBO, Disney and others have carved up their rights in the old model and they will stop doing that.

When you try to distribute a show and you have these legacy things, it can be on one of your competitors. In fact, Netflix has Disney shows in Europe and in Asia. If I want to watch one of Disney's new titles, it may be on Netflix. Disney loses that distribution advantage in some ways, until they can produce enough to get to global scale and global rights.

Who do you think has power in the value chain?

The old adage that somebody came up with, that content is king and that's the advantage, I think is partly true. Every time there's a showdown with the traditional cable providers and the content – we're going to drop AMC or CBS – content wins, because the content is available somewhere else. If CBS is not being carried on Comcast then you can go get it on Time Warner cable or a direct channel. These new battles that are being fought with HBO Max not being carried on Amazon's Fire TV platform or Roku, or these battles of carriage that we used to have, are going to continue. I don't know if the dynamics are the same, but having great content still matters a lot. I couldn't get HBO through my Fire TV, so I just went to a website, signed up for it and got it. It is an inconvenience that it is not playing on my Fire TV, and that makes it less likely I will watch it sometimes, so both sides have a little bit of power in that.

If this goes on for long, I probably won't buy a Fire TV, I will buy an Apple TV instead. We have a marketplace that allows for substitutes and competition and these battles will continue. I don't know what position they are jockeying for, but there's even regulation about what Apple charges for its iTunes 30% cut and scrutiny around the distribution, gate-keeping monopoly effects which will play out over several years. However that landscape plays out, what you want to have is great content, at a great price, wrapped in a great service. I think that is what Netflix has. If somebody decides to stop their Netflix or Disney, it is going to be the consumer that puts pressure on both sides and they will apply that pressure by saying we want Netflix. I have yet to meet a distributor that is ready to enter into battle with Netflix.

Even Comcast, in its heyday, and all the net neutrality, there was a lot of, would Netflix be throttled by Comcast? They put those deals in place. It will happen.

Do you think that's a risk though? Do you think the Comcasts of the world can squeeze Netflix, even slightly, to put pressure on them?

I am sure they could but I don't think it would be smart. Comcast and others have realized this is potentially a win-win business. Comcast is now, probably, on a transition out of the cable business and will see high speed internet be much more critical to their growth than traditional cable bundles. What is best at selling high speed internet? High speed applications like Netflix that use intensive bandwidth. Comcast is going to be able to move users up its high-speed price tiers, because services like Netflix and Disney are there. Should they extract some rent from that? Probably, maybe, I don't know what will happen. I don't think the smart operator is going to say, we need to do this right now. Just like Netflix has plenty of growth in its existing business, there's plenty of growth still in the data business. We are all going to move to 5G and higher speed connections. We are all going to become more data hungry with smart devices and homes. I am hoping we avoid some of these battles, as people understand it is only destructive when you do this. Investors are not focused on the squeezing.

Whether you make a dollar and penny or a dollar and two cents, it is about whether you have 10 million or 100 million users. That is the focus, as opposed to these distribution services.

If you were looking at Netflix what would you be worried about? What do you think are the biggest risks?

A creative fatigue would certainly worry me. HBO was king in the 90s and early 2000s, with shows like Sex and the City and The Sopranos. They could not miss, or if they missed, it certainly wasn't noticeable. They then went through a creative fatigue period where they did not have a lot of great content. I don't know if it's because they took less risk or the executives, but something happened in there and they had a real renaissance with Game of Thrones and West World and we can name a million shows. Should Netflix ever start to rest on its laurels at any of those categories, you will see users flock to better content. It is a dynamic marketplace and that worries me most.

Ted Sarandos was just named co-CEO and has an excellent team. They talk about rewarding and seeking more risk and failure. They want shows to get canceled because it means they are taking chances. I think they have the right creative culture there. That could happen, as it happened to HBO. It happened to Disney in the 90s. A lot of that can happen when you start relying on franchises and sequels only. The executives become a little complacent on success. I don't see that now, but that worries me, just like any big company worries me. Regulation is a secondary worry that we could talk about. That is what keeps me up.

What is it about the culture you experienced that drives creativity?

Both entertainment and technology are creative cultures. Silicon Valley, Hollywood and California have a creative culture. They push the envelope forward in that culture. Hollywood has been doing that, the way we talk to what we think about. Very serious topics like religion and race have been introduced in entertainment, as well as more lighthearted measures. The same can be said about technology, you have both creative cultures in technology and content. I am probably creating my own narrative here but the two CEOs, Ted and Reed, are both very innovative, creative thinkers and they have formalized that structure now that both tech and creative culture innovation are equally important. Netflix is one of the few to recognize this.

Most media companies shun technology or partner with somebody like YouTube and you get in this skirmish. Do you respect the rights? Do we respect your business model? Do you respect consumer preference? From day one, Netflix has had both those competencies in the driver's seat. It has a wrapper around it that believes you have to take risks and chances to grow. With a growth-minded orientation, they are just naturally there.

How do you see the market shaking out?

Streaming videos are here to stay. On this call, we talked about 90 million linear packages at peak. We are approaching 80 and downward to 60 in time, if not lower. There is a replacement of linear packages to streaming packages. Do streaming packages come from one provider or multiple providers? Probably multiple providers. It is likely that you will have Netflix, Amazon and Disney, or Disney, Amazon and HBO Max, and users will put together their own bundles. It is hard to believe you can have five to 10 providers, where users enter their credit cards and keep track of what is being released by each. We are coming, in many ways, to a little bit of a vulcanized world because I don't think you're going to get a simple TV guide. That is the other part of this world. As much as it is better and maybe lower-priced and more convenient on demand on any screen at any time, I still cannot do a simple search for a show on my Apple TV or Fire TV across providers

You do not have that TV guide world, which means it is going to be pretty hard for a small provider to get distribution and access. You can be on Amazon's platform, Fire, iTunes or Roku, but what is the incentive for me to download your app when I've already got these four providers giving me nearly $40 to $50 billion of content spend? That is going to get very interesting. As these battles weigh out, it is hard to imagine that HBO Max has the muscle to fight and jockey with Amazon, but does a small provider? I don't mean small like me and you go start a startup; I mean Discovery networks or AMC networks that are late to the game and do not have huge catalogs of content. They do not have huge engineering teams to build these global platforms. I do think this is a scale game as we talked about.

What do you think happens to those players?

Some fold, some get acquired and some might make it through in a niche way. Discovery's content is lower priced. They are not hiring Leonardo Di Caprio and paying him $100 million to produce three films for Netflix. They are shooting nature documentaries. Can you have a lower cost of content and have a niche offering? Potentially, but it will be hard although that is a strategy for some. A lot of them move to advertising because with that model, the TV dollars will come out as that bundle goes out. Video ads are more targeted, more able to get data feedback loop on who watches and re-target. You have seen a little bit of activity there with Pluto and others. On advertising, you have to have massive scale and data infrastructure to do this correctly. YouTube and Facebook look to be natural winners there.

I feel there is a consolidation that most consumers are going to have three to five entertainment choices, more on the three than the fives and power users have five. You have to have heavy infrastructure that we talked about, to produce a technology product on par with Netflix or Disney. It is very hard to imagine so many direct services. Those few folks will merge and consolidate but a lot of them will look to become “arms dealers” that will distribute to the highest bidder. You can produce a great show and bid Netflix against Amazon if you are Discovery, versus producing your own Discovery direct distribution channel. I do not mean to pick on Discovery; maybe they have a great strategy in place. You want to call it Viacom, Discovery, Scripps Networks, a few of these guys are behind where they need to be now and will have to figure that out. For the big ones, the future is theirs.

In 10 years’ time do you see Netflix with any sports, news or even some advertising on the platform?

10 years is awfully dangerous to predict, but I do see them being a large player in movie entertainment. That will still be their base. I don't imagine, at this point, when you say a 10-year thesis, why they would move into advertising and sports the way we look at that industry, right now. It was a little more confusing a year ago that sports represented something and live represented something, but as the trends look now, boy, advertising invites a lot of scrutiny. From political advertising that Facebook and Twitter are dealing with, to social issues with advertisers having to drop certain networks, because of all the social changes that are going on in the US and the world. The ad sales force technology is not an area that investors should be flocking to.

Sports itself is undergoing massive changes from the social pressures, the pandemic issues that they're facing, where the rights are going to be very complicated on how many games get played. As that shift happens, the major sport leagues are going to face increasing competition from eSports and gaming that users are going to condition themselves to over the next year and a half. I would expect complete ratings decline and engagement for a lot of these leagues that do not make an attractive industry.

Do you think Netflix would get into gaming?

I certainly think that is more likely than signing up the NFL rights in a decade. If they start bets, I don't think it's traditional gaming where Xbox is heading to, with that intensive hardware and a cloud computing platform, but look at what they are doing in interactive right now. A few years ago, they launched Black Mirror and Kimmy Schmidt interactive, choose your own adventure. I have now seen that appear in kid's titles. They will be doing more of the gaming/interactivity in a decade. They may go beyond that, but a seed has been planted for the decade of interactivity. I would not call it gaming, but how they apply interactivity on their platform looks the most interesting to me. As smart TVs get smarter there will be buttons, voice and other things they can take advantage of, which we cannot predict right now.

It is going to be interesting to see what happens. Bobby, it's been a pleasure, thank you very much for your time.