Netflix Business Model & Economics

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.

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.

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.

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.

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.