Assif Shameen Thu, Apr 21, 2022
In 2008, at the height of the Global Financial Crisis, a small listed DVD-by-mail distributor made a hard pivot to video streaming, delivering content online. Few gave the fledgling DVD distributor a chance.
Sceptics argued when the world was ready to consume movie and TV content online, the business would be dominated by media giants like Walt Disney Inc or NBCUniversal. Last November, with its share price surging to US$691 ($941), Netflix had a market capitalisation of US$310 billion, far bigger than any other media company on earth. In late 2009, Netflix stock was trading around split-adjusted US$7 a share.
Over the past five months, Netflix stock has plunged nearly 70%. The latest slide wiping out US$54.3 billion in market value — came in the wake of a disastrous earnings announcement a day earlier when streaming pioneer revealed it had lost subscribers for the first time since 2011 and was pivoting to an ad-supported model to keep growing. Excluding Russia, where it has suspended operations, Netflix missed its estimated guidance of 2.5 million new subscribers for the quarter by 2 million. Aside from some growth in Asia, subscriber numbers fell across the board in all geographies.
Netflix is a member of the original elite group of large-cap tech stocks affectionately dubbed as FANG that includes social media giant Facebook owner Meta Platform, e-commerce behemoth Amazon.com and search supremo Google’s holding company Alphabet Inc. The group has since morphed into FAANG to include iPhone maker Apple Inc. Unlike its other stablemates each of whom at one point have had, or still has, a value of over US$1 trillion, Netflix remains a minnow. Last week, its market value plunged to just over US$98 billion.
The streaming pioneer’s stock slide is seen as a wake-up call for video streaming companies who have been pouring billions each year into original programming to woo more subscribers to their platforms and get a better market valuation. Covid-19 induced lockdowns helped fuel a huge surge in Netflix subscriber numbers in 2020 and 2021. The pandemic-fuelled boom in video streaming is now over.
Founded in 1997 by Reed Hastings and Marc Randolph as an online movie rental service, Netflix initially sold and rented out DVDs in red envelopes by mail. As Internet bandwidth expanded to allow easier and quicker downloading of videos, Netflix began streaming content to customers directly over the web. 90,000 titles that it streamed were rented from studios.
Before the movie studios like Disney, Warner Brothers, NBCUniversal and Paramount could begin their own streaming services and pull out their content from Netflix, it pivoted again to produce its own original programming — movies, TV series and documentaries. In less than a decade, Netflix had successfully remade itself three times.
Netflix used capital as a weapon to fend off competitors throwing billions on original content every year. Its total content budget for 2022 is reportedly over US$19 billion. That is more money than the top four studios will spend on new streaming content combined this year. Netflix funnelled cash into original content to attract paying subscribers. It used additional content to grow subscriber engagement. It then grew cash flow from higher monthly subscriptions, notes tech commentator Neil Cybart who runs the Above Avalon blog.
Since 2008 when it began streaming, its cheapest plan was US$5 a month and a premium plan was US$9.99 a month. In nine separate hikes since then, the two main plans have doubled while a third middle tier or standard plan has been included. Until the latest dip in subscriber numbers, Netflix had actually grown total subscribers even after each successive price hike. Clearly it has no pricing power in the current inflationary environment.
Wall Street helped fund Netflix’s arsenal of content by ascribing a huge valuation for years even though it was not profitable until recently. Only two large unprofitable tech companies have been given the benefit of doubt by Wall Street investors since the tech bubble burst in 2000 — Amazon.com and Netflix.
Amazon lost money for years, first as an online bookstore, then as an e-commerce giant, while Wall Street looked the other way as its losses burgeoned. But Netflix is no Amazon which a decade ago found an incredible profitable business in building cloud infrastructure for corporate clients. The bulk of Amazon’s profits now come from its cloud business rather than its better known and larger e-commerce operations.
Netflix has 220 million subscribers around the world. In North America, 75 million out of a total 142 million households have a subscription to Netflix. Growth in subscriber numbers in the North American market has been anaemic at best over the past year. Most of the growth has been coming from lower-paying overseas subscribers.
In the US, Netflix charges US$9.99 per month for its cheapest “basic” plan. In India, Netflix’s cheapest basic plan costs US$2.61 a month. In the US, most households prefer a standard plan (US$15.49 a month) or Premium Plan (US$19.99 a month). In India, an overwhelming number of households pay for the basic plan. Overseas expansion means Netflix needs to spend more money to create content in German, French, Spanish, Hindi, Arabic and an array of other languages. As it expands overseas, Netflix costs are rising while average revenue per user is falling.
Until Netflix came along, people watch TV through their PayTV subscriptions and movies mostly in cinemas or at home on a DVD. The cable or PayTV business model was all about bundling. In most developed markets including North America, consumers bought a bundle that included a ton of channels — often up to 200 or more. In many markets, those channels were bundled with broadband Internet access, a fixed-line phone and in some cases even several cellular phone plans. A common complaint was that Pay-TV operators offered too many channels but nothing worth watching. To watch premier sports events or first-run movies, you needed to pay extra.
The arrival of streamers like Netflix eventually led to cutting the cable cord and unbundling of the services. Instead of buying bundles, people began subscribing to basic a la carte services and added additional streaming services like Netflix that gave them premium content. Netflix’s business model was purely subscription-based. It shunned advertising. It also shunned news and sports. You could cut the cord but still had to subscribe to a basic PayTV package to watch your favourite sports or catch up on the news.
Netflix faces a ton of headwinds. Economies around the world are slowing, inflation is rising and nearly half of the households that subscribe to Netflix are sharing passwords which restrict its ability to grow subscribers. More importantly, for the first time in its history, it is facing fierce competition. There is no shortage of Netflix wannabes: Media giants Warner Bros Discovery (the firm founded earlier this month following a merger between Warner Media and Discovery Communications), Walt Disney Co, Paramount Global ( which changed its name from ViacomCBS in March) and Comcast’s Peacock (that bundles NBCUniversal’s programming in an ad-supported platform) are joining tech players like Apple TV+, Amazon Prime Video, Google’s YouTube TV and Roku to compete with Netflix.
One reason why people were eager to switch from PayTV bundles to streaming services was that they could save money. The average American family pays between US$65 to US$95 a month on their TV bundles. You put together a do-it-yourself bundle of streaming services and a few basic channels for much less. You might end up with fewer channels but a better selection of programming that you really want to watch. But as streaming firms like Netflix have steadily raised their prices over the years many TV viewing households are finding they are paying almost as much or in some cases more than what they paid for the PayTV bundle.
To be sure, the slump in video streaming is a global phenomenon, not something confined to North America where competition for streaming subscribers is fierce. British households are cancelling their streaming subscriptions in record numbers as they curb non-essential spending to cope with the cost of living squeeze amid soaring inflation Financial Times reported last week.
Analytics group Kantar reports that consumers in the UK have walked away 1.5 million video-on-demand accounts from services like Netflix, Disney Plus and AppleTV+ in the first three months of this year.
A bigger headache is passwords or subscription sharing. Netflix has long allowed subscribers to share passwords with family members. Unfortunately, the practice has been abused people share passwords with extended family and friends. Now Netflix is threatening to clamp down on password mooching. “We’re working on how to monetise sharing,” CEO Hastings said at Netflix’s earnings call on April 19.
Netflix rolled out a payment structure for extra users in Latin America last year and expects to launch one in the US and Asia next year. If Netflix can force even a third of 100 million password moochers around the world to get their own subscription that could add billions to its bottom line or help pay for additional exclusive content that distinguishes it from competitors.
The problem with binge-watching
Binge-watching is another problem that is ironically driving down subscriptions. Netflix enables members to binge-watch all the episodes of Bridgerton, a period drama that follows the lives and loves of eight Regency era siblings of a powerful clan, or The Queen’s Gambit, a show about chess prodigy Beth Harmon’s struggles with addiction in her quest to become the greatest chess player in the world, or Inventing Anna, a series about a Russian woman who stole the hearts and money of New York elites by pretending to be a German heiress, in one sitting over a weekend while Disney Plus, HBO Max or AppleTV+ encourage their subscribers to watch one episode at a time every week.
Much to Netflix’s chagrin, the way it works is people subscribe to the streaming service, binge-watch all they can for a few days or weeks, only to quickly cancel their subscription when they are done. In the hit-driven world of videos streaming, the only loyalty of the viewers is to TV hits, not the platform.
Netflix fans say the streaming giant has been written off far many times only to come back from the brink as a more powerful player. Aside from tapping on advertising revenues to roll out a cheaper service, Netflix co-CEO Hastings has talked about a pivot to lucrative video gaming. Netflix subscribers these days are spending more time on short-form videos like TikTok as well on video games and while Hastings wants to avoid short videos he has a plan to make the streaming firm a big player in video gaming.
For now, Netflix needs to adjust to a new reality that it is no longer a dominant player in a fast-growing video streaming business. Until last year, Netflix was priced as a disruptor. Every other media company wanted to imitate Netflix because of its valuation. Now as a company that has decelerating subscriber growth and decelerating revenues, investors are rightly valuing Netflix as a mere distributor and producer of content. Traditionally, content producers and distributors trade at much more modest valuations because they are not seen as growth companies.
So, what’s next? One of Netflix’s hottest offerings is Stranger Things, an American science fiction horror drama series set in the 1980s. The popular show follows a group of young friends in a small midwestern US town who witness supernatural forces and secret government experiments. From pivoting to an ad-based business model to a push into video gaming, Netflix has a lot of options though it is unclear whether they will turn streaming pioneer into a growth player again. The streaming giant’s investors and subscribers have seen stranger things before.
Assif Shameen is a technology and business writer based in North America