Netflix: A Way Back to the Throne
Pressing Play on Streaming
Founded in August 1997 by Reed Hastings and Marc Randolph, Netflix has an origin story that is now the stuff of pop-culture legend. Reed Hastings’s idea for Netflix was sparked by a $40 fine he received for returning the movie Apollo 13 six weeks late to the now defunct Blockbuster. Netflix got its start by emulating Amazon's e-commerce model, renting out DVDs by mail through a pay-per-use system. In 1999, the duo decided to pivot to a subscription-based business model whereby clients could rent unlimited DVDs for a set monthly fee. The rest is history; subscribers topped 1,052,000 in 2003, Netflix launched video on demand via the internet in 2007, and the company began making original shows in 2012. Netflix now boasts subscribers in 190 countries and uses 15 percent of global internet bandwidth.
Small Screen & Big Competition
In 2022, the global video streaming market size stood at an estimated $80.83 billion—an increase from $27.68 billion just 5 years ago, representing a compounded annual growth rate of 23.9 percent. This growth has been fueled by a combination of favorable trends: a 52.3 percent increase in the global population with internet access from 2016 to 2021, a 26 percent bump in worldwide streaming traffic during the COVID-19 pandemic, and the introduction of several major video streaming platforms such as Disney+, HBO Max and Apple TV in the past 5 years. New entrants into the industry have also taken away Netflix’s subscriber base, such as Disney+ capturing 47 percent of all subscribers who left Netflix.
Troubling times lay ahead for ‘Subscription Video on Demand’ (SVOD). The U.S. household penetration rate has dropped 0.3 percent to 87 percent (Q3 '22) in addition to average paid subscriptions per household leveling off at 3.7, signalling a mature market rife with competition. Additionally, consumer surveys support this claim, showing that nearly two-thirds of American users have canceled a subscription or intend on doing so in the next 12 months. This oversaturation of SVOD means that customers are tapped out and want to drop unnecessary subscriptions which starts a fundamental shift in the way that major SVOD players must compete. While companies aimed to capture new users in the past, they must now address fierce opposition to keep the attention of existing clients and pry users away from other platforms.
Netflix and Not-so-Chill
Netflix has suffered quite publicly, reporting back-to-back quarterly user declines (Q1’22, Q2’22) for the first time in a decade and seeing its stock price slide 60.59 percent YTD (Oct. 14). Although Netflix recently announced through their Q3 earnings report a subscriber add of 2.4 million over the summer, all is not well. Netflix saw its domestic market share drop to 61 percent (Q3’22) from 66 percent a year ago (Q3’21). Given that the U.S. and Canada represent a hefty 44 percent of Netflix’s revenues, failures in these core markets represent worrying trends that should be addressed. However, these shifts have not gone unnoticed by executives, as Netflix ended subscriber guidance moving into 2023. This change in behaviour indicates that Netflix has “all but admitted that it will be a low to no-growth media company going forward” according to Bank of America Analyst Nat Schindler. Given Netflix’s current trajectory, there exists a clear need to alter the company’s strategy with a renewed focus on an efficient content strategy.
Content Not at its HBO Max
Netflix’s current content strategy is to develop a comprehensive IP catalogue to combat studios reclaiming marquee titles. In the words of Netflix co-CEO Ted Sarandos, the company’s playbook involves “making pop culture TV across every genre and every market.” As such, Netflix began ordering as much content as possible hoping something would stick. In Q3 '22 alone, Netflix released 1,026 episodes of original content, up from roughly 900 episodes in Q4’21. This content creation represents almost five times the output of Amazon Prime Video, over seven times Disney+, and around ten times that of HBO Max. Netflix’s 1,026 episodes corresponds to 159 original shows, but this has not materialised into increased U.S. subscriptions nor prevented customer churn. This result contradicts KPMG’s findings that consumers choose a streaming platform based on a “desire for more choices, […] older shows, [and] deeper libraries for both movies and TV shows.” If volume is so important for retention, then why isn’t Netflix winning?
Evidently, Netflix’s strategy of relentless volume is misguided and should be pursued in conjunction with a greater emphasis on content quality. Netflix’s priority should be on building or acquiring quality IP, which drives customer acquisition and maintains a steady enough volume to limit churn. It becomes tricky, however, as even Netflix doesn't have bottomless pockets. This sentiment is echoed by CFO Spencer Neumann’s wish to keep future annual content spending around $17 billion despite years of persistent spending hikes. With competitors like Disney+ outspending Netflix on content to the tune of $30 billion (21’-22’), Netflix must take a new approach that is deliberate and cost-efficient.
Netfixing the Content Strategy
Netflix should reinvent the way it compensates content creators and establish mutually beneficial partnerships with studios, which would lower licensing costs and reward engagement-driving content. Currently, Netflix uses a licensing model where they pay an upfront flat fee and can stream content for a particular term period. Netflix should look to pivot towards a variable pay structure, where a fixed fee is paid in addition to a new pay-per-stream (PPS) system similar to that of Spotify. This PPS model would pay out a predetermined royalty to the content producer every time a title is viewed by a Netflix user once cumulative views exceed an agreed upon level. This new “engagement-sharing” pay system will systematically reward traffic driving content, enable Netflix to lower their fixed-fee bid level, and remove risk from large and long-lasting licensing deals. Instead of posting a large flat fee for licensing, a variable rate contract involving a lower upfront payment means that Netflix could aggregate a greater volume of content onto its platform with the same amount of capital investment.
To remain flexible, Netflix can, under this proposed model, negotiate different PPS rates for particular titles based on anticipated user demand. An added benefit for Netflix is that acquiring content with a variable cost strategy reduces risk in the acquisition process. If a title is watched extensively, although royalty payments would be made, Netflix has already benefited from content that has resonated with viewers—contributing to subscriber retention and acquisition. If a title does not perform as well as first anticipated, Netflix would simply not pay out the variable engagement fee. Whereas with a bulk sum licensing model, Netflix would be out a lot of cash with negligible benefit in terms of subscriber engagement.
With SVOD having proven to be so lucrative for Netflix in the early days, many competitors and studios entered the space in order to build out their own platform. As a result, SVOD has seen a great deal of forward integration, with media companies who produce their own content now add an in-house streaming platform. This has seen many content catalogues tied exclusively to a single platform such as Disney & Disney+, Universal Pictures & Peacock, WarnerBros and HBOMax, etc. As Netflix seeks PPS arrangements with independent studios they must consider not just the quality of a studio’s media but its ability to resonate both culturally and on a personal level for customers. As quality is subjective to the individual, this could mean anything from beloved franchises, to critically acclaimed work, to pop-culture significance, and to personal relatability. Examples of such studios who fit the bill include Sony Pictures, Columbia Pictures, Lionsgate Entertainment, and A24, which have a history of producing the most iconic titles.
Additionally, Netflix acquiring more content for cheaper will enable the platform to access valuable IP and open the door for further IP investment and expansion. By bringing more shows like Manifest onto the platform Netflix can see what resonates with viewers, reward studios, and then buy out IP rights or co-produce more content. Spinning off treasured IP into new content has been a recent industry trend as seen with HBO’s “House of the Dragon” and Amazon Prime Video’s release of “The Rings of Power,” proving to be extremely successful in customer engagement as seen with elevated acquisition rates. Netflix has recognized this and already announced a spinoff to their most iconic brand, Stranger Things. However, with only a select few franchises which have successfully infiltrated the cultural zeitgeist, Netflix would greatly benefit from accessing co-production & spinoff opportunities with partner studios which have a larger volume of well-established IP.
There are several benefits that could be derived for studios entering into a PPS structure with Netflix, along with additional lucrative incentives. Without a SVOD platform of their own, these studios are currently unable to directly capture recurring revenues from an industry that generates $81 billion in revenue annually. Although studios could licence their IP to SVOD platforms for a one-time payday, SVOD platforms have only so much capital allocated towards content acquisition. Consequently, much of a studio’s back catalogue is passed over and simply under-utilised. A PPS model completely transforms the industry norm by allowing studios to monetize content that currently offers limited value. For studios, the prospect of gaining sources of recurring revenue on their back catalogue is extremely attractive. Netflix should take advantage of this to establish a stronger working relationship with studios and to obtain right of first refusal or exclusive access on future productions.
Roll the Credits
Netflix has been the undisputed king of the small screen of the last decade but has seen itself slip into a worrying decline over the past year. With SVOD reaching a point of maturity, subscribers are no longer easy to come by, and competitors hoping to replicate Netflix’s success have only aggravated the issue further. As an institution which has long served as an ideal example of industry disruption, Netflix should pursue a PPS content licensing strategy to ensure the company’s story does not end in tragedy. By doing so, Netflix could aggregate a greater volume of culturally significant IP onto its platform, seek co-production opportunities, lower its content acquisition costs, and reward high-engagement titles. This would translate into higher customer engagement, retention, and acquisition, along with entrenching Netflix as a major SVOD player. Innovating on the industry standard licensing fee model would help Netflix take meaningful steps into reshaping and retooling their back catalogue as a valuable asset to future success. Reed Hastings, it’s time to fast forward into a better and more sustainable strategy.
