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Netflix’s Economic Engine

Netflix’s Economic Engine

 

With more than 139 million paying subscribers, Netflix is the largest streaming company in the world. In its most recent quarter, the company added more customers than it expected (8.8 million new subscribers – 1.5 million in the US, and 7.3 million internationally, which is 1.3 million more than analysts projected). Its pace of user acquisition continues to accelerateAt a high level, Netflix’s strategy is to create a virtuous cycle:

 

STEP 1: Raise debt in order spend more money on new content.

 

STEP 2: Use the cash to invest in more and more content – as can be seen in its increasing cost of revenue

STEP 3: Raise debt in order spend more money on new content.

 

STEP 4: Profit! Increase its margin as it can spread out the fixed cost of content to an ever increasing user base.

 

The 4 steps above lead to a virtuous cycle and create an impenetrable competitive moat that makes it very difficult for competitors to compete with Netflix’s scale (with the exception of perhaps Disney). You can see this effect in Netflix’s operating margin that has continued to increase from 4% in 2016, to 10% in 2018. In 2019, the company expect this number to be 13%.

 

To achieve this 13% margin by the end of 2019, Netflix announced a price hike in the US. Depending on the subscription plan, the price hike is about 13 – 18% of the old price (about US$ 1 – 2/month). This will increase the company’s average revenue per user (ARPU) starting in 2019. Netflix is doing this because it is spending more on content creation, and likely because it is facing an increasing customer acquisition cost (CAC). We can estimate Netflix’s blended CAC from dividing the marketing expense by the actual net paying subscriber addition. We can also estimate the ARPU by dividing total revenue by the number of subscribers. The numbers for 2016 – 2019 are shown in the image above.

 

 

As you can see, the rate of increase of CAC is faster than rate of increase of ARPU. As such, the average breakeven time (the time it takes for Netflix the recoup the cost of acquiring a new paying subscriber) is increasing from ~8 months in 2016 and 2017 to 9 months in 2018. Note that this 8 – 9 months time period is still very small to compared to (what we estimated) the lifetime of a typical US Netflix subscriber. If you’re interested in learning more about Netflix’s strategy, you can read here and here.

 

 

This article is meant to be informative and not to be taken as an investment advice, and may contain certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms.  Examples of forward-looking statements include, without limitation, estimates with respect to financial condition, market developments, and the success or lack of success of particular investments (and may include such words as “crash” or “collapse”). All are subject to various factors, including, without limitation, general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors that could cause actual results to differ materially from projected results.

 

Our team members at Vested may own investments in some of the aforementioned companies. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for an investor’s portfolio. Note that past performance is not indicative of future returns. Investing in the stock market carries risk; the value of your investment can go up, or down, returning less than your original investment. Tax laws are subject to change and may vary depending on your circumstances.

 

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