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Rosalie Checca
My logic for that belief was very sound. Netflix has been in content distribution business which has a very low barrier to entry. Technically, anybody can put up a platform like that in a few months (albeit, a less robust one) and start streaming content. On top of that, most content providers now a days are very reluctant to share any premium content with Netflix and they are coming up with their own OTT (over the top/broadband) solution (such as HBO GO, CBS, etc.) Also every single carrier ranging from Dish to Verizon are launching their OTT solution, which would compete with Netflix.
While Netflix has come up with chartbuster content like House of cards and Orange is the new Black, I could not believe that that the company could possibly come up with smashing content like that on a consistent basis. In fact other than Disney, how many content providers that we have seen could produce consistently hit content? Even for Disney, they could not have been so consistent with their content strategy if they did not have such amazing franchise collection from Disney, Marvel, Pixar, Lucas films.
Netflix on the other hand does not have any major franchise and building a new franchise brand takes years of consistent success. On the whole, I thought, if we take it as a content brand, it could not be bigger than NBC, Warner Bros or Fox. If we take it as a distribution brand, it has a very low barrier to entry. Overall, I thought my analysis was sound but the new quarter came and once more Netflix had an amazing growth in subscriber numbers and even more amazing growth in its stock.
This time though, I thought that I would take a hard look at myself. I wanted to see my own interaction with Netflix brand to understand why I have been so wrong. I realized that I have a Netflix account for several years now. I cancelled the subscription in 2011 and re-subscribed it in 2013 and I really did not feel the need to cancel it any more. I called up a few friends and family. Everyone has Netflix, everyone use it sparingly and no one thinks of cancelling the service.
I started to think why I did not cancel it in spite of the fact that I am not a very frequent Netflix user. Well, for one thing, my daughter who is five years old, watches her program in Netflix occasionally. And it seems plausible that I was actually quite content paying $7.99/month fee to Netflix after watching the House of Cards series (1,2 & 3 and waiting for something new to come).
I found three reasons why the Netflix brand has gained such strength. I am not a marketing strategist and brand marketers may comment on the validity of this analysis but I could not find any other reasons how Netflix has become a strong content brand. (Not a content distributor brand)
When we watch content on Netflix, we know for sure that we are watching Netflix (because the overall experience is so different). How many of us remember very quickly, in which network we saw our hit TV series one year after watching it for the last time? HBO Now could become such a brand but it still early days for it. Amazon Video is still trying to find its feet and while YouTube certainly has a good brand, it is truly a brand for short form or user generated content.
I watched the 1st season of House of Cards series in a span of week during a holiday break when my family was away. I had to forgo part of my daily sleep quota. I barely shaved once in three days and survived on pizza most of the time. I had difficulty concentrating on anything else for that week. I repeated my acts with every new season. (Reed Hastings talked about this strategy of binge viewing in Q4 2011 earnings call and how good it has turned out)
While the growth of the Netflix brand is great, what has really propelled Netflix to a new high is the growth of its international business. It took a while for Netflix to understand its brand power internationally. But when it did, there was no stopping back. In last two years when the domestic market grew at an average of 5% every quarter, international market has grown an average rate of 15% every quarter.
The big advantage for Netflix in international market is, unlike its TV cousins, it is not stuck with multitude of complex deals that inhibits its content being distributed freely. This is particularly true for its original content. Television content distributors are so tangled in these international contracts that they have no option of offering them to international customers in a no holds bar fashion. In addition, European Union is pressing hard for a new rule that that will render geo restriction of content in OTT medium illegal. If that happens, all third party content that Netflix distributes, will be widely available for everybody in entire EU through Netflix.
If you look at the difference between Domestic and International growth in last two years, it is very clear that for international market winter holiday/Christmas is still the peak growth time and it continue to hold for 1st quarter, probably due to House of Cards new season opening.
In contrast, the domestic market is picking on 1st quarter, which is primarily due to House of Cards New Season. One can conclude that international market is a more resilient growth engine and not dependent on power of one show alone.
International paid subscriber base of 22 million in 2nd quarter 2015 stands at more than half of the domestic paid subscriber base of 41 million. At the current growth rates, Netflix will have equal number of international and domestic subscriber base in two years and in four years it will have 65% of its business from international market. One must remember that Netflix has just launched in Japan and it will be launching its services to China in 2016. Indian market could potentially be huge also once India up its broadband penetration.
Why did we discount the international growth all along? I suspect once again we took Netflix as a content distributor and not as content provider and believed any local content distributor could dislodge Netflix with ease. We forgot the fact that the local distributors will not have so much of US content and they will certainly not have House of Cards or Orange is the New Black. Sometimes we underestimate how big a brand United States is and content based on US plots still is a big draw for audiences worldwide.
Now all this is good but the nagging question remains. Is this growth sustainable in the context that everyone is coming up with their own OTT offerings? HBO Now ($14.99/Month) has gone live in April 2105. CBS has just launched Showtime ($11.99/month) as well as CBS all access ($5.99) OTT service. Disney is mulling over ESPN OTT service. From the carrier side Dish has launched $20 sling OTT service. Verizon is launching its OTT service just about any time now.
No doubt, these launches will put question mark on Netflix. However my belief is that these services will impact TV services more than Netflix. HBO and Showtime has a pricing inflexibility so not to cannibalize its TV audience. As a consequence Netflix will continue to have the pricing advantage. On top of that, these OTT services are still domestic, whereas Netflix growth engine is international, which will not be impacted by these domestic developments. I also believe that the faster the TV content goes OTT, the faster will be the phenomenon of cord cutting and that might actually give additional support for Netflix domestic growth.
Among the other major competitor in this field is Amazon Web Video Service. My assessment is that if Amazon is serious, they could disrupt Netflix somewhat. But Amazon has its tentacles in so many places, I doubt they will be able to match the intensity of Netflix. Very recently YouTube has announced that it is going to introduce premium original content and also will launch a subscription service. We still have to watch and see how it spans out.
If one thing that is proven right by all these developments is that Netflix is on the right side of this business model and it will continue to grow. It has the 1st mover advantage and it has built a strong brand. Considering its large subscriber base, which allows it to keep its price very low could very well provide a very strong barrier to entry for any new entrant.
Whenever it comes to pricing power of Netflix, people refer to Quarter 2, 2014 result of Netflix when allegedly Netflix subscriber growth dropped because of price Increase. However, if you look at the growth pattern in Q2 over Q1 year on year, it is very clear that the domestic growth is in a declining mode. The problem in Q2 of 2014 was that of the international growth which stumbled to 9.8% and could not make up for domestic decline. The slowness of Q2 in 2014 could not be attributed to price as there was no price increase internationally. It was an international execution issue as explained by Netflix when they presented their Q4 2014 result.
However, I suspect that for several years Netflix themselves has feared the pricing sensitivity of its business model. With better content at its disposal, Netflix could feel liberated now. The current pricing base is so low for Netflix, that even a $1 increase in subscription fee will add more than 12% to the bottom-line. New OTT services like HBO and ShowTime, which are priced at $14.99 and $11.99 has given Netflix a legitimate reference frame to work with. As of now, Netflix could easily increase its subscription by a dollar and I am positive it will not have any impact on its subscription base.
It could however face challenge with Verizon like OTT service which are powered by ad revenue. It may be possible that in future Netflix has to offer a premium an ad supported model for its content. That kind of a model could provide a lot of pricing flexibility to Netflix.
Netflix operating profit was at 3% of its revenue in Q1 2013. Over a period of year and half it grew up to 10% (Q2 2014) of revenue. However operating profit again went downhill from here and at the last quarter (Q2 2015) the operating income stands at 4% of revenue. The decrease is primarily due to increase in Marketing and Technology cost. I would presume that it is driven by their international expansion.
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