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[Argelia Long]

Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer. The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, top-rated podcasts, and non-profit The Motley Fool Foundation.

Video streamer Netflix (NFLX -0.56%) saw its profits plunge in the fourth quarter. Net income was just $134 million, down 67% from the third quarter and 28% year over year. The company blamed the timing of new shows. Netflix's original content gets depreciated on an accelerated basis, meaning more of the costs are booked up front.

But other costs rose as well, most notably marketing. Netflix poured $730.4 million into marketing during the fourth quarter, a 57% jump compared to the prior-year period. That's a much larger increase than the 27% revenue growth and the 26% paid subscriber growth reported by the company.

Netflix now has 58.5 million paid subscribers in the U.S., along with another 2 million users on a free trial. That's less than half the total number of households, but the company is clearly running out of runway in its home market. Netflix added 1.53 million paid U.S. subscribers in the fourth quarter, but its customer acquisition costs are through the roof.

Winning a new U.S. customer now costs Netflix more than four times what it cost a few years ago in terms of marketing spend. One factor is that the company is simply running out of households that don't have a subscription or don't use the account of a friend or family member. Another factor could be increased churn. Netflix doesn't disclose how many users drop the service, so there's no way to tell.

International marketing spending also jumped, but that increase was more in line with subscriber growth. Netflix spent $417.6 million on international marketing, up 63% year over year. But it paid less than $60 in marketing for each new paid subscriber.

This increased difficulty winning U.S. customers comes before a fresh batch of competitors arrive. Disney plans to launch a streaming service this year; AT&T will expand its streaming offerings by the end of the year; Apple is rumored to be close to rolling out a streaming service of its own. These new services will join other Netflix competitors like Hulu, Amazon.com's Prime Video, and a slew of skinny TV bundles like Philo and Hulu's Live TV offering. Winning customers is only going to get harder and more expensive for Netflix.

Not all of the increase in Netflix's marketing spending was due to escalating customer acquisition costs. Netflix reclassified certain personnel costs in the fourth quarter, moving that spending from general and administrative to cost of revenues and marketing. That change didn't affect the bottom line, since it's just shifting numbers around. But it was one factor behind the increase in marketing spend.

Under the new classification system, general and administrative expenses were reduced by $199 million in the fourth quarter compared to the old classification system. About $83 million of that was shifted to marketing, with $30 million added to U.S. marketing spending and $53 million going to international marketing spending.

These numbers aren't big enough to change the trends. U.S. customer acquisition costs are still rising rapidly, even under the old classification system. Excluding these accounting changes, U.S. marketing costs would have risen by 34% year over year, and the U.S. customer acquisition cost would have been $184.

Despite a price increase announced earlier this month, Netflix still expects to burn around $3 billion in cash this year. Content spending is the main driver of this cash burn, but high marketing spending will also play a role. Winning new customers requires not only escalating content spend, but escalating marketing spend as well.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Timothy Green owns shares of AT&T. The Motley Fool owns shares of and recommends Amazon, Apple, Netflix, and Walt Disney. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

Netflix is an American subscription video on-demand over-the-top streaming service. The service primarily distributes original and acquired films and television shows from various genres, and it is available internationally in multiple languages.[6]

Launched on January 16, 2007, nearly a decade after Netflix, Inc. began its pioneering DVD-by-mail movie rental service, Netflix is the most-subscribed video on demand streaming media services, with over 277.7 million paid memberships in more than 190 countries as of July 2024.[5][7] By 2022, "Netflix Original" productions accounted for half of its library in the United States and the namesake company had ventured into other categories, such as video game publishing of mobile games through its flagship service. As of October 2023, Netflix is the 23rd most-visited website in the world, with 23.66% of its traffic coming from the United States, followed by the United Kingdom at 5.84% and Brazil at 5.64%.[8][9]

Initially, Netflix offered a per-rental model for each DVD but introduced a monthly subscription concept in September 1999.[20] The per-rental model was dropped by early 2000, allowing the company to focus on the business model of flat-fee unlimited rentals without due dates, late fees, shipping and handling fees, or per-title rental fees.[21] In September 2000, during the dot-com bubble, while Netflix was suffering losses, Hastings and Randolph offered to sell the company to Blockbuster for $50 million. John Antioco, CEO of Blockbuster, thought the offer was a joke and declined, saying, "The dot-com hysteria is completely overblown."[22][23] While Netflix experienced fast growth in early 2001, the continued effects of the dot-com bubble collapse and the September 11 attacks caused the company to hold off plans for its initial public offering (IPO) and to lay off one-third of its 120 employees.[24]

DVD players were a popular gift for holiday sales in late 2001, and demand for DVD subscription services were "growing like crazy", according to chief talent officer Patty McCord.[25] The company went public on May 23, 2002, selling 5.5 million shares of common stock at US$15.00 per share.[26] In 2003, Netflix was issued a patent by the U.S. Patent & Trademark Office to cover its subscription rental service and several extensions.[27] Netflix posted its first profit in 2003, earning $6.5 million on revenues of $272 million; by 2004, profit had increased to $49 million on over $500 million in revenues.[28] In 2005, 35,000 different films were available, and Netflix shipped 1 million DVDs out every day.[29]

In 2004, Blockbuster introduced a DVD rental service, which not only allowed users to check out titles through online sites but allowed for them to return them at brick and-mortar stores.[30] By 2006, Blockbuster's service reached two million users, and while trailing Netflix's subscriber count, was drawing business away from Netflix. Netflix lowered fees in 2007.[28] While it was an urban legend that Netflix ultimately "killed" Blockbuster in the DVD rental market, Blockbuster's debt load and internal disagreements hurt the company.[30]

On April 4, 2006, Netflix filed a patent infringement lawsuit in which it demanded a jury trial in the United States District Court for the Northern District of California, alleging that Blockbuster's online DVD rental subscription program violated two patents held by Netflix. The first cause of action alleged Blockbuster's infringement of copying the "dynamic queue" of DVDs available for each customer, Netflix's method of using the ranked preferences in the queue to send DVDs to subscribers, and Netflix's method permitting the queue to be updated and reordered.[31] The second cause of action alleged infringement of the subscription rental service as well as Netflix's methods of communication and delivery.[32] The companies settled their dispute on June 25, 2007; terms were not disclosed.[33][34][35][36]

On October 1, 2006, Netflix announced the Netflix Prize, $1,000,000 to the first developer of a video-recommendation algorithm that could beat its existing algorithm Cinematch, at predicting customer ratings by more than 10%. On September 21, 2009, it awarded the $1,000,000 prize to team "BellKor's Pragmatic Chaos".[37] Cinematch, launched in 2000, was a system that recommended movies to its users, many of which might have been entirely new to the user.[38][39]

Through its division Red Envelope Entertainment, Netflix licensed and distributed independent films such as Born into Brothels and Sherrybaby. In late 2006, Red Envelope Entertainment also expanded into producing original content with filmmakers such as John Waters.[40] Netflix closed Red Envelope Entertainment in 2008.[41][42]

In January 2007, the company launched a streaming media service, introducing video on demand via the Internet. However, at that time it only had 1,000 films available for streaming, compared to 70,000 available on DVD.[43] The company had for some time considered offering movies online, but it was only in the mid-2000s that data speeds and bandwidth costs had improved sufficiently to allow customers to download movies from the net. The original idea was a "Netflix box" that could download movies overnight, and be ready to watch the next day. By 2005, Netflix had acquired movie rights and designed the box and service. But after witnessing how popular streaming services such as YouTube were despite the lack of high-definition content, the concept of using a hardware device was scrapped and replaced with a streaming concept.[44]

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