Wednesday 06 Dec 2023
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This article first appeared in The Edge Malaysia Weekly on April 25, 2022 - May 1, 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 that when the world was ready to consume movie and TV content online, the business would be dominated by media giants such as Walt Disney Co or NBCUniversal Media. By last November, with its share price surging to US$691, Netflix Inc 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 — a 36% decline on April 20 — came in the wake of a disastrous earnings announcement a day earlier when the streaming pioneer disclosed that it had lost subscribers for the first time in more than a decade and was pivoting to an ad-supported model to keep growing. Excluding Russia, where it has suspended operations, Netflix missed its 2.5 million new subscribers estimate guidance for the quarter by two million. Apart 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 internet stocks affectionately dubbed “FANG”, which includes social media giant Facebook owner Meta Platform, e-commerce behemoth Inc 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, however, each of which at one point has had or still has a value of more than US$1 trillion, Netflix remains a minnow. Last week, its market value plunged to just over US$98 billion (RM420.5 billion).

The streaming pioneer’s stock slide is seen as a wake-up call for video-streaming companies that 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 movie studios such as 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.

Netflix used capital as a weapon to fend off competitors, throwing billions of dollars into original content every year. Its total content budget for 2022 is reportedly more than 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 subscription, notes tech commentator Neil Cybart, who runs the Above Avalon blog. Since 2008, when it began streaming, its cheapest plan has been US$5 a month and the premium plan, US$9.99 a month. In nine separate hikes since, 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.

Netflix is no Amazon

Wall Street helped fund the Netflix 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 the doubt by Wall Street investors since the tech bubble burst in 2000: Amazon 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 incredibly profitable business in building cloud infrastructure for corporate clients. The bulk of Amazon’s profits still come from its cloud business rather than its better-known and larger e-commerce operations.

Netflix has 220 million subscribers worldwide. In the US and Canada, 75 million out of a total of 142 million households have a subscription to Netflix. Growth in subscriber numbers in its core 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 a month for its cheapest “basic” plan. In India, its cheapest basic plan costs US$2.61 a month. In the US, most households prefer a US$15.49-a-month standard plan or US$19.99-a-month Premium Plan. In India, most 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, the company’s costs are rising while average revenue per user is falling.

Until Netflix came along, people watched TV through their pay-TV subscriptions and movies mostly in cinemas or at home on a DVD. The cable, or pay-TV, 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 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 such as Netflix eventually led to the cutting of the cable cord and unbundling of the services. Instead of buying bundles, people began subscribing to basic à la carte services and added additional streaming services such as Netflix that gave them premium content. The Netflix business model was pure subscription. It shunned advertising as well as news and sports. You could cut the cord but still had to subscribe to a basic pay-TV package to watch your favourite sports or catch up on the news.

Netflix faces massive headwinds. Economies worldwide are slowing, inflation is rising and nearly half of the households that subscribe to Netflix are sharing passwords, which restricts 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 Inc (the firm founded earlier this month, following a merger between Warner Media and Discovery Communications), Walt Disney Co, Paramount Global and Comcast Corp’s Peacock are joining tech players such as Apple TV+, Amazon Prime Video, Google’s YouTube TV and Roku Inc to compete with Netflix.

One reason people were eager to switch from pay-TV bundles to streaming services was that they could save money. The average American family pays between US$65 and US$95 a month on their TV bundles. You can put together a do-it-yourself bundle of streaming services and 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 such as Netflix have steadily raised their prices over the years, many TV-viewing households are finding they are paying as much as — or, in some cases, more than — what they paid for the pay-TV 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 from 1.5 million video-on-demand accounts from services such as 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 as 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 the company’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.

Binge watching

Another problem is binge watching, which 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 a quest to become the greatest chess player in the world; or Inventing Anna, a series about a Russian girl who stole the hearts and money of New York elites by pretending to be a German heiress, in one sitting over a weekend whereas Disney Plus, HBO Max or AppleTV+ encourage their subscribers to watch one episode at a time every week.

Much to Netflix’s chagrin, people subscribe to the streaming service and 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 video-streaming, the only loyalty of the viewers is to TV hits, not the platform.

Netflix has been written off far too many times only to come back from the brink as a more powerful player. Apart from tapping 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 such as TikTok as well 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 the 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 revenues, Netflix is being valued by investors 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, a 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, although it is unclear whether they will turn the streaming pioneer into a growth player again. Its investors and subscribers have seen stranger things before.


Assif Shameen is a technology writer based in North America


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