Where is all the Doom and Gloom Now?
Until a few weeks ago, the positive articles on Netflix were greatly outnumbered by those that felt the stock was over priced. Fast forward to now, and a $35 (183 to $218) gain. I don’t know what causes it, but the cautionary story gets more air play, despite it just being plain wrong. Netflix is positioned to further accelerate their Video On Demand (VOD) growth, and to maintain and improve margins. Although there is a lot of saber rattling by Time Warner over expectations on higher pricing for their “premium” content, such as the HBO, it is inevitable that content providers will embrace on-demand suppliers to offset their decreasing revenues in DVD’s. Given that the cost of physically producing, packaging, and marketing DVD media is eliminated, margins for content providers will improve, with this trend. As Netflix grows their customer base beyond 20M, and industry momentum shifts to the VOD model, there are not a lot of companies with the subscriber base, cash flow, or capital to compete with Netflix, in a bidding war for content.
Netflix Buying Power, and Operating Efficiency
In the end, they will be the market makers on pricing, as content providers will opt for revenue sharing digital rights agreements, that benefit from large subscriber bases. That is, Netflix could be outbid by a smaller player, and the content provider may gain a greater per subscriber price for their offering, but netted out over the subscriber base, the short term focus on per subscriber content price will loose out to the larger revenues enabled by lower content pricing and larger subscriber bases. One way to track the industry trend, and Netflix performance is to consider a few key performance metrics. There are a few metrics that provide some insight into evolving trends in Netflix performance, and efficiency. As other related firms break out their operating performance differently, it is difficult to get a direct apples to apples comparison basis. Keep your eye on these metric trends within Netflix, and you can get a handle on revenue and margin performance in the coming months and years.
+ Fulfillment Cost Per Customer Quarter – One of the largest components of cost of servicing customers at Netflix is the cost of fulfillment. That is the storage, and distribution of DVDs based on Netflix mail order DVD rental business. The trend is that these costs are decreasing based on a customer by customer basis, decreasing from $3.50 Q4-2009, to $2.70 Q4-2010. This trend should continue as more customers adopt the Video On Demand model, and rely less on DVD by mail.
+ Marketing Cost Per Customer Quarter – Netflix continues to successfully rely on internet based advertising, word of mouth, and trial offers, and affiliate marketing through packaged branding on Netflix enabled devices, resulting in decreasing marketing costs per customer quarter, decreasing from $2.71/Customer Per Quarter Q4-2009 to $2.29/Customer Per Quarter Q4-2010. During this same period, customers increased from 12.27M subscribers to 20.01M subscribers. This market leading growth is being attained without significant increases in marketing dollar.
– Revenue Per Customer Quarter – As more customers adopt the Video On Demand model, the tiered pricing related to the Mail Order business is abandoned by customers, to a fixed $7.99/Month. Note that the current pricing plans from Netflix include a low range of unlimited disks 1 out at a time at $10.99/Month, to a high of $56.99/Month for 8 DVD’s out at a time. The end result, as Video On Demand (VOD) takes hold, is that revenue per customer is decreasing, as evidenced by a slide from $32.27/Customer Per Quarter for Q4-2009, to a low of $29.79/Customer Per Quarter Q4-2010.
+ Subscription Cost Per Customer Quarter – The general doom and gloom being forecast by analysts is that there will be increasing content cost, as content providers such as Time Warner, need to recoup revenue lost in their Home Entertainment DVD offerings. The cost of subscription per customer doesn’t support this concern as of yet, as subscription costs per customer have decreased from $18.88/Customer Quarter Q4-2009, to $16.83/Customer Quarter Q4-2010. Pressure to shift revenue focus from DVD sales to digital rights associated with VOD sales is inevitable, as penetration of VOD erodes DVD sales. This revenue shortfall from content providers can be overcome without high net increases in subscription costs, as unit “sales volume” of VOD movies will be higher than unit sales of DVDs, enabling content providers to benefit from revenue sharing agreements. Further, margin improvements to content providers will be enabled through the reduced cost of fulfillment associated with manufacturing, distributing, marketing, and selling physical DVDs. That is, it only takes a few mouse clicks to make a movie available to millions of subscribers in a VOD model, but a lot of labor, storage, and transportation to move millions of DVDs.
My money is on Netflix to continue its growth, and to offset reduced revenue per customer with introduction of tiered VOD plans, and decrease in fulfillment and marketing costs. Any upward pricing in content costs, which hasn’t been problematic from a per customer basis, will be offset by tiered pricing allowing customers to buy-in to a Netflix service offering at a price point that makes sense to their individual pocketbooks. Given the ease with with a VOD provider can package and bundle content, one can expect a la carte selection of content not previously afforded with cable / telco offerings. The end result will be more choice, and less aggregate cost, as physical logistic cost get taken out of operating costs, and Netflix is able to address a global market place with less legislative constraint than that associated with cable and telco owned offerings. Given Netflix isn’t in the Internet Service Provider Business (ISP), unlike Comcast and Verizon, their success doesn’t rely on expansion of last mile physical network infrastructure, that tends to be constrained by telecommunication’s regulations.
Technology Crossroads 