Netflix in 2011

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.

AppleTV, Netflix and Cord Cutting

Blockbuster and Redbox

My family tends to be early adopters, biased by cost and convenience.

Meaning, we buy when the value equation tilts in our favor, usually driven when a new product or service offering appears and we re-evaluate how we spend our limited spending dollars.  We are also spontaneous in nature, wanting to act on our impulses soon after the neuron fires the idea to our consciousness. For example, consider movie services.

A few years back, given the option of Blockbuster, Redbox, and Netflix, we became heavy users of Redbox.  For a $1 a movie, it was well below Blockbuster pricing, was convenient (4 locations within a 5 mile drive), and the selections kept up well with recent releases.  We haven’t rented a movie from Blockbusters for at least 5 years.  Although Netflix offered a better dollar value, and we had used the service several years earlier, the delay between wanting to see movie X and getting to see movie X was something we couldn’t live with.  We did, however, use the service for several months, and “caught” up on all the movies we had wanted to see, but were no longer in circulation.  For months we tried to convince our family and friends to try Redbox (they were using Blockbuster), until even they recognized the sparseness of customers within Blockbuster was due to the Redbox kiosk in their grocery store next door.

AppleTV

Fast rewind to September 8, 2010.  After watching Steve Jobs review the upcoming product line-up for Apple, I was intrigued by the AppleTV.  At $99, I pre-ordered it that day.  After receiving it and hooking it up a few months later, we were quite pleased with its functionality, size, picture quality and convenience.  The convenience was further enhanced as we used the iRemote app on our iTouch and iPhones to navigate the menus.

Netflix and YouTube

I had originally gotten AppleTV with the thought we share pictures with the grandparents when they visit us  After fiddling with it to try to get Flickr to work with it, I gave up on that idea.  We did however, immediately use it for playing YouTube videos (Fred, Annoying Orange, Goosebumps).  The kids thought it was pretty cool being able to play the videos for us, that they often talked about, but we never had seen.  We had resigned ourselves to live with the generation gap, as we just weren’t into gathering around a small computer screen as the kids surfed to YouTube and brought up the latest video that they found entertaining. We even had a “YouTube” birthday, as my youngest wanted to center it around “Goosebumps” a TV series, and we could only find the content on YouTube.  The $4.99 per show for AppleTV content is a non-starter for us, and perhaps targeted to families in a higher earnings bracket.  Perhaps once in a blue moon, for must see content that we can’t get from Redbox.  I think we have used it once since receiving the unit in October.  The $1 per TV episode we may take advantage, but haven’t to date.  We then tried out Netflix again.

For $7.99 per month, we could have unlimited video on demand.  I know they are not as current as Redbox, but we don’t care.  They are current enough. Although we have cable, we don’t have the premium channels.  The good news is that we could see premium content (Showtime, National Geographic) that we didn’t subscribe to on cable.  It has the shows I liked, but didn’t have the time to see (The Office, Weeds, Dexter), and old shows that I loved when I was growing up (Monty Python, Fawlty Towers).  All grouped neatly into season by season serialized lists.  These lists are great! You can actually keep track of a multi-episode theme.

It had the classic movies that I wanted see again (Seven Samarai).  After a few months, we use Netflix more than cable or network programming.  I believe we are on the path to “cord cutting”, with the one barrier being that our only provider of broadband is Comcast, and our broadband service price is contingent on maintaining some level of cable service.  Prior to adopting Netflix, we were using the On-Demand Comcast service, free to subscribers.  This worked fine, but the available content ages out over time, and the user interface was not the easiest to navigate through.  We haven’t used that service since adopting Netflix.  The first company that offers us broadband unbundled from cable and we’ll be able to cut the cord. Currently, Comcast is the only broadband provider in our neighborhood.