The Netflix Effect
-
Audio Recording by George Hahn
Despite receiving scant coverage, the biggest business stories last week were Netflix and Meta’s quarterly earnings. The numbers were striking: NFLX profits hit $1.6 billion (up 20% from a year earlier) and the platform added 9 million new subscribers. Meanwhile, the company is raising prices. Over at Meta, revenue increased 24% and costs declined 7%, resulting in a doubling in profits. For this post though, I’ll focus on Netflix, as its management has better hair, and they’re not mendacious fucks.
Rewind
A year ago, Netflix was losing 1 million subscribers per quarter and had shed 75% of its market cap. It was the worst performing stock in the S&P 500. Fast-forward one circumnavigation of the Sun, and Wall Street is “gushing” over its “beautiful” results while the rest of the industry flounders.
However, rebounds are not new for Netflix. Since it delivered DVDs in envelopes, the company has defied the odds. Think about it: a DVD-by-mail company turned internet platform turned Hollywood giant that would eventually join the same power acronym as Apple, Amazon, and Google. We’ve discussed entertainment’s woes at length this year, but Netflix has replaced Disney, Discovery, and Paramount on the content Iron Throne and boasts a market cap equal to all three combined.
Told You So
Five months ago I predicted the writers’ strike would do more to help Netflix than harm it. My thesis: The strike would “force” a universal reduction in spending, while actually increasing the relative value of Netflix to consumers. The streamer was able to cut costs without materially affecting the user experience, as it already had a content library as deep as the Mariana Trench. Also, it helps to not be cable, because unlike news, late-night, and sitcoms, Ozark and Bridgerton aren’t perishable.
In addition to a 20% profit bump, the company is expected to generate $6.5 billion in free cash flow this year. That’s up from $1.6 billion in 2022. Meanwhile, revenue is also up, but only slightly (8%). Which means the multibillion-dollar windfall is a direct consequence of lower costs — that is, not having to spend $20 million per episode on The Witcher. Analysts are even cautioning against too much optimism, as the “resolution of the writers’ strike will bring higher costs” and thus depress profits. Put another way, investors don’t want the strikes to end. Would we be surprised if we found out the folks running the WGA/SAG-Aftra were covert assets working for the streaming giant? NETspionage if you will (couldn’t resist).
Anyway, Netflix’s strength in the face of the work stoppage was both a function of the strikers’ lack of long-term strategy and Netflix’s abundance of it. Over the past two decades the company has employed several simple but important business strategies that have endured. Let’s review them.
Diversify
I asked ProfG.AI to explain the value of diversification. Its answer: “Diversification is the kevlar that protects you from fatal financial injuries. It’s a defensive strategy that limits your downside, even if it limits your upside.” I’d hate to hang with this guy, but he isn’t wrong.
Netflix has invested heavily in diversification, in the form of international content. The company is shifting spending away from Hollywood and increasing investment in local-language productions. In the past two years, spending in Asia has increased to $2 billion and European investment has doubled. More than half of Netflix’s scripted titles are being produced abroad. Compare that to Warner Bros. Discovery (a third) and Paramount (a quarter). The effect has been protection against supply chain interruptions (i.e. content shortages), because while American actors and writers went on strike and TV series orders declined 25%, the foreign production gears kept grinding.
In addition, Netflix has diversified its library with a mix of original and licensed content. One of its more creative moves this year was approaching NBCUniversal to buy the rights to Suits. After debuting on Netflix this summer, the 2011 legal drama (featuring the divorcée who saved a prince from the horrors of Buckingham Palace) performed better than any original Netflix show this year. Scratch that — better than any show, period. Suits was the most streamed show across all platforms for three straight months this year, hitting the record for most-ever weeks at No. 1. This is the Netflix Effect in action: Take a solid series, reheat it, and make it the most consumed content on the planet.
Adapt or Die
The species that survive aren’t the strongest or fastest but the most adaptable. As we’ve discussed before, the most valuable companies in the world all have one thing in common: They build a thick layer of innovation on top of investments made by the premier VC in history, the U.S. government. Apple used Darpa’s GPS to build the iPhone. Facebook built an app on top of a government-funded hosting service called the Internet. And Netflix, like Amazon, leveraged the nation’s largest content distribution platform — the U.S. postal system — to send DVDs by mail.
Mailing DVDs sounds dense now, but it was a great business. The company launched in 1997, went public in 2002, and reached a billion dollars in revenue in 2006 by addressing a pain point: that IED in your kitchen drawer, the VHS of Turner & Hooch you forgot to return. The company’s leadership could have settled and backed away from the massive investment required to pivot to streaming. But CEO Reed Hastings recognized another multibillion-dollar investment in broadband would soon render DVDs obsolete. “Don’t be afraid to change the model,” Hastings said, and in 2007, Netflix introduced streaming to the world.
Streaming was not the company’s only bold pivot. In 2011, despite its reputation as a “platform,” Netflix decided to foray into original content. At the time, it seemed absurd. The company was going up against Universal, Paramount, Warner Bros., Disney, and Sony — Hollywood titans known in the industry as the Big Five. Still, Netflix dove in headfirst, spending $2 billion on content in Year One. One of its first original series, House of Cards, went on to earn 33 Emmy and 8 Golden Globe nominations.
Opportunities vs. Problems
Peter Drucker said invest in your opportunities, not your problems. Few have done this better than Netflix. For a long time, the company’s obstacle was plain to see: It was burning hundreds of millions in cash every year. But Netflix knew brute force was its strength. Specifically, it recognized the market viewed it as a tech company, so it did what other media companies couldn’t: Massively invest, lose money, and grow.
In 2015, Netflix registered negative $840 million in free cash flow. By 2017, that number was negative $2 billion; two years later, negative $3 billion. Fearless spending was its differentiator. Capital as a weapon, if you will — specifically, cheap capital. Original content spending at Netflix grew faster than at any other streaming service, and by 2021 the company was investing $18 billion on content per annum, with free cash flow still in the red. Meanwhile, the legacy media players were beholden to a different investor base that wouldn’t tolerate the losses needed to go toe-to-toe with the streaming platform.
Netflix is now firmly profitable in all aspects of the business. It is the only entertainment company with a profitable DTC streaming business, and the legacy players are playing catch up.
Name Your Price
Netflix’s decision to increase subscription prices this quarter reflects the strength of the platform. It has reached utility status. There are 140 million households across the U.S. and Canada, and 77 million Netflix accounts. Consumers no longer consider the cost benefit of a subscription. The question isn’t if you subscribe to Netflix, but rather, what other platforms you decide to accessorize it with.
The premium plan is now $22.99 per month, up 15%. Meanwhile, the standard ad tier remains $6.99. Netflix has correctly adjusted for the most fundamental economic trend in America, income inequality. It has adopted a means-based pricing strategy that retains low-income users while squeezing more from upper-income households. Plus, research has found that introducing lower-quality products actually increases sales of your higher-margin premium products. I was skeptical of Netflix advertising at first, but it may ultimately drive more users to the premium product.
Threats
I’m tempted to say the only thing that can stand in the way of Netflix is Netflix. But that’s not true — it’s TikTok and YouTube.
We’ve discussed TikTok’s ascent before. The Chinese juggernaut is stealing eyeballs (especially young ones) from the streamers and generating $25 billion in quarterly revenue in the process. BTW, that number is up 34% from last year.
Less discussed, however, is the threat of YouTube. Netflix gave it a casual mention in its shareholder letter, but the implication was so relaxed as to be tense. “Our share of TV screen time in the U.S.,” the letter read, “is greater than any streamer other than YouTube.” This was meant as a not-so-humble brag. It isn’t. YouTube is the most popular TV streaming service, and that doesn’t account for the minutes it gets on laptops and mobile phones. I assume (hope) management recognizes this is a problem.
Bill Maher
I’m going on Bill Maher tonight. It’s my fourth time, and when they introduce the panel a wave of fear always envelops me that this will be one of the times I have a panic attack. (I get them 0.7% of the times I speak.) It’s important to me, as I respect Bill and his team, and my 93-year-old father only watches two things: Maple Leafs hockey and Bill Maher. He recently called me to announce I was on, as if it was news to me. He’s struggling.
I’m sitting in my room, on the 60th floor of the Wynn hotel, writing this. Every year for the past 35, my three closest friends and I have come to Vegas for my birthday. The trip’s changed: We now spend more time in the spa and less in the casino, but the company remains the same. I look out my window and see Summerlin, where I lived for seven months 20 years ago. My mom, battling cancer for the third and final time, asked to die at home. I moved in with her. She had raised me alone, on a secretary’s salary, and it was the right thing to do. It wasn’t much of a sacrifice for me, as I had no real relationship and no real career, and found the experience rewarding. During the day I’d manage her health care and we’d watch Everybody Loves Raymond and Jeopardy together. At night, I’d venture downtown where I’d party with a friend, a young guy who’d moved from Houston to open a cigar bar, and strippers. One night, I met him at the Rio hotel and he gave me a “healing candle” for my mom, whose breast cancer had metastasized to her stomach and was terminal. A candle. People are strange, and wonderful.
Today’s appearance on Maher will happen, but not really. Whenever anything really great happens to me, I instinctively think to call my mom and bask in our collective victory … we made it. Her response would cement it, make it real. These days, wonderful occurrences sometimes don’t feel as if they’ve happened, as she’s not there. I am 58 and, two decades later, still not over the death of my mother. And that’s OK. I hope my boys feel the same way about me when I’m gone.
Life is so rich,
P.S. Our Prof G Markets podcast is hitting new records. Tune in every Monday for our fresh take on what’s moving the capital markets.
P.P.S. Ex-Netflix VP for Product Gibson Biddle is teaching the Product Strategy Sprint starting Nov. 6. Watch the first lesson on his DHM (delightful, hard-to-copy, margin-enhancing) model for free.
Your Father is a Leafs fan?!??!!??
You seemed cool as a cucumber on Bill. Always appreciative of your insights. You are a 90% spot-on guy in my book. Bill has dropped to 50%. I wish he would STFU about the covid and the masks.
Professor Galloway, I lost my mother earlier this month. Came here for the analysis, stayed for the human touch. Thank you for your mind and heart.
Happy Birthday. Welcome to 58. Love the data. I like the way you write. We’ve had similar paths. Wall Street to Higher Ed. You’re right, life is so rich. Looking forward to hear about the Pivot trip to the WH.
Insightful and beautiful as ever. My same issues with my mom although she died sooner than I expected but I was still very close at the time. She loved Bill Maher too. So did I for a long time but not now. He’s gone over the ego edge. I will be missing you on his show, haven’t watched in over a year.
‘No mercy.’ Perfect sentiment for the tyrannical, Covid merchants of death your hindsight’s wisdom has bestowed upon you. Where was the grace and forgiveness when people died isolated from their entire families? Not from Covid, but Remdesivir and ventilators. Where was the grace in vilifying cheap and effective medications? Where was the grace in cancelling real medical pros? You’ll get No Mercy from us whose wisdom came then, and not now. Your “imperfect information” seemed so perfect for you all at the time. You tyrants can all go to Hell together.
Exactly! I’m a long time Prof G fan, have completed multiple Sprints, and assign his books to my classes. But it’s going to take a lot more than appealing to my Christian charity and using the buzzword “grace” to dig out of this hole, Prof. You showed no mercy or grace to those who disagreed on vaccine mandates. You told half of America it had its head up its rear end; very graceful of your. You were cruel and tyrannical. On Maher, you blatantly copped out by using the “did the best we could given incomplete data” act. But the data was there, it just didn’t fit the chart you wanted to publish. You and your ilk are going to catch hell, and you deserve it. As you sowed, you will reap, you hypocrite.
To Miller & Watson,
Both of you sound like OrangeTreason loving boomers. Cheap medication like Bleach, and blaming ventilator shows that you can’t count pass your toes.
Most that got it survive the initial pneumonia and started improving by day 7. The ones that in trouble got worse in day 7+. Reason is simple. The virus killed off a lot cells in the lung, heart and kidneys. The body’s repaired system kicked in . No different that if you got in a small burn in your hand. First it get a blister that if you popped is filled with clear liquid which is plasma as the body fill the area with plasma to allow other cells to move in to clean up and repair. If you wait a few days and pop it is puss filled. That puss is mostly white blood cells doing the repair. Same thing happened in the lungs, heart and kidneys. Except that those organs can’t handle it. So in the lungs where gas exchange happens across very thin membranes the excess fluid blocks it – requiring mechanical positive pressure force. In the heart, the excess fluid blocks electrical activity required for heart contraction causing arrythmias, in the kidneys it affects the filtering system causing fluid build up in the body that along with heart and lung failure caused death with many having 7-9 liters / 20-30lbs of excess fluids in their body.
Thank you for the pathology lesson, Dr! I’m smarter for your contribution! For the record, I gladly accepted the vaccine and boosters. I don’t love Trump, but your description betrays your bias. And I’m a Gen X, not a boomer. Sorry that I ruffled you.
Your pedantic prose missed my message: asking for grace after authoritarian tirades and personal insults isn’t good enough. Scott knows that; if he doesn’t, he should. His groveling won’t undo the damage he admits was done.
Keep doing the work, champ!
You just had to us make me cry at the end…calling my parents right now. In this grind we call life, thank you for always reminding us how little time we really have to share with those who truly matter.
Great article, but missed a few comments on Netflix’s pivotal revenue stream: subliminal advertising for big tobacco.. original content on a reeeeally old playbook..
The best article / post i have read ever! Thank you.
Netflix as a utility- interesting to think what the future ‘utilities’ look like
You brought a tear to my eye reading about how you want to tell your mom you both made it Scott. Death of a parent is something I’ve thought about the past year or so and make the effort to see mine as much as possible now, because I realized that at my parents’ age (early 70s), if I only see them once a year then I might only see them 5 times more in my life. That’s a terrifying thought. In the times I worry about losing people (and pets) though, I revisit the transcript of your conversation with Mo Gawdat when he bravely and frankly spoke about the death of his son. I find it helpful.
As an aside, my wife occasionally listens to your podcasts with me, and since she also struggles with public speaking, something she has to be able do in her vocation, I told her how you’re also shy and fear public speaking. It inspired and motivated her and made her believe she could do it if you were able to speak so confidently on tv and pods. She’s joined Toastmasters as a first step. Thanks for your inspiration.
That is your best post ever. Thank you.
Lost my mom ‘only’ a year ago. Your reflection reminded me that I don’t want to ‘move on’ or ‘get over’ the loss of her. I want my life to ‘move with’ her for the rest of my life. That’s what she’d do for me. Thank you for sharing.
Hey Scott – that healing candle was for you but your male friend was too proud and alpha to tell you. It did the job though, and you’re thinking of him with affection. How wonderful is that? Thanks for all that you do. Tom
Never gave Netflix a penny, never will.
As insightful and astute as the Netflix related commentary in this is, the last paragraph is very powerful. Your mother would be very proud at how you enrich the lives of others. Happy Birthday!
What a touching personal story today❤️happy birthday!
What a touching personal story today❤️happy,happy birthday!
Your last three paragraphs made me cry and very emotional. I was going to write a long post about being a single mom that raised an only son in a one bedroom apartment on a secretary’s salary (all true), but I will say Thank You instead. You really inspire people to be better humans. It is the sweetest thing! BTW – Is it just me or does a young Scott Galloway resemble a young Bruce Springsteen? I watch Springsteen concert videos from 80s/90s all the time, and I see a resemblance. 🙂
Scott – great, intriguing comment on Netflix. We are Netflix members! I guess when you are successful, you go up on your rates – they gaian but where’s our reward? I lost my mother 30 years ago – we were very close – I still miss her and thank God for her…also still talk with her! Thanks for your professional and personal comments! Will watch Maher!
Love your sharing about your mother and father, and the nerves about going on Maher.
Scott boasting about his predictions: “I told you so”, is hilarious. Remember when he predicted that threads would take down Twitter (eventhough he hates Zuck more than Musk). Scott – you are brilliant, and NMNM is great. Leave emotion and bias out of your prognostications.
Interesting as always.
Peter was my faovrite porfessor at NYU back in the day.Years later, I can still remember his words. I miss my mother too, she had pushed me to go to graduate business school in ’67. As for todays words of wisdom, it’s still the same old tale…don’t be like everyboy else, be you!
Thank you for sharing your feelings about your mom. I’m presently suffering the recent loss of my own mom, whom I took care of for many years in her late old age. I know I’m never going to stop missing her. It’s reassuring to read that you have lived with your feelings of loss without having to try to deny them. It’s clearly the price we pay for loving someone who dies before we do.
Insightful and thought provoking! What made me comment, however, was that last paragraph. You have described grief so beautifully in a few sentences, and it perfectly describes how I feel about losing my mother. Thank you!
Great piece (per usual), both insightful and funny. And then you come with the sucker punch last few sentences to make me cry.
You’re really a terrific writer.
Beautiful. Tears in my eyes.
I loved this, Scott. Especially the last paragraph. I love it when you talk about your experiences and family. It reminds me what’s most important with my little ones. Crush it tonight!
Great analysis but the best part of the article was the surprise tear-jerker last paragraph. We can probably all relate in some way. No matter our relationship with our parents, someone who loves us feeling proud of us is oxygen for the driven. Thanks for the great read.
The part about your mom made me tear up. Always appreciate your personal stories. Go kill it tonight on Bill Maher!
Thank you for that beautiful reflection at the bottom. The loss of a mother is a wound that never fully heals but we learnt to live with.
Thank you for generously sharing with all of us your thoughts on business and life every week.
Bests,
Sam
mendacious fucks…nailed it
A loyal reader, but first time commenter, Scott. I share an upbringing similar to yours: my mother raised two boys, also on a secretary’s income in the “shorthand” era. And like your pa, I loyally follow the Leafs and have religiously since youth. From those days when owner, Harold Ballard, would not allow the games to be televised until 30 minutes after the start, fearing that folks would not pay to attend the games and fill the arena, if it was full-coverage. Lastly, reading of Netflix’s success, I wonder .. were those early days of shared passwords, perhaps just a growth gimmick? Warmest regards .. darrell ~
Great Article, I had been wondering how Netflix’s price hikes would affect subscriber growth, this was an excellent summary per usual. Reading these newsletters makes me feel like I always get the inside scoop.
Avid podcast listener. Love pivot especially. Always appreciate your insight. But to be honest I can’t stand Bill Maher. What exactly is his claim to fame other than just “sounding very opinionated”? He’s not a professor like you. He’s not particularly educated, and he is clearly tapping into “white male fragility” (I’m a white male, your age, so i see the appeal) to sell himself. Truly confident men don’t and shouldn’t need him.
Anyway, love hearing your ideas all the time. I’m from Hawaii, lived all across the US, Europe, and Asia, retired airline director, now small entrepreneur in paradise (Kona).
Scott, so appreciate your critical thinking and analysis. This is a superb article. Would love to have you as a guest on our podcast Brand Shorthand. We are just starting (and learning). We were privileged to interview Roy H Williams, known as the Wizard of Ads. You both are Wizards, root word “wisers.”