The Business Of
Movies | Netflix | How Do They Make Money?
Morning All!
Yesterday we mentioned that Netflix started their streaming business in 2007. But they were already making $1 billion in revenues by this point! So the question is - what on Earth were they doing before? Well let’s not waste time… we have a lot to cover today - so let’s dive in!
The Amazon Of DVDs?
So, let’s take a little trip back to the 1970s. As we highlighted in last Friday’s newsletter, the increased number of TVs in houses was one of the major disruptors of the movie industry. People were renting movies from stores and watching them at home. And by the 1980s, one of the more popular stores people went to for their rentals was Blockbuster.
However, by the 90s, the internet was starting to flourish. And two chaps named Reed Hastings and Marc Randolph thought they could make movie rentals easier. Instead of going to a physical store to get your DVD and then going back once you’ve watched it. They thought, why not just order online and get it delivered to you. And once you’re done, you just post it back. Well, would you believe it - that was the birth of Netflix.
Before making the switch to streaming, Netflix basically just stored loads of physical DVDs in massive warehouses. Subscribers ordered the DVDs online. And then Netflix used UPS to deliver them to subscribers. Sounds very similar to another business model…
However, by 2007, a shift was occurring. YouTube was founded in 2005 and was growing rapidly. And Netflix management thought now was the right time to go into streaming content. And so, in 2007, Netflix pivoted from being a DVD-focused company to a streaming-first company.
And what a pivot is was. Because just 5 years after introducing their streaming service, the revenues from streaming had overtaken DVD revenues! The chart below shows us how the split between DVD revenues and Streaming revenues has changed over time.
I just wanted to highlight one incredible story in Netflix’s journey. In the year 2000, Netflix was struggling to stay alive. Revenues were growing but losses were mounting. And so the founders decided to sell the business. However, in what’s rated as one of the biggest corporate mishaps - Blockbuster turned down the chance to acquire Netflix for just $50m. Blockbuster has since filed for bankruptcy and has one store left. Netflix is now worth $150 billion…
… right, that’s enough of how Netflix became Netflix. Let’s chat about how the company makes money!
The Second Big Pivot!
We saw last week with Cineworld that the equation for calculating Movie Ticket revenue was fairly straightforward. It was…
Well, the equation for calculating Streaming revenues is also pretty straightforward. It’s…
We’ll start off first looking at subscribers. And then focus on pricing in the next section.
So, when it comes to subscribers, Netflix originally started off in the US. And Netflix was purely a US-product for 13 years. It was only in 2010 that the company branched out to Canada. And over the last decade or so, Netflix has expanded to most regions in the world. The graphic below shows us the international expansion by region.
What has this meant for subscriber numbers? Well the chart below gives us this info. In 2011, Netflix had 20m subscribers from the US and only 1m overseas. However, over the last decade, the international subscriber growth has been absolutely phenomenal! And by the end of 2022, their international subscriber number was more than double their US subscribers.
International subscriber growth has been 53% CAGR since 2011 and total subscriber growth has been 24% CAGR over the same period.
Okay, so we know the subscriber count evolution. But let’s go one step deeper and look at the drivers behind the strong subscriber growth. What have Netflix done to maintain such strong subscriber growth? Well a good place to start to understand this is 2012.
What happened in 2012? Well in 2012, all the Sony and Disney films that Netflix subscribers could watch were taken off the Netflix platform. The 4-year agreement between Netflix and Starz (the company that had the rights to distribute the Sony/Disney films) had ended. And Starz didn’t want to renew the contract. Instead, Starz created their own streaming platform and became a competitor to Netflix!
When this happened, Netflix understood that they were in a similar position to Cineworld. They didn’t own the shows or films on their platform. They were just a distributor - like an online cinema operator. And if one day, Disney, Paramount, and the other film studios all got into streaming (which they have done). And take their shows/films off Netflix (which they have done). Then why would anyone subscribe to Netflix and Netflix would be dead (which they are not). But the reason Netflix aren’t dead is because of the second big pivot the company had. They started creating their own content.
In 2013, Netflix’s first original series, House of Cards, was released and it became wildly popular. What followed were several more hits including Narcos (2015) and Ozark (2017). But the main takeaway from this is that Netflix adapted. From being just a middleman between film studios and viewers. They became the film studio themselves! And the constant stream of original content has kept subscribers engaged and brought on plenty of new subscribers too!
Another way Netflix has maintained their strong subscriber growth is through their customer experience. Have you ever looked down at your remote and wondered how the Netflix button got on there?
Well, back in 2011, Netflix management realised that streaming on your laptop was cool. And hooking it up to your TV wasn’t too difficult. But what if subscribers could just press a button on their TV remotes and bring up Netflix on their screens?! So what did Netflix do? They partnered with all the top TV makers to create this button!
Now, of course, this button has made life a lot easier for subscribers. But think about the advertising! Every time someone buys a TV now, they’ll have Netflix flashed before them. And who knows how many potential-subscribers will have converted to actual-subscribers from seeing the daily advertising. But do we think these TV makers agreed to creating this button for free? Aha of course not - and tomorrow we’ll look at the interesting cost structure for this deal!
The final thing I want to touch on regarding subscriber growth is quality. When you press the Netflix button, find a show to watch and then hit play. You don’t want to see this…
And Netflix have gone to incredible lengths to make sure subscribers see as little buffering as possible. The company has created their own content delivery network (Open Connect) in order to ensure a high-quality, no-lag experience for customers. Don’t worry if you don’t know what a content delivery network is. We’ll go into this in much more detail in tomorrow’s newsletter! (Here’s a nice, easy to understand video if you can’t wait till tomorrow though!)
But seriously, imagine if Netflix was always lagging and the experience wasn’t so seamless. Would as many people be recommending Netflix to friends? Would subscriber growth have been so strong? Would subscribers be as price inelastic when prices go up? Probably not!
Charge The Swiss!!
And speaking of prices, let’s now look at this second element of the revenue equation. Netflix has only started disclosing the average subscription price that subscribers pay since 2014. And the chart below shows us how the average monthly subscription revenue has grown since then. As we can see the monthly average subscription paid by subscribers was $8.20 in 2014. And this had grown to $11.76 by 2022.
However, this subscription figure is a combination of Basic/Standard/Premium subscriptions. In the Japan for example, the Basic plan costs $7.34. The Standard plan costs $11.04. And the Premium plan is $14.68.
And then we also see the combination of subscriptions from wealthier and less wealthy countries. Currently, the monthly price for a standard subscription in the US is $15.49. The cheapest standard subscription can be found in Pakistan, where it costs just $3.06. However, the most expensive standard subscription is found in Switzerland, where it costs $20.29 per month.
So, whilst Netflix pricing plans vary by region, the important thing to note here is the intended evolution for prices. As we can see in the chart below, the pricing for US plans has changed markedly over the last decade. The Standard plan has almost doubled in price from $7.99/month in Nov 2010 to $15.49/month in Jan 2022. Over the span of 12 years that works out to average price increases of 6% per year.
And this is the roadmap Netflix would like to see in every region! Start low and bump up the prices gradually. How high could Netflix charge before a lot of people quit? Well, for the last decade we’ve seen Netflix have very low churn rates (the % of subscribers who cancel their subscriptions). The increases in price have had a less than proportional fall in volumes. However, this may be changing…
With increased competition from Disney+, Hulu, HBO, Apple TV, Amazon Prime, etc. there’s only so many subscriptions we can all have! Throw on top of that, the cost of living crisis. And earlier this year we actually saw Netflix lower their prices in 30 countries! With the company already having such high subscriber numbers, price increases would be key for revenue growth. So watch this space to see what Netflix does with pricing going forward!
Blockbuster Numbers
So we saw subscriber growth has been 24% per year over the last decade (20% since 2014). Pricing growth has been 5% since 2014. And those two drivers have translated into total annual revenue growth (CAGR) of 24% since 2014. The chart below shows that the company hasn’t had a single year where revenues have fallen!
Whilst these revenue numbers are pretty incredible, tomorrow we’ll turn our attention towards EBIT. And see whether Netflix’s impressive topline growth has been translating into strong EBIT growth. Because after all - remember - the goal is profits, not revenues!
Giveaway! Refer A Friend!
Oh and just before we go, a reminder that you have 24 hours left to refer a friend. To have a chance of winning, ‘That Will Never Work’ - a brilliant book by Marc Randolph (the co-founder of Netflix). And someone who seems to be one of the ‘good guys’.
11th Apr 2023
On that note. Have a great day all! And we’ll see you tomorrow.
The Business Of Team