Why the paid sharing push by Netflix is a sign of weakness

In Netflix’s Q4 2022 earnings, the world’s pre-eminent subscription video on demand (SVOD) service painted a bullish picture of a company having navigated a difficult 2022. In its own words :

“2022 was a tough year, with a bumpy start but a brighter finish.” 

Overall global memberships were up 4% to 230.75 million and year-on-year revenues were up an admittedly modest 1.9%. During this period, the company went through two difficult quarters of declining subscriber numbers for Q1 and Q2 2022 which, although modest, spooked investors who bought in on Netflix’s seemingly unstoppable growth story. These declines were attributed by investors to a combination of increased competition and exit from the Russian market (due to Russia’s invasion of Ukraine). As a result, Netflix announced that it was launching an ad-supported subscription tier. It offered greater pricing flexibility for its addressable consumer base and was a PR gesture to investors (Netflix was famously the only hold-out against ads in the direct-to-consumer space). Launched in 12 markets in November 2022, Basic with Ads has had mixed results to date, with Netflix falling short of ad-supported viewership guarantees made to advertisers and allowing them to take their money back for ads that have yet to run. However, on Thursday’s release, the company made a point of stating what the overall unit economics were:

“ ..our ad-supported plan has strong unit economics (at minimum, in-line with or better than the comparable ad-free plan).”It was also notable that Netflix did not break out the number of subscribers to the new tier, preferring to bundle them in with the overall subscriber numbers. More significant for investors was the impact on the company’s margins in 2022; while year-on-year revenues for Q4 were up 2% from $7.7 billion to $7.8 billion, operating income declined by 13% to $550 million. The result was a decrease in the company’s operating margin from 8.2% in Q4 2021, to 7% in Q4 2022.

Enter the paid push

To help offset these shrinking margins, Netflix’s 2023 focus is on product and pricing through its continued development of Basic with Ads and, more significantly, through its paid sharing feature. The SVOD service estimates that 100m+ households engage in account sharing (where members share their logins with friends or family). Converting these into paid subscribers would increase the size of Netflix’s membership by 43% - a huge win. Netflix’s feature rollout aims to be more pull than push with new features offering the ability for members to review which devices are currently using their account and then to transfer a profile to a new account. Members will also have the option to pay extra to share Netflix with people whom they do not live with.

While focusing on reducing free usage of its service is a valid and important step, it is also a reactionary one. Netflix traditionally did not even count subscriber churn because they were so confident in the appeal of their service that they knew that their former customers would return. In Q3 2022, 5% of consumers were unsubscribed from Netflix but planned to resubscribe (Source: MIDiA Research Q3 2022 consumer survey). The sudden switch to policing un-monetised users comes at the expense of innovating alternative ways of monetising digital consumers. Fundamentally, Netflix’s answers to its margin challenges reside in pre-digital monetisation of TV – subscriptions and advertising. 

Netflix has stopped being a monetisation innovator 

Netflix’s declining margins come after a decade and a half of focusing on becoming “a pure-play streaming company” after its 2007 pivot into SVOD. It is no longer a young company, and the lack of imagination in how to address its slowing business fundamentals reveals its Achilles heel: pre-digital TV thinking. In the Netflix world, there are only two ways of monetising audiences, through subscriptions and advertising. However, we are now in the streaming TV era. Netflix’s content proposition must compete equally with non-TV-type content; where in-app purchases, dynamic pricing, and digital merchandise are increasingly the norm. All these are value enhancers for consumers – unlike imposing advertising and clamping down on password sharing (signs of a defensive business running out of innovative solutions to growth challenges across the macro economy).

To be clear, the investor pressure that Netflix is under to stabilise its maturing business model (Netflix’s debt repayments of $700 million in 2022 were 12.7 times larger than its full year net income of $55 million for 2022) is also one which Disney is currently facing from activist investor Nelson Peltz and his Trian Fund. While Disney is a diversified media major at an earlier stage in its streaming strategy, Netflix has had nearly two decades to calibrate its business model. Both companies, however, are fundamentally sound in their focus on streaming, with MIDiA predicting an additional billion subscribers being added between 2023 -2030. However, as with all consumer-focused business strategies, success comes from delivering improved products and services, not from forcing consumers to stick with what works from an abstract business perspective alone.

Netflix is being forced to act like a traditional TV business to please investors, putting at risk its ability to compete in the new monetisation wave unfolding across streaming TV. Short-term gain for long-term pain.