Why Netflix Struggles and how it can Fix it

April 19 saw the release of Netflix’s Q1 2022 report, which was weaker than expected and paints an uncertain-looking future for the media giant.

Subscriber growth slowed virtually to a standstill and the number of subscribers even declined in the US. Revenue growth was primarily fueled by price increases and, while operating margins are reasonably strong, a projected margin decline going forward put a further dent in analyst’s expectations. Netflix is citing the pandemic subscriber boost clouding the long term picture, as well as macroeconomic factors as major contributors to the weaker performance and short term outlook, but remains bullish about its long term potential. 

I believe that the main problem is that the current business model is flawed for what it is trying to accomplish in the future. A premium subscription model is fantastic if you want to reach specific parts of the market. However it is not the best approach if you, like Netflix, want to get the maximum revenues from everyone globally. I think it will be very difficult for Netflix to materially increase the number of subscribers if it maintains the current business models.

The step to get in as a subscriber is high, with entry level prices at least $10/month and most people taking a $15/month plan. At the same time, many consumers are not consuming more than a couple of series and it just doesn’t seem worthwhile for them to pay for a full subscription. Instead of generating any revenues for Netflix, these casual viewers resort to password sharing or pirating. While Netflix is constantly fighting for customer retention, especially in relation to password sharing, it needs to be careful not to make it too difficult for real customers with normal family consumption. Ultimately, if Netflix continues to focus too heavily on average revenue per user (ARPU) rather than reaching a wider audience, it will struggle to continue its long term growth.

Fundamentally, I think Netflix has three ways to go:

Become a more traditional premium media company

First, Netflix can transform itself into a more traditional premium media company. While this may not be in Netflix’s DNA, it can certainly, with ease, reduce growth ambitions to be in line with traditional media, around mid to high single digits. With this, Netflix can then also significantly reduce spending on content and technology. I believe Netflix will be able to generate annual cash flows of $10B relatively quickly.

Lower the entry barrier to restart growth

Second, it can boldly go for an ad-funded Netflix tier. This will undoubtedly lead to considerable subscriber leakage, but done cleverly, the revenues from the ad-funded tier should more than compensate for the revenue loss from the subscriptions. New releases may only be available on the subscription services, but I would otherwise assume that all content will be available to ensure the traffic levels necessary to drive significant revenues.

Retain subscribers with personalized offerings

Third, Netflix now has enough content and enough brand recognition to be able to segment the market more effectively with new types of subscriptions. Instead of only offering different subscription tiers based on quality and functionality, it can segment the market based on content availability. Netflix should also have enough customer data to draw conclusions about consumer behavior to design these new offerings. Maybe a lower priced Netflix Kids might be attractive for some segments? Maybe a Netflix Classics subscription which only includes older Netflix originals? Or maybe on the premium side creating release windows, where only the top subscription tiers will get the releases immediately, while lower tiers will get the releases a couple of weeks later? The opportunities are endless. Netflix has certainly done its share of experimentation already, but they have been local and limited, and we have yet to see a significant transformation.

It is of course possible for Netflix to go with a multipronged strategy, but I think it is wary of introducing too many changes at once. My personal guess is that it is very tempted by advertising, but wants to ensure there is a new level of  innovation related to ad-funded business models and the advertising experience. It is also deliberating what to include in a basic advertising tier to make it attractive enough for users, but not so attractive that it will cause unnecessary subscriber losses. 

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