July 17, 2018

What Goes Up Sometimes Goes Sideways

Netflix released its Q2 2018 numbers this week, and the results were less than inspiring. The streaming giant added 5.2 million subscribers worldwide (the exact same number as Q2 2017), adding less than 700,000 new customers in the US. Given its stratospheric stock price, this is hardly the level of growth people have come to expect.

So what’s really going on with Netflix and what does it tell us about the future of TV?

1. Netflix has Saturated Several of Its Key Markets.
The idea that everyone is the customer for Netflix, or pretty much any product or service whatsoever, is almost always an extremely flawed assumption. Netflix currently has over 57 million customers in the US, out of roughly 120 million households (as tracked by Nielsen). In other words, Netflix has penetrated half the households in America. This is an amazing achievement, but how much further can they really go?

The US does have positive household growth (at the moment), and new household formation should continue to drive some organic growth for the foreseeable future. After all, new households do often want some kind of access to premium video, and Netflix remains appealing to at least some of those folks in terms of both price/value and perceived quality.

The harder question is whether Netflix can actually grow its household share much further. Consider me skeptical. Netflix is not a utility. A household can function perfectly well without it — either by subscribing to legacy TV, a skinny bundle vMVPD service, Amazon Prime, Hulu or (here’s a thought) nothing at all. Despite its awards and name recognition, I really struggle to name a current Netflix show that owns the cultural conversation to such a degree that people feel like they have to get it in order to avoid being left out. HBO still seems ahead on that score, and both Hulu and Amazon seem like they are rapidly reaching parity with anything Netflix offers on the originals front, which brings us to our second point.

2. Premium SVOD is Not a Winner-Take-All Market.
An interesting point here is that Netflix (if not some of its investors) explicitly acknowledges this, arguing in its latest shareholder letter that:

Consumer appetite for great content is broad and that there is room for multiple parties to have attractive offerings.”

I couldn’t have said it better myself. Premium video is not a social network like Facebook, Instagram, or Twitter. It’s not even a search engine like Google or YouTube. The network effects are simply not strong enough to create only one winner. Folks who think Netflix is the next “horsemen” alongside Alphabet, Amazon, Apple, and Facebook are just mistaken.

Netflix has never been and will never be a global giant with 1-2 billion customers. Premium SVOD just isn’t that kind of service. That would be like thinking that The New York Times (or CNN) was going to take over the entire worldwide news market, or that ESPN was going to take over the entire sports market. That’s simply not how media markets work. Brands certainly matter, but they don’t really create winner-take-all markets. Even a brand like Disney has never been able to monopolize the kids market, even after spending billions to acquire Pixar and Marvel Comics.

The best-case scenario for Netflix has always been profitable co-existence with other media brands like HBO, Hulu, Showtime, and others. This is exactly what Netflix has achieved, and there is nothing wrong with it, except among those who think Netflix is about to take over the world, which leads us to our last point.

3. Many People are Never Going to Subscribe to Netflix.
I see (at a minimum) four segments that are extremely hard for Netflix to reach, and thus put a cap on the service’s ultimate market penetration. Importantly, these segments exist in every market, not just the US.

The first are older viewers who are comfortable with TV as it is, whether delivered over a legacy network or streamed over the Internet via vMVPDs. Netflix has little appeal for this demographic, which is growing in every country. The second segment includes individuals living in rural areas that lack sufficient bandwidth to stream Netflix adequately. This group is nonzero in the US, and ever more substantial in many international markets. This is neither Netflix’s fault nor its responsibility, but it is a reality that limits the addressable market. The third segment includes extremely low-income households. Yes, Netflix is cheap, but it is still a recurring monthly fee on a credit card that also requires a reasonably fast bandwidth connection as well as devices capable of rendering that stream on a sufficiently high quality screen. Few people subscribe to Netflix solely so they can watch shows on their phone while on Wi-Fi at Starbucks or the local library. That’s just now how (or when) TV is consumed. So despite Netflix’s low price, a segment of the market is still not able to afford it.

Fourth, some people simply don’t watch TV anymore, preferring other amusements (or none at all). Again, plenty of folks are content to live life without Netflix, and no amount of original content is going to attract people who don’t watch TV in the first place.

Netflix is a very successful brand that has millions of fans and still has some potential for growth. In the broadest sense, Netflix is totally fine. What the latest quarterly numbers clearly demonstrate, however, is that Netflix is neither a monopoly nor a utility, and it is extremely unlikely that its market share will increase dramatically beyond current numbers. Once the market digests and acknowledges this reality, the Netflix stock price will find significantly more rational levels.

Stick with TDG and stay ahead of the curve.

Joel Espelien is a Senior Advisor for TDG and serves as an advisor and Board Member to the video ecosystem and technology companies. He lives near Seattle, WA.

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