Why Is Netflix Changing Its Core Strategies?

Netflix saw some of its best quarters in 2020 even as other sectors struggled with the onset of the pandemic. However, as economies started reopening and businesses returned to normalcy, Netflix is faced with a major problem – a potential decline in subscriber numbers.

The subscriber base of the company declined by 200,000 subscribers in the first quarter and the loss was attributed to the suspension of the company’s operations in Russia. If one is to exclude the loss of the Russian subscriber base, the platform gained 500,000 subscribers during the period. But the number pales when compared with the 37 million subscribers that were added during the pandemic in 2020 – translating to an average addition rate of more than 3 million subscribers in a month. However, the markets appear to be more worried about the announcement of a potential loss of 2 million subscribers in the second quarter.

The company has cited several reasons for the potential decline in user numbers. For instance, the increasing competition in core markets as multiple streaming platforms offers a wide range of content. Increasing inflation could potentially be another trigger for some users to cut down on non-essential expenses. Further, the company’s own strategy of increasing subscription prices to cover the costs of running operations and creating new content could cause users the leave the platform. In addition, Netflix has said that a slowdown in the adoption of smart TVs and broadband connections has impacted its subscriber additions.

A more controversial reason was the attribution of subscriber loss to password sharing among household members. With around 222 million paying households, the company estimates that another 100 million households use an account shared with paying users. The market’s strong reaction to the negative news resulted in a 37 per cent decline in the stock’s value. The sharp reversal in the company’s fortunes has prompted a rethink on several core strategies that had been strongly advocated by its management previously.

The company’s famous no-advertisement policy is likely to be withdrawn as the company looks to stall the subscriber decline. For years, Netflix has stayed away from the advertisement-led model in favour of a premium subscription-led model. An ad-based model allows content streaming platforms to compensate for low to no subscription fees by making money through advertisements. As a result, the company receives higher user engagement while earning revenues from third parties. Usually, the ad-based business has lower margins compared to a subscription-based business, making it a less desirable business.

After years of opposing ad-backed business, Netflix has now said that it would look to build a cheaper ad-backed service for users who wish to pay lower fees. However, analysts have questioned whether the company might be sacrificing revenues for a higher subscriber base. Though the move could boost subscriber numbers, a significant shift to lower value plans could possibly mean little change in total revenues for the company.

Another strategy, heavy spending on content to differentiate itself from other platforms, is being re-considered. The company has said that it would look to lower its heavy spending on acquiring or creating content. South Korea saw several production company stocks drop after the Netflix announcement, as Netflix had planned to spend around $ 500 million on Korean content. Over the last few years, the company has been spending upwards of $ 10 billion each year on acquiring content for the platform.

Similarly, the practice of password-sharing among members of a household was once applauded by the Netflix management. But since last year, the company has been attempting to get households to pay over pass-word sharing. In the quarterly letter, the company said that it estimates that 100 million households are sharing passwords with other households, which implies a loss of revenue for Netflix. Arguing the need to monetize the sharing, the company said that it is trying out new mechanisms for receiving payments in case an account is being shared.

The steep decline in technology stocks like Netflix, Meta and others does indicate that the markets had been probably been expecting consistently high growth in these businesses. Paying up for businesses with blind faith in growth and often illusory competitive advantages can be dangerous for investors. It remains to be seen whether the company’s deviation from its core strategies could be rewarding for the company’s shareholders.