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Netflix looks to low-price India tier, originals to fix Q2 ills

Q2 2019 saw Netflix lose subscribers in the U.S. and suffer weak performance internationally. The company is continuing to focus on originals and introducing a cut-price India mobile tier to return to more robust growth.

The quarter results

By the company’s primary benchmark, subscriber growth, the second quarter was not a good one. The company lost subscribers in the U.S. for the first time since it introduced streaming services in 2007. Paid subscribers fell 126,000, leaving the company with 60.1 million U.S. paying customers. However, the May increase of $2 per month for the HD and Ultra HD plans help lift revenue and 11% over Q1 2019 and 21% over Q2 2018, to $2.3B.

From a subscriber perspective, international results were only marginally better. The grew paid memberships by 2.8 million. In Q2 2018, Netflix added 4.6 million paying customers. Revenue rose 8% from last quarter and 33% from Q2 2018, to reach $2.6B.

Globally, Netflix increased the number of paid subscribers 2.7 million, against its forecast of 5 million from last quarter. The financial markets reacted swiftly with the stock falling 12% in after-hours trading.[i]

Two things appear to have impacted Netflix subscriber growth negatively. In the U.S., the price increase was likely a factor. More significantly, the lack of a big title release in the quarter put a drag on all markets. Big title releases are a very effective mechanism for attracting new subscribers. In the earnings call, Ted Sarandos commented that the new season of Stranger Things has already accelerated subscriber growth in Q3.

Netflix submits to the inevitable in India

Last quarter, Greg Peters, Netflix’ Chief Product Officer, indicated the company was testing different pricing models in India. This week, Mr. Peters confirmed the company would introduce a lower-priced mobile tier of service:

Greg Peters – Netflix

“It’s going to be at a lower price point in a market where the typical pay TV package is under $5. We need to have a lower price offering to improve accessibility. But also, to complement the existing tiering infrastructure that we have.”

Mr. Peters is understating Netflix’ pricing problem in India. The number one service there is Hotstar. Disney (which now owns the company) says it has 300M active monthly users (free and paying customers) and Counterpoint estimated at the end of 2017 the service had 75M subscribers paying $3 per month. Netflix has a tenth of the paying subscribers and charges more than twice as much.

Dealing with the loss of Friends and The Office

With so much viewing accruing to hit shows like Friends and The Office, people are wondering what will happen when those shows leave, starting next year. The Q2 investor letter commented:

“From what we’ve seen in the past when we drop strong catalog content (Starz and Epix with Sony, Disney, and Paramount films, or 2nd run series from Fox, for example) our members shift over to enjoying our other great content.”

It is critical for Netflix that original content pick up a lot of the slack when big shows leave. Speaking in the earnings call, Mr. Sarandos emphasized how essential originals are to Netflix’ future:

Ted Sarandos Netflix

Ted Sarandos, Netflix

“Over six years ago we got into original programming, betting that the licensed programming would be more and more difficult to come by and that the sources of content to license from would be under different levels of strain. That has paid off we think, and it is very important to the business to continue pushing down that road.”

There is evidence original content is stepping up to compensate, according to Kathi Chandler-Payatt, Executive Director, Entertainment Analyst at The NPD Group. She says that in 2018, 13% of new shows on Netflix were original, increasing to 16% in 2019. Viewership of originals is growing just as fast. In 2017 and 2018, the average minutes watched per Netflix profile per day remained the same, 33 minutes. Over the same period, the original content’s share of those minutes increased from 13% to 19%. 2019 has seen time spent with originals leap ahead to 24% while time spent rose to 44 minutes.

No advertising in the foreseeable future

There continues to be speculation that Netflix will eventually add advertising. Reed Hastings was emphatic on the point:

Reed Hastings

Reed Hastings – Netflix

“This year, we will add around $5b of incremental subscription revenue, which is almost all gross margin. That’s greater than any entertainment company has grown in the history of the world. We want to keep that revenue engine going and not get distracted with alternative revenue sources, which don’t add up when you’re growing at $5B a year.”

The Q2 investor letter put it more bluntly:

“When you read speculation that we are moving into selling advertising, be confident that this is false.”

Why it matters

Netflix lost U.S. subscribers in Q2 for the first time and showed weak gains in international markets.

The lack of a big hit in the quarter and price increases in the U.S. are likely to blame.

The company will continue to focus on originals and will introduce a lower price mobile tier in India.

There will be no advertising version of the service for the foreseeable future.

[i] As of 7:30 PM Eastern on July 17th, 2019


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