Netflix thoughts -- part 1

 

What is the end game for Netflix?

There has been an ongoing debate on what is going to happen to Netflix and the narratives range from the very bad (bankrupt) to the very good (Monopoly). Most participants debate on short-term issues when the focus should be on the end game. 

In my opinion, Netflix wins and the end game will likely be a global oligopoly between Netflix and Disney, with the former being far more profitable than the latter. This post and following parts will talk about this and the reasons behind it.

What do customers care about? 

In this world where multiple content producers across various platforms are competing for eyeballs, customers have the negotiating power and can choose the content they want to watch. 

This is unlike the past where customers are essentially limited by the contents that are available to them, known as linear television. Things have changed when accessibility to cheap and fast internet resulted in a paradigm shift to video on-demand, further emphasizing the importance of offering the best and most content. 

The biggest player wins 

So with the assumption that customers chase content, then it is important for the platform to have the content. The platform that has the most desired content will capture the most eyeballs, under the obvious constraint of price. 

Scale matters because of this fact.

The largest player has the most capacity to spend on content as it has the ability to amortize cost of content over a large user base, which allow that player to capture the most number of customers and charge the most.

For instance, a platform (lets call it Platform A) with 150 million paying customers that charges customers $10/month will generate $18 billion annual revenue. Assuming a variable cost of $20/year (e.g. marketing, G&A, customer support) implies Platform A can afford to spend $15 billion in content and remain cash flow break-even.

On the other hand, another platform (call it Platform B) with 15 million paying customers, at the same price point, will only generate $1.8 billion annual revenue. Assuming the same variable cost, that implies Platform B can only afford to spend $1.5 billion content and still remain cash flow break-even.

Because of the huge difference in unit economics, Platform A would be able to provide more content (to a factor of 10) than Platform B. As Platform A provides more content, it will be able to acquire more customers, which in turn gives Platform A even more ammunition to further scale content spend in the future, resulting in a virtuous cycle where size leads to size. 

As for Platform B, it would not be able to charge the same price as Platform A due to a smaller content library (which leads to higher churn). This erodes Platform B capacity for content spend due to a smaller revenue base and higher expense, resulting in a viscous cycle where being sub-scale limits the platform's ability to scale.