Netflix changed the entertainment industry forever, but can the company change itself now that it finally faces some real streaming competition?
Around noon on Wednesday, March 16, hundreds of Netflix employees gathered on the second floor of the Anaheim Hilton Hotel expecting to hear good news. The company had thrived during the pandemic. It added 36.6 million customers in 2020, a record, and its aggressive investment in original content paid off in 2021 with the French crime show Lupin and the South Korean thriller Squid Game, two of its most popular programs ever.
Netflix had also broken through at Hollywood’s biggest awards shows, winning two of the top three Emmys and receiving 27 Oscar nominations, the most of any company. A couple of years into the streaming wars, it looked as if Netflix had not only survived but emerged stronger.
South Korean drama Squid Game was one of Netflix’s best performing shows. Netflix
Co-chief executive officer Ted Sarandos, who turned Netflix into an award-winning powerhouse, took the stage to open the company’s annual business review meeting after a brief sizzle reel recapping its many hits. But as soon as he ceded the stage to Spencer Wang, the vice president for finance, investor relations, and corporate development, the mood in the room began to darken, according to two people who were present but aren’t authorised to talk about it.
Netflix’s growth had spluttered in recent months, putting the company on pace to lose subscribers for the first time since 2011. As executives followed Wang onto the stage to outline ways they could reverse the slide, many employees started to grasp that Netflix was in trouble.
Its remarkable success over a 25-year history had instilled in staff a belief that it could never lose. A small DVD-by-mail service from Los Gatos, California, had seen into the future time and time again, outflanking much larger players to remake Hollywood in its image. This was the first time anyone could remember Netflix’s leadership saying that competition was negatively affecting the company’s streaming business in a significant way.
A month later, executives shared even worse news with investors during a quarterly earnings review: The company would lose around 2 million subscribers in the second quarter, 10 times the number it lost in the first.
Sarandos and co-CEO Reed Hastings blamed several different factors – increased competition, slowing adoption of connected TVs, and an exit from Russia following the Ukraine invasion – while trying to assure investors that the pain was short-term.
It didn’t work; they freaked out. The next day, Netflix shares plunged 35 per cent, wiping out more than $US50 billion ($79 billion) in market value. Its shares continued to drop over the following weeks, rebounding slightly after Netflix reported losing only 1 million customers, not 2 million, in the second quarter. “Our excitement is tempered by the less bad results,” Hastings said on a call with analysts in July.
With 221 million subscribers and a huge lead on the competition in almost every major market, Netflix is still the world’s most popular streaming service by a wide margin. And despite Wall Street’s rediscovered scepticism, streaming is still growing. But the company’s initial boom is over, as is the lofty valuation that came with it.
For years, Wall Street treated Netflix more like a highflying tech start-up than a media giant such as Walt Disney or Paramount Global. Investors cheered as Hastings and Sarandos borrowed money to outspend the competition, burning through more cash than they made.
Now investors see a mature company that faces increased competition from cheaper alternatives. They’ve begun to question whether streaming is even a good business. Netflix has had to fire hundreds of employees and lease office space it no longer needs. It’s also pledged to slow down spending on programming – though not cut back – and shelved dozens of film and TV projects.
According to more than two dozen current and former employees, Netflix’s plunging stock price has damaged morale at a company that often ranks as one of the most desirable employers in the world. Hastings wrote an entire book about the company’s culture as a guide for others. He pursued the best people and doubled or tripled their salaries. He gave all executives freedom to make decisions and spend money as they saw fit. He also shared unprecedented amounts of internal data, giving employees access to their peers’ salaries and the company’s financial performance.
But as Netflix has grown, it has instituted a more traditional hierarchy and centralised decision-making. Veteran executives willing to challenge leadership have left, and, like other tech companies, Netflix is hiring more junior staff in its engineering group to create lower tiers of employees and manage costs.
All that enlightened unorthodoxy proved hard to execute at scale. When Netflix fired people earlier this year, executives didn’t send out the customary note explaining the decision, as they have for years. Nor did the cuts include senior leadership.
Sarandos and Hastings argue that Wall Street is overreacting and that the subscriber drop is temporary. They are, after all, the most popular streaming service in a world that’s still transitioning from linear TV to the internet. The service now accounts for about 8 per cent of all TV viewership in the US, the most of any network, and has more customers abroad than Disney+, HBO Max, Paramount+ and Peacock combined.
Morale, though shaken, has stabilised as the company fixes its sights on the next big goal. Hastings and Sarandos still say the company can more than double current subscribers to 500 million, if not 1 billion. (The co-CEOs declined to comment for this story.)
“We still think and believe we have a lot of room for growth,” says chief financial officer Spencer Neumann.
Neumann says Netflix has identified the underlying causes of its recent struggles and is working on two new initiatives to address the problem. It has introduced an ad-supported tier for $US6.99 a month, appealing to those who think Netflix is too expensive – the service went from $US7.99 to $US15.49 per month in just nine years – and will start charging people for password sharing. The company had long said it would never try these initiatives because they aren’t customer-friendly.
Netflix’s Ted Sarandos with Cate Blanchett at the premiere of “Guillermo Del Toro’s Pinocchio”. Getty
“Netflix has made errors in the past out of hubris,” says Mark Mahaney, head of the internet research team at Evercore ISI. “Not having an advertising service until 2023 is a sign of that hubris. Ratcheting up prices over the years is also a sign of that hubris.”
Hastings never wanted to sell advertising. He first built Netflix as a consumer-friendly alternative to Blockbuster. It offered a broader selection of DVDs and charged no late fees.
He took a similar approach with streaming. Pay TV had become a cumbersome product that most consumers loathed. There were too many channels, and it was too expensive. The average TV network was showing as many as 15 minutes of advertising per hour.
Netflix had a simple proposition: Stream anything you could ever want to watch on demand for a fraction of the price of pay TV. “It’s all on Netflix. No ads. One low price,” the company still says in some promotions to customers.
As Netflix grew, Wall Street analysts, peers, and journalists pestered Hastings about ads. Almost every great media business in modern history has made money by selling its customer base to advertisers. The networks had been airing commercials since the 1940s, and some of Hastings’ own employees thought Netflix should do so as well.
But Hastings always said no. He said customers preferred Netflix to pay TV because it didn’t have ads. He also had little interest in collecting personal data beyond your preference for thrillers or soap operas. Most of all, he didn’t want to compete with Google and Facebook, where he once sat on the board. “Long term, there’s not easy money there,” Hastings told an industry analyst in January 2020. Instead, Hastings wanted the company focused on adding more subscribers.
In late 2019 and early 2020, rival media companies started introducing streaming services of their own, such as Disney+, HBO Max and Paramount+. Most of them cost less than Netflix and also offered dozens of original programs, buttressed by deep libraries of movies and TV shows amassed over the past century.
But Hastings routinely dismissed the threat the competition posed. Netflix had long operated as something close to a utility. People might sample and cancel other services, but Netflix was irreplaceable. The rate of customer cancellations long sat at around 2 per cent, according to streaming analytics company Antenna, half the industry rate. Netflix had taken advantage of this customer loyalty by raising its prices every 18 months or so.
But the churn rate – the number of customers who sign up and then leave a service in a fixed period – started to creep up during 2021 and jumped in 2022. Netflix became more expensive than most of its streaming competitors at the same time inflation forced consumers to cut back.
Now more than 20 per cent of people who subscribe to Netflix in the US cancel after one month, which is in line with the industry average, according to Antenna. To make matters worse, the people who cancel often leave Netflix for a rival service.
Meanwhile, fewer people were signing up. Netflix had been adding an average of 27 million customers annually since 2016 and recorded its best-ever year in 2020. But that was because of a surge in sign-ups during the first half of the year; its business slowed in the second half and remained lacklustre through most of 2021. At first, Netflix saw the slowing growth as a byproduct of the pandemic – a one-time sign-up frenzy followed by an inevitable correction.
By the end of 2021, the numbers couldn’t be ignored, and executives needed to find an answer. In March, Neumann, the CFO, let loose a trial balloon at an investor conference. Netflix wasn’t religious about advertising, he said, adding, “Never say never.”
A month later, as the stock plunged, Hastings made the move official. He said Netflix would experiment with advertising in the next year or two. The comment blindsided most of his employees, especially old-timers who saw a lack of advertising as central to the company’s mission. But once Hastings decided to go for it, Netflix wasted no time. After selling no ads for 25 years, it would now build an advertising business within the next seven months.
The task of figuring out what advertising on Netflix should look like fell to chief operating officer Greg Peters. Because Hastings set such an aggressive time frame, Peters decided to outsource advertising technology and sales.
Most industry executives assumed Google and Comcast were the front-runners because they’re the market leaders in online video advertising. But Netflix surprised everyone when it selected Microsoft, which has almost no business in streaming video. But Netflix saw that as a bonus, Neumann says. They could build the video advertising operation together.
Despite the push, Netflix is trying to keep ads as unobtrusive as possible. No one who pays for the service now will need to watch commercials unless they choose to downgrade. The ad-supported version costs less than half the current plan. (In comparison, Disney+ charges $US7.99 for its service with ads and has raised ad-free monthly service from $US7.99 to $US10.99. Netflix’s new tier is also $US3 lower than HBO Max’s ad-backed service.)
The cheaper tier will carry commercials for only about four minutes per hour, less than traditional TV but comparable to rival streaming services. It won’t show advertisements in kids’ programming or new movies, at least at first.
It will limit the data it collects on viewers to their location and programming tastes, as well as the number of times people can see the same ad. By limiting the number of ads, Netflix also hopes to jack up the prices the advertisers pay. The company is asking for more than $US60 per thousand viewers, about double the market rate.
Online video has a rich history of screwing up with ads. Hulu was a leader in experimenting with new formats; now everyone in the ad industry agrees the customer experience on Hulu is terrible. People see the same ad played over and over again. It’s annoying.
Yet, everyone also agrees that the potential for Netflix is massive. Industry executives and analysts estimate the company will generate at least $US2 billion in sales from its ads and subscription tier in the first year. By 2027, ads will probably contribute at least $US3 billion to sales, according to market-research company Ampere Analysis.
Netflix also says it might eventually make more money per viewer from ad-supported subscribers than from its current customers. “If you quit [the service] now, there’s nothing Netflix can do. Soon if you quit, they can offer you a cheaper tier,” says Michael Pachter, an analyst with Wedbush Securities. Pachter, a longtime skeptic of Netflix, has changed his tune: he now advises investors to buy its stock.
The impact of password sharing is harder to gauge. Netflix for years considered the practice a de facto advertisement, all part of the company’s global takeover of pop culture – “Netflix and chill” and all that.
But by 2019 or so, as the population of moochers grew to the size of a largish country – more than 100 million now use shared accounts, by company estimates – Netflix began exploring countermeasures. “We wish we’d launched it [the crackdown] sooner,” Neumann says. “We’ve known we had a pretty consistent percentage of our membership that was borrowing for years.”
Netflix is testing two ways to attack the problem in Latin America, where password sharing is especially prevalent. It’s asked people in Chile, Costa Rica and Peru to pay around $US2 to add as many as two additional users to their account. In five other Latin American countries, Netflix is asking customers to pay $US2 or $US3 to use their account in an additional home. The company has yet to decide on the best approach, but aims to have something in place next year.
Yet even if Netflix can distinguish someone’s ex-girlfriend from their child, the very idea of clamping down on passwords creates a public-relations problem. Many people are worried they’re going to lose access. Others say Netflix is getting greedy. No one has ever attempted to limit password sharing at this scale. That’s a big reason Netflix has tried to frame the move as charging for the practice, as opposed to cracking down on it. “If it were easy, we wouldn’t be doing so much testing,” Neumann says.
It’s important to note that, in some ways, Netflix has never been stronger. It’s profitable and no longer needs to borrow money. In any given week, it accounts for about eight of the 10 most popular streaming TV shows in the US and a majority of the most popular streaming movies. Many of its current challenges are a reflection of its hugeness.
Wall Street has always judged Netflix by how many new customers it signs up every quarter. But if you consider everyone using each Netflix subscription, it already reaches more than 500 million customers. That’s a majority of people with internet-connected TVs (excluding those in China). Netflix’s problem isn’t that consumers aren’t watching. It’s that it doesn’t make enough money when they do.
Streaming’s share of total TV time reached a new high this summer and now accounts for about 35 per cent of total TV viewing in the US. That means 65 per cent of viewing is still locked into linear TV and will gradually shift to the internet.
Netflix’s primary challenge is to capture as much of that viewership as possible. That’s why, while looking for ways to limit costs, Netflix will continue to churn out more original programming than any company in modern Hollywood history.
It releases 700 to 800 titles a year, collectively producing the most movies, animation, stand-up comedy, documentaries, reality TV and scripted TV of any network. Maintaining quality with that kind of output is almost impossible, but Hastings and his team say quantity is key to signing up more subscribers.
When Hastings and Sarandos try to address doubts and inspire confidence in their staff, they’re quick to remind them of 2011. That was the year Hastings decided to split the company’s streaming service from its DVD-by-mail service and rename it Qwikster.
His instinct was correct. The streaming service was the future. But splitting it off amounted to a 60 per cent price increase for current customers, who quit in droves. Netflix lost 800,000 customers in a single quarter, or about 3 per cent of the total. Yet, Hastings was quick to realise his mistake and got rid of the name Qwikster. Netflix continued to lose DVD subscribers, but its streaming service emerged stronger than ever. The message being: we’re Netflix, we take chances, we’ll figure this out.
Many of the people who guided the company back then have left, and it’s unclear how much longer Hastings will stick around. In 2020 he named Sarandos his co-CEO and Peters the company’s COO, the first step in his inevitable departure.
Hastings said at the time that he wasn’t going anywhere. He’s a 62-year-old billionaire with little interest in starting a new company. But he’s taken a step back from the day-to-day operations of the business, according to employees. Sarandos oversees the entertainment side of the house, and Peters handles the engineering and product.
As the problems at Netflix have escalated, Hastings has expressed the need to reassure workers he isn’t leaving. At a company retreat in May, he told a room of several hundred senior employees that he’s fully engaged with Netflix, a message he’s echoed in subsequent meetings.
Hastings took advantage of being the nimble upstart to upend an industry. But Netflix is no longer an upstart, and it’s harder to be nimble when you have 10,000 employees. The company has remade Hollywood in its image. Now it needs to remake itself.
— Bloomberg Businessweek
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Netflix advertising play opens new front in streaming wars with competitors Disney+, Paramount, HBO – The Australian Financial Review
Netflix changed the entertainment industry forever, but can the company change itself now that it finally faces some real streaming competition?