The Netflix Story

Mihai Avram
7 min readApr 26, 2022

In the last few months I became very curious about how Netflix’s path to movie industry disruption is going. On one hand, I am a big fan of the Netflix model and I support the way they are changing cinema. On the other, I just became an ex-customer of theirs as part of the massive client loss wave they had in Q1 of 2022 (nearly 640,000 subscribers left the streaming service). In a few paragraphs, I will point out what I like about Netflix so far, what I think they could do better and what is likely to happen to the company in the next quarters of 2022.

Box office and the studio-cinema dependancy

Netflix is a new way of doing things. For years, the movie industry was built in the following way: big movie studios such as MGM, Paramount would sponsor movie projects and then rely on the cinema box office to get a return on their funding. If the movie would be successful in cinema, the investors would be happy i.e. Avatar, a movie with a budget of about $ 250 million, had a $ 2,87 billion box office and in consequence it made a $ 2,62 billion profit. A major fail would be when the box office would be lower than the movie budget, because this would essentially mean that the investors lost their money. For instance, the 4th Matrix movie (Resurrections) cost more than $ 190 million to make and its box office was only $ 140 million.

What this means is that cinemas and cinema companies were the guarantee for investors to get back their money and there was a general rule (not sure if law) that movies that are shown in cinemas would become available on TV no sooner than 1 year after the cinema premiere. This would encourage people to go see the movie on the big screens and thus contribute to the investor’s money going back to them and … in a way… the survival of the cinema industry.

The first disruptor

Netflix was one of the first businesses to try and change this model by launching the movie “Beasts of no Nation” on streaming platforms at the same time as in cinemas. The reaction to this was the boycotting of the movie by the cinema companies. Movie theaters make about 40% profit off every ticket sale and they make most of their money off beverages, snacks, popcorn and other merchandise. Obviously, streaming platforms are their biggest competitors once the movie launch delay is removed. Watching a movie at home is almost always, cheaper. The cost of a Netflix month is about the price of a movie theater ticket…

Covid

Since the “Beasts of no Nation” incident in 2015, much has changed. The Netflix business grew and started actively producing movies. Covid happened and cinemas closed down. The movie industry production slowed down and many movie productions were delayed or cancelled altogether. Studios would delay movie premiers in the hope of the pandemic ending and big box office openings becoming possible again. In other words, streaming platforms grew due to Covid and cinemas shrunk as an industry. Due to this, Netflix invested heavily in its own production of series, movies and some of its movies even go to the Oscars. Netflix started competing with studios for big name directors, producers and actors. At the same time, the costs for its subscriptions remained relatively stable and quite frankly quite low. Netflix was relying on audience growth rather than increasing the pay per customer, which was a sound strategy until recently.

In order to increase their audience, Netflix tapped into broader audiences:

By all measures, Netflix was on a winning streak until 2022 hit.

2022 — the make it or break it year

“Netflix was expecting to add 2.5 million subscribers in the first quarter of 2022, but did not hit that target. The suspension of its business in Russia cost it 700,000 subscribers, and without that loss, Netflix would have added 500,000 paid global users, which is still well below its projections…”

In my view, the loss of the Russian market was not a big hit for Netflix. Russia is not an interesting audience for them because (1) Russian language content is not widely available on Netflix yet, and (2) piracy rates are very high in Russia. Furthermore, most of the Netflix users in Russian might continue to be Netflix customers by using VPN and not showing off as Russians in the audience statistics.

What did make Netflix bleed subscribers in Q1 was a sum of two factors:

  • Many new competitors (Hulu, Disney+, HBO Max, Amazon Prime),
  • High production costs of Netflix content,

The competitors offer products maybe not of better quality but of comparable quality, which is enough to make a dent in the Netflix customer base. HBO is not better as a platform, but it has some movies that are not available on Netflix and the cost of cancelling Netflix and switching to test other platforms is very low. Users can cancel Netflix at the push of a button and they can open a new account with another streaming service almost instantaneously.

Netflix became a production company with Oscar-level movies and multi-season series. This is a huge cost that cannot be covered by subscriptions alone, so my guess is that they took loans based on expected user subscription increasings. Not meeting the Q1 expected user subscription milestones is just to show that the financial plan that was proposed for the repayment of those loans was more ambitious than the reality of the market.

The reopening of cinemas and reduction of in-door time + availability of many other streaming services + high production costs = are enough to pull down the Netflix from its ‘Number 1’ / Monopoly throne into a much fairer competition.

Now, prior to its Q1 user loss, Netflix was already under financial pressure and was considering to either:

  • Increase their subscription pricing, or
  • Limit subscribers to one screen (thus hitting hard into the attractiveness of the multiple users per one subscription phenomenon that allowed Netflix to expand into middle and low income countries…), or
  • To include advertising.

Fact of the matter is, their sales were too low to cover the costs of production and in order to guarantee their growth as a corporation, they’d need to make adjustments to their sales strategy. This again, was prior to Q1…

The perfect storm

Now, in order to get back on track financially and in terms of performance, Netflix must indeed take some drastic measures. The most likely action that they will take is to push harder on the ‘1 screen per subscription’ model, which is risky because it would involve investing into the technology to develop safeguards for this and because users may drop their Netflix subscriptions if they can’t share the price of it among friends/family. It could backfire… possibly. Or it could make some users to go and new users to register, thus compensating for the loss.

If however, Netflix is the only streaming service that is hitting on the ‘1 screen per subscription’, the competitors will gain an immediate advantage and it will show in terms of new users added. With each action against user comfort, Netflix is hurting itself and helping its competitors grow. This effect will be noticed at least in the short-medium run (the year 2022). This sudden drop in users, share price and value offer attractiveness may turn hit Netflix so hard, that it may never recover…

HBO is a studio, turned streaming platform. Disney+ is also a studio turned streaming platform. Only Netflix is a streaming service turned studio and this could mean that it is less efficient at production compared to its studio competitors. Production is expensive and the risks associated with it are enormous, meaning that if one or two big projects fail it could lead to immediate bankruptcy. Yes, it is great to work with Martin Scorsese and Leo DiCaprio, but the costs of playing this game are very high. With the cinemas back to regular pre-pandemic activity, the streaming platforms have one more important competitor.

My prediction is that 2022 is the perfect storm for Netflix, that will lead to its failure as a company. The stock sales will drop, financial targets won’t be reached, the loans will be difficult to repay and this in conjunction with high user volatility will make Netflix plummet. As much as I like Netflix for their boldness and ambition, I don’t think this year will do them any good. Furthermore, in order to keep audience growth, a studio needs to keep producing Martin Scorsese movies, Oscar-level movies and other expensive TV-series… If this current crisis is hindering Netflix’s ability to keep up with production, this will fasten its decline.

Absolute worst case scenario would be this: “We’re losing money, so let’s increase subscription costs and halt production.”

Normally, any company in a crisis would seek to increase sales and decrease costs. This strategy would be the killer strategy for Netflix. For this reason, I expect their fail, but I am curious to see them navigate this perfect storm. I am hopeful and am open to be surprised by some marvellous sailing manoeuvre. I expect a difficult year ahead for them and unless something crazy, like Musk buying Netflix will happen, they are not in for an easy ride.

Final thought

I am not an experienced financial analyst so please pardon my superficiality. Maybe some of the things I said and the terms I used are incorrect. Even so, the big picture seems to be as I described it. I am a Netflix fan and at the same time their former customer. I wish for them to succeed, but at the same time often the disruptors don’t end up well and their success remain to be shared amongst the smaller competitors that wait out the storm. It is difficult to be an ice-breaker, to be number 1, to be the one that challenges all of the movie industry and makes lots of enemies… it may be that Netflix’s fail will set the ground for a better competition in the streaming market and better customer services in the long run. Healthy market competition means that the users usually win in the end … let’s wait and see :)

--

--

Mihai Avram

Founder @zenzylab. Lover of SciFi, Absurdism, Nihilism and the Moldovan emotional cuisine.