What’s Eating Netflix?

Netflix’s stock has been in freefall ever since they reported their first quarter earnings for the 2022 fiscal year over two weeks ago. After initially falling by around 35% following the disappointing results, the stock has not recovered. In fact, it has fallen further and further since then: The streaming giant’s stock is now down nearly 50% after reporting their earnings, trading at around $188 dollars a share at the time of writing. At the start of the trading year — according to trading data from Google Finance, the share price was at about $597. Before then, the stock touched $700 during the height of the COVID-19 pandemic. 

The precipitous decline in value comes from a disastrous earnings forecast which indicated that the growth of the company was slowing. For the first time in 10 years, Netflix reported a net loss in subscribers, with 200,000 net subscriber losses in the first quarter. This figure stands in stark contrast with their stated expectations from last quarter, where they forecasted a 2.5 million subscriber gain, according to their quarterly letter to shareholders. To make matters worse, the same letter anticipated dire straits ahead: Management projected a net loss of two million subscribers next quarter. 

To explain the bad news, Netflix pointed at several external factors: Disruption from the war in Ukraine (Netflix halting services in Russia), inflationary pressure leading to subscribers cutting the cord and subscription growth headwinds from COVID-19 subsiding. Arguably, the most urgent aspect of the letter — from a shareholder perspective — is the recognition that competition is now a serious threat to future growth; Netflix no longer enjoys the de facto monopoly status it once held in its early years when there were no other streaming services in town. 

From a consumer perspective, the worry comes from how Netflix seems to be internalizing this new era of slower growth and increased competition. The company which once tweeted that “love is sharing a password” now wishes to capitalize on that love — highlighting in their shareholder letter that there is now focus “on how to best monetize sharing.” This announcement was supported by Netflix’s internal calculation that there were over 100 million non-paying households using shared accounts. Such an admission is stunning in its own right, but especially significant now that growth is slowing. In the past, Netflix prioritized subscription growth, neglecting to police password sharing out of fear that it would hurt the user experience and thus slow growth. Layered on top of this thinking was the philosophy that more eyeballs on their content would generate attention that was positive for long-term subscription growth.

But that thinking no longer fits this situation. Netflix needs to find more growth, even if it requires taking harsher measures. Already, Netflix is testing different approaches to monetize, or in other words, crack down on password sharing. In March, they rolled out features allowing users to either transfer existing profiles to new accounts or to add extra members on existing plans in three smaller markets in Latin America: Perú, Chile and Costa Rica. Accompanying the roll out of these features was the introduction of anti-sharing measures that could detect users accessing accounts that they did not pay for. There exists the real possibility that these features could be rolled out universally across the platform, ending the days of easy password sharing. 

In order to capture more growth, Netflix is also exploring the prospect of adding a lower-priced subscription tier with advertisements. If Netflix were to introduce this advertisement supported tier, they would be joining Disney+, HBO, Hulu and other smaller streaming platforms that already offer the option. On a practical level, there is nothing wrong with consumers having more options. But from a more symbolic perspective, this move would signal that Netflix is not in a league of its own — that their platform is more similar to their competitors’ than not. It would mark a turning point in history where Netflix is copying smaller platforms, as opposed to smaller platforms historically following in Netflix’s footsteps. 

Make no mistake, Netflix is still a strong company. No matter how you look at it, Netflix still produced billions in revenue and net income in their first quarter, all while being free cash flow positive. Their platform is still the largest — by subscription count — and they have the cash and data trove on hand to continue producing blockbuster shows and movies. But the unfortunate truth is that Netflix has picked off all the low-hanging fruit for their growth. Most of Netflix’s existing subscriber base is based in North America and Europe. Essential to Netflix’s continued success is subscriber growth in foreign markets: Asia, Latin America and Africa. Efforts to squeeze blood from the stone by cracking down on password sharing or introducing advertisements could backfire by turning off prospective subscribers. Or worse yet, it could lead to current subscribers canceling their subscriptions. After all, there are now plenty of other streaming platforms to subscribe to instead of Netflix. 

Betting against Netflix has historically been unwise. But the same was once said for Blockbuster. Only time will tell if this moment is truly different.