Published the results of the third quarter Netflix yesterday and we started to play a little with their numbers. If there is something attractive about the Netflix model, it is relatively easy to play with them since they have a very understandable business model.
The model as I said is quite simple. In principle, it is a matter of gaining critical mass and scaling the model so that a sufficient number of users pay a monthly fee that allows you to cover the costs of delivering the content they want to consume and how it often happens in many internet businesses. Earn as quickly as possible a critical mass of users who are then willing to remain in service when you increase rates to achieve profitability.
As for the capture of users at the moment Netflix is doing great. It had 66 million users a couple of years ago, had 83 million users 1 year ago and closed this quarter with 104 million users, with growth in the US already somewhat exhausted but with a still apparent good route ahead of growth at the level international.
At the rate level, it is also doing well. The average monthly rate two years ago was $ 7.98 per month, a year ago of $ 8.64 per month and today is at $ 9.21 per month. Rate increases of 8.2% and 11.6% without having significantly affected growth. (It would be necessary to understand well how the exchange rate affects the rest of the currency in the part of the international average rate to see if it is also able to raise tariffs in the new markets as it is doing in the USA.
So far everything goes according to the foreseeable in any business model scalable on the Internet and would show that it is working
And yet, despite the fact that in two years the number of users has gone from 66 to 104 million and the rate of $ 7.98 per month to $ 9.21 per month, the reality or the drama would be that today Netflix burns every quarter almost twice as much as 2 years ago. Today Netflix burned a whopping -463 million dollars in the third quarter of 2017 versus -248 million in the third quarter of 2015.
To see it differently, two years ago Netflix burned about $ 1,500 of cash per month per user and today still burning about $ 1,500 of cash per user, the problem is that two years ago had 66 million users and today has 104 million with what the hole is enlarging.
And here are two problems linked in part to the reason why people become Netflix subscribers:
1- It is the content. If you want more people on your platform, you have to offer better and more diverse content and create your own quality content to differentiate yourself. And creating content is very expensive.
2- Without ties. Registering with Netflix is extremely easy, and you can also unsubscribe, there is no minimum period of permanence, we do not know the monthly losses that occur, only the average increase in the number of users, so trying to make a coarse number, acquire a new subscriber to Netflix is coming out on average for about $ 62 …. or seen otherwise, only after the seventh month of stay Netflix starts earning money with a new user. If there are no strings attached to unsubscribe, the only way to have it paying for the subscription is to get your own quality content … which, as we have already told you, is expensive to produce.
How much should the price of the subscription go up?
However, the situation is not as dramatic as it seems, especially if at some point Netflix can begin to stabilize the costs of producing content. Today to avoid losing money Netflix should raise the price of the average monthly subscription (USA + Rest of the world) from $ 9.21 per month to $ 10.70 per month (in a way Netflix is subsidized to each subscriber $ 1.5 per month). Any cent above $ 10.70 would go directly to profit. It’s a 16% increase. Also keep in mind that as your user base increases this price increase to be profitable is diluted.
I explain myself with an example. If within a year, Netflix manages to increase the number of subscribers in the same number as it has done in the last year (about 24 million more), and keeps its production costs constant at the current level (which is a lot to assume from its trajectory) but the level of quality of the own productions of Netflix already is in more than attractive levels), without touching the present prices Netflix already would be generating a cash surplus of 100 million to the quarter.
It does not seem so complicated, and the current valuation has taken years to discount this scenario where the scale can turn Netflix into a machine to generate money. For the moment, the reality that shows us is that it has not yet achieved it, although every time it seems to be a little closer. We will see if within 12 months you have been able to maintain your business model, finally containing the costs of content production.