Are Netflix CEO Reed Hastings And CFO David Wells Serious?
by Rocco Pendola
Grab some popcorn and read the following excerpt lifted from the Seeking Alpha transcript of Netflix's (NFLX) Q4 conference call:
Ellie Mertz: Looking at your Q1 guidance and utilizing the midpoint, it seems that your guidance is suggesting that a DVD subscriber is contributing about 6x more to profits than a streaming subscriber, or around $15 per DVD customer but only $2.50 for a streaming customer. Do you still feel it is a wise strategy to push customers towards the streaming service? And if so, what effects do you anticipate on long-term margins?
Well use your head. Does the hypothesis make sense? Which sounds like it is more profitable:
1 - You pay $8 a month. I warehouse DVDs and mail them to you, and pay for the cost to mail them back. You can do this as many times as you can in a month. I pay all the warehouse costs, the property taxes, the labor to sort and catalog the DVDs, and the postage, and the packaging. And I pay for the DVDs.
2 - you pay $8 a month. You log into a website and ask for a movie. My computer plays it for you over the internet.
Which business model do you think would be more profitable? 1 or 2? Clearly 2 would be much more profitable.
However, the one thing missing is the licensing cost. NFLX is paying a lot of money to license movies to stream that they are not necessarily paying in the DVDs. Both those costs are front loaded. Right now they own a lot of old DVDs that people rent - NFLX already paid for those DVDs so every time they mail it out they are making more profit than they would on brand new movies which cost them maybe $10-50 per DVD. That is why DVDs may be more profitable right now, because they are mailing out a lot of DVDs that have already been fully amortized. On the stream side they are paying upfront for new licensing rights and have not fully amortized those costs. They will thought.
At say $2 billion in new licensing costs, divided by 17 million stream only subscribers divided by $8 per month, it will take about 14-15 months to amortize those costs. Shorter if they add 1 million per quarter.
So this is the reason why they want to move to stream. It is more expensive up front to pay for the streaming rights, but on the backend a customer becomes a lot more profitable because the overhead, mailing, sorting, postage, packaging and labor costs are mostly wiped out. Most of the labor become automated, and the "mailing costs" are literally passed onto the DSL, 4G wireless and Cable companies. They just need to maintain the server farm. On the backend this will be immensely profitable.
And as I've said many times, I expect NFLX will add a pay for premium content (newly released rentals) which is similar to the way AAPL does it, you pay $4 or so to watch a movie streamed to you. Again, lower cost and higher margin.
Yes, and if you give me the choice to get off my recliner, walk to the mail box get my DVD, watch it, have to walk back to the mail box and send it back, or push a button on my Roku remote and watch a movie and never leave my recliner, I choose to stay on my recliner... STREAMING IS THE FUTURE.
My understanding is that once a DVD is purchased, it can be sent out over and over again to customers for only the cost of postage. I believe that licensing fees are recurring. When you talk about amortizing the cost of new content, what is the term of the license? If it is only two or three years, then NFLX will have to pony up again in two years. These licensing deals are not perpetual.
If break even is 14-15 months with streaming costs of $2B a year, then do they not have a problem?
If number of subscribers increases by 30%, how likely is it that the current content providers will continue to charge the same amount for the streaming license? The point is that although 1,000 extra streamer likely brings in an additional profit of $8,000 per month, because content costs are fixed over such a small change in the number subscribers, it is doubtful that 5 million additional subscribers will bring in additional profit of $40m a month because content costs will change - maybe not immediately, but when the contract comes up for renewal.