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Netflix’s billion dollar question: How do you keep people hooked?

Daniel Howley
Technology Editor

Global coronavirus lockdowns have meant consumers have little else to do but stay indoors. And that has sent Netflix (NFLX) subscriptions through the roof. 

The company dramatically out-performed even the most bullish Wall Street expectations for subscriber growth, reporting on Tuesday that it added 15.7 million users in Q1 2020. Netflix was originally forecasting as many as 7 million new subscribers, while analysts were pointing to 8 million to 9 million additional users. 

But, eventually, those same subscribers will be able to leave their homes again. So how does the streaming giant retain those users when life returns to some semblance of normalcy?

“That is the billion dollar question right now,” Raymond James analyst Justin Patterson told Yahoo Finance on Wednesday.

The answer, Patterson said, likely lies in Netflix’s ability to continue to provide localized content to its various international markets.

But at least one other analyst believes the path forward will force Netflix to add a lower-priced tier to the service complete with—deep breath—ads.

Keeping the international markets happy

According to Patterson, the U.S. market has reached a saturation point for Netflix, meaning you’re not likely to see the kind of explosive growth you may have in the past. That fact is laid bare in the company’s Q1 earnings.

The U.S. and Canada (UCAN) market added 2.3 million subscribers in the quarter, while the Latin America region (LATAM) added 2.9 million. The Asian Pacific region (APAC) saw an even greater jump of 3.6 million users, while the Europe Middle East and Africa (EMEA) had the largest increase, piling on 6.9 million subscribers in Q1.

With such explosive growth in the international markets, Netflix will have to work to ensure it is able to retain as many of its new subscribers as possible, by offering more localized content to each market.

HOLLYWOOD, CA - APRIL 20: In this handout photo provided by Netflix, is a view of Netflix's headquarters located in Los Gatos on April 20, 2020 in Los Gatos, California. (Photo by Netflix via Getty Images)

“You tend to see a lot more ebb and flow based on the local content offering in those markets,” Patterson said. “So if Netflix, for example, starts producing more originals for India, that's a really good sign for retention. If, conversely, you see some more shifts there, there's less relevant local content, that's where you tend to see churn spike a bit.”

The international markets have been a major fixture for Netflix’s quarterly reports for some time now. In Q4 2019, the company added just 550,000 subscribers in U.S. and Canada, while Asia Pacific added 1.75 million, Latin America added 2 million, and Europe Middle East and Africa added 4.4 million.

But with such massive growth in Q1, the company is keen on holding on to its new subscribers, who have the potential to be lured away as cities around the world begin to relax social distancing measures and things like live sports become available again.

“There's nothing on live TV, there's no sports, so that competitive dynamic, who is garnering the most incremental hours, becomes more of a conversation once sports comes back into play and once we effectively have a more level entertainment playing field,” Patterson said.

During Netflix’s earnings call, CEO Reed Hastings touched on retention, and what the company can do to ensure its newest users stay around for the long term.

“There's nothing that separates the people just joining from anybody else,” he said. “And then our job is to do the same things we've been doing to retain them, that is have incredible shows, make it very easy to choose, help the recommendations, all the things we do that make the experience so wonderful.”

A Netflix with ads?

Just as the coronavirus lockdowns have buoyed Netflix, they are forcing millions out of jobs that require face-to-face interaction, pushing the global economy towards what could be a punishing slowdown.

And if Netflix subscribers begin to see their discretionary income dry up, they may ditch the service for less expensive options. 

In the U.S., Netflix starts at $8.99 per month for a basic subscription, while Disney+ (DIS) starts at $6.99. Hulu starts at $5.99, while Comcast’s (CMCS) upcoming Peacock and Apple TV+ (AAPL) start at $4.99.

Both Hulu and Peacock are able to offer their services at such low prices, because they include standard advertisements during programs. That, Needham analyst Laura Martin wrote in a recent note, is exactly what Netflix will have to do, as well.

“We believe NFLX must add a second, lower-priced option to compete with Disney+, Apple+, Hulu, Comcast’s Peacock and CBS All Access, each of which have $5-$7/month (or free) consumer options,” she wrote.

“Since NFLX’s balance sheet cannot withstand lower revenue, we recommend a 6-8 minute/hour ad load to supplement a $5-$7/month consumer fee as a second option for consumers who are becoming more price sensitive owing to COVID-19 layoffs and global economic weakness. “

Analysts have been calling for Netflix to add some form of in-show advertising to its service for quite a while, but the company has, so far, refused to do so.

During the company’s Q4 2019 earnings, CEO Reed Hastings shot down any chance that the firm is considering advertising, saying going up against the likes of Amazon, Google, and Facebook, the dominant players in online advertising, would be too difficult of a proposition.

If the company can continue to grow, while keeping churn low, it may never have to resort to advertisements, but nothing is guaranteed.

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Got a tip? Email Daniel Howley at danielphowley@protonmail.com or dhowley@yahoofinance.com, and follow him on Twitter at @DanielHowley.

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