The economics of Netflix

Jan 05, 2015

For the past decade, DVD revenue has been shrinking rather quickly, due to piracy and changing consumer viewing habits. The industry is hoping that the new kid on the block, Video On Demand (VOD), can fill this shortfall. In 2014, I surveyed 1,235 film business professionals and found that 61% of them expect that within the next four years VOD revenue will be equal to the amount DVD generated at its peak. We're still a way off that goal, but there's no doubt that VOD income is becoming an increasingly important part of the film recoupment chain. In 2013, VOD provided 7.9% of all income generated by films in the UK, up from just 2.7% in 2008. Compare that with DVD stats (39% in 2008 and 23% in 2013) and the trend is clear.

The biggest player in the VOD market is Netflix. It began in 1997 as a mail-based DVD rental service, adding internet streaming (VOD) services in 2007 and by the start of 2014 they were providing over 1 billion hours of movies and TV shows every month. In 2002 the company went public, meaning that it is legally required to publish a whole host of data. I spent some time going through ten year's worth of annual reports in order to pick out useful data points on the economics of Netflix. In summary...

In 2000, Blockbuster refused to buy Netflix for $50m.
In 2013, Netflix generated $4.4 billion in revenue.
In just three months (July to Sept 2014) Netflix spent $1.2 billion acquiring new content for its streaming service and a further $16 million on new DVDs.
In 2013 Netflix spent $470m marketing its streaming service and just $0.2m promoting its DVD service.
10% of Netflix's non-US streaming subscribers are receiving the service for free.
In the US, 6 million people still pay for the DVD-only service.
In the UK, 4.5 million people are Netflix subscribers.
The average Netflix subscriber streams 45gb of film and TV shows per month.

How many people subscribe to Netflix?

In the early days of Netflix, it was DVD-only. When the streaming service was eventually added it was initially part of the same package, with subscribers able to stream one hour for each dollar they paid a month (i.e. those on the $16.99 plan could stream 17 hours each month). From 2008 this restriction was lifted and users could access unlimited streaming. As of September 2014, the average Netflix subscriber streams 45gb of film and TV shows per month. In July 2011, Netflix split the DVD and streaming parts of its business. The streaming service continued to grow and the DVD began to decline. Despite this, as of September 2014, almost 6 million people were still paying for mail-based DVD rental packages. In the UK, 4.5 million people are Netflix subscribers. Note: in the following graphs, "Domestic" refers to America.

So they must be generating a lot of revenue?

The company was started with a seed investment of $2.5 million from one of its co-founders Reed Hastings. In 2013, the company generated revenues of $4,374,562,000 and it looks likely to beat that figure when the 2014 figures are published.

Are they making money?

Yes, and lots of it. In 2000, Blockbuster turned down the chance to buy Netflix for $50 million, or in other words, 18% of their 2013 profits.

How much does Netflix pay for its film and TV shows?

I'm afraid that exact amounts paid to film and TV distributors is rarely released on a 'per film' basis. However, we do have clear data on the total amount Netflix spent on acquiring new content. In the four years between 2010 to 2013 inclusive, Netflix spent $8.6 billion acquiring new films and TV shows for streaming and DVD. In just three months (July to Sept 2014) Netflix spent $1.2 billion acquiring new content for its streaming service and a further $16 million on new DVDs. Netflix spends far less on acquiring new films and TV shows on DVD.

How much do economics of Netflix allow for spending on marketing?

In Q3 2014 Netflix spent $146 million on marketing its streaming services and a total of $0 on marketing its DVD services. Yes, that's not a typo: in 2014 Netflix has not spent a single dollar on marketing its DVD plans. In 2013, they spent a total of just $292,000 the entire year (the streaming marketing for 2013 cost $470 million). Netflix seems to be following the example of AOL in the 1990s by offering free trials to any and everyone. I crunched the numbers on what percentage of Netflix subscribers actually pay for the service. In September 2014, 10% of subscribers to Netflix's non-US streaming service were receiving the service for free.

Epilogue

I should disclose that I am a Netflix subscriber, and would count myself in the 63% of subscribers who say that they are “extremely satisfied” or “very satisfied” with the service. 2015 could be the year that VOD steps up to fill DVD's empty boots. Despite this, the industry has been very slow to share data on VOD sales, prices and viewing figures. As a film stats bod, I find this rather frustrating. Hopefully in 2015 I'll be able to uncover more data on VOD to share with you here.