Netflix Is Having A Google Moment - Circa 2000
Is subscription better or Ad-supported?
At the outset, let me put it out there that Netflix is no Google. Google is a high margin software company, it does not have to invest $17-18 Billion in content annually. Netflix ads are not intent based, Google’s are. Intent based ads are more valuable. Netflix is subscriber first vs ads-first & their market share is nowhere close to Google’s.
However, there is one small sliver of Google’s history that I believe Netflix is living through today.
Why is Google not subscription based?
I've always wondered what Google would be like if it wasn’t ad based and was instead subscription based and found my answer in the most unexpected of places.
I was recently listening to a podcast titled “Is Google Getting Worse?” from Freakonomics Radio. The summary is that Google is a reflection of the web. The number of links on the web & content on the web has grown so much in the last decade that it is making it harder for Google to deliver great results. It's a totally different context from what I expected it to be about.
But here is an excerpt from the podcast that I found most interesting and was the genesis of this Article. At 10:51 in the pod, in Marissa Mayer’s voice (Marissa Mayer designed the search interface of Google's home page. As the product manager for the company's search engine, Google Search, for more than 10 years, she was credited with increasing the number of daily searches from a few hundred thousand to more than a billion)
“As we started to do, a sort of thought experiment, around how to monetize, like, should we just have people pay us for this search service? You know, we looked at it, okay, $20/year that seems like a reasonable price point for that time and we then, we were like theoretically, what if we could make a penny a search, and by the way, search ads are sold by the thousands, they use roman numerals, CPM (CPM meaning cost per 1000). So, we were like a $10 CPM, a penny per page, then we were like, well, we think people are start going to do more search, not less, and as people start doing searches, let’s assume they do 20 searches a day 5 days a week, they take the weekends off. That’s a 100 searches a week and there are 52 weeks in a year, that’s 5200 searches, which means if we do a $10 CPM, we could make $52. So, then you are like, well wait, that means with ads, we can make $52, where consumers are really putting a value on this as closer to $20, so it’s two and a half times as lucrative as ads as monetizing the customer directly.”
Netflix’s Google Connection:
I believe Netflix finds itself in a similar moment today.
In their most recent earnings, Netflix said that in the U.S. its ad-based plans are generating more revenue per subscriber than the standard subscription plan. (That standard plan is $15.49 a month, and the ad-supported plan is $6.99 a month. The math suggests the company is generating more than $8.50 a month in ad revenue per subscriber.)
Source: Barrons
People keep talking about Netflix cannibalizing its own subscriber base. From Netflix’s perspective, those customers are not trading down, they are trading up! Once Netflix’s ad business is up and running, Netflix will wish for their no-ads subscriber base to ‘trade up’ to the ad-based subscription, given it is already bringing in more revenue per customer.
The best part is that it is indeed a ‘trade down’ from the customer. It is one of those rare situations where everyone wins. The customer pays less (in exchange, watches some ads), advertisers get access to an engaged customer base, Netflix makes more money making investors happy.
So we’ve established that 1. The ad business is more lucrative than subscription 2. Netflix has already started seeing that behavior, literally less than a year into being in the advertising business.
Now let’s look into some other attributes that make Netflix special, not as much as Google but special nevertheless.
Other Factors/Catalysts:
Reach:
Netflix has a very broad reach. Hollywood reporters reported in this article on May 13th, 2022:
Here’s how the nine measured outlets rank in minutes viewed (September 2021 to August 2022):
1. Netflix, 1.334 trillion minutes viewed
2. CBS, 752.8 billion
3. NBC, 596.7 billion
4. ABC, 471.9 billion
5. Fox, 323.1 billion
6. Disney+, 245.4 billion
7. Prime Video, 173.7 billion
8. Hulu, 128.1 billion
9. Apple TV+, 21.7 billion
Netflix has almost the same minutes viewed as CBS and NBC combined!!! So Netflix has a lot of eyeballs, nowhere close to the market share as Google has but it is by far the leader in streaming.
The Death of Linear TV:
Linear TV is paid for by advertising. Until now the biggest inventory in streaming (Netflix with 1.334 trillion minutes viewed in) was unavailable to advertisers. They had nowhere else to go but TV. Now they do.
I cannot fathom why someone would sit and watch linear TV in today's world. Everything that is on Linear, is on streaming and you can watch it on your schedule, no DVR needed.
So with Netflix now finally available to advertisers and all other streamers, either already there or getting there, I would say linear TV will be dead in 10 years, could also be 5. Goes without saying, this is very bullish for Netflix.
Password Sharing:
Password sharing is another lever that Netflix has just started pulling which will drive higher margins.
From the most recent earnings call on password sharing crackdown, co-CEO Greg Peters said:
"This last of the country rollouts have gone well, and maybe most important, were directionally consistent with what we saw in Latin America," Peters said. "Very much like a price increase. You see an initial cancel reaction. And then we build out of that both in terms of membership and revenue as borrowers sign up for their own Netflix accounts. And existing members purchase that extra member facility for folks that they want to share with."
That knowledge led to a broader rollout of the program slightly slower than some observers expected, he added. "It was better to take a little bit of extra time, incorporate those learnings and make this transition as smooth as possible ... And we think that approach also best serve the long term business goals as well."
Source: Seeking Alpha
I am bullish on this tailwind that is yet to be implemented in their biggest market, the United States. It looks like it was pushed back a little but is likely to land around July 2023.
I also like that Netflix is doing a slow rollout, learning more as it goes along before implementing it in their biggest market.
Growth at all cost is over, incumbents should have the upper hand.
The other big factor is that the free money era is now over and companies that have reached scale and are cash flow positive are likely to succeed and other newer entrants will either get acquired, perish or have a very hard time surviving. Uber is in the same boat with ride sharing.
What Netflix could do better:
Improve Content Quality:
Netflix could improve the quality of their content - I find their current quality acceptable. The value proposition fits for me, I get a wide collection of old movies and once or twice a month, Netflix drops something that is actually worth paying for which makes the ad-free subscription ‘worth it’ for me. But there is a lot of great talent out there who can make a lot of great content and I hope someday Netflix can deliver Apple TV+ like quality with Netflix’s scale & volume.
Improve Recommendations Engine:
There is a lot of room for improvement for Netflix to improve their recommendation engine. Netflix sometimes has some great movies that I would love to watch but they never surface on my home screen. I diligently try to train the Netflix model by liking/disliking/super liking movies but the recommendations leave a lot to be desired.
What’s not like Google:
As mentioned at the top of the article, Netflix is not even close to Google. For this article I have only focused on Google Search but Google has a Display business, a programmatic business, YouTube, YouTube TV, Apps too and that is just the Ads side. Netflix is just going through one specific moment that Google went through and will benefit within that specific scope but it won’t be at the scale that Google did. Here are some specific reasons that differentiate Netflix & Google.
Intent vs No-Intent - Price Difference - Advantage: Google
Anyone who has spent any time in digital advertising knows what an ‘intent based query’ is. One of the reasons Google is the juggernaut that it is, is because users often come to Google with a specific intent. The customer (which you are for Google), is literally telling Google what’s on their mind. This is very powerful because Google can show you ads for exactly what you are looking for and in the moment you are likely to buy. The specificity of 1. What you are looking for and 2. The customer's readiness to buy now is significantly more valuable to advertisers. An intent based ad click can cost 10-100 times more. So, this is clearly advantageous to Google. Netflix does not have an intent based model.
Ads First vs Subscriber First - Advantage: Google
As we established earlier, the ad model is more profitable than the subscription model. Google has 100% of their users in the Ad model and while Netflix might want to have all their subscribers to go ad-supported, it is likely not going to happen. It’s too good a deal for the customer to let go off. So yeah Netflix has some pricing power in that context but they will never get 100% of their users to be ad-supported, so they will continue to miss out on the incremental margin they could have earned if they were ads first. (Also to clarify, I am not recommending that Netflix should have done that, but just a hindsight comparison. I don’t think Netflix should have been ad first).
Streaming rotation - Advantage: Google
The other big issue that streaming faces is how easy it is to rotate streaming services. You can’t do that with Google.com. So even if someone removed their Netflix subscription for a couple of months, that's 17% less revenue for Netflix. Google does not have that risk. Obviously not taking into consideration the ChatGPT issue.
Market Share - Advantage: Google
It’s widely known that Google has over 90%+ of the search market share while Netflix accounts for 17% of all worldwide online video subscriptions (Source). Again, no comparison.
Average Daily Time Spent - Advantage: Netflix
In terms of time spent on Netflix Vs Google, on average I think a user would spend more time on Netflix, on average, than they would do on Google - However I could only find conflicting data on this - so let’s assume users spend more time on Netflix. In which case, Netflix will be able to show them more ads but those ads will be cheaper as they are not intent based. - I’ll call this one a tie.
Total Number of Users - Advantage: Google
Google (across all its ad products) has a lot more users. Google is likely 10+ times more users than Netflix
Why do you think Google has that many more users than Netflix?
Could one of the big reasons be because Google is free?
And what could that do for Netflix now given its ad-supported model? It’s not free but it’s cheaper!
Conclusion:
I think the total number of subscribers will continue to grow over time and if Netflix 'cannibalizes’ its paid subscribers and they move to the ad-supported model, Investors should cheer that on. Either way free cash flow should continue to increase.
Netflix’s Forward Price to Cash Flow is 34.55
P/E GAAP (FWD) is 29.54
PEG Non-GAAP (FWD) is 1.14
I’ve been adding to my Netflix position below/close to $300.
Past performance is no guarantee of future results.
The ideas discussed in this article should not be constituted as investment advice.
Disclosure: We own positions in some/all of the tickers mentioned in this article.