Netflix: Tech's New Superstar?

Posted by: Cliff Edwards on January 27, 2009

You can’t blame investors who are scrambling to grab stock these days in DVD rental service Netflix. The company’s stock jumped nearly 16% to $35 in early trading Jan. 27 after it reported boffo earnings. Its better-than-expected fourth-quarter results were like a ray of sunshine when compared to the gloomy tide of layoffs and plummeting earnings being at other tech companies.

But I wonder if Netflix could have done even better? In many ways, Netflix raised prices a lot of its subscribers over the year. But its average revenue per subscriber showed a surprising decline.

To recap, Los Gatos, Calif.-based Netflix said it earned $22.7 million, or 38 cents a share, compared with $15.7 million, or 23 cents a share a year ago. Revenue rose to $359.6 million from $302.4 million. Analysts were expecting a profit of 36 cents a share, excluding stock-based compensation, on sales of $354.3 million.

Netflix CEO Reed Hastings noted in a conference call that “it’s very clear that streaming is energizing our growth.” And well it should. It’s a service that costs $4 extra over the base $5 price for renting one DVD at a time; it’s free for people who already have unlimited plans.

Impressive? Yes. But I wouldn’t have expected anything less from a company that has spent nearly $200 million, or 18 percent of its revenue, marketing itself in online ads, print and other media over the past 12 months. Netflix also struck high-profile deals with Microsoft, LG, Roku, TiVo and others to stream a fraction of its vast library to TVs and set-top boxes.

In fact, I would argue Netflix should have posted even higher growth. As I dug through the report, I was surprised to learn that average monthly revenue per subscriber fell year-over-year to $13.58 from $14.22.

No one doubts that consumers are tightening their belts during this global fiscal crisis, but Netflix last year began charging subscribers $1 extra if they wanted to rent Blu-ray Discs. Company execs recently said they actually did a good job of convincing 700,000 such customers (of 9.39 million total) to accept the increase.

Since Hastings called it out, I also would have expected average revenue to rise because of the streaming service.

Given that churn stayed about the same and subscriber acquisition costs fell sharply, why the average revenue per subscriber didn’t increase? One answer: the company said gross margin for the year fell to to 33.3 percent from 34.8 percent (though margins improved sharply in the fourth quarter over the year previous). The company spent more on technology and purchasing and mailing out the DVDs, too.

A Netflix spokesman also noted that the company adjusted many of its pricing plans lower over the past year or so. But he wasn’t immediately sure why average subscriber revenue didn’t rise with the reported success in passing on higher rates to Blu-ray users and streaming subscribers.

Seems to me like there are two reasons for the disparity. The publicity might be bringing in new subscribers, but it’s not quite translating into high-paying ones at the break-even level that pays for all the new technology.

The 25 percent jump in fulfillment expense also could point to the fact that Hollywood may not be happy with Netflix’ growing power over the consumer purse. As its rental offerings sap away retail sales of DVDs and Blu-ray, might they be charging more to Netflix for its movie purchases?

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Reader Comments

A Born-again Subscriber

January 28, 2009 10:58 AM

My subscribed for a couple of years when NetFlix was new. We had the three-a-time subscription. However, we found ourselves watching too many movies. As soon as one would arrive, we'd watch it that evening to get it back in the mail. Eventually, we cancelled the subscription but I never felt satisfied with what was available at Blockbuster. Last November I received notice that I would receive a free month as a result of the class action suit so I reactivated my account for the free month. I loved it again. I've always been amazed at Netflix's ability to predict what we'll like. There must be a processing center close to home since turnaround time is extremely quick. At the end of the free month, they announced streaming to Tivos and Macs. I have both. I am now a born-again subscriber. I haven't rented from Blockbuster in possibly four months. I stream TV shows and concerts to a second monitor in my home office while doing other computer stuff. I have a queue of 15 instant viewing movies ready to go should we want to watch in the family room. Plus two DVDs at a time is just right. Go Netflix!

pcyh

January 29, 2009 11:35 PM

Why hsn't NetFlix make its service available to customers outide the United States?

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BusinessWeek writers Peter Burrows, Cliff Edwards, Olga Kharif, Aaron Ricadela, Douglas MacMillan, and Spencer Ante dig behind the headlines to analyze what’s really happening throughout the world of technology. One of the first mainstream media tech blogs, Tech Beat covers everything from tech bellwethers like Apple, Google, and Intel and emerging new leaders such as Facebook to new technologies, trends, and controversies.

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