Netflix's (NASDAQ:NFLX) Growth Fix Might Have These 3 Problems

Netflix, Inc. (NASDAQ: NFLX) was not built in a day. After the humble start as a DVD-by-post rental company, it rode the tech tide to become a leader in a quickly growing niche.

While we cannot take the credit away from its management for creating a unique, idea-cultivating work culture – we have to take notice of many tailwinds that contributed to the growth. Even the most significant turbulence since the Great Recession, the 2020 pandemic, actually contributed to the company's growth.

Yet, no good episode lasts forever. As we roll out the credits for the era of the monetary expansion, Netflix has to transform into a less exciting status of a mature company.

Q1 Earnings Results

• GAAP EPS: US$3.53 (beat by US$0.62)
• Revenue: US$7.87b (miss by US$70)
• Revenue growth: +9.9% Y/Y

Other highlights

• Global streaming paid net additions: -0.2M vs. 2.5m guidance
• Q2 revenue guidance: US$8.05b vs. US$8.22b consensus
• Russian suspension of service: -0.7m on paid memberships

Losing 200,000 subscribers on a net basis is disastrous if you were guiding for a 2.5m addition. This was the first subscriber loss in a decade, taking the overall subscriber count down to 221.64m. Furthermore, Q2 expected subscriber drop is now at 2 million.

View our latest analysis for Netflix

What Could Netflix do to Turn the Stock Around?

Reflecting on the results, the management pointed out key factors contributing to the situation – rising competition, geopolitical crisis, the threat of stagflation, and last but not least, account sharing.

By their estimates, account sharing is rampant, reaching over 100 million additional households. This is on par with 45% of the existing 221.6m customer base. These numbers are not minuscule by any accord, so it is natural that solving this problem is now a priority.

Thus, it is not surprising to see CEO Reed Hastings start warming up to changes in the subscription tier. Mr.Hastings, who has been a fan of the simplicity of subscription, is looking at advertising-tolerant options.

In practice, this means creating a new, cheaper Netflix subscription that would cater to a price-sensitive but advertisement-tolerant audience. Yet, there are 3 problems we see with this solution.

1. Subscription Downgrades

By offering lower-tier pricing, some subscribers would likely downgrade from the currently cheapest service. While premium tier subscriptions have been rising in the latest years, the majority still have a basic one. Thus, while it is better to have a downgrade than churn, it could still suppress the positive effects of new subscriptions.

2. Advertising Effect

Online advertising has a big problem. It is hard to distinguish between a selection effect and an advertising effect. Ads are primarily targeted based on the data, although this situation has been somewhat changing lately.

Yet, the line between selection (a customer who already made the purchase or a purchasing decision) and advertising (winning a new customer) is blurred. While the advertisers lose in the process, they have been getting more conscious in recent years, as we can see with examples from Uber and eBay.

3. Monetizing the Lowest Tier

Advertisement-friendly subscription sounds like a matter of time now. But, we have to point out that its target will be the market segment with lower purchasing power. Advertisers are aware of this, and we can expect them to leverage it in negotiations. Furthermore, the constraining macroeconomic outlook could put further pressure on advertising rates since marketing budgets are likely to be cut.

Conclusion

For a long time, Netflix steered clear of other ways of monetization, preserving its simple subscription-based business model. Yet, as we explored above, launching a quality advertising operation is not a simple, turnkey solution.

Finally, a dip in subscriptions is not encouraging because it could be a canary in the coal mine for the broad market. When an average consumer needs to trim their expenses, subscription entertainment could be high on the list of things that need to go.

If you're interested in diving deeper, our analysis shows 3 warning signs for Netflix, and we strongly recommend you look at these before investing. If you are no longer interested in Netflix, you can use our free platform to see our list of over 50 other stocks with high growth potential.

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Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.