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Netflix Has a Growth Problem

Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
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At some point, everyone knew, Netflix's subscriber growth in the U.S. had to slow down. The company's video-streaming service is nearing market saturation among its core demographic -- affluent young-to-middle-aged people -- meaning further gains will be harder to come by. Still, it was a bit of a shock for investors to learn from Monday's earnings report that Netflix had added only 160,000 U.S. subscribers in the second quarter -- a 0.3 percent gain over the previous quarter.

International subscriptions grew by a more impressive 1.52 million, but that was below what the company had forecast as well. The earnings report was seen as a major stumble, and Netflix's stock is down about 14 percent on the day as I write this.

Still, since we all knew this U.S. slowdown was coming  (to be followed several years down the road by similar slowdowns overseas), it seems like the really important question is how Netflix copes with it. Does the company have the ability to get more money out of each subscriber as subscriber growth slows? So far, it looks like the answer is yes -- albeit not a lot more money.

In 2013, Netflix began experimenting with tiered pricing that charged new U.S. subscribers more for higher video quality and the ability to stream on multiple screens at the same time. As it rolled that out, revenue per subscriber (average revenue per user, or ARPU, is the standard industry term) began a steady rise, as is apparent in the above chart. In the second quarter, Netflix began "un-grandfathering" longtime subscribers and putting them on the tiered plan too -- leading to a 4 percent increase in revenue per user over the previous quarter, but also a lot of churn as irked customers cancelled. 

The "un-grandfathering" in the U.S. won't be completed till November, so the rest of the year could be interesting. Still, the second quarter is usually the weakest one for subscriber growth at Netflix. Annual subscriber growth will surely be substantially higher than the 1.2 percent that the second-quarter numbers imply (it was 14 percent in 2015). Revenue per subscriber, meanwhile, has been rising at about a 5 percent annual pace since early 2014.

Put those together, and you've got a company that can keep revenue and earnings growing, even in its most mature market. How much can they grow? At $8.55 a month, Netflix's per-subscriber revenue has a long, long way to rise before it gets anywhere close to cable giant Comcast's $82.41. On the other hand, the same technological changes that have allowed Netflix to disrupt cable TV at a relatively low cost mean that other streaming services face low barriers to entry as well.

Netflix has gotten a lot of advantage from being first and being smart, but it's not a natural monopoly in the way that a cable provider is. Instead, it's becoming a big media company. That may not be as exciting as a technology startup, but can still be a pretty great business.

  1. I date my awareness to an April 23, 2015 research note by Michael Nathanson and two other analysts at MoffettNathanson Research, which is not available online.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Justin Fox at justinfox@bloomberg.net

To contact the editor responsible for this story:
Susan Warren at susanwarren@bloomberg.net