Netflix (NASDAQ:NFLX) is one company which has sustained its growth due to innovations in its business model. The company started way back as a DVD rental company but moved into online streaming as customers' preferences and habits changed with the advancement in technologies.
A couple of years back Netflix realized the importance of international expansion for its future growth and subsequently it expanded its operations into Canada, Latin America, the UK and other European countries. Now, with the shift in power towards content providers in the cable and internet television industry, Netflix has changed its strategy towards content creation. The company believes that its future growth will be driven by the original programming content which will assist in retaining its existing subscribers as well as bringing new subscribers, thereby increasing its profitable subscriber base.
Shift in Focus
Over the previous years, Netflix has operated mainly as a content distributor. It operated through content licensing from popular content networks. Now, there is a shift in the focus of Netflix and it is offering licensed content as well as original content to its subscribers.
Netflix has already launched the first season of its original series "House of Cards" this year. The series has already become a hit with Netflix's subscribers and has become the most watched show on Netflix. Netflix has other original content lined up for release as well in 2013 like the new season of the comedy "Arrested Development", "Turbo F.A.S.T.", "Orange is the New Black", "Hemlock Grove" and maybe the second season of House of Cards. Netflix has big plans for its original programming.
Reason for Shift in Focus
In the online streaming business, Netflix is a niche player. It does not offer a whole suite of content which include news channels, sports channels, drama, kids' shows etc. It offers content dedicated towards movies and TV shows.
Currently it offers 3 types of Content: movies more than one year old, previous seasons of TV shows and Original content. Now, with the increasing competition in the streaming market due to the presence of Amazon Prime, Hulu, HBO etc. Netflix cannot bank only on content licensing in order to drive its future growth. The USP of Netflix in providing original series not available elsewhere will increase its subscriber base and hence, revenue.
Use of Analytics in Increasing Customer Experience
According to a recent post by Netflix's CEO Reed Hastings about the long term view of Netflix, internet TV is poised to grow exponentially in the future and it will replace the linear TV. The growth in the penetration of Internet TV will be based on the simplicity and usability of the different apps providing content streaming.
Netflix is working towards increasing customer experience. It is spending about $350 million per year in improving its service and the user interface of its app. Analytics can play a huge role in the aim of Netflix to increase customer experience. Netflix has access to enormous amount of data associated with the past viewing history of its subscribers. This data can be analyzed using various data mining software to identify patterns in the preferences of Netflix's subscribers. With the use of some algorithms Netflix is able to identify what kind of programs will appeal to a subscriber demographic. These can be used to recommend programs to users thus increasing the usability of the app.
The biggest advantage which the current business model of Netflix offers as compared to its competitors is the pricing of its services. Netflix charges a flat monthly charge of $7.99 for unlimited streaming and viewing. Its services are very cheap compared to its competitors like HBO which charges $15 per month. Netflix has not increased its price and is neither looking towards increasing it in the near future. Netflix wants to operate as a volume player, increasing its subscriber base significantly. As mentioned in its report about the long term view of Netflix, Netflix is aiming to double or triple its subscriber base from the existing 30 million to 60 or 90 million in the future. It is aiming to increase its revenue by increasing the number of subscribers while keeping the price of its service unchanged.
Another advantage which Netflix offers to its customers is that it does not carry advertisements and provides flexibility to the user in terms of viewing its content.
The change in focus towards creating original content will be a costly affair for Netflix. The creation of two seasons of House of Cards cost about $100 million to Netflix.
The company is spending $2 billion in content licensing and the creation of original content. It's a huge amount of money considering the total revenues of Netflix which were around $3.6 billion in 2012.
The company is banking only on an increase in the subscriber base to achieve a positive ROI. The company's target of even doubling the current subscriber base looks overambitious and its resistance in increasing the tariff of its services puts a question mark on the sustainability of its plan of shifting towards content creation.
Netflix should review its business model and its current pricing strategy. It should look towards alternate methods of increasing revenue. Maybe it can earn revenue by licensing its original content to other players. The strategy of Netflix in shifting focus towards content creation will only be successful if it is coupled with identifying ways of increasing revenue for the company.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: StockRiters is a team of analysts. This article was written by Sahil Saini - BTech in Electronics and Communication, ITM Gurgaon, MBA in Finance, IIFT - one of our analysts, and edited by Shas, StockRiters' Editor-in-Chief. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.