Netflix Cutting Costs: Will It Be Enough?

| About: Netflix, Inc. (NFLX)
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Netflix (NASDAQ:NFLX) already relies on cloud computing to stream movies and television programming, but recently, the company announced plans to move internal applications to the cloud (intranet, email, security, and other internal systems used by employees). Netflix plans to use cloud services provided by Amazon (NASDAQ:AMZN), which already provides the cloud environment for the company's online media streaming service.

By abandoning its large data center in favor of virtual servers to run internal computer systems needed to handle day-to-day business operations for the company, Netflix hopes to run internal applications on roughly 50 servers instead of the 2,700 currently in use.

Cutting operational costs seems a likely reason for Netflix to move to a smaller, more efficient cloud-based system. Over the past few years, cloud computing has changed the way businesses operate. Not only can businesses reduce initial costs for equipment, over time, they can save in maintenance and service update expenses. But the savings could take some time to realize as Netflix has reported it will need about 18 months to complete the transition from its current system.

Once Netflix moves data and other information from its data center to remote servers, the company will start to see some savings. Hopefully, the company will make use of this extra income to help bolster lagging interest by consumers in Netflix overall. So far this year, the company has seen a drop in DVD memberships (approximately 850,000 subscribers dropped the service) with only a moderate increase in streaming memberships (roughly 530,000 new memberships in the U.S.).

With increased competition from Amazon, Apple (NASDAQ:AAPL), and others, the company needs to develop/enhance services to maintain its edge or find even more ways to cut back on expenses.

Instead of focusing solely on improving overall user experience, Netflix has opted to increase its subscriber base in other parts of the world. While expansion into other markets should definitely help improve its bottom line, the company should also find ways to keep current customers from moving to other online streaming services.

In a recent study, published by NPD, more and more people have turned to cable companies to download media. Ultimately, as cable companies continue to offer increased movie and television selections, some customers may decide to cancel paid subscriptions to services like Netflix if the company can't compete by offering better media selections. Even a small loss in subscribership at this point could prove fatal to Netflix.

But with improvements to its Android app UI (User Interface), perhaps the company hopes more people will stream media through their mobile phone in addition to streaming through their televisions. Similar to the Android app for tablets, users can easily access movie details, and navigate through the site to choose and download media. Unfortunately, these improvements may prove too late as some cable outlets have already started streaming media through their websites and provide apps for mobile device streaming as well.

To add fuel to this fire, TiVo (NASDAQ:TIVO) has designed a device that allows people to stream recorded television shows through computers, tablets, and smartphones. And, as more and more cable companies move to the cloud, they too will start offering movie and television streaming options. Some cable companies, including Comcast, plan to start streaming video games starting as early as 2014. This could pull even more Netflix customers away in the long run, as Netflix doesn't stream this type of media.

Putting more into research and development may or may not help the company at this point. During 2011, Netflix spent $259.03 million in R&D projects; sales and revenue totaled $3.2 billion. While this is impressive, maintaining sales and revenues numbers like these will be a challenge going forward.

Staying on top, especially in a rapidly changing business as online sales, remains a challenge for Netflix. With increased competition from Verizon (NYSE:VZ) (pairing with Redbox, owned by Coinstar (NASDAQ:CSTR) to stream movies by early 2014 or sooner), Apple, and Amazon, Netflix may have to step aside. Early signs of this include failure to secure movie licensing deals with large Hollywood studios, decreasing catalog of popular movies and television shows, and attempts to improve the website's UI that are gaining attention, but may not mean much to customers that prefer watching media on a large screen or those with shared data plans for mobile devices.

With a simple premise - allow customers to download unlimited streaming media - it would be impossible for most companies to remain number one forever. Other companies that provide online streaming services have additional outlets in which to earn revenue - Netflix does not.

Reducing operating costs and increasing the volume of popular movies and television programming seem the best options going forward if the company wants to maintain or grow its subscriber base. The company may also need to start streaming new types of content including video games. In the end, expanding into new territories, offering new types of online content, and continuing to cut operational costs could provide the company with the strength needed to hold onto its position going into 2014.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.