Netflix’s Streaming Service Did Not Drive Increased Earnings

After Netflix gave earnings last week, various news sites pointed to Netflix's streaming service as the reason why Netflix earnings beat estimates. Most seem to attribute this to the comment Netflix's CEO said on the earnings call, which was, "It's very clear that streaming is energizing our growth."

What I didn't see anyone asking is what "growth" Netflix was talking about? Since the CEO didn't elaborate on exactly what he meant, too may people assumed he meant revenue or subscriber growth, which is not the case. I was going to just leave it alone and not even blog about that point, but a week later folks are still talking about this and also being way too vague about the Netflix content offering as well. Today I read an article about the success Netflix is having with their "digital downloads", which sounds great, except for the fact that Netflix isn't in the "digital download" business. Netflix doesn't download anything since they stream all of their movies to multiple devices.

This may seem like I am splitting hairs over terminology, but I'm not. It's important to break out the market from digital download services like iTunes and others versus the streaming media service that Netflix offers where the user never owns any actual piece of content. We've got to talk about this technology right and we have to make sure expectations are set properly.

Getting back to my main point, at no time on the earnings call did Netflix say that the streaming service allowed them to beat or increase their earnings. In fact when I asked them for more details about this after the call, Netflix said the exact opposite, saying, "Reed Hastings was referring to growth in the generic sense, not tying specific subscriber growth, revenue or earnings to the success of streaming.  We haven't said that instant watching has driven a specific number of new subscribers."

Netflix was very forthcoming with this and made their point very clear in their follow up response. Did anything think of actually asking Netflix what they meant on their earnings call before they ran with stories proclaiming streaming as the reason they beat estimates? Sure, one can speculate that down the road their streaming service could generate a whole new business model, or earn them revenue in some other way, but right now no one can say they make more money simply because they have a streaming service.

The fact that they are seeing an increased demand for their watch now service might indicate that over time, Netflix can increase their P&L if it is cheaper for them to deliver a movie via streaming as opposed to having to pay to ship a DVD to and from the customer. Streaming could be a cost savings but that will only happen with serious economics of scale and with the DVD business growth slowing, which Netflix does not see happening until 2012. We don't know what it costs Netflix to stream a single movie and the watch now service could actually cost Netflix more money if the convenience of being able to see movies at any time allows a member to consume more movies instantly then they would ever get if they were only coming in the mail. These are all speculative questions since Netflix has yet to break out numbers for the digital portion of their business but right now, Netflix's streaming service is not increasing their revenues.

  • Since you apparently didn’t listen to the earnings call, or even bother to read the transcript, let me quote Reed Hastings very explicitly tying better-than-expected subscriber growth to an uptick in streaming activity.
    Here’s the full quote, which didn’t appear in all the news reports:
    “In hindsight in Q4 we under-forecast our subscriber growth primarily because we underestimated the positive impact of the introduction of the multi-function CE devices from LG Electronics, Samsung, Microsoft and TiVo that promote Netflix streaming. The second smaller factor in our outperformance was better than expected responses to our marketing.
    The precise impact of the recession is unclear but it’s very clear that streaming is energizing our growth.”
    Netflix CFO Barry McCarthy later linked streaming to higher subscription rates, lower subscription acquisition costs, and higher profits:
    “As Reed indicated our CE partnerships and our expanding library of license content had a positive impact on our growth in Q4. We’ve been heavily investing in Internet delivery for several years and Q4 was the first time we saw the benefits in terms of significantly faster sub growth, lower SAC, more profit and greater enterprise value.”
    McCarthy also made clear that the company expects that, if more users take to streaming as opposed to DVD watching, Netflix will see increased profit margins as postage costs are replaced with streaming costs:
    “Two additional observations about gross margin, one, we are seeing early signs of less DVD usage with some subscribers who are also watching instantly as compared to subscribers who only receive DVDs. Time will tell whether this substitution effect is an attribute of early adopters or a mainstream behavior.
    Over the long term if this substitution effect becomes a mainstream behavior and other things being equal Netflix profit margins would expand as postage and packaging expense is replaced by streaming expense.”
    Maybe YOU don’t know what it costs Netflix to stream a movie versus sending it in the mail, but Netflix does — and it’s pretty bullish that increased streaming will, over time, allow it to make more money.
    http://seekingalpha.com/article/116612-netflix-inc-q4-2008-earnings-call-transcript?page=-1

  • hk

    the starz play with distribution deals defenitely helped NFLX retain/attract subs. it is pretty clear from management’s statements that the streaming helped – also the eocnomy helped – compare to canadian on-line rental company that also said it had growth during quarter but only 10% i think – it does not have streaming

  • Hi Ryan,
    I listened to the entire call and followed up that call with a set of questions to Netflix but I think we are talking about two different things.
    You say that Netflix is “pretty bullish that increased streaming will, over time, allow it to make more money.” I don’t disagree with that. I even say in my post that over time, Netflix could make money or save money from streaming. I’m not debating what Netlfix may or may not do down the road, my post was very specific about what is taking place with Netflix – today.
    Nettfix made it crystal clear in the follow up quote to me that streaming did not increase their earnings. “Reed Hastings was referring to growth in the generic sense, not tying specific subscriber growth, revenue or earnings to the success of streaming.” That’s a very clear statement from Netflix saying that while the streaming service had a postive impact on their company all around, and from a high level, they can’t specifically tie the streaming service to the growth in subscribers. And how could they?
    If someone signs up for a Netflix account because they bought an XBOX 360, how would Netflix know that? How would Netflix know that it’s the device that drove them to get a Netflix account? They can probably tell that with the Roku device since for so long that was only for Netflix content. But since the Netflix streaming service comes free with a Netflix DVD account and you can’t yet get a streaming only account, they can’t yet say that the devices are driving new subscribers or revenue growth when the devices, like gaming consoles, do other things besides just Netflix content. It’s too early for them to know the financial impact this will have, which is clearly stated by the CFO saying, “Time will tell whether this substitution effect is an attribute of early adopters or a mainstream behavior.”
    Reed’s quote on subscriber growth says that the devices had a “positive impact” on their growth but no where does he says streaming is the reason they had better “earnings”. Having a postive impact on subscribers and have “increased earnings” are two very different things and that’s the thing I take issue with when you Google Netflix and get more than a dozen articles that says Netlfix had higher “earnings” from streaming. When I heard Reed say that I thought it was phrased in a generic way, hence asking Netflix to clarify, which they did.
    The quotes from the CFO about gross margins indicate that they are seeing some interesting things, but they make it clear from the quote that this may or may not play out over time. The CFO also said they “saw the benefits” in Q4 from the device partnerships, but no where does Netflix break out, with numbers, what those benefits are. Netlfix does not even give out the number of movies they stream as that would then allow us to have a good idea what they are spending on digital delivery each month. Over time, Netflix will have to break out these numbers as they become bigger and their streaming service becomes a more important part of their business, and revenue.

  • Well Dan, I don’t know what to say. I can’t help with your reading comprehension or cognitive skills, but purely based on the comments of the CEO and CFO, the entire premise of this post is FALSE.
    You claim that Hastings never said more streaming led to more subscribers, but he did. You claim that Netflix didn’t say streaming led to increased profits, but there was the CFO saying that the company’s benefits from streaming included four things: “significantly faster sub growth, lower SAC, more profit and greater enterprise value.”
    I don’t know what Netflix’s PR machine seeks to gain by sending you the email it did, but the company’s comment directly contradicts public statements already made by the CFO and CEO. They weren’t talking about some nebulous concept of growth in a general sense, but specifically talking about (and I’ll repeat, since you seem to have missed it the first few times): “significantly faster sub growth, lower SAC, more profit and greater enterprise value.”

  • Yes, I see what the CFO said, but I think it’s the words being used across multiple quotes that’s causing some confusion. Streaming could drive lower costs, which equals better profit, but that’s different than saying that streaming drove earnings, as in streaming is the reason Netlfix had more revenue. Better P&L yes, but none of the quotes from the transcript use the word earnings or revenue when referencing the streaming service.
    I just had another call with Netflix and again, they reinforced the point that they don’t know if the streaming service drove more “revenue” or “earnings” since as they said, they have nothing to compare it to year over year and nothing to benchmark it against since they weren’t doing streaming in 2007.
    My post does not say that streaming didn’t have an impact on P&L or more profit and Netflix made it clear that “The more subscribers watch online from Netflix the more likely we think they are to remain subscribers and to watch slightly fewer DVDs in a month.” That clearly impacts their bottom line, in a positive way, but that does not drive more revenue, only better P&L.

  • Naturally, Netflix is actively exploring how they can turn the great potential into great profits: http://www.hackingnetflix.com/2009/01/netflix-survey-would-you-pay-an-additional-999-per-month-for-hbo-shows.html

  • shaun

    i think something that is not being looked at is the potential cost savings the video game publishers could realize as they stream the games they own directly to the consoles and computers. if they get a decent deal on the CDN services, this could have a HUGE impact on their margins as they also cut out the retailers who take a big chunk.
    Ryan, you are confused and we can’t help your cognitive skills. you clearly didn’t read dan’s post carefully. he is talking about now, while you are simply speculating about the future, which is not only not what we are discussing here but also not helpful.

  • Hi Shaun, I don’t get the game example? In order to play any game on the XBOX 360, you have to have the game saved to the hard drive and/or on a CD. So streaming would not replace that. If you mean download games to the XBOX, yes, that could be a costs savings for the game developers but they have already been doing that for some time.

  • The company reported fourth quarter earnings of $30.9 million, or 56 cents a share, on revenue of $444.5 million, up 24 percent from a year ago. Non-GAAP earnings were 59 cents a share.