Wall Street Fails to Understand Netflix (again!)

By Aarthi Rayapura July 25, 2016

By Craig Barberich, Global Head of Media Solutions at Zuora

Subscribers and their growth – when it comes to Netflix, these are the only metrics that Wall Street really cares about. While these are critical indicators, they are by no means the only business metrics in the Subscription Economy. Wall Street has once again failed to understand this and as a result, we saw Netflix shares plunge by more than 15% last week.

Yes, Netflix just reported its weakest subscriber expansion in two years. The number of Netflix subscribers now stands at 83+ million members with Q2 having added just 1.7million new members. This fell way short of their Q1 results which had seen a record addition of 6.74 million new subscribers and also failed to meet their forecast of 2.5million new members. In addition to these slow acquisition numbers, Netflix admitted that “churn ticked up slightly and unexpectedly”.

But here’s the thing – the metric that matters the most for subscription businesses is Customer Lifetime Value (CLV), a metric that can be calculated in various ways and is not reported (another Wall Street fail). CLV essentially predicts the value a business can derive from a customer relationship. Will a customer pay for 3 months of Netflix or for 3 years of the service? Since subscription businesses are all about customers, this metric is a key driver of business decisions and influence where a company should spend its resources. It’s really Business 101 – identify subscribers who show signs of being the most profitable (higher CLV), understand their needs, cater to them and grow their tribe. You cannot save every churn and let’s face it, many won’t be worth the fight.

In the case of Netflix, while their pricing changes probably played a role, I see their poor international numbers as indicators that the company is still trying to figure out their global business strategy. In the US, Netflix has always been way ahead of everybody in using data to truly understand their customers and thus, their CLV. They really know their long-term US customers, but do they know their new international subscribers? Probably not and thus, the low acquisition numbers.

Media subscribers are by no means homogenous. The leading characteristics of Netflix’s prime subscribers in North America will not necessarily match subscribers elsewhere nor will their behaviour follow the same path. As the company rightly points out – “Prior to the global launch of our service in January, Netflix was available in 60 countries. In these earlier expansion markets, our adoption rate in the first several months (as measured by penetration of broadband households) has been highly varied and the initial uptake is not necessarily indicative of our long-­term penetration.”

What we are seeing isn’t a problem, but a very methodical business building a deep understanding of its customers before investing. The company obviously wants to identify loyal customers who’ll stay with the service for a long time and make sure they’re focusing investment on the right type of long- term subscriber in the international markets as well.

Ideally, your CLV determines your acquisition spend. If I know I’ll receive $100 from you over a year, my acquisition spend should be much lower so there’s a profit margin woven in. Acquisition investment must be as targeted as possible so you’re not over-investing and wasting money. Think about it – Netflix can probably go on a marketing binge and report fantastic subscriber growth numbers. But if they don’t attract the right customers, it’ll be followed by a high churn rate a few quarters down the line. And all the initial investment will in fact be a loss.

As part of their international growth strategy, Netflix must first identify region-specific characteristics of users who will maximize CLV. It must continue to focus on understanding these new markets and fine-tune their offerings to cater to local preferences and identify long-term customers. Netflix is a company that has been built on strong data and analytics. They’ve done it before and there’s no reason they can’t do it again. Once the company gets a better understanding of their new customers to help them maximize CLV, we’ll begin to see them acquire more customers and maximize revenue from their international investments.

This isn’t a story of failure but on the contrary, it’s a story about a very smart and methodical business working its way from being a regional success to a globally successful media business. It’s time Wall Street caught on.