The economics of Netflix

By Felix Salmon
March 31, 2010
Netflix has a market capitalization of $4 billion, on 2009 net income of just $116 million? That's about $325 per subscriber, even as each subscriber generates on average about $145 in revenue and $10 in net income per year.

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How come Netflix has a market capitalization of $4 billion, on 2009 net income of just $116 million? That’s about $325 per subscriber, even as each subscriber generates on average about $145 in revenue and $10 in net income per year.

Ethan Epstein makes a pretty compelling case that Netflix’s business model is threatened by problems at the US Postal Service: a rise in postal rates would be bad, and the abandonment of Saturday delivery would be much worse.

But the fact is that the economics of Netflix have always been unique and hard to put into old-fashioned business models, and I think they’ve done quite a good job of reinventing the whole way that we pay for consuming movies. By turning it from a cost-per-movie into a cost-per-month, they can somehow charge more money but cause less pain while doing so.

I’m aware that I’m extrapolating wildly from my personal experience here, but in the olden days I hated paying late fees on rented movies, and as a result was an eager and early adopter of Netflix. But pretty much since day one, I’ve paid more money to Netflix in any given month than I ever would have paid in movie-rental fees, including late fees. I just don’t watch that many movies, and the occasional $10 late fee is still much less than the regular $20 or so I pay Netflix. And while Netflix has done a good job of reducing its rates noticeably: my plan has dropped from $23.84 in 2004 to $18.50 now, including tax, that’s still more than I’d ever be likely to pay a video-rental store.

Indeed, I still occasionally get DVDs from my local rental store, because of the way that serious-and-earnest Netflix DVDs tend to pile up unwatched when the whole reason for wanting to relax with a movie in the first place is because you’re frazzled and just want to kick back with something funny or brainless. The Netflix tail is long, but when you have no more than three movies out at a time, your choice is actually much more constrained than at the video store. And similarly with the streaming stuff: it’s great in theory, but in practice it’s going to take me a long while to work out how to hook it up to my video projector.

Yet despite all of that, I’ve been a loyal Netflix customer for nine years now, and I’m likely to continue to pay them their $18.50 a month pretty much indefinitely, bearing them none of the ill will that I used to have towards surly clerks charging me late fees for scratched DVDs. There’s just so much less pain involved, when you pay for access to movies rather than for the movies themselves.

Still, $4 billion seems pretty crazy to me. Netflix is just a middleman, a delivery company. Shouldn’t that be a commodity, rather than something trading on a p/e in the mid-30s?

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Comments
11 comments so far

i would guess that the NFLX longs would take serious issue with your classification of NFLX as a “middleman” and a “delivery company.”

I have never had a position in NFLX, but something about that description disturbs me too – i mean, is AMZN just a middleman and a delivery company? Netflix seems to have pioneered a way to get you what you want very quickly and efficiently – and now they’re perfecting digital content delivery. I guess maybe their expertise is in supply chain management or something – but it certainly doesn’t seem as simple as just a delivery company.

speaking of which – would there be massive synergies, then, with UPS or FDX and NFLX??? natural fit!

Posted by KidDynamite | Report as abusive

I think there’s also a lot less regret with the subscription/access model. There’s psychological trauma involved with dropping $5 on something terrible and driving it back; it’s less tangible when you didn’t pay for the movie itself and you just drop it back in the mail.

In another area, I think if Apple weren’t such a dominant player (and so opposed to it), we’d have already seen a reasonably successful music subscription service.

Posted by absinthe | Report as abusive

The killer feature of Netflix for me has been their selection and the queue. They carry foreign films, classics, and TV series that used to be impossible to find at the store (the long tail). And when I read about a movie I’d like to see I’m almost certainly on the computer so I can queue it immediately. Then I don’t have to remember them on the spot at the store. The streaming works well, but the selection is poor (though the first 2 seasons of This American Life were excellent).

Posted by grumblecakes | Report as abusive

Netflix’s online rental option gets better by the week

Posted by Story_Burn | Report as abusive

Netflix? Nice company. Got that “we’re not Blockbuster” thing going for them but they’re still just a signal transporter, like AT&T, TWC or Comcast.

I’d buy a PS3 streaming subscription if only to see them put AT&T where it deserves, under the ground just like Blockbuster, and keep on down the line from there. Transporters trying to wag the dog are not my cup of tea.

Netflix needs a vertical to survive. Closing down Red Envelope was probably the honest thing for them to do when they did, but they still need something to call their own. Like buying MGM, maybe?

Posted by HBC | Report as abusive

Their streaming service that runs over a variety of devices, most notably game consoles like the Xbox 360, is becoming more important than their snail-mail delivery. It costs Netflix about a nickel to stream a movie. I pay them the $20 or so a month and watch a dozen or a score of streamed movies while ordering 2-3 disks of new releases and stuff that isn’t yet in the streaming library. Pretty good economics for them, but the challenge is aggregation since the digital rights on movies have to be negotiated on a film by film basis.

Posted by mscotthillis | Report as abusive

I think there might be some tension between the profitability of content creators and distributors. When there is serious innovation in technology or process distributors generate the bulk of profits. Over time as technology and business processes mature, a larger share of economic value swings back towards creators of original content.

Posted by albertsun | Report as abusive

It costs Netflix MUCH more than a nickel to stream a movie. That’s just the distribution cost; the big money is the sum they pay the studio. Which reportedly can be as much as $4.

Felix, I am a longtime reader and can’t say I agree with you here. Looking at Netflix as a company w/ Post Office exposure is not acknowledging the key area in which Netflix is growing: digital content distribution. I wrote a little blog post in response to get the story going more: http://alatazerka.wordpress.com/2010/04/ 01/netflix-and-the-new-media-model/ .

Regards,
Elliot

Posted by offpeak34 | Report as abusive

I was a Netflix subcriber for 3+ years…until I purchased a blu-ray player. After waiting 2 months for several new releases in blu-ray, I tried a 2 week trial membership to Blockbuster and had no issues with blu-ray dvds. Now I imagine someone will either purchase the Blockbuster business or it will go out of business at some point, but they don’t seem to have the backlog that Netflix has developed. I looked into this stock as a short based on the postage issue as well as the potential for supply constraints creating disgruntled customers (such as myself). I don’t have the risk tolerance to jump in front of this freight train just yet, though.

Posted by Funisnotfinance | Report as abusive

Felix, Try the one-DVD-at-a-time plan for $8.99 plus tax and maybe that will help solve your issue.

Posted by dsucher | Report as abusive
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