Netflix, the international subscription video service, reported a 47 per cent year-on-year growth in revenue in Q4 2011, reaching a total of $876m. The domestic (US) streaming sector was responsible for 54 per cent of this, or $476m in revenues in the quarter; while domestic DVD was the second largest contributor, earning 42 per cent ($370m), despite a decline of 2.76m in subscribers taking discs, equivalent to 20 per cent of the customer base.
Such revenue growth was possible, despite the declining physical disc subscriber base, because of a split between digital and physical subscriptions that took place in summer 2011 and effectively imposed a 60 per cent price-hike on a large number of Netflix customers.
The company also saw the total number of paying digital customers in the US decline by just under 2 per cent in the quarter; however IHS analysis reveals that the biggest hit was from customers taking both discs and streaming which declined by 3.1m in the period, a decline of 27 per cent in just one quarter
International subscriptions to Netflix's online streaming service generated $29m in revenues in the last quarter. The company ended the year with 1.4m paying subscribers to its international streaming service, after launching in 43 countries across Latin America and Caribbean territories in September 2011.
Following a tough second half to 2011, which included a substantial price hike for subscribers, the total number of unique subscribers (paid and free) in the US grew 25 per cent year-over-year, up to 24.4m, compared to 19.5m at YE 2010.
Netflix's physical service is the largest source of the company's contribution profit (defined in their quarterly report as revenue less content and marketing costs) and generated $193.8m in the quarter - equivalent to 104 per cent of the company's consolidated figure (once domestic and international streaming have been accounted for). This is despite physical subscriptions only making up 42 per cent of revenue, and just 34 per cent of the total subscriptions (whereas per the company's reporting practices, digital and physical subscriptions from a single customer are counted separately).
This overrepresentation in revenues and profit can be attributed to two factors:
i.) the generally higher cost of a physical subscription, which start at $7.99 but can go as high as $43.99, compared to the flat $7.99 for streaming.
ii) The costs (content + marketing) that Netflix is incurring on digital subscriptions mean that its domestic streaming business only had contribution profit margins of 11 per cent.
This is significant as, while the transition from a disc business to a streaming business occurs, the company will be shifting users from a higher revenue, higher margin product to a lower revenue, lower margin product. Netflix does expect the combination of subscriber growth and better margins for the streaming service to grow the business segment's contribution profits, but not necessarily enough to offset the declines in profit from the DVD segment.
The streaming business taken as a whole, including international, lost $7.6m in the quarter before other costs are taken into account. IHS Screen Digest understands that the biggest contribution to these costs was content licensing. We understand that Netflix regards these costs as pretty much fixed, while the streaming costs associated with each additional digital customer are negligible. But we have some questions about this view of the company's streaming economics: while it is certainly true that each additional customer added today will improve the company's margins, what this leaves unasked is the question of Netflix's total content spend. As things stand, we do not expect Netflix's content expenditure, even in the US, to remain static as it looks to compete with the likes of Amazon Prime, Hulu Plus and TV Everywhere-like initiatives from the major US pay TV operators. In this light it seems probable that content acquisition is likely to become more of a cost center for the company in the near to medium term as it looks to compete by both investing in original shows like Lillyhammer and House of Cards, and growing the size of its library by buying content from rights holders who are mindful of either protecting their existing TV businesses or who are keen to augment their declining revenue from physical discs.
Internationally, we believe that Netflix also needs to increase its content spend in order to improve the attractiveness of its services. In the UK, Netflix has first subscription pay-window deals with just three studios, with the bulk of the deals and much of the best content in the market remaining with satellite player Sky.
Revenues from international streaming accounted for $29m - only 4 per cent of the revenues in Q4, with cost of revenues at $89m. Netflix, recently launched in UK and Ireland, is expecting international contribution loss to increase to up to three times this level, mainly because of significant investments into content and promotion of services. However, it should be noted that faster initial member growth was seen in the UK and Ireland when compared to the Canada service launch. Nonetheless, at least in the short term on the international stage, matters are likely to look worse for the company, and the size and state of Netflix's content library, particularly in the UK, is a key weakness that we believe should be addressed before sustainable growth in the size of the overseas streaming business can be achieved.