Netflix has announced that it had more than paying 38m streaming subscribers worldwide at the end of Q3 2013. The company's physical disc subscription business declined to 7m paying subscribers, a loss of 355,000 subscribers in the quarter and almost 1.5m since Q3 2012.
Netflix's total number of paid streaming subscribers increased by 2.4m over the quarter, to reach 29.9m subscribers in the United States and 8.1m subscribers internationally. The international streaming service saw a larger than expected increase of free trialists to 1.1m driven by Latin America and the September launch of the service in the Netherlands.
Global quarterly revenue grew three per cent to $1.1bn with a contribution profit of $198.9m and a contribution margin of 18 per cent. Within the US domestic streaming market, revenue in the third quarter was $701.1m, a year-on-year increase of 26 per cent, with a contribution profit of $166.5m (a margin of 24 per cent). The US physical business earned $221.9m in revenue, with a contribution profit of $106.7m - a margin of 48 per cent. The international steaming service recorded a loss of $74.3m despite revenue growing by 10 per cent to $183.1m. Netflix's combined domestic and international streaming revenue reached $884.1 million with contribution profit of $92.2m or 10 per cent of revenue, compared to only one per cent in the third quarter of 2012.
The third quarter of 2013 is a significant milestone for Netflix, as the quarter in which the Netflix US streaming subscriber count pulled even with the US subscriber count of pay TV giant HBO. The company ended the quarter just shy of 30 million streaming subscribers with estimates for HBO at roughly the same level.
The comparison with HBO is the most appropriate for companies such as Netflix, Amazon and Hulu's subscription service, rather than with the pay TV operators. Netflix, as well as Hulu Plus and Amazon, are acting as premium channels in investing in acquired and original content and following in HBO's early-1990s footsteps. Despite the investment Netflix has made in its own original programming, the company has reported that a greater percentage of overall viewing on the platform is of previous-season TV episodes and catalogue movies. Netflix indicates that it plans to double its investment in original content in 2014, although this will still represent less than 10per cent of global content expenditure.
The company's 'contribution profit' from US streaming has now reached $1.85 per subscriber per month which is up $0.50 year on year. This suggests that the company has managed to get the increase its content costs in check so that they are now growing at less quickly than revenue. However, the contribution margin of 24 per cent remains appreciably below HBO's ~40 per cent margin. Based on the trends of the last few quarters Netflix would have to reach ~10m additional subscribers for its US digital business to match HBO's margin. In this context it is perhaps not surprising that the company is considering taking greater ownership of its original programming so that it can enjoy the additional revenue streams that opens up (e.g. physical home entertainment sales) rather than merely acting as the commissioning broadcaster as it did with 'House of Cards'.
Netflix's international business remained a loss-making venture as the company struggles to gain profitability without scale and without a legacy high margin physical business. Whereas in the US the company initially bundled its streaming proposition with disc rentals add value to the physical subscription. Netflix has not had a preexisting business from which to launch a digital subscription internationally. At present, the international ventures are subsidized by domestic market return and with ongoing market expansions planned by Netflix; IHS does not expect this to change in the mid-term.
The launch in new markets has negative impact on margins, with a $10m negative impact on 'contribution profit' tied in with the latest (Netherlands) launch. Nonetheless it will in the long-term give the company a scale that will ultimately help its contribution profit margins. As a consequence of the Dutch launch, the recent results are an exception to the previous seven quarter trend of narrowing international losses. Nonetheless, the $74.2m loss is the second smallest loss since the service expanded to the UK and Ireland in January 2012, and during this period international revenue has grown by more than 500 per cent.
Despite this, the fragmented nature of international markets, local content requirements and tailored marketing ensures that international lacks some of the cost efficiencies of the US. With content negotiations at a more granular level the cost of revenue per average paid subscriber in the third quarter was 71 per cent higher internationally than in the United States.
Disc subscribers domestically continued to decline in the third quarter and IHS forecasts that Netflix will end the year with 6.9m subscribers. Netflix began to see significant declines in its physical subscriber base in mid-2011 when it split its disc and streaming services, first for new customers and then existing subscribers, with the following five quarters seeing the loss of five million subscribers. Over the past few quarters those losses have begun to abate, especially in the first quarter of 2013 when the company nearly doubled its disc marketing budget.
Despite the laser-like focus on streaming at Netflix, its disc rental business continues to have the largest contributing margins, at 48 per cent compared to 24 per cent for domestic streaming and -41 per cent for its international business. The company's revelation that the coming $0.03 increase in US postage costs will cost it an additional $3-4m each quarter implies that the company is still shipping nearly 250 million discs annually, about 2.6 turns per average 2013 paid subscriber.
However, domestic disc rental is no longer the cash-cow for Netflix. Since the first quarter of 2013 domestic streaming has led contribution to profit with $449.1m made in the first nine months of 2013 versus $328.8m for the physical business. Despite the focus on the streaming business, IHS expects Netflix to continue shipping discs for the foreseeable future, particularly in light of the slowing physical subscriber losses.