On Netflix
NOTE: All of what follows was written in 2018 before I became a Netflix employee and does not reflect my opinion as an employee nor does it contain any information gained from being an employee. Also, like most of what I write, it’s a reflection of thinking still in progress, likely wrong in some ways, and likely to change.
- Netflix has navigated three eras:
- DVD by mail (1997-)
- Internet streaming (2007-)
- Content production (2012-)
- Key stats as of Q2 2018
- Link to income statement and shareholder letters
- ~$150B market cap
- ~$15B revenue (~40% yoy growth for latest quarter)
- 124M streaming subscribers (56M US + 68M non-US), growing at ~20M per year
- $123/yr average streaming price ($135 US vs $113 non-US)
- Negative $1.5B/yr operating cashflow (financed by billions in bonds at ~5-6% interest)
- Netflix is still in growth mode and expects negative cashflows ‘for many years’
- Discrepancy between negative cashflows and positive profits is due to accounting - a couple years back Netflix switched to a slower 10-year depreciation schedule, which shifted paper profits from the future toward the present
- At a profit margin of 10%, every 100M subscribers paying $100 a year equals $1B in annual profit
- So a $150B valuation implies perhaps 300M subscribers at $200 a year at a 10% margin for 50 years minus a 50% risk premium
- Of 3 inputs to profitability (subscribers, price, cost), biggest lever to raise value is subscriber growth, since price and cost are both capped by competitive alternatives (whereas subscribers are really only capped by the birth rate of the human species, and there there’s still room to grow 60x)
- Culture
- Company cultures help coordinate actions and expectations
- Netflix’s 2009 culture deck is famous in Silicon Valley: https://www.slideshare.net/reed2001/culture-1798664/
- Key highlights:
- Culture is what you do, not what you say
- A common failure mode for companies goes as follows:
- As companies scale from small to big, complexity rises and talent density falls
- As a result of mismatch between complexity and talent, the company institutes processes to avoid mistakes
- As a result of process burden, talent density falls further
- When the market shifts and the company needs to reform itself, the company is killed by its high complexity, burdensome processes, and low talent densities
- To avoid this failure mode, Netflix aspires to do a few things:
- Stay very focused, so that complexity doesn’t rise and get sclerotic
- Avoid burdensome processes and policies
- E.g., Netflix’s expense policy is “Act in Netflix’s best interest”
- E.g., Netflix’s vacation policy is “there is no policy or tracking”
- Hire top talent who will flourish in a low-process environment with high levels of freedom and responsibility
- E.g., Netflix is known for wide pay bands and high salaries, often even higher than Google and Facebook
- Netflix emphasizes that they are a team, not a family. Loyalty is conditional, not unconditional. Managers are asked of each employee - would I fight to keep this person? Adequate performance will be met with a generous severance, so that room can be freed up for stars.
- Netflix structure is relatively flat and decoupled. ~5,000 employees with ~5 management levels implies a span of control of 5.3 (which is pretty normal, but actually doesn’t seem all that flat - my sense is that flat organizations have spans more like 10-15, though certainly there is more to flatness than managers’ spans of control.)
- Board
- C-suite
- VPs
- Directors
- Managers
- ICs
- Competition
- A competitor is someone whose success crowds out your own success. If they do well, you do worse. And if you do well, they do worse.
- Narrowly, Netflix competes in subscription-funded internet streaming of studio-produced video. Broadly, Netflix competes against everything taking your time and money. Along this spectrum, its competitors can be demarcated into nested sets:
- Netflix originals streaming
- Pirates
- Shared memberships
- Subscriber-funded internet streaming of studio-produced video
- HBO Now (5 million streaming subscribers, 50 million traditional)
- Amazon Prime Video (26M watchers)
- Hulu (20 million paid subscribers)
- Disney/Marvel/Lucasfilm/Fox streaming site (planned launch in 2019)
- Plus plenty of foreign players
- Internet streaming of studio-produced video and sports
- Streaming services from Comcast, other cable companies
- SlingTV (2.2M subscribers)
- DirectTV Now (1.5M subscribers)
- Hulu Live TV (0.85M subscribers)
- YouTube TV (0.3M subscribers)
- Plus streaming services from various TV channels
- TV (~100M US subscribers, ~$100B/yr US revenue)
- Comcast Xfinity (22M subscribers)
- AT&T DirectTV (21M subscribers)
- Charter Spectrum (17M subscribers)
- Dish Network (5M subscribers)
- Etc.
- Plus plenty of foreign networks (e.g., Sky in Europe)
- Ad-funded platform internet video streaming
- YouTube (revenue hidden by Google, but probably order of $10B)
- Twitch
- Media & Entertainment ($2,000B worldwide revenue)
- Tourism / vacations ($1,000B/yr worldwide)
- (Not encompassed by $2T Media & Entertainment figure, I think)
- Books ($120B/yr worldwide)
- Video games ($75B/yr worldwide, $18B/yr in USA)
- Cinema ($45B/yr worldwide revenue, $12B/yr in USA)
- Music ($40B/yr worldwide)
- Board games ($3B worldwide)
- NYTimes ($1B/yr) and other news sites
- Messenger, Whatsapp, SMS, other chat apps
- Reddit, other discussion forums
- Tourism / vacations ($1,000B/yr worldwide)
- Everything (e.g., a pair of premium socks, a marginally nicer car)
- World GDP (~$100,000B)
- Netflix originals streaming
- In communicating with investors and the public, CEO Reed Hastings likes to emphasize that HBO/Amazon/etc. are not their competitive set: “At Netflix, we are competing for our customers’ time, so our competitors include Snapchat, YouTube, sleep, etc.”
- This narrative seems believable - apparently something like 60% of Hulu and HBO Now subscribers also pay for Netflix subscriptions, suggesting that they are not substitutes (in fact, a positive correlation would not surprise me - in my non-representative experience, people seem to be either price-sensitive, and pay for no subscriptions, or they are price-insensitive, and pay for a handful.)
- Sources of competitive advantage in streaming video
- Building companies and cultures that execute well is always an advantage
- Content is biggest differentiator
- Scale is also key due to cost structure (high fixed costs, tiny marginal costs)
- A platform with 100M viewers vs a platform with 50M viewers should derive 2x the value from the same piece of content, and consequently be able to pay 2x as much for the same piece of content
- Unfortunately, everyone realizes scale is key and other players (Disney, Amazon, Apple, Comcast, etc. have tons of cash to throw around)
- Scale is not homogenous - scaling from the US to India brings fewer synergies as video preferences are quite different. Same too for intra-US segments with different preferences.
- Low marginal costs of delivery mean that winning business model will have low marginal price - either ad-supported (cable TV, YouTube) or all-you-can-watch bundles (cable TV, Netflix).
- iTunes trying to sell TV per episode makes no sense to me. Nor do efforts to ‘unbundle’ TV into separate buyable channels.
- Key strategic decisions for video streaming sites (TBD)
- Bundling vs unbundling
- Focus vs breadth
- Neutral platform vs branded content
- Ads vs subscriptions
- Vertical integration vs disintegration
- Problem of discovery
- 6 key strategic decisions for Netflix (TBD)
- Focus or expand? Concentrate or dilute?
- Invest in licensing or originals?
- How to promote originals and how much to promote originals?
- Big catalog with high price or small catalog with low price?
- Juice growth with debt or grow organically?
- Expensive mass-market hits or cheap hit-or-miss bets
- Potential winners and narratives
- Pirates: Piracy gets easier. Everyone starts pirating everything.
- (Seems unlikely given today’s trajectory, but who knows. May vary a lot by legal jurisdiction and culture. I’m guessing the Hollywood lobby has less power in Pakistan than the USA.)
- Disney: Disney enters the market, content is king, their deep back catalog attracts a burst of pent-up demand, their family friendliness aligns with the customer segment most willing to spend, and despite growing pains along the way, they emerge as the dominant player in 2030.
- Or the opposite: Disney and friends come out with their own streaming services that are priced higher than most people want to pay, struggle to approach Netflix’s 100M subscribers, and 5-10 years late admit that they will make more money selling to the enemy at a high price rather than by needlessly restricting content to their own subscale subscriber base
- Comcast & friends: ISPs reduce net neutrality and use their leverage their control over distribution to transition their cable customers to internet TV. Despite missing out on the early years of internet streaming, their scale and experience and captured customer base prove too formidable for others to overcome. Looking back, it becomes clear that technology was only important in determining who got to market first, but after everyone arrived, the past determinants of success remained the determinants of success in the future.
- Or the opposite: Everyone hates Comcast for being terrible. Comcast is terrible because terrible was the profit-maximizing business strategy for their quasi-monopolies. As the internet opens up competition in video, Comcast remains terrible, with no chance of somehow reversing from their sclerosis. A terrible organization with terrible products can never become a great organization with great products. Attempts to reinvent the TV side of the business only accelerate its demise as the flailing burns through cash and remaining customers. Lastly, Comcast TV’s stalwart base of retirees die off and, unfortunately for Comcast, the next generation of retirees knows how to use computers. By 2030, the writing is on the wall.
- Netflix: Netflix produces high quality originals, cracks the problem of discovery & marketing for those new originals, invests hugely in catalog size, and that catalog size accelerates their customer growth and retention, giving them more money to increase the size and quality of the catalog yet further in a virtuous cycle.
- Or the opposite: Netflix Originals are boring, missteps are made by an inexperienced and overgrown content team, subscription growth slows, and $20B of junk bonds predicated on higher growth catch up to Netflix in a disastrous bankruptcy in 2030.
- YouTube: The long tail of cheap diverse internet content ends up being more valuable than expensive, gatekept studio productions. A neutral platform with all sorts of weird stuff wins more users than a heavily branded platform where only polished, broadly acceptable content is allowed to exist. Software lowers the cost of video production, reducing the disadvantage of individuals over studios. The desire to gain attention and share subsidize production in a way that studios can never compete with. Lower barriers to entry allow unknown talents to make beautiful amazing productions. Advances in search & recommendation technology reduce the penalty of having billions of garbage videos drowning out the good stuff. Information continues wants to be free and the vast scale ad-funded video, especially in price-sensitive developing markets, ends up earning more than subscription-funded video. YouTube wins from all these trends plus their dominant scale and willingness to invest billions. They expand into YouTube TV, YouTube Sports, YouTube Gaming, and more, and by 2030 they are the number one site on the internet by time, $ value, bandwidth, and visits.
- Or the opposite: YouTube continues to succeed, but its forays into adjacent segments flop. YouTube realizes it’s better to do one thing well than to become an agglomerated portal to different types of content. Expensive content like Game of Thrones never finds a home sitting next to a cat vlogger and, instead gets funded by increasingly rich streaming services with broad subscriber bases. YouTube succeeds in its corner, but never leaves it.
- All of the above: Most likely, the future is some combination of these narratives. Simpler futures are easier to imagine than complicated futures, so our expectations of the future are biased toward overly simplistic scenarios. Almost never does a single company win a market for all time. Circumstances change. Technology changes. Not all customers can be satisfied by the same product. Mistakes get made. Rules get rewritten. The world is vast and complicated and inconceivable, and by 2030, it will remain so.
- Or the opposite: Technology shook up the market from 2010-2020, but as Moore’s law ends and things settle back down, the pace of change slows. The paradigm and business of Internet TV becomes more established, and remains established for the next 50-200 years. Although media companies continue to skirmish on the margins, there exist a few easily identified winners who continue to be the main players for the next few decades.
- Pirates: Piracy gets easier. Everyone starts pirating everything.
- Zachary Jacobi has written that tech’s biggest innovation is to enable goods to be sold as club goods (club goods are goods that are non-rival but still excludable). Netflix is the prime example he supplies. Back in the day, to watch a movie at home you’d buy a piece of physical media like a VHS tape. If you owned the VHS tape, that meant that no one else owned the VHS tape (economists call this type of good a rival good). When internet streaming started, the business model changed. If you bought a Netflix subscription, that didn’t stop anyone else from buying a Netflix subscription.
- I frame the tech industry differently. To me, the key innovation behind Netflix isn’t that they turned a non-club good into a club good. It’s that their distribution costs got so low they were able to offer a cheap all-you-can-watch bundle.
- Like, movie theaters were already club goods. Movie rental companies like Blockbuster were already club goods. But even though they were club goods, they still didn’t offer all-you-can-watch bundles. The reason movie theaters and rental stores didn’t offer all-you-can-watch bundles is that if they tried, they’d reach congestion and expanding capacity was too expensive given the technology cost structure (more seats at the cinema, more cassettes in stock at Blockbuster, more deliveries for DVD by mail). Ultimately, the variable costs of distribution were comparable to or greater than the fixed costs of movie production.
- The key innovation of Netflix video streaming just seems to be that new technology made distribution cheaper. I.e., it turned out that after computer chip technology got good enough, building a network of fiberoptic cables and computer boxes across every neighborhood became cheaper than manufacturing a bunch of seats/cassettes and shipping those to every neighborhood. And not only did digital tech become cheaper than seats/cassettes, it became so cheap that congestion was no longer a problem. Because each movie stream cost only pennies (and probably fractions of a penny by now), building extra capacity was cheap. Finally it was possible to offer an all-you-can-watch bundle without worrying about the increased costs.
- Second, I’m not convinced at all that other tech innovations like ride-sharing or room-renting counts as a club good. Like, if I take a Lyft, now you can’t take that Lyft. If I rent a room for tonight, now you can’t rent a room tonight. The author says that it’s a club good because we’ll never run out of capacity due to surge pricing. I sorta get the point, but couldn’t you extend that argument to any good? Like, are bananas now club goods because the grocery store isn’t going to run out of bananas no matter how many bananas I buy? Even if everyone buys 100x more bananas, now farms will just switch over to growing more bananas.
- This narrative of club goods was very thought-provoking, but to me, I think I prefer the following narrative: technology is making it easier to send information around, which is making some things cheaper. For informational goods like music and movies, cheap distribution has made marginal costs so low that all-you-can-consume bundles are possible, which results in a lower price. For capital goods like cars and rooms, sending information cheaply makes it easier to share/schedule those goods, which results in a lower price.
- One pointless question is whether Netflix should be called a tech company or a media company
- Points in favor of calling it a tech company: founded in the 90s, HQ in Silicon Valley, CEO is a software guy, huge growth, new business model enabled by new technology
- Points in favor of calling it a media company: Netflix sells media, buys media, creates media. Netflix’s biggest differentiator is its content, not its streaming tech. It has more job openings for Marketing & PR (128) and Content (96) than it does for Engineering (107) and Data, Analytics, and Algorithms (48). Just as using electricity doesn’t make you an electricity company, using digital technology doesn’t make you a tech company. As tech permeates more products and sectors, I think the tech label will be attached to fewer companies.