In London Netflix Doesn't Take Gold

By David Danna - August 13, 2012 | Tickers: AMZN, AAPL, MSFT, NFLX | 0 Comments

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Netflix (NASDAQ: NFLX) is set to have another bad summer and learn that international expansion can be pricey and unrewarding. A year after Netflix announced a 60% price increase and botched a spin-off of their DVD only business, Netflix continues to struggle. Their current position is a far shot from the poster child of forward thinking they were not too long ago. Their transition from a DVD by mail subscription to an online streaming company was the essence of strategic adaptation; however, since then the shift it has not been smooth sailing. With their latest quarterly results, the bad news continues for Netflix.

For the second quarter, Netflix reported a 91% drop in earnings and predicted slower than previously predicted future growth. Netflix did make money in the second quarter but only $6.2 million compared, to $68 million a year ago. In the first quarter of 2012 Netflix actually posted a loss of $4.6 million, mainly due to their costly expansion into the United Kingdom. Netflix added 1.1 million internet streaming customers but lost 850,000 DVD customers, a far cry from the 1.8 million customers they added this time last year. This could partly be because this time last year was before Netflix’s large price increase.

Of the 9.2 million remaining DVD customers, Netflix estimates that they will lose up to 900,000 during the current quarter but that they will hang on to their DVD business for the next ten years. Netflix ended the quarter with 26.5 million US subscribers, up from 26.1 million, and has 30.1 million customers when you include international customers. 6.7 million customers currently pay for both streaming and DVD’s, while 2.6 million pay just for DVDs those are down from 7.4 million and 2.7 million last quarter respectively. The steady decline of DVD customers disproportionately hurts Netflix’s profits because the DVD business is roughly three times more profitable than the streaming one. This is especially painful because Netflix is currently plowing money into unprofitable international expansion while losing highly profitable DVD customers.

Netflix also warned that it is likely to suffer more losses this year. The reasons they gave were two-fold. First, it is likely that fewer people will sign up for Netflix during the current quarter because of the London Olympics. Second, Netflix plans to continue its rapid international expansion with a fourth international market by the end of this year. This is likely to result in another quarterly loss in the fourth quarter of 2012; Netflix has not stated what international market they will expand into. It is currently in Canada, Latin America, and the United Kingdom. Their international division lost $89 million in this last quarter. The loss came despite the fact that Netflix added 560,000 international customers, and it puts their international business on track to lose $400 million for the full year. After these results came out, the stock dropped to 2010 levels.

Not only is Netflix losing their profitable DVD business and expanding rapidly into expensive international markets but they are also facing increasing competition. The most notable competition that Netflix currently faces comes from Amazon (NASDAQ: AMZN). Under founder, CEO and visionary Jeff Bezos, Amazon has undergone several transformations. What started as an online bookstore quickly became the largest online retailer selling everything imaginable. Now Amazon is making yet another strategic shift. They are getting into both consumer hardware and digital services. Their hardware comes in the form of the Kindle line of E-readers and the Kindle Fire tablet; their digital services come in the form of a music store, Cloud storage and, of course, streaming TV and movie services.

Amazon’s streaming service is bundled with their free two day shipping service called Amazon Prime. Amazon Prime costs $79 per year, which is slightly less than the $8 a month that Netflix charges for their streaming only service. However, at this time the selection of streaming content is severely lacking compared to Netflix. Amazon is serious about boosting Prime’s offerings and several times they have put large messages on their homepage advertising recent additions to their streaming library. Content makers are also looking for alternatives to Netflix before it becomes the only player in town and gains the ability to set what it pays for content. Amazon also owns a service in Europe called LoveFilm which uses the same monthly subscription model that Netflix uses, and as Netflix expands internationally they will run into LoveFilm and Amazon more and more.

More non-traditional competitors come from companies like Apple, Google and Microsoft. For Apple (NASDAQ: AAPL) and Google (NASDAQ: GOOG), their streaming options come though their content stores, iTunes and the Google Play store. They are not all you can eat streaming for a monthly fee like Netflix. You pay by the TV episode or movie, and you can also buy a season pass for a TV show or rent the content. This content is not only available on smartphones and tablets running iOS and Android but also on the Apple TV and Google TV. One of the main selling points with Google’s new Nexus 7 tablet was the way it seamlessly integrates with the content available from Google. Apple’s iPad and tablets in general have always been centered around content consumption rather than content creation.

For Microsoft (NASDAQ: MSFT), their streaming content has been rumored for the Xbox since 2011 but the plans for a streaming service have apparently been put on hold. With Window Phone 8, Windows 8 and the Xbox, Microsoft has the opportunity to launch a content platform that would rival what Apple and Google have. In fact Microsoft is rolling out a music service, and a streaming video service is no doubt not far behind. One advantage that Netflix has over Apple, Google and Microsoft is that Netflix apps are available on all of these platforms, whereas the other offerings are limited to one platform.

Netflix also faces additional compition from the reincarnated Blockbuster, which is now owned by Dish Network and offers a monthly streaming service very similar to Netflix’s. Additionally, Wal-Mart owns a video streaming service called Vudu that recently came in first in a ranking of online video services; Wal-Mart has the weight to make Vudu into a credible competitor to Netflix.

Netflix CEO Reed Hastings has made a number of strategic mistakes over the past year from the huge one time price increase, to the DVD spin-off Qwikster failure, to announcing on his Facebook page not too long before the earnings that they had doubled the number of hours of video they streamed in June 2012 from June 2011. This set expectations higher than they should have been for second quarter results. Netflix has a rough road ahead of it when you combine competition, losing their DVD customers and costly international expansion. One upside is that once Netflix has struck their content deals they have the content and every additional streaming customer costs them very little. 

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