Unveiling the Thorn: Challenges in Netflix’s Thriving Performance

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Netflix, under the cloud of a Hollywood strike, may not deliver the final season of ‘Stranger Things’ next year, but for now, it has presented an impressive financial report.

On October 18, local time, Netflix released its third-quarter financial report. The global net addition of subscribers was 8.76 million, far exceeding Wall Street’s expected 6.2 million. This is also the largest net addition record since the peak of the pandemic in the second quarter of 2020, with 10.1 million new subscribers.

Quarterly revenue was $8.542 billion, a 7.8% increase compared to the same period last year, slightly higher than Wall Street’s expectations. In addition, Netflix’s third-quarter profit margin, operating profit, free cash flow, and other metrics all achieved year-on-year growth, surpassing Wall Street’s expectations.

Does this mean that Netflix has “won” over the Hollywood strike, fearlessly moving forward despite its impact? The subscription model, crackdown on shared accounts, and price increases have been Netflix’s three-pronged approach in recent times, and they have been the heroes behind Netflix’s thriving performance. However, in the visible future, the lower-cost ad-supported subscription model’s contribution to revenue is yet to be fully realized, the crackdown on shared accounts has already covered more than half, and price increases will continue but are not without limits.

At the same time, Hollywood writers and actors’ unions are both seeking a larger share of the pie from streaming, undoubtedly increasing Netflix’s content costs in the future. The ongoing Hollywood actor strike will also continue to impact Netflix’s subsequent content releases.

Although the Writers Guild of America (WGA) strike has ended, the strike by the Screen Actors Guild‐American Federation of Television and Radio Artists (SAG-AFTRA) continues. Fans of “Stranger Things” still don’t know when they will see the final season. The producer and director of the show, Shawn Levy, stated that the filming of the fifth season of “Stranger Things” would “start shortly after the actor strike ends.”

However, how long this “shortly” will be is uncertain. This double strike by writers and actors, which began on July 13 last year, was a major event unseen in Hollywood for 60 years. The writers’ strike ended on September 24, lasting 146 days, while the actors’ strike temporarily ended without hope after a dramatic turn.

Behind Netflix’s thriving performance, the thorn of the Hollywood strike has not been removed, neither swallowed nor spat out.

1 Although Netflix has introduced advertising and started cracking down on shared accounts, it still relies on paid subscriptions as its core, and price increases are a key means to boost revenue.

The good news is that Netflix reported that 30% of new registered users in the third quarter chose ad-supported plans. However, according to Visible Alpha, the revenue from ad subscription plans in the third quarter is estimated to be $188.1 million. Considering Netflix’s total revenue in the third quarter is $8.542 billion, the revenue share from ad subscriptions is only 2%.

In January of this year, when announcing the fourth-quarter 2022 financial results, Netflix management expressed the hope that the advertising business could achieve a revenue share of at least 10% and estimated that future ad revenue would increase to at least $3 billion to $4 billion. As of now, achieving this goal seems to be a considerable distance away.

In the past few years, Netflix has frequently raised prices. In the case of the United States, the pricing cycle before 2020 was generally over a year. For example, after a price adjustment in January 2019, the next adjustment was in October 2020. However, in January 2021 and January 2022, Netflix raised subscription prices in the United States for the second and third times. Simultaneously, the cost of the standard plan for playing on two devices has increased from $7.99 per month to $15.49 per month.

After the announcement of the third-quarter financial results, Netflix once again announced a price increase in the European and American regions. In a letter to shareholders, Netflix announced that it would raise subscription prices in the United States, the United Kingdom, and France. The ad-supported subscription and the standard plan in the U.S. market will remain unchanged, while the highest Premium membership price will increase from $19.99 to $22.99.

As expected, when the news came out, American users were not happy about it. Some called for a return to cable TV, as for $25, they could watch content from over a dozen TV channels, including NBC, ABC, CBS, Fox, and their affiliated channels. Meanwhile, Disney’s streaming service, after a price increase in August, has the highest plan priced at $24.99, only $2 more than Netflix, but it includes Disney+, Hulu, and ESPN+.

The impact of “frenemy” pricing is not to be underestimated. While Netflix has raised prices in some regions, it has also lowered prices in others to cope with increasingly fierce streaming competition in overseas markets. In February of this year, Netflix lowered subscription prices in over 30 countries in the Middle East, sub-Saharan Africa, Europe, Latin America, and Asia, with most regions seeing a reduction of 20% to 45%.

When user subscription fees still wield “absolute power” in revenue, price adjustments are crucial, and these adjustments are influenced by changes in the external competitive environment and the company’s own goal adjustments. Just as Netflix introduced advertising plans, after the strategic shift from growth to profitability, the company actively seeks more revenue sources. Netflix’s CFO stated last month that the company would be involved in the gaming industry for the long term and has already released 70 games. Historically, Netflix’s decisions to combat shared accounts and raise prices have always sparked negative discussions and were at times doubted to be more trouble than they’re worth. However, looking at the financial reports, these concerns from the outside world have not materialized. In other words, Netflix’s appeal is still greater than people imagine, and users have not really mass-canceled subscriptions.

2 The question remains whether Netflix can continue to retain users in the future?

The ongoing actors’ union strike will impact Netflix’s future content releases. Although Netflix will use local resources for localized content in different regions, the majority of its original productions are still from the United States. Omdia estimates that in 2022, Netflix will release a total of 935 sets of content, with 403 sets produced in the United States. Consequently, the Hollywood strike will inevitably affect Netflix’s original content.

Worse news is that Netflix’s overall “return on investment” for original content needs improvement. Reports from Omdia and PlumResearch this year show that the proportion of viewers watching original content is not very high. In the first three months of 2022, the proportion of total viewing time by American viewers watching Netflix’s original content was only 35.6%, and in places like Japan and South Korea, it was less than 30%. Considering Netflix’s annual investment in original content in the tens of billions of dollars, this return on viewing time seems somewhat lacking.

Investing in original content is crucial, and the key lies in betting on “blockbusters.” The sequels of works that have already been market-validated and proven popular are particularly valuable. For example, Netflix’s performance in the second quarter of last year exceeded expectations, mainly attributed to the release of the fourth season of “Stranger Things,” which garnered 1.3 billion hours of viewing within a month of its release.

However, there is currently more than one highly anticipated Netflix original series sequel that has had its production suspended. As mentioned earlier, the fifth season of “Stranger Things,” as the concluding part of the series, has been paused since May of this year—when the writers’ strike began—and is now further delayed due to the ongoing actors’ strike, making it possible that it might not be smoothly aired in 2024.

Another series, “The Witcher,” faces a similar situation. Originally scheduled to start filming in September, it concluded its main filming in May 2024, but it is now confirmed to be delayed, with the earliest start date in the coming year and a potential release in 2025.

It appears that for TV shows and films with longer production cycles, the true manifestation of the impact of the Hollywood strike may not be immediate but rather in the future. Even if the Hollywood strike ends entirely next year, Netflix may not be able to release “guaranteed” hit sequels for a certain period, creating an awkward period of low-quality content on the platform.

3 Regarding the Hollywood strike, Netflix, as a streaming giant, has been a crucial player at the negotiation table. Netflix has expressed its hope for the strike to end multiple times, calling for full efforts to advance negotiations.

Even as early as June this year, Netflix shareholders voted against supporting the company’s executive compensation plan in solidarity with Hollywood writers on strike. Before that, the Writers Guild of America had urged Netflix investors to oppose the company’s executive compensation plan. The argument was that since Netflix had the capacity to pay executives over $160 million in compensation last year, paying an additional $68 million to writers to increase their income shouldn’t be difficult.

It seems like Netflix’s intentions are sincere, but changing the rules of profit distribution is not easy. Since the beginning of the strike, Netflix has been in a dilemma—content is affected if the strike doesn’t end, and costs increase if it does.

The Hollywood strike started in May, and in July, the actors’ union also joined, forming a double strike of writers and actors—an unprecedented scene in Hollywood for 60 years. The demands of the writer’s and actors’ unions can be simplified into two main points: compensation and regulating the use of AI in the film and television industry.

On September 26, after 148 days of strike, the Writers Guild of America (WGA) and the Alliance of Motion Picture and Television Producers (AMPTP) reached a settlement. Writers achieved key victories in areas such as AI, data transparency, residual compensation, and minimum crew requirements. The AMPTP camp includes major companies and platforms in the film and television industry, such as Amazon, Disney, Netflix, Universal Pictures, Paramount, and Apple.

According to the summary of the agreement, AMPTP can still use AI, but not to write or rewrite literary material, and the generated material cannot be considered original works. Regarding data, AMPTP has agreed to disclose confidential data on streaming playtime and pay more residual compensation based on this.

Residual compensation refers to the remuneration that creators receive when TV shows or movies are replayed. In the era of cable television, this was standard practice, and the main cast of shows like “Friends” still receives tens of millions of dollars in residual compensation each year. However, in the streaming era, creators either cannot receive or only receive very little residual compensation, and streaming platforms operate like a black box. In the future, initial compensation and profit-sharing ratios for writers in streaming will increase. For movies with a budget above $30 million and a duration of more than 96 minutes, the initial compensation for writers will increase by 18%, and the profit-sharing ratio will increase by 26%. If the movie attracts more than 20% of subscribers in the first 90 days, an additional bonus of $40,000 will be given.

While the income is the same, one party gets more than before, and the other gets less than before. For streaming platforms, this is like suddenly reducing their food intake, which may be beneficial for long-term health but will not feel good in the short term.

On the actors’ union side, because the money distribution wasn’t negotiated, the strike, which was expected to end, suddenly pressed the “continue playing” button.

Just last week, there was a precedent of successful negotiations with the writers’ union, and everyone was expecting the actors’ union’s negotiations, which were thought to be nearing the end, to come to a conclusion. Instead, they received news of the negotiations breaking down. AMTPT stated that the pay raise and profit-sharing ratio proposed by the actors’ union were unacceptable, and the actors’ union was not convinced.

The focus is on the “bonus,” where the actors’ union requests major Hollywood companies to pay an additional fee based on the number of subscribers on their streaming platforms. The specific amount claimed by AMTPT is $800 million per year, which, when divided, exceeds $1 per subscriber, but the actors’ union claims it’s about $500 million, roughly $0.57 per subscriber.

Netflix’s Co-CEO Ted Sarandos publicly stated that the “bonus” proposed by the actors’ union is challenging and goes against Hollywood norms. This is a rare confrontational statement from the Netflix side during the entire strike negotiation process.

Originally, Netflix planned to announce price increases in Europe and the Americas when the actors’ union strike ended. However, probably seeing that a resolution was unlikely in the short term, they announced the decision to increase prices on the occasion of the financial report release.

In the earnings call after the financial report, Sarandos stated that this strike had caused harm to the entire industry and economy, and the company is “very committed and fully committed to resolving this strike.” However, the new demands presented by the U.S. actors’ union last week “really disrupted our momentum.”

Despite the positive financial performance in the third quarter, Netflix’s guidance for the next quarter is relatively weak, with revenue, earnings per share, and profit margins all below Wall Street expectations.

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