Netflix call: focused on the prospect of advertising and account payment sharing

Below is $ Netflix. US 1Q23 call minutes, financial report comments can refer to "White party is difficult to fight, mature Netflix "fly" does not move"

Q1: Regarding the recent large-scale price adjustment, is this a local strategy similar to the one implemented in India in 2021? Or to drive the successful implementation of paid sharing and ad-supported programs?

A1: We have further refined our pricing and profitability strategies over the past few quarters. When we launched globally in 2016, [the pricing strategy] was basically a rough approach and not particularly complicated. Therefore, we see this price adjustment as the next step in our evolution, which is better product fit, market fit, pricing fit, with the aim of increasing our penetration in these markets and obtaining better revenue in the medium to long term.

But we want to emphasize that the impact of this change is not visible in the short term – the price adjustment covers many countries, but the impact is less than 5% of revenue, so we are more hopeful that it will benefit us in the long term. We can give you an example, as we saw in India, where last year we saw a 20% to 60% drop in prices in India, while user stickiness increased by 30%, and the net revenue of paid games grew very fast. As for revenue, FX-neutral income growth accelerated to 24% last year from 19% the year before. We're not saying that every market will develop this way, but it's a sign of success.

Q2: Regarding the new password sharing measures, can you provide the first user churn, retention and conversion rates in Canada?

A2: This new measure is an important shift for us. So we're trying to make sure we're doing a good job and thinking as fully as possible. The rollout of this last group of countries is progressing well – and, perhaps most importantly, in line with what we see in Latin America.

It's a lot like price increases – we see the initial unsubscribe reaction, and then we build on that to work on membership and revenue, with account-sharing borrowers signing up for their own web accounts, and existing members buying additional membership services for the people they want to share.

Therefore, seeing consistent results in these new countries is a strong validation because they have different market characteristics from each other and different from the countries where the original Latin American launch was launched.

You mentioned Canada (the first region to roll out the new measures), and we're now back to positive user and revenue growth relative to before the launch. So it's a strong proof that we've found a way to apply it to many countries with different market characteristics, including our highest-income countries.

We've also learned from a series of recent releases some improvements we can make, like being able to access Netflix on the go and making sure we have the right tools to manage their accounts and devices.

All in all, based on these results, we felt it would be better to take a little more time to combine these lessons learned to make the transition as smooth as possible for our members, and we believe this approach is also best served by long-term business goals. As a result, we will be rolling out this new and improved version broadly, including in the US in the second quarter.

Q3: What is the outlook for the rest of the world in the second quarter? Regarding pricing ideas, do they tend to convert current account borrowers into subscribers?

A3: Our update rollout in the second quarter will be very broad, including the United States as well as many other countries. We reserve the rights of some countries that we believe should adopt different strategies. But I would say that given the revenue recognition perspective, the vast majority of our countries will be available in the second quarter.

In terms of pricing, we'll decide based on the market basis, but obviously, we tested different pricing. Then we'll be tested in Latin America, which will give you an idea of how we're thinking about what is the best pricing, especially in wealthier countries and countries.

And then in terms of preferences, what we have to do is really support diverse choices, and there is no preference and deliberate guidance in this regard. This gives users a chance to choose a different plan, borrowing an account that they think is the right solution, such as someone wants to buy Netflix for a family member or something like that – and we hope that extra member will be in place as well. We are not trying to consider long-term pricing to meet these customers' selection goals from a single perspective, as well as long-term revenue optimization.

Q4: Regarding whether the password sharing measures bring incremental costs, it seems that content distribution and marketing expenses are already in the current operating expenses, are there other incremental costs? How to see incremental profit margins? Will it be reinvested?

A4: There is nothing else other than general resource allocation. I wouldn't say there are real incremental costs here, but of course, we always want to reinvest. As you can see, we want to re-accelerate revenue growth, and that's the path we're on now. As we do this, we want to balance the gradually increasing profits. You can see in our guide that we want to increase our profit margin to 18% to 20% for the full year, but with the huge bonus we had before. So reinvest more and more entertainment for our members, drive more entertainment, more value, and ultimately acquire more and more members, and then build a truly large and profitable business.

Q5: Regarding the advertising business, Netflix seems to have a huge advantage in TV advertising (because the incremental cost is not much, and the revenue generation can basically be counted as revenue), and considering the limited ad load, premium video content, your huge influence and exposure to some fairly hard-to-reach demographics, and the massive shift from linear to streaming, your position is enviable.

That being said, you seem to be very cautious when it comes to launching ads. What are the main lessons learned so far, and what are the possible growth headwinds?

A5: As you said, we are very optimistic about the long-term opportunities for the reasons you mentioned. But frankly, it's a step-by-step process. It follows a very similar process that we've used in many other areas – as we learn, we iterate, and we find that having this approach basically produces great long-term results.

So what I'd say is that we have a lot of work to do today – continue to develop features that support advertisers. We're rolling out measurement and verification, but we have a bigger, longer roadmap that we have to do. We are working with Microsoft to improve our go-to-market and sales capabilities.

You've seen we've added programmatic private auction marketplaces to give advertisers more ways to buy as inventory increases. And then we're working on improving the consumer-facing side — we're adding more features to our advertising program, and we're making the experience better for our members.

Through this process, we expect these iterations that we try to be as fast as possible while being wise and thoughtful about the business to really become an important, highly material and highly lucrative, highly profitable business over a period of time. But there's still a lot to do, and we're trying to keep it at a fast pace, but also with a thoughtful pace.

Q6: Can media coverage of building adtech capabilities provide an overview of the plan, time frame, and costs?

A6: I would say that we have the ambition to innovate in this area, and a lot of innovation is thinking about an experience that suits members, thinking about what is the right time to play an ad, things like that. But what I also want to say is that we're building a business model right now and are doing a lot of work to follow a good path to building a big business when you think about verification, measurement, what to do in programming, and so on. These are relatively simple things. So a lot of the work we're doing is in this area.

Regarding costs, and how it affects our overall financial situation, our revenue and our incremental profit contribution, we can do that in a very healthy way. That's where we're headed. So, yes, there's some cost to that, whether it's based on the cost of working with Microsoft, or the cost of building our capabilities, people, and technical capabilities — but these are easy to manage. We also talked about some content costs because we continued last quarter where we increased the level of content parity for our plans, which is good. So that's about 95% more viewing parity, which is also a huge improvement.

So we move on, but it's all to the extent that we think it's not only better for members with a lower price option, but better for our business, and we think we can do it, and I want to think it's like 50% or more incremental profit contribution to the business.

Q7: Regarding next month's advertising, Standard service has been introduced at this stage, are there any plans to introduce Premium service in the future? How big will the current commitment be when the fall arrives?

A7: Regarding your first question, we have been considering and working hard to improve the pricing structure. We have two goals:

First, we want to have a wide range of consumers, and ideally, more and more consumers will be able to access our great content at the right price and with the corresponding features.

The second goal is to consider optimizing long-term revenue. A good example is the optimization of the economic model based on the economic benefits of our advertising program, based on the switch between standard and premium services that we have already seen.

We've upgraded the features of our advertising program to include video resolution or video quality and the number of concurrent streams, as we think it supports both goals. This is a good example. I would say that we have — we will continue to assess as usual, you have seen our actions in this area before, but we have nothing to add today.

And then in terms of scale, it's clear that we're growing every day and will seek to continue growing, but we're not going to announce or set targets, or projections that we're expecting.

Q8: Can you provide details about what the ad ARPU is currently seeing?

A8: Overall, we are satisfied with the advertising performance of each of our members.

It's higher than our overall basic plan overall, and like you said, in the U.S., it's actually even higher than our standard plan. So, we really like where we are now.

Like I said, it's a win because it's a lower priced option for our members. This is both incremental revenue and incremental profit for the business. So it makes the business stronger, and of course, we can reinvest more and more entertainment. So we love this path.

But it's too early. We've only been past a few quarters, so we'll get better returns in the future. As said before, better positioning and measurement, better tools and buying options. We believe that all of this will be built on that basis. This will strengthen the quality CPM ad network we are building.

Q9: Regarding return on capital and free cash flow, you did improve your free cash flow guidance, but this year you kept your margin unchanged. What are your current long-term profit margin gains or expectations? Can you provide any updates?

A9: We have never provided long-term guidance on profit margins. However, I would say that we have entered a place where we are happy with the existing business. It's a great business model. The size of the business is over $30 billion in revenue, healthy profit margins, growing margins, growing free cash flow. It's a starting point, and as I mentioned earlier, when we accelerate revenue, improve those profits and also reinvest back into the business and back to the membership base, we feel like we're so small today.

We talked on a recent earnings call that we think about 5% of consumers spend directly in entertainment, and we're mostly in film, TV, and gaming today. When we just consider the available membership population, today those more than 1 billion broadband households about 450 million to 500 million are TV-connected households, and we only have about 230 million or so paying subscribers now, right? That's why we're so focused on paid sharing, and then making our business and the value we bring better, bringing in more members. That's what we're working towards.

In the long run, the profit margin now is not a short-term ceiling. There are many agency intermediary platforms that have traditionally been well above our operating margin of approximately 20% in terms of the size of entertainment services and networks.

So we believe we still have a long way to go and we have some inherent advantages. We're a truly global entertainment network, perhaps the first, with truly healthy leading engagement and a truly scalable content model. So we believe we still have a long way to go, but haven't really come up with more specific guidelines yet.

Just like I could add an example – the scale of our global business, every important piece of our content starts with a local victory. Then success, they get regional, then they get huge global success, and when we're right, there's no marginal cost to all that extra audience. The potential for growth margins to even exceed what we have today is very, very high.

Q10: Can you update us on your return on capital plan? Can you tell us your thoughts on long-term capital returns?

A10: We are pleased to reach full investment grade in the first quarter. So it's a good milestone for the company. You're right, our capital allocation philosophy hasn't changed. Therefore, our goal remains to maintain a minimum cash equivalent to approximately two months' income.

According to the first quarter, the minimum cash amount is about $5.4 billion. At the end of the quarter, we had approximately $7.8 billion in cash on our balance sheet, so we did have approximately $2.4 billion in excess cash. That's why we stated in our letter that our share buybacks will accelerate during the year.

Q11: How do I prepare for a potential creator strike?

A11: First of all, we respect writers, we respect WGA, and we can't be here without them. We don't want a strike. The last time there was a strike, it was devastating for creators. It's really hard in this industry. It's painful for the local economy that supports production, and it's very, very, very bad for fans.

So if there's a strike, we want to try to make sure we can find a fair deal so we can avoid it. But if there is one, we have a large number of shows and movies from around the world, and we may serve our members better than most.

We really didn't want that to happen, but we had to plan for the worst, so we did have a fairly powerful distro that would have taken us into for a long time. But to clarify, we are already at the negotiating table and we will try to find a fair solution so that there will be no strikes.

Q12: How do you expect content spending to change in the coming years? You already have a $17 billion cadence, is it dependent on revenue growth? Can you give us some of your thoughts.

A12: Yes, it depends on the growth of revenue. Also remember that the way to earn or spend content is through initial production and delivery. We're still working on it, or going through or closing those floodgates that opened after the coronavirus outbreak, so that really will — make the content a little rough to spend. We expect to return to around $17 billion by 2024, and the growth rate will definitely depend on the growth rate of revenue.

We've said we'll stay around $17 billion on average for a few years from 2022 to 2024, but there's a huge entertainment market to pursue. So as we re-accelerate revenue, we see a lot of opportunities to become watching, engaging business opportunities. So we hope to be there, we just have to build it.

Q13: Do you have any thoughts on revisiting film strategy? In terms of theatrical productions and distribution, you have a lot of success with the Oscars. So, does this change anything for you? You have also recently reorganized this department, is there anything to interpret?

A13: The film department is doing a great job. They're really making some great movies. As you pointed out, the success of the Oscars was huge. But even better than that, those big award-winning movies are also very, very popular with fans. So it's an award-winning review, very popular with fans, and even, like I said, Pinocchio in No War on the Western Front is certainly like that, and we're really proud of the mixed movies because they're loved by fans.

So we're really happy with the investment in film. Of course, we're working on improving it, just as we do with all our films. But with our distribution strategy, keep in mind that there are many ways to create and collect demand for films.

Driving people to the theater is not our business at all. We created that demand. We charge our members for our subscription service needs. I think having a lot of desirable new content, including a first-window feature film, can bring value to our members and create value for the business. So, apart from an effort to continue improving the movie for our members and making a splash in movies that are loved and watched, there aren't any major changes in the game.

We believe that this is really an advantage that tends to provide value to our members. But because of our size, which has an average revenue of over 230 million paying members, it offers the opportunity to invest in these big movies and bring them to our members. It is just another or area, a wide variety of content, must-watch content and entertainment. So that's really an advantage.

Q14: How has the live streaming strategy evolved? Chris Bullock was a huge success, but there were some technical problems with the live stream. Is live streaming a huge advertising driver? Do you need to invest more money to strengthen your technical capabilities?

A14: First of all, I want to say that we are really sorry to disappoint so many people. We do not meet the standards we expect to serve our members. From a technical point of view, we have the infrastructure, we only have one vulnerability, and we implemented some changes in March to try to improve live performance.

We just didn't see this bug in internal testing, because it only became apparent if we put multiple systems under load from millions of people.

So we hate these things happening, but we'll learn from them, we'll get better, and we do have the basic infrastructure we need. I would say that the good news is that in the end 6.5 million viewers watched and enjoyed the show.

We've said we want a creative live stream, and when it helps the content itself be a reunion show that will cause news and sensation. It really plays better when people can enjoy it together. Of course, Chris Rock's stand-up show was so great because people were looking forward to what he had to say in that episode. So when we had the opportunity to do a project like this, we liked that we could choose to do it. As said before, we were very disappointed that we could not see all the live streaming products that wanted it first, because love is a blind reunion. But we're very excited and people love the show. It really shows the love people have for the brand, as well as the growing love for those unscripted brands on Netflix. Some of them will be alive. I do think that sometimes these results-oriented shows work better on a live stream and they do generate a lot of dialogue. But remember, just like I'm Chris Rock, about 90% of the views happen afterward. But that doesn't change the fact that this was a big event when it happened live.

We are not currently advertising in live broadcasts.

Q15: Regarding the question of password sharing, what is the conversion rate of potential members?

A15: Those account borrowers represent people with a certain level of technical literacy, who use Netflix and need to know how to use smart TV, broadband access. And, they have clearly enjoyed our services.

These people have as many people watch our shows as a regular paid account, so there's a good chance that these sticky people will be converted. But we're also going to see a situation where in high-audience penetration markets (like the US), some people won't convert, but they're going to be something we can do by improving our product and launching more amazing movies, TV shows, and games, and ultimately making these people part of our membership.

Q16: Back to advertising, what are the advertising features you are most excited about?

A16: I'm very excited about this advertising model, and the work that we really need to do, and I'm excited about how we're getting bigger. There are taxes, a lot of which are about measuring, verifying, targeting, expanding the way advertisers buy. So I'm excited about the commercial return of these works.

But when you look at the technology product experience perspective, what am I excited about? That's where I think we have the opportunity to bring the concrete characteristics of a fully addressable, fully targetable, fully deterministic high-end ad streaming system into the world. That means we can do a lot of things, how we associate brands associated with certain shows. It considers how to tailor the user experience to meet the user's current needs, rather than one fit for all the rules of flying advertising. So we can continue to pursue an amazing line of innovation that, frankly, will continue to pursue for many years. We don't even know what all this stuff is because we mostly work with advertisers and affiliates to try something and then let them tell us what works and what doesn't.

Q17: What do you think of the steady growth stage?

A17: I think we've entered a phase of steady growth after we started. This can be a combination of various factors.

Obviously, scale is relevant. We get a certain scale to change the way advertisers think about us. This is partly due to the technical characteristics of advertisers facing advertisers. This is largely in line with measurement, validation, targeting, programmatic purchasing power, which is an integral part of it. So I think that's really constituted, and we're basically in the middle of growth. Frankly, we have a lot of work to do as we enter the operational phase. It was a multi-year build and a gradual build-up and crawl-to-foot run. And we, we only did a few quarters. I hope we get into the walking phase at the end of the year and next year – I think it's a year from crawling to walking.

Q18: To confirm some expenses, I think you are talking about a 50% profit margin. I mean, generally speaking, the profit margin of advertising can be as high as 80% or 85%. Or maybe you think it's just a 50%+ profit margin business.

A18: I added a plus, so I say at least 50%, just to emphasize that we're still in entrepreneurial mode in this industry. This is also a bit conservative. But over time, our expectations are indeed over 50%, but I don't want to give a specific number yet.

Q19: Can you give us some data on game engagement and what data you've seen on retention?

A19: I won't give you those specific figures, but let me review our current situation. We currently have 55 games. There are also 40 very exciting games this year.

Our first new game from an in-house studio will launch later this year. You can see that it combines licensed and internally developed games. It's after the trajectory we've seen, and I would say that in these other new content categories, if you think of film, where you hear people talk about film progress or non-fiction or international, our build over a multi-year period gives our members a new way of entertaining and more ways to enjoy the incredible universe and deepen their fan base.

We do this in order to drive the main metrics we face with consumers, which are engaging with services, bringing retention and incredible stories where people talk about games, games they have to play, creating services and motivating people to sign up.

Q20: Do you plan to monetize your game directly, such as through advertising or licensing game developers?

A20: There are no plans for this at this time. We think we're very much in line with what we're doing in other areas. The best thing for us is to really focus on the core plan, which is how we now bring IP-based games, terminal games, to our members, directly to the fans of the IP.

And, we believe we want to have a differentiated gaming experience and part of the game is to give game creators the ability to think about building games purely from a player enjoyment perspective, without having to worry about other forms of monetization, whether it's advertising or in-game payments.

Q21: Last year, localized content in India grew by 28% year-on-year, can you talk about your long-term strategy in India? Is it already profitable?

A21: I think we talked about it before. When our pricing is a little better and better suited to the market, you can see that we can increase revenue and thus increase our engagement. We have to get what people are really after. We saw steady progress in that quarter, and in our series it was a great show that we just loved across the country. This brings great excitement to the service.

Now that we have the goal again, we have to get the pricing and payment method right. India is a huge market because it has a large number of people who love entertainment and you have to have a product that they like, which is any product that they can do business with. So we have, we're doing the creative part, and our pricing is better. And in India, there are always plenty of prospects for continued growth. It's a very specific market because they love local content, but you also see more of their local content than ever before. I think it's been an incredible year, and with the ever-expanding content opportunities and our ability to enter the market, for these audiences to continue to grow, we can do well in India. We are still a long way from that step. We are still investing, and I think this will ultimately achieve a great India.

Q22: When you see something about ancillary revenue and products, can you tell us an outlook or update on your expectations for consumer goods? Are there incremental opportunities?

A22: Yes. We continue to develop it. The main driver of our consumer goods business is to build and deepen our fan base. It does drive some revenue. But, overall, we're really looking for those opportunities to help fans connect with their favorite shows, their favorite movies, their favorite talents, wearing a shirt or carrying a notebook, and other ways people really love expressing their fans.

Through these very successful life experiences, we are very excited to see us walk into even a new Stranger Things stage show with all kinds of magical things in that world. But keep in mind that this is mostly about building a fan base in a way that drives revenue, mostly because it strengthens the core of the business.

Q23: Follow-up work on password sharing. In the marketplace where you launched password sharing, have you seen changes between different levels? For example, if a family originally subscribed to the Premium edition, will they later switch to two Standard editions?

A23: We're seeing some of these implications, and we know that in a particularly price-sensitive market it's a very different situation in different markets. In some price-sensitive markets, consumers basically subscribe to Premium and then have others pay for a fraction of it — because they share accounts.

So after implementing the paid sharing strategy, therefore, we are seeing some people spinning it off from these plans and getting them to sign up for the personal plan, while we are implementing changes to prevent password sharing and giving them the ability to use an advertising plan like an extra member or in the applicable country as a new entry-level price. I think you'll see some of these changes.

Also, we think it's better for the business. Ultimately, this alignment allows us to build one-to-one relationships with more members, enables all systems to operate more correctly, and makes our pricing relationships with different members of different plans more transparent. So we're happy to go through that. But I think it's an approach that's very specific to certain countries, some countries react to it, while others don't do it very much, it's more about sharing at will.

epilogue

We are really happy with the quarter. 2023 is a good start. Netflix is the leading streaming service in terms of engagement, revenue, and profit, and streaming is the future of domestic entertainment.

So, just yesterday, Nielsen released data showing that in the first quarter of 2023, Netflix was the most watched broadcaster or anchor in the United States. We have – and we have a lot of room to grow, and even with that much viewing, we only account for 10% of total TV time in the most mature markets like the US and UK.

In revenue and profit, we are growing, not as fast as we believe, not as fast as we want to, but we are growing, we are profitable, and we have a clear path to re-accelerate revenue and profit growth, and we are executing. You'll see the launch of wider paid sharing in the second quarter, and we'll continue to grow this advertising business as well.

Our goal is also to continue to grow our free cash flow. As we said this year, we will generate approximately $3.5 billion in free cash and improve profit margins. So keep in mind that this account-sharing program helps us have a larger base of potential paid memberships where we can continue to serve and grow Netflix in the long term, which is why we're so focused on execution.

So we have to watch the variety and quality of the movies, we have to watch the TV shows, we have to play the games, and we will continue to work hard to improve discovery, to have more funky and more creative marketing, because when we serve our members, we deliver as a business. We've been doing better and faster than our competitors monthly, quarterly, yearly.