To date, Netflix has lived by the mantra users first, profit second.
It has concentrated on driving subscriber growth, and in doing so, created an increasing Free Cash Flow (FCF) deficit. Last year that deficit stood at over $2bn. A new report from Ampere Analysis suggests that an ARPU growth of just $1.68 a month would render Netflix FCF neutral, pleasing recently disappointed stock markets. Here the research firm previews what’s coming next in part two of this unfolding drama.
1. A growing deficit
Internet companies are driven by user growth first and profit second, creating a large FCF deficit. And although Netflix is a TV company, its business strategy mirrors Internet companies. Netflix’s FCF stood at -2.019bn last year, as its spend on content and marketing increased. This deficit has grown consistently year-on-year since 2014. (see Chart 1 below).
2. The international roll-out has dragged the pace of ARPU growth
General ARPU growth has been steady, increasing by 10% overall in 2017, although domestic growth has continued at a higher rate than international growth.
3. An increased ARPU could deliver break-even point
ARPU has grown by a total of $1.14 a month over the last three years, whilst Netflix’s basic subscription fee has changed very little. Ampere Analysis suggests that if ARPU was increased by +$2/month, Netflix would have been in profit as far back as 2012. And while FCF was -2.019bn in 2017, Ampere calculates it would have been positive $377.14m in the $2+ ARPU scenario (see Chart 2 below).
4. Netflix could soon be on the right track
If Netflix had grown its ARPU by 27% in 2017 (an additional 17 percentage points over what it achieved), it would have been FCF neutral. That may sound like a tall order, but that 17% is lower than the growth rate a year earlier, when it would have needed to grow ARPU by an additional 19% to reach FCF neutral. If Netflix can reduce its deficit whilst increasing acquisitions and productions, cash flow might be positive.
Guy Bisson, Director at Ampere Analysis says: “Netflix is a TV company, run like an Internet company. If part one of the Netflix growth story has been about customer additions, part two must be about ARPU growth. Switching from one to the other will be the key to long-term success. Netflix has already begun to do this by adopting the classic pay TV strategy of introducing premium tiers. On a very low ARPU to start with, an additional spend of just $1.68 a month by each of their current customer base would make Netflix FCF neutral. With its appealing content offer and its marketing might, this looks perfectly doable. We think the Netflix story arc may be heading in the right direction after all.”