Smartphone with Netflix logo is seen in front of a descending stock graph Image Credit: Reuters

Strange things are happening at Netflix, the home of ‘Squid Games’, ‘Bridgerton’ and, of course, ‘Stranger Things’. And the markets are well and truly clued into what’s happening there. Many, especially investors, are getting spooked too.

It is as compelling as anything that Netflix has put out recently, and there iss also a sub-plot to this. Does this spell the end of the growth wave that Netflix, Disney, HBO, Apple and Amazon have been riding in winning subscribers for their streaming content the world over?

Before that, let us connect to Netflix’s issues of the moment.

What happened?

On April 19, 2022, Netflix reported losing subscribers for the first time in a decade and predicted more contraction in the second quarter. The streaming giant saw 200,000 subscribers tune out in its first quarter, and falling well short of its modest predictions that it would add 2.5 million subscribers.

Netflix, which has 221.6 million subscribers, last reported a loss in customers in October 2011. Investors who were so getting used to hearing only about subscriber gains quarter-on-quarter reacted by sending the company's stock 26 per cent down in after-market trading on April 19.

“In 2020-21, the streaming platform enjoyed a boost in its share price and rallied to almost $700 a share,” said Raed Hamed Alkhedr, regional Head of Market Research at the trading platform Equiti. The picture is completely different now; the share is now standing at $218, a multi-year low.”

Why did subscriptions plunge?

Netflix offered a gloomy prediction for the next quarter, forecasting it would lose 2 million subscribers. Netflix’s CEO Reed Hastings and co-CEO Ted Sarandos had previously dismissed the company's slowing subscriber sign-ups as a speed bump related to the pandemic, which had accelerated Netflix's growth in 2020.

However, the growth in new subscriber patterns has not returned to pre-pandemic levels.

The ‘pirates’ are back

Remember the not-so-distant past when pirates sites would offer the latest movies and TV series? Then came the global crackdown on such freeloaders of entertainment content, and tightened up the ways viewers could download these.

Well, the pirates seem to be back, and this time they are even offering OTT content, for a pittance. “VPNs and super-fast networks are helping to deliver pirated content, and without losing anything by way of HD definition,” said a tech analyst. “For $40 a year or thereabouts, these packages are being offered on the WWW - the younger ones are already signing up to these and getting what they want and when they want it.

“Netflix says it has a problem with subscribers sharing their passwords. That’s only a marginal problem - the real issue is what pirate sites are offering”

Intense competition

The world’s dominant streaming service was expected to report slowing growth, amid intense competition from rivals like Amazon, Disney, Warner Bros Discovery and cash-flush newer entrants like Apple.

“With the pandemic easing, people have been finding other things to do,” said Alkhedr. “And other video streaming services are working hard to lure new viewers with their own programming.”

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In 2021, the OTT giants spent $50 billion on new content, in a bid to attract or retain subscribers, according to research. That’s a 50 per cent increase from 2019, which was when the likes of Disney and HBO entered the fray.

“Fierce competition from Disney+ and Amazon Prime played a big part in why Netflix lost its shine,” said Alkhedr. “In addition, data costs, the uptake of connected TVs, and account sharing are among the biggest issues of why Netflix underperformed in Q1.”

What is their revenue model? Is it a problem?
Netflix's revenue model works best when each quarter comes with additional subscribers tuning in across its global footprint. That helps the platform to double down on poaching the best shows, the most outstanding talent, and go eye-to-eye with Hollywood's powerhouse studios. Of course, win Oscars too.

It was the ideal script that Netflix was coming up with for more than a decade - and investors and markets were getting used to that. Then comes the shocker of a result, showing a steep decline in that all-important metric - subscriber numbers. Blanking out the Russian market after the start of the conflict too would have hurt.

This is why Netflix executives have been talking about tightening password sharing, and introducing lower-priced bundles - with ads. The addition of ads, however limited they will be, is a major rewrite of the Netflix business model. The streaming experience was built around offering an immersive experience into the best content out there - and all without an advertising pitch popping out anywhere.

Raise bundle rates

Netflix will try and offset the subscriber loss by hiking the subscription charges, which it had done in the US and the UK. But will subscribers elsewhere be fine with shelling out more? These are uncharted waters as OTT platforms have so far relied on keeping the connection costs as affordable as possible to retain subscribers. While no one is thinking of their charges ever matching those from pay-TV providers of the past, increases could be a big put off for viewers.

The pandemic sent Netflix’s paid viewership on a mission and by October 2021 had swelled its market cap to $310 billion. However, Netflix still faced the same problem as other Nasdaq high-fliers. Eventually, the heavy expenditures on movies and series needed to fall sharply as a proportion of revenues for Netflix to retain the $300-billion-plus market cap.

Is there a way out of the current crisis?
With a handful of other streaming giants - backed by the biggest Hollywood studios and media companies - having launched in the last two- to three years, a plateauing of the subscriber growth numbers was inevitable. What the markets didn't see coming was the sharpish decline in these numbers, and that's what spooked them into driving Netflix shares down 30 per cent plus.

Will the other OTT platforms from the mighty Disney and HBO continue to show strong growth numbers?

Shift in consumer habits

Streaming services are not the only form of entertainment vying for consumers’ time. The latest Digital Media Trends survey from Deloitte found the Gen-Z, those between 14 to 25 years, spend more time on online games than binge-watching through OTT content.

The majority of Gen Z and Millennial consumers polled said they spend more time watching user-created videos on TikTok and YouTube. Netflix added a gaming option recently, but these are very early days for any sort of payback.

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No easy sharing, please

Netflix is seeking ways to stop a loss of subscribers and tackle investor fears that its best days are in the past. CEO Hastings had said for years that he does not want to offer advertising and had no problems with password sharing.

However, the company changed its course after losing those 200,000 customers in first quarter 2022. Netflix blamed password sharing, in part, for failing to hit its subscriber growth targets.

The extent of the shared accounts - estimated at 100 million - was a warning sign of its own. Netflix Chief Operating Officer Gregory Peters on Tuesday told investors the company would not stop a subscriber sharing with a sister.

"But we're going to ask you to pay a bit more to be able to share with her and so that she gets the benefit and the value of the service, but we also get the revenue associated with that viewing,” he said. Netflix has been working on the issue for two years and conducting tests.

Is having ads a good solution for OTT?
The whole OTT experience was built around affordable bundles compared to cable and satellite subscription options. Without ads intruding into the viewing experience. Surf as much as the viewer wants - and not a single ad placement will stream into that vision. That was what Netflix delivered all these years. Now, with the mention of ads, albeit for lower-priced bundles, is this an experience that viewers will trade down?

Watch the space.

In March, Netflix began charging users in Chile, Costa Rica and Peru an additional fee to share their accounts with up to two people. On Tuesday, the company said it plans to introduce the new charge for password sharing globally, within a year.

The company sure needs a change in strategy after losing customers in three of its four regions in the first quarter, including more than 600,000 in the US and Canada. Netflix blamed most of that on a price increase, and said the decline was expected.

Russia's attack on Ukraine cost the company another 700,000 customers when it had to pull its service in Russia, resulting in a loss of 300,000 customers in Europe, the Middle East and Africa.

Cracking down on password sharing is a risk for a company that started by giving customers a cheaper, more convenient alternative to cable. By nudging customers to pay - and inserting advertising - Netflix begins to resemble, what it replaced.

Big shift to lower-priced service with ads Netflix plans to create a lower-priced version of its service that has advertising, a big change for the company after years of only offering its movies and TV shows commercial free.

"Those who have followed Netflix know that I have been against the complexity of advertising and a big fan of the simplicity of subscription," Hastings said on the call. "I am a bigger fan of consumer choice, and allowing consumers who would like to have a lower price and are advertising tolerant to get what they want, makes a lot of sense."

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Not an easy sell

“The growing number of streaming options has made consumers more price-sensitive,” said Equiti’s Alkhedr. Netflix is among the few major streaming services that have yet to offer a cheaper, ad- supported option. Disney’s Hulu has long done so, while Warner Bros. Discovery’s HBO Max and Disney+ have also pushed into ad-supported streaming.

The step reflects the prevailing mood that rising prices will curtail consumer spending on nonessential goods and services. Netflix will now work on creating an ad-supported version of the service over the next year or two, Hastings said.

Netflix also will curb its spending on films and TV shows in response to the customer losses.

Other streaming platforms too suffer

Netflix investors punished the company for its shock loss in subscribers and abrupt turnabout to embrace advertising after years of shunning it.

Shares of the streaming leader plunged 35 per cent, erasing $54 billion of market value in its biggest drop since 2004. It made Netflix the worst-performing stock of the year on both S&P 500 and Nasdaq 100 indexes and triggered drops for Warner Bros. Discovery, Roku and others.

Is it a warning sign for the streaming industry?
Massive additions in subscriber base across the world, with each quarter. That was the Netflix juggernaut. Now, that particular metric has taken a beating in the quarter gone by. The hope for the streaming industry was that viewers will keep on growing, in one market or the other. That the anywhere, anytime viewing habits will keep viewers glued. It worked and even more so during the Covid years. No longer.

What next?

Netflix's troubles are a warning sign for its competitors. After watching millions of customers abandon pay TV for streaming, US entertainment giants merged and restructured to compete with Netflix. Investors encouraged this strategic shift, boosting shares of companies like Walt Disney that demonstrated a commitment to streaming.

The drop-in customers could lead other competitors to break some of its long-standing rules: introduce cheaper content, an ad-supported option for subscribers, and start to crack down on people sharing their passwords in order to limit account sharing.

- Raed Hamed Alkhedr of Equiti

Netflix remains well ahead of most of its competitors outside the US, and is the largest streaming service in the world. The company believes it can execute its way out of the current predicament by luring new customers with even better programmes and finding more ways to charge its existing user base. It still expects to add customers this year, and will have a stronger slate of new shows in the back half of the year.