How does Netflix make money and why is it at a loss?

The financial strategy of the global leader in the streaming-on-demand entertainment business

Reading time 8 minutes

During the three-month period, the streaming giant laid off around 450 employees due to a loss of a raft of subscribers. According to the statistics provided by Macrotrends, from 2014 to 2019, the loss of Netflix has only increased, although the situation was rectified in 2020 and the coronavirus pandemic, which brought in a profit of almost two billion USD, 2021 again ended with negative indicators for the platform. Many experts attribute this situation in the market to the economic model in which the platform operates.

THE BIRTH OF STREAMING AND THE DEATH OF CABLE

In 1999, Netflix started as a DVD rental service, offering customers an unlimited monthly cassette subscription, as well as a personalized movie recommendation system. To create a large movie library, the company purchased the rights and licenses to a wide variety of content, part of an online cinema portfolio that still includes these acquisitions.

A decade later, Netflix pioneered the Internet streaming market, while other media giants offer cable TV subscriptions for $100, Netflix only requires its subscribers from 8 up to 15 dollars. In addition to the pricing policy, viewers are bribed by other factors: multiple people can use the same account from different devices, favorite shows can be viewed at any time, and the library constantly being replenished with hit shows that Netflix buys the rights to and content of its own production.

All this caused consumers to abandon cable subscriptions in favor of streaming, and movie and TV series creators not to release their products on TV, simply because Netflix and its similar companies offered more money than cable channels that were losing money. According to Bloomberg’s statistics in 2018, 6 people give up cable TV every minute, of which in return, many people subscribe to online services.

THE FLYWHEEL MODEL
Flywheel model for Netflix
Flywheel model for Netflix

Despite the removal of these competitors, Netflix is still operating at a loss. This is largely due to their economic policy, known as the “flywheel method”. It works like this: the service takes money from a user’s subscription and spends it on content creation, content distribution and creating a pleasant user experience, which forces the user to renew the subscription theirs and everything went back to the way it was. The problem is that Netflix spends more than $500 per user while it only brings the company about $10. This difference is covered by the new viewer’s subscription, i.e. your payment for one subscription offsets the cost spent by the user who purchased it before you and the amount the next subscriber will reimburse you.

The problems of this plan will become apparent once Netflix hits the subscription threshold – there will simply be no potential buyers left in the US and the world able to cover these losses with their own money. Analysts estimate that the maximum number of Netflix subscribers in the US is 60-90 million and around 200 million in the rest of the world, while in the first quarter of 2022 there were around 80 million people in North America and about 150 million people in the rest of the world.

Simultaneously, due to the peculiarities of the market, a subscriber outside the United States brings the company much less money than an American: for example, the cost of a subscription in India at the start was only $3 – three times less than in the company’s homeland.

By way of explanation, in order for the flywheel to continue working, Netflix is forced to look for new subscribers outside the United States, in the face of the fact that local markets cannot offer a profit comparable to the United States, as well as to raise prices in richer and more developed countries, which already leads to an outflow of subscribers.

COMPETITORS AND WOLVES OF WALL STREET

For Netflix, the situation is compounded by increased competition: almost every major corporation has already launched or is preparing to launch its streaming service. Coincidently, knowing the need for their competitor to raise prices, other streaming services deliberately underestimate the cost of a subscription: Disney+ asked for only $ 7 at the beginning, while providing exclusive and discussed content like the new parts of Star Wars and the Mandalorian series, as well as absorbing another online movie theater Hulu. In other words, purchasing Disney+ for a price half the price of a subscription to Netflix, the user received two streaming services at once.

Netflix official account tweet saying "Love is password sharing"
Netflix official account tweet saying “Love is password sharing”

Simultaneously, Netflix itself is also forced to take not very pleasant measures for users, along with the mentioned price increase, the company also wants to ban users from sharing passwords with loved ones, and about 1/4 numbers all subscribers do this, although the company previously considered this function as one of the important being.

This policy affects the number of people who unsubscribe. Users are also canceling subscriptions due to the lifting of quarantine restrictions in many countries: people work, study, travel, and less sit at home in front of computers and TVs. As a result, in the second quarter of 2022, one million people canceled their Netflix subscription, and a similar number of unsubscribes is expected before the end of the year.

Netflix's largest shareholder Bill Ackman
Netflix’s largest shareholder Bill Ackman

This situation in the market also affects the investment attractiveness of the company: in the past year, the value of shares has decreased by more than 60%, in such a crash, one of the company’s largest shareholders lost more than a billion dollars, and then sold his entire three million shares.

Despite the unfavorable economic situation and loss, Netflix is unlikely to stop, in a letter to shareholders the company assured that canceling family subscriptions will only lead to new users. Streaming and the loss of subscribers are also tied to macroeconomic factors: the consequences of the pandemic and the Russian invasion of Ukrainian territory. In addition, the company will not reduce its content costs: in 2021, online cinemas have spent 17 billion dollars on it.

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