The Great Netflix Shift

by Erica Thinesen

Are consumers changing their viewing preferences, or is Netflix (NFLX) slowly altering its business model? Once a dedicated provider of DVD’s and streaming movies, the company now provides a wider selection of television programming, and consumers seem to really enjoy it. According to recent reports from Nielsen, 19% of Netflix viewers prefer to watch television shows over movies. This is an increase of 8% from 2011. This shift could suggest a change in consumer demand or highlight a growing problem for Netflix: increased competition. Losing its contract with Starz didn’t help either. In February, the Netflix movie database lost around 1,000 movie titles after the two companies couldn’t agree on the terms of a new agreement.

I believe the company will retain its current format and try to cater to increased consumer demand by making more television programs available. I don’t think the company is as concerned about what consumers are streaming, just that they continue to stream from the Netflix website.

Unfortunately, Netflix has a lot more to worry about than whether consumers watch more television programs than movies. Over the past two months, Netflix stock price has slowly dropped from $69 to $59 per share. This drop has caused investors and analysts to wonder how low the stock will drop. The reasons for lowered stock price vary, but include a decrease in DVD-by-mail memberships, lack of faith in Netflix current business and marketing strategies, and increased competition.

Losing the DVD Market

Maintaining a solid online streaming media audience is pivotal to the success of the company going forward. As demand for its DVD-by-mail service continues to dwindle, Netflix must rely more and more on streaming media. Last year, after the company’s now infamous move to separate DVD-by-mail and streaming into two separate packages, profits for DVD rentals have plummeted.

Even though I think the company anticipated this reduction in DVD-only memberships (and maybe even welcomed the idea of going totally online as this would help reduce overhead and operating costs), the company didn’t anticipate DVD consumers going elsewhere for movie rentals – Netflix probably assumed that most existing members would just opt for the online streaming package.

With other online streaming options from Amazon (AMZN) and Apple (AAPL), along with DVD rentals from convenient little red boxes from Redbox, owned by Coinstar (CSTR) and cable providers like Verizon (VZ) consumers have options – and aren’t afraid to use them. What this translates into is a loss of 850,000 DVD members during Q2 2012. Overall, the company manages 9.2 million DVD memberships, a drop from 13.9 million as recorded in September 2011.

Fewer Sales Equal Less Revenue for New Content

Providing members with thousands and thousands of movie and television titles is not cheap. To do so, Netflix must buy the rights to offer content and pay a fee each time content is downloaded. This can get pretty expensive, especially if the company wants to remain competitive and offer new releases or popular television shows.

In 2011, the company earned 3.2 billion in sales/revenue and spent 2.04 billion in COGS (Cost of Goods Sold) to maintain its operations. This includes buying movie and television rights for streaming and keeping its DVD-by-mail service operational. Moving exclusively to an online streaming format would help reduce this cost, but so far, the company hasn’t made any announcements about abandoning the service.

International Sales

As of now, Netflix’s answer to regaining not only its popularity, but also sales/revenue, is to move into new territories and try to find additional members. This means moving into other countries. And while this may seem like the next logical step for the company, it just isn’t sitting well with investors. After disappointing Q2 financial reports recently, coupled with current marketing strategies, investors seem to have lost faith in the company.

Moving into other countries such as Canada, UK, and South America may temporarily increase sales/revenue. But once the company has tapped out these markets and others, what’s next? It’s not like Netflix has other products or services to offer. And with growing competition, it no longer stands out. One could argue the same about companies like Amazon, but Amazon has many other products and services in its portfolio. Even if the company decides to pull out in a few years due to market saturation, Amazon will still thrive because of its diverse portfolio. Companies like Netflix will have a much harder time surviving over time.

Investor Jitters

I completely understand and appreciate why investors may suddenly view Netflix more cautiously than in the past. When DVD-by-mail was new and Netflix was the only company offering this kind of service, Netflix seemed invincible. Even after the company started offering online movies, the stock price still remained high. But times change and the competition has arrived.

My advice to any Netflix investor: Wait a little longer. If the stock price continues to drop, then consider pulling out. Unless the company announces some radical new business model or strategy, expanding into new territories is only a temporary solution. For investors that want to eke out a little bit more before the stock takes a complete nosedive, then stay with it for now. The company will make a profit through its expansion.

But for those that don’t feel comfortable with the uncertainty, it may be wise to pull out now before the stock falls any lower. For those that want to start investing in Netflix, now might be a good time. With the stock price falling a little bit more each day, the stock is more affordable. All stocks crest at some point and then rebound. It’s just a matter of how long investors want to wait or how low the bottom actually is. Given that consumers really enjoy downloading movies and television programs and know the Netflix brand, perhaps the company will rebound to become a major player once again.