Netflix, Inc. (NASDAQ: NFLX) was not built in a day. From humble beginnings as a DVD rental company by mail, it rode the wave of technology to become a leader in a growing niche.

While we can’t take credit for its leadership for creating a unique work culture conducive to nurturing ideas, we must consider the many tailwinds that have contributed to growth. Even the most significant turbulence since the Great Recession, the 2020 pandemic, actually helped the company grow.

Still, no good episode lasts forever. As we roll out the credits for the era of monetary expansion, Netflix needs to transition into a less exciting status as a mature company.

First quarter results

  • EPS GAAP: $3.53 (beaten by $0.62)
  • Revenue: 7.87 billion USD (shortage of 70 USD)
  • Revenue increase: +9.9% over one year

Other Highlights

  • Net paid additions in global streaming: -0.2m versus 2.5m guide
  • Revenue forecast for the second quarter: $8.05 billion vs consensus of $8.22 billion
  • Suspension of Russian service: -0.7m on paid subscriptions

Losing 200,000 subscribers on a net basis is disastrous if you were planning on adding 2.5 million. It was the first loss of subscribers in a decade, bringing the total number of subscribers down to 221.64 million. Additionally, the expected second quarter drop in subscribers is now 2 million.

See our latest analysis for Netflix

What could Netflix do to turn the stock around?

Reflecting on the results, management highlighted the main factors contributing to the situation – growing competition, geopolitical crisis, the threat of stagflation and, last but not least, account sharing.

According to their estimates, account sharing is rampant, reaching more than 100 million additional households. That’s on par with 45% of the existing customer base of 221.6 million. These numbers are by no means miniscule, so it’s only natural that solving this problem is now a priority.

So, it’s no surprise to see CEO Reed Hastings start preparing for changes in subscription level. Mr. Hastings, who has been a fan of subscription simplicity, is exploring ad-tolerant options.

In concrete terms, this amounts to creating a new cheaper Netflix subscription who would respond to public sensitive to price but tolerant to advertising. Still, there are 3 issues we see with this solution.

1. Subscription Downgrades

By offering lower tier rates, some subscribers would likely downgrade to the currently cheapest service. While premium level subscriptions have increased in recent years, the majority still have a basic one. So, if it’s better to have a downgrade than an unsubscribe, it could still remove the positive effects of new subscriptions.

2. Advertising effect

Online advertising has a big problem. It is difficult to distinguish a selection effect from an advertising effect. Ads are primarily data-targeted, although this has changed somewhat lately.

Yet the line between selection (a customer who has already made the purchase or a purchase decision) and advertising (gaining a new customer) is blurred. While advertisers are losing out, they have become more aware in recent years, as can be seen with examples from Uber and eBay.

3. Monetize the lowest level

Advertising-friendly subscription seems like a matter of time now. However, it should be noted that its target will be the market segment with the lowest purchasing power. Advertisers are aware of this and we can expect them to take advantage of this in negotiations. Additionally, the tight macroeconomic outlook could put additional pressure on advertising rates as marketing budgets are likely to be reduced.

Conclusion

For a long time, Netflix avoided other modes of monetization, preserving its simple subscription-based business model. However, as we explored above, launching a quality advertising operation is not a simple and turnkey solution.

Finally, a drop in subscriptions is not encouraging as it could be a canary in the coal mine for the whole market. When an average consumer needs to cut back on spending, subscription entertainment can be at the top of their to-do list.

If you’re interested in diving deeper, our analysis shows 3 warning signs for Netflix, and we highly recommend watching them before investing. If you’re no longer interested in Netflix, you can use our free platform to view our list of over 50 other stocks with high growth potential.

Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position at any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials.