Netflix: Hopes to restore investment levels to drive growth (3Q23 earnings conference summary)

Netflix 2023 Q3 Earnings Highlights

Here are the key points from Netflix's Q3 2023 earnings report. For a detailed analysis, please refer to the article "Growth Questioned? Netflix Fights Back with Price Increase".

Q: How does the recent strike affect Netflix?

A: We hope this issue can be resolved soon. We take this matter very seriously and prioritize these negotiations above everything else. We are committed to ending this strike. In terms of impact, the cost of content production has been increasing every year, and we have not specifically focused on the impact of the strike. The biggest opportunity lies in improving the quality of our content lineup.

Q: How do you view the strike as providing more transparency for talent and becoming a new benchmark for talent compensation? Has the entire industry standardized this?

A: Data transparency will become more common. The reason for not releasing it in advance is partly due to our commitment to creators. When they start creating original projects, creators feel that they are trapped in a situation where overnight ratings and weekend box office numbers determine their success or failure. This show may achieve tremendous success in the future, but it is not reflected in the opening weekend box office. We will release a top 10 list, an annual summary list, and everything that provides great transparency for viewing, and we hope it will become more and more transparent.

Q: Regarding the issue of account sharing, have you identified the identities of most account borrowers? How many account-sharing users are still being targeted? What challenges does the crackdown on account sharing face?

A: We are very satisfied with the progress. You can see the progress from our Q2 member growth and the Q4 revenue guidance, which includes the current situation.

I think paid sharing represents a challenging problem that requires finding a balance between consumer experience and commercialization. We leverage the core execution capabilities we have built over the past decade, such as how to develop a product with a good experience, how to solve more problems through them, and how to establish an iterative model to obtain consumer feedback that tells us what is effective and what is not.

But because this is such a challenging issue, as we are fundamentally changing consumer expectations and their expectations of us, we have always believed that this change should be done in a stable and thoughtful manner.

Therefore, our plan is to gradually roll out solutions for account sharing. We provide our product experience to different categories of account-sharing users. As of today, there are still many users who have not received this product experience.

Therefore, over time, building the ability to develop features and improve model accuracy can ensure that we accurately develop and apply our innovations and interventions and provide consumers with the most effective and positive ways possible.

We hope to provide users with the right product experience at the right time, allowing them to transition from borrowing someone else's account to subscribing to their own account, rather than causing these users to stop using Netflix. We aim to maximize product revenue, so we will continue to introduce measures for account sharing in the coming quarters, and we expect to attract more paying users as well as users who have never registered for Netflix before.Q: Can you talk about why there have been changes in the management team and what goals you hope to achieve?

A: Jeremy has shown a truly positive impact and outstanding results in several different roles. She recently led a large global team and is aware of our desire to expand our advertising business. She has previously held positions in business development and financial strategy at Netflix.

When it comes to linear TV and streaming TV, this is an $180 billion opportunity, not including YouTube, China, and Russia. We are in a favorable position and we have great content. These brands want to follow suit, as it is a safe haven for brand survival. We have received positive engagement from our members. This is a very solid foundation for collaboration. But we still have a lot of work to do, and we know that there is a lot of work to be done to unleash this potential.

Scale is our top priority. This quarter, our advertising plan membership has grown by 70% MoM. Last quarter, our QoQ growth rate was 100%. Now, we have 30% of new registered users choosing our advertising plan for their country/region selection.

We achieve this by improving the competitiveness of our advertising. Non-advertising plan content has already reached over 95% of the content period. We have made improvements to features such as streaming and video resolution. We will continue to do so.

Our second priority is to provide the features and products that advertisers want. In October, we entered into a measurement partnership with Nielsen in the United States. We launched the Top 10 Media Buying Program and will launch the Binge advertising product later this year. We are rolling out more ways to access our inventory through programmatic buying with Microsoft, providing more options for buyers.

Q: You have gradually phased out the basic subscription service for new subscribers, and you have gained additional members or paid more fees per subscriber, and you have launched advertising in 12 countries/regions. Can you talk about the prospects for ARM in the next 24 years and beyond?

A: It is expected that the balance between membership and ARM growth will be more pronounced in the next 24 years. There is expected to be a strong lineup to drive the business forward, such as increasing advertising members and increasing our advertising revenue.

In addition, with some pricing adjustments that you have seen in our letter, all of these will drive ARM. 2023 was an exceptional year, and all of our growth basically came from membership growth. In the next 24 years and beyond, we will develop our business by continuing to improve our service, increase engagement, and increasingly meet the needs of current and future members.

Now, with the account sharing solution in place, we have a clearer path to penetrate deeper into this massive and growing potential market of 500 million connected TV households. As our plans evolve, pricing becomes more complex, and all the efforts we put into our advertising business, we will continue to monetize through expanding coverage and engagement.Q: How to expand the scale of advertising?

A: As our influence grows and competition becomes stronger, the situation varies in different countries, largely depending on the competitive channels and landscape. In each country, there are several relevant objectives that we consider as important components of market penetration, which help us focus and drive the growth rate we desire. We are not satisfied with the scale in any country. We want to become bigger, and we know we can become bigger.

We can employ various techniques for pricing and consider how to approach the optimal pricing for advertisements, rather than the advertisements themselves. This is part of our planning evolution and thinking. In fact, some of our streaming competitors have not done a good enough job in building the advertising experience, which reflects this expectation - part of it is simply educating consumers about the actual advertising experience of Netflix and making them think about what choices are suitable for them. Do they want lower advertising prices and what we believe is a good advertising experience for consumers? Or do they want to pay more and skip the ads? Therefore, it is the combination of these factors that ultimately allows us to achieve a scale that satisfies us multiple times over.

Q: But you mentioned many innovative products that you plan, some of which are sponsorships. This is very unique and different. When do we reach a point, or when do you reach a point - where it is targeted, so it is really important for consumers?

A: We are currently working on positioning with Microsoft, so you will see the launch of that feature in the near future. I think this is the first step in our consideration of improving target relevance through product bundling. Brands can purchase what types of advertising products to increase relevance and enhance what we call the complexity of targeting from a digital perspective, essentially matching consumers who are most interested in specific brand information.

Q: Can you elaborate on the content spending in the advertising technology field? You did mention later on the content spending in new areas, but are there other meaningful investment areas that they may not have considered?

A: The profit margin target is the best judgment on how to grow Netflix's long-term value, attempting to strike a balance between investments for future growth and short-term profitability. After investing heavily in the global launch of Netflix in 2016, we hoped to establish profitability while increasing revenue in a disciplined manner, firstly because it is a good way to build profitability throughout the company. Secondly, we know that investors - who have been patient with us - want to see the scalability and health of the business model, which has allowed us to go from a 4% operating margin in 2016 to the current rough 20% - we believe this is a fairly good indicator that advertising-scaled streaming can be a very good business.

Our financial goals have not changed, and our long-term profit expectations have not changed. Given our current profitability and scale, we believe it is wise to balance the historical pace of margin improvement with investment for growth. We have plenty of room to continue investing, with enough space to further invest in our existing content categories, as our market share in each country/region where we operate is still small.Assuming there are no significant fluctuations in foreign exchange rates, we expect the operating profit margin for the year 2024 to be around 22% to 23%, which is higher than the current expectation of 20% for this year. Looking ahead, we will adopt a rigorous approach to balance the increase in profit margin and investment in our growth.

Q: What about third-party content business?

A: Authorizing third-party content has always been a part of our strategy, and what we are very good at is matching the audience.

Q: Referring to other internet platforms, the long-term profit margin has always been in the range of 40% to 50% historically. Will the profit margin continue to rise over time?

A: We haven't seen any upper limit. This is a highly scalable content model. It is a large-scale global network that has many aspects that traditional entertainment networks do not have. We still have a long way to go and hope to strike a balance between short-term profit growth and long-term investment opportunities. In terms of profit growth, we have a long and healthy runway.

Q: You have announced the premium and fundamental price changes for several countries today and more countries in the future. Can you provide your views or a standard timeframe for the current price increases?

A: The focus on planned evolution over the past 18 months has mainly been about paid sharing. Now that this strategy has been launched, we have seen its benefits extensively, which is that it becomes a normal part of our business and allows us to return to our core pricing methodology, and the philosophy behind this methodology has not changed.

We want to invest the money that members pay us wisely, to deliver more exciting stories and more entertainment value to them. And then, when we do that, we occasionally ask them to pay a little more to sustain this virtuous cycle. Of course, I think it's worth seeking a broader and even wider range of prices on a corresponding set of features, so that entertainment fans with different needs from around the world can access the wonderful storytelling our creative partners are doing at a price point that suits them, and part of this broad application is a low entry price point.

That's why we keep the low entry price point unchanged. We won't comment on other price changes or other tier changes. We will find our way based on this philosophy and see when it is appropriate to ask users to pay a little more.

Q: There is another question about pricing. Why did you only increase the price for the premium and basic plans, but not the standard plan? Will you insert ads in the standard plan? Will this price increase cause changes between different package levels for users?

A: I think pricing always leads to some changes between different package levels, and these changes depend on how users sign up. However, in general, there is relative stickiness in user subscription plans, so it takes time to see the impact and changes.

Q: The shareholder letter stated that the projected content investment scale for 2024 is 17 billion, while the investment scale for 2023 is 13 billion. It is clear that this is influenced by this year's strike. What are the driving forces for user growth in 2024?A: What we are doing is increasing content expenditure, bringing it forward by half a year compared to revenue. We hope to restore content investment to the level of $1.7 billion by 2024, but the factors that may affect this are how we resolve the agreement with SAG after the strike. The ratio of cash expenditure on content to cash amortization and profit and loss is expected to be approximately 1:1.1x.

It is difficult for us to provide a target for free cash flow in 2024, but we hope that over time, our increased content investment can translate into sustained and healthy revenue growth.

Q: There is currently an abundance of original content. Can you talk about the current focus of investment, such as how to evaluate the value of local language films and TV series? You have had successful deals with many third-party film and TV production companies. Can you discuss how you view content investment?

A: There are many third-party companies, but we need to find the ones that recognize us. For example, with Skydance, it may take ten years to produce a good animated work, so we need to quickly choose successful companies that have released two or more animated films within a year. Therefore, we hope to have a long-term partnership with Skydance to achieve mutual success.

By maintaining a proper balance of investment and finding products that suit the market, we can expand our content field and increase the value of user experience. We want users to pay a little more but be able to enjoy and experience more content.

Q: Spence, you announced a significant increase in share repurchases today. Does this mean that the $2.5 billion repurchase limit for the third quarter is sustainable?

A: No, it doesn't. When our business growth slows down, we also slow down the pace of share repurchases. We must acknowledge the fact that although we hope for continuous acceleration in our business, our forecasts for future performance are often inaccurate based on our predictions over the past year or so.

Currently, because we have a better outlook for the future, we have increased share repurchases using accumulated excess cash while maintaining a minimum cash target of around $6 billion, which is equivalent to two months of revenue.

Q: What are the short-term and medium-term strategies for the gaming business? Is it also a wait-and-see approach like the advertising business?

A: Gaming presents a huge growth opportunity in the entertainment industry, with the global gaming consumer market reaching $140 billion, excluding China and Russia.

From a strategic perspective, we can develop gaming into a powerful content category. The main way is through our membership system, leveraging our core movie and TV content to connect fans of specific IPs with games they will love.

If we can establish these connections, we essentially solve the biggest problem in today's mobile gaming market, which is acquiring game users at a lower cost. We believe we can achieve this:

We provide our members with exciting games and entertainment experiences they love. Then we benefit from our core business. This not only increases engagement and retention but also adds value to our core business. By offering various content entertainment in games, we essentially expand a category of content, thereby increasing user stickiness and engagement, helping our core business increase monetization value. Currently, we are more focused on game content that can have a significant impact on our current business and finding ways to increase user stickiness.We are facing a mid-term challenge where the scale and ranking of games, as well as their current investment intensity, are relatively small compared to our overall content. Therefore, our current task is to gradually expand into areas where games have a significant impact on our business. We hope that in the next few years, our engagement can truly increase several times over what it is today.

In the fourth quarter, there will be some major game releases, such as "Dead Cells" and "Football Manager 2024". We will consider how to integrate them with our concurrent film and television content IP. Expanding into new entertainment content such as games is similar to our previous trend of expanding into new regions. We always find ways to enter the market and seize opportunities.

Q: Regarding the sports business, you plan to hold the Netflix Cup next month. Is this considered a strategy for sports content? How should we view this?

A: We already have a sports business line, but what we do is sports dramas. You can take a look at the success of documentaries like "Drive to Survive" and "Tour de France". And recently, the documentary "Beckham" gained 500,000 new followers on social media within a week of its release.

The Netflix Cup is a live event that will bring together the cast of "Drive to Survive" on November 14th. This is just one of the ways and strategies we use in our sports business and does not change our previous content strategy of licensing and broadcasting sports events.

Q: You recently mentioned your derivative business, including Netflix House (offline retail stores). Can you talk about what it will look like over time? Does it mean there will be higher investment, but it will also become an important contribution to performance in the future?

A: This business falls under our "consumer experience business". It is currently operating very successfully, with high fan participation and enthusiasm. You can think of this business as an expansion of a theme park, but it doesn't have the high cost of building an actual theme park because it is actually a mobile offline experience that can be done globally. We hope that fans will visit multiple times a year, not just once every few years.

It is a way of operating a company that is truly good at developing our brand and strengthening our brand. They can also go to Netflix House to experience Netflix's food along with all the Netflix food brands. So, it does strengthen the brand to some extent and enhances people's excitement for watching and falling in love with things on Netflix.

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