Netflix: In addition to advertising, we will also focus on cracking down on account sharing next year (3Q22 conference call summary).

The following is a summary of the Netflix Q3 earnings call Q&A section. For a financial report analysis, please see "Netflix: Surging Against the Trend, Good Content is the "True Remedy" to Growth Bottlenecks".

Key Points:

1. The economic benefits of early advertising business are expected to be small and gradually expand over time; it will not have a significant impact on Q4 performance.

2. Content expenditures will maintain a scale of $17 billion, and free cash flow is expected to reach more than $1 billion in 22 years, with significant improvement on this basis in 23 years.

3. A paid sharing (account) plan will be launched in early 23, with an emphasis on combating account sharing to obtain more potential users. The company detects multiple logins to the same account at different addresses, and will require payment of additional fees.

In March and July of this year, the "add subaccount" function was launched in different regions. Yesterday, two new features were launched: "personal profile transfer" and "shared account payment on behalf of others", all of which are designed to facilitate and encourage shared account users to switch to their own accounts and pay.

These two functions ensure that users who previously watched Netflix using someone else's account can still enjoy content recommendations based on their viewing history after creating their own independent accounts. In addition, sub-accounts can be set up under the main account, allowing friends and family to make payments on behalf of the user.

1. Overall, in Q4 22 and 23, Netflix will continue to expand its competitive advantage and influence in content, improve user experience, and actively promote advertising business and paid sharing (account) plans.

2. Foreign exchange fluctuations have a significant impact on revenue and profits, and also affect Q4 performance guidance.

Q&A:

1. Advertising Business

Q: How is the pricing and product features for "Basic with Ads" determined?

A: The pricing is based on the value the company wishes to deliver to users.

The company calculates the expected revenue in different countries to ensure that the subscription price and expected monetization, or unit economic benefits, of Basic with Ads are positive. The company is very confident that this lower-priced, consumer-friendly approach will attract more members in the long run, and generate significant revenue and profits.

Q: When determining whether the unit economic benefits of the advertising plan are positive, which subscription plan is mainly used as a comparison?

A: Firstly, it is important to note that subscribed members rarely change their current subscription plan. Generally, users will select a plan based on a specific feature, such as 4K resolution. Therefore, when the company determines that the unit economics of the advertising plan (Basic with ads) have reached neutrality and become positively progressive over time, the comparison is with the ad-free basic subscription version (Basic without Ads). Q: Confidence in advertising business; current advertising client interests and needs

A: The advertising business originated from the establishment of models based on advertising campaign information from different countries, which are now being applied in practice.

Microsoft and the company's sales team are working hard to contact brand advertisers and ad agencies, and clients are very interested in our positioning backed by excellent content. Currently, the initial demand is very strong, and the expectations set in the model are being met in actual sales.

Before iterative improvement, the model will be in a stage of "crawling - walking - running". In the coming quarters, the company is building features that are very important for advertisers to increase ad appeal, and is testing the features it has. The recently announced verification partner is an excellent example, and the company will also do more work in this area to serve brands.

Q: Is the user positioning selection at launch relatively limited; how will the user positioning improve?

A: Basic with Ads was quickly pushed to the market (delivered in just 6 months), which is the result of the efforts of the internal team and Microsoft team, and also proves that the company has basic user positioning capabilities, which is consistent with the TV world. In the digital world, 100% registered users are completely addressable and locatable. Over time, additional user positioning indicators will be gradually added.

It is worth noting that Netflix values ​​privacy, and all personal data is only used to provide more relevant ads.

Q: Is the CPM 1-2 times higher than other CTV or AVOD platforms?

A: No comment. Netflix provides attractive products for advertisers, which drives demand and pricing.

Q: In addition to strict frequency capping (4-5 minutes of ads per hour), what other innovations are there in the initial release and future development?

A: The advertising business begins with a user-centered experience, which will definitely affect the ad load rate and frequency cap. Fortunately, the demands of advertisers and the things the company thinks are beneficial to users are highly consistent. They are enthusiastic about not setting high frequency caps and providing more unique services, and the limited amount of ads also makes them more distinctive.

In terms of personalization, personalized functions will be established using presentation methods. In addition, the company is also working with advertisers to think about the advertising forms and experiences suitable for paid TV.

It is worth noting that part of innovation is the commercial innovation of market speed. Basic with Ads was delivered in just 6 months, and now the revenue from these 12 markets accounts for more than half of the total revenue, and the flexibility and speed embodied in it will push the company's innovation road farther.

Q: How do you view the new users and existing user group users of Basic with Ads?

A: Once again, it is reiterated that not many users have changed their subscription plans. Netflix is not guiding users to adopt one plan or another, but launching options that are beneficial to consumers to help them choose the plan that suits them.

The company has simulated the expected revenue from advertising monetization and incorporated it into pricing considerations, thereby determining that this would be a more attractive consumer-oriented model (lower price). Even if some consumers switch from subscription packages to advertising packages, their economic benefits will be better. Therefore, when considering adding new users, the company expects to bring substantial incremental revenue and profits.

Q: How to reduce churn by considering the characteristics and penetration rate of different markets?

A: Generally speaking, lower prices help reduce churn. We are still in the early stages and must launch this project. We will learn more in the coming months. Again, the best way to reduce churn is to keep users entertained.

Q: What are the special features of the Netflix-Microsoft deal that give the company confidence in advertising revenue prospects and how does it compare with long-term subscriptions?

A: One of the important factors in choosing Microsoft is the high degree of strategic alignment between Netflix and Microsoft. Microsoft's rapid learning and iteration capabilities are of great help to Netflix's innovation, and the ability to integrate the two has great flexibility in entering the market. Microsoft has many capabilities to enter the market, while Netflix currently has few, but will slowly establish them over time.

Both Microsoft and Netflix will recruit and build teams to better serve more advertisers.

Cable TV is declining, and the decline in the 18-49 age group is even faster than that of pay TV. This is the real reason driving this cycle, that is, the position of linear TV as an advertising carrier outside of a few areas such as sports has really collapsed.

Q: Is Netflix pursuing linear TV revenue or digital revenue?

A: When focusing on Netflix's distributor capabilities, the company has strong competition in linear TV. Over time, attractive digital portions will be gradually incorporated into the product.

In fact, the boundaries between the two will gradually become blurred. The company's job is to be highly competitive in new technical components such as targeting and positioning; on the other hand, the company currently has great competitive advantage - great content and audience that advertisers want to connect with.

Q: Currently Microsoft is responsible for the majority of advertising sales. What are the key costs and investments in advertising business?

A: Over time, unit economics will shift from neutral to positive; then incremental revenue and profits from subscription users will bring huge incremental revenue.

With our collaboration with Microsoft, costs will be generated in areas such as internal team building, etc.

Overall, as indicated in the Q4 guidance, the scale of the advertising business is initially small, and profits will gradually increase over time.

Second, on the content side

Q: Two of the largest English series, Stranger Things 4 and Dahmer, were produced in a period of 3-4 months. (1) Will this kind of content rhythm become normal in the post-epidemic era? (2) What contribution do these productions make to Q3 subscription growth and how to achieve greater growth momentum in Q4? Q: As content creation matures, the tempo of creating original content will improve. What level of progress can be expected in the status quo and next year to eliminate the impact of the epidemic on the monthly content?

A: The epidemic has caused many contents to be delayed, slowing down the overall production progress. It will take several years to completely eliminate its impact. Historically, the film and television cycle in the autumn is generally affected by film festivals and award cycles, so the proportion of Q4 content is slightly heavier than Q1Q2. The company actively smooths this out so that users can see the content they want at any time.

Moreover, this smooth supply of content is not only in English films but also in non-English ones. Many outstanding global local contents will be available in the third quarter, such as Brazil's "Sintonia," Germany's "AMbers," Poland's "High Water," and Korea's "Narco Saints."

A very good local content example is the Korean film "The Good Lawyer" with a global viewing time of 400 million hours.

Q: Has there been any change in the content selection strategy regarding content approval? Do you need to change it?

A: Over the past 10 years, the company has gone from nothing to building its IP library as quickly as possible, gaining more views, revenue, and profits, surpassing competitors who have worked in this field for more than 100 years. In this process, we have continuously grown from our mistakes, developed stronger skills and processes, and worked with creators to provide tools to ensure delivery quality. Some of these are proprietary, some of which benefit from business scale, which ensures that creators do what the company really wants -- pleasing the audience. In this way, Netflix has formed an unmatched scale, creativity, and user connection. Whether our strategy has changed, I would say we are constantly improving and becoming more mature. Last quarter alone, the company released its seven most popular works ever.

Q: Excluding the incremental costs caused by the epidemic, the cash spent on content of 17 billion has increased compared to last year. How to ensure that the quality and quantity of content provided in all regions meet expectations?

A: The scale, scope, and rhythm are all improving, and we are increasingly satisfied with the 170 billion content spending. The company's focus is that every $1 billion spent produces a better impact than anyone else. When revenue growth re-accelerates, the amount of content spending will be re-examined.

Q: We are looking forward to the sequel of "The Knives Out," "Glass Onion." We know it will be online on December 23, but why choose to be "released in 600 cinemas for one week"? Some people expect the release to be extended. How do you see this kind of film's distribution to promote Netflix's viewership?

A: Netflix's focus is on entertaining Netflix users by producing movies for them.

Netflix's movies are created by excellent filmmakers and are therefore very popular and have an important position in film festivals around the world. For those who cannot attend a film festival in person, this one week of screening on 600 screens is a way to create a sensational effect and a way to create some publicity and reputation for this work before it is released on Netflix. About Offline and Online Platforms

Q: After being online for a week, 600 films were offline and then released on online platforms.

About Subscription Accounts

Q: Yesterday it was announced that non-paying users can transfer their recommended and historical records to new accounts. When will this program be launched? Can you discuss how this plan can convert potential users into new paid subscribers or add them to existing user sub-accounts?

A: By keeping users at the center, the company has learned how to provide services that balance entertainment value and compensation.

"On the one hand, there is a personal account data transfer function (profile transfer)," which has many use cases. For example, if a child was watching before and an adult now uses the platform after the child has left, they would need to switch account information.

This time, the company tried different methods in different countries and found a suitable solution based on user feedback. After accessing Netflix using someone else's account, people can create their own independent accounts and continue to benefit from their viewing history and other information. In countries where the Basic with Ads plan is launched, this independent account is more attractive because of its lower price.

"The key here is that this feature also helps reduce account sharing. That is, it encourage users who borrow other people's accounts to create their own account to pay for services, because personal information such as browsing history can be easily transferred to the new account."

"On the other hand, account owners can create additional users (extra members or sub-accounts) to pay for Netflix services on behalf of friends or family."

"The company is actively proposing a series of options to support user choices, which are planned to be launched in early 23."

Q: Will the potential revenue from reducing account sharing be greater than the revenue generated by the advertising business in '23?

A: I don't want to say which one is better between it and the advertising plan. But in many ways, these two are complementary. The company is trying to meet different needs and find a balance, such as paying for friends or family to share Netflix services is a reasonable demand, and providing lower prices to balance advertising monetization is a reasonable demand for making Netflix content. The company is working hard to scale up to serve more people correctly.

Q: Why is there no customer growth guidance starting from Q4?

A: New sources of revenue will be developed in '23, such as advertising and paid sharing (accounts), and subscription users are only part of the revenue.

It should be noted that the company will still announce the user situation worldwide and by region in the financial report when announcing revenue and net subscription addition. In terms of revenue guidelines, basic driving factors for revenue forecasts will still be provided, but not the net increase in paid advertising. Everything else remains the same.

Performance and Future Prospects

Q: Q3 added 2.4 million subscription users. Why does the guidance for Q4 set at 4.5 million? A: The user churn rate in Q3 has increased slightly, similar to the situation at the end of Q2, but overall, the increase in new subscribers of 2.4 million has exceeded the company's expectations. The company is preparing for a good performance in 2023 in terms of content, marketing, reduced advertising prices, and paid account sharing.

1. In terms of content, Monster, the Jeffrey Dahmer story, The Watchers, and others will make Q4 a strong seasonal quarter.

2. In terms of advertising, there is no significant financial impact expected in Q4. In terms of paid account sharing, a plan will be launched in early 2023 to realize monetization of unpaid views.

In addition, short-term suppressive factors regarding revenue growth, such as exchange rates, competition encountered in entering the online TV market, energy prices, high inflation, macroeconomic and political pressure, etc., although still relatively vague, have already been included in the guidance.

Overall, the growth in net paid revenue for Q3 and Q4 has paved the way for accelerated revenue growth in 2023.

Q: What are the factors affecting the operating profit margin in Q4 excluding foreign exchange?

A: The main factor is still affected by foreign exchange, with a 2.5% forex drag effect equivalent to a $1 billion drag on revenue and $800 million drag on profit. With the accumulation of this year, the impact will also be evident in Q4.

Q: What is the impact of $17 billion in content cash expenditure on free cash flow in the next few years?

A: The company believes that $17 billion in content cash expenditure is correct. If revenue growth restarts, this expenditure level will be re-examined. Currently, every dollar of content expenditure now brings more user value than in the past. It is expected that the content will become better and better in the next few quarters and years.

Translated into cash flow, free cash flow has remained at about $1 billion in 2022 (fluctuating by tens of millions of dollars), and is expected to improve significantly on this basis in 2023. It is expected that the overall free cash flow in 2022 will greatly exceed $1 billion.

Q: What is the outlook for the development of streaming media?

A: Netflix and Disney are currently investing heavily and will become the two major brands in the paid field. YouTube is very powerful in connected TV, and all parties will continue to grow. It is believed that depending on whether the NFL's SUNDAY TICKET streaming content lands on Apple, Amazon, or other platforms, some sports-focused users will be converted to on-demand viewing.

Netflix's share steadily increases every year. The company has the best content and the lowest price, and is excited about the next stage with the motivation to do better than others.

Q: What is the most important thing you and your team hope to accomplish in the next 12-24 months?

Theodore A. Sarandos, Co-CEO, Chief Content Officer, and Director: Continuously refine tools to deliver higher quality and larger-scale content to serve more people. Spencer Adam Neumann, CFO and Chief Accountant, intends to increase profits and strength, as well as ensure that acquisitions in the past year meet expectations.

Gregory K. Peters, COO and Chief Product Officer, is actively improving the selection experience (content discovery and recommendation) behind the scenes to maximize user value around the world.

Q: Other Outlook on Q4

A: In terms of content, The Watcher has already amassed a large number of views; there will be return seasons of The Crown, Emily in Paris, Manifest, Dead to Me, Firefly Lane, Ginny and Georgia; an original story based on the World of Witcher; a new action series The Recruit starring Noah Centineo; Tim Burton's film debut will be on Wednesday; and Del Toro's new series Cabinet of Curiosities; Alice in Borderland, Barbarians, and Elite will return for new seasons.

Netflix is currently very satisfied with the level of user stickiness. It provides users with a large number of popular series and movies at an extremely cost-effective price during times of economic difficulty, and has stood out in the fierce competition for streaming revenue and viewing time.

In 6 months, Netflix will launch its advertising business. Based on the huge demand for this product and the good partnership with Microsoft, Basic with Ads will attract new users with its low price and excellent content.

In the future, television, movies, and games will all become streaming. Netflix seeks to expand its competitive advantage in these areas by actively bringing beloved shows, movies, and games to viewers, and obtaining healthy returns.

Risk disclosure and statement for this article: Disclaimer and general disclosure for Dolphin Research