Jen van der Meer

The Netflix Narrative: Subscription Superstar

Published: (Updated: ) in Business Model Narratives, Business Models by .

Swerving and pivoting a business model story for customer joy and massive shareholder value 

Thinking of a switch to a subscription model? We have much to learn from the swerves and pivots of today’s leading subscription company: Netflix.

Of the top 5 tech companies, only Netflix depends entirely on a subscription revenue model for success, keeping it free and clear from impending regulatory threats for data usage with advertisers.

“NFLX continues to execute extremely well, emphasizing its case as the best global, secular growth story in tech.” J.P. Morgan analyst Doug Anmuth

The company at first glance appears to be executing the subscription business model flawlessly. But take a look under the hood and you see bold, risk-taking bets and swerves by the founder that continue today.

What you can see in the Netflix business model narrative is how the company adapted and subscription model by adding new levers for growth, customer experience amazement, user lock-in, and world domination.

Driver 1: From Rentals to Subscription

The first big bet was to start the company on a new media type that had just emerged: the DVD. The founders had run a few experiments with the lead technology of the day, the VHS tape, but found the format too bulky and costly to ship. Slim, durable, and lightweight, DVDs could be shipped in envelopes and the founders believed that browsing the internet would be just as effective as shopping in a store. After first attempting one-time rental fees (with no late fees) and shifted to also offer a subscription model by 1999.

Subscription, be forewarned to those admiring the model from afar, is not that attractive in the early years. Netflix had to spend to acquire content, and then spend on huge US Postal Service fees as the service grew popular but before the longevity of customer cash flows arrived. The company was increasingly unprofitable as they grew. In 2000, the founders offered the company for sale to Blockbuster, and in a true Kodak moment, the board of Blockbuster rebuffed to a sale price of $50 MM, only to declare bankruptcy 10 years later.

Driver 2: From Envelopes to Streaming

The adoption of DVDs kicked in and the company continued to grow, but Netflix kept an eye on the rise of streaming technology as the next wave of media use. In 2008, the founders started to invest in streaming as if they were a pure-play streaming company. Most companies going through digital transformation tend to favor the leading revenue generating business. Instead, Reed Hastings demoted the DVD execs off of the core management team and executed a hard shift to offer streaming experiences. Netflix’s famous “culture” philosophy of high accountability originated at this time.

The streaming roll-out was accompanied by increased prices, which caused customer protests and a decline in stock value. In the long run, however, the bet paid off. The company is the global market share leader in streaming subscribers and affords the opportunity for almost limitless global market expansion.

Driver 3: From Licensing to Original Content

As content owners started to squeeze Netflix in content licensing negotiations, incumbent media companies started to increase their investments in streaming offerings such as Hulu and HBO Go. In order to keep their subscribers and attract new customers, Netflix had to up their game and create content not seen anywhere else. The company decided to invest in original content.

The introduction of the David Fincher series House of Cards about the charming Underwood couple changed how we watch media. Providing the full series all at once, Netflix gave us the opportunity to watch the whole series in one sitting, an experience now commonly referred to as binge watching. From a subscription model perspective, Netflix amped up their ability to achieve growth and customer lock-in. After last week’s earnings call, analysts estimate Netflix’s current customer retention in the 85%-91% range.

Today the company is one of the top 5 buyers of media and plans to spend over $8 billion next year to develop original content. As you can see in the Business Model Narrative above, the decision to invest in original content was the value supercharger that has driven growth in customers and company value. To be sure, the company has taken on substantial debt in order to fuel this international expansion. One day, revenue generated by customer may start to pay ahead of content required. For now, investors carefully watch ratios of spend-to-revenue and reward Netflix for over-delivering on growth.

Driver 4: From Hollywood to Bollywood and beyond

International growth plans have been brewing for some time, and recently paid off. This past quarter, of the 7.41 MM subscribers, 5.46 million were international, and last year the company doubled its customer base despite raising prices in all regions. Netflix combines local market strategies with an understanding of “taste communities” that the company mines from actual user behavior and determines what you might like based on activities of other people that like similar shows.

Netflix plans to spread the enormous content budget on local market production, while also finding shows to back that would have deep local appeal, giving high talent local creators access to a global market. Thus, Netflix achieves a virtuous circle of subscription lock-in and growth. For now, the rate of growth justifies the costs of original content, marketing in local regions, and global expansion.

Lessons for Future Subscription Business Modelers:

The best practices of business models cannot be easily copied. It’s not just about transforming your business from box or product sales to subscription. Look back to the origin stories of the more successful subscription models and you will see key decisions. How did the company strengthen user lock-in and ongoing investment in creating extraordinary experiences, to achieve massive customer growth and high customer retention? How will your company do the same? Are you prepared for the commitment to continuous investment in the customer experience? What will you do to earn the benefits of recurring revenues – the holy grail of the subscription model?

Learn more about the promises and pitfalls of the subscription model in Reason Street’s business model library.