By most accounts, it was a stellar fourth quarter for Netflix (NASDAQ: NFLX). The streaming leader brought in another 8.5 million paying customers, easily exceeding Wall Street estimates. It also more than doubled its operating revenue year after year, highlighting the triumph of membership growth.
However, be careful in assuming that Netflix’s fourth-quarter explosion of profit margin represents the new norm. The transmission giant has cut spending in an area where it cannot save for long. In fact, we are already seeing subtle evidence of the adverse impact of this cost cut.
Image source: Getty Images.
Curious cost cut
Last quarter’s revenue of $ 6.64 billion was a 21.5% year-over-year improvement. The cost of Netflix’s revenue – its spending on purchasing or producing video content – has also grown, but not so much. The company spent $ 4.16 billion on content, 20.2% more than the $ 3.46 billion it spent during the last quarter of 2019. Technology spending grew nearly 9% year-over-year, while administrative expenses increased 8.2%. Keep in mind that administrative expenses are the smallest portion of this company’s operating costs, so the slowdown in growth has generated the least tax benefit.
However, there is a curious disparity in Netflix’s fourth-quarter income statements. Instead of increasing along with other expenses, marketing expenses fell 13.2% year on year, from $ 878.9 million to $ 762.5 million. This $ 116.4 million difference accounts for about a quarter of the additional $ 496 million that the organization reported as operating income during the fourth quarter. And, assuming that marketing expenditures would have grown similarly to other expenditures in a non-pandemic environment, it can be argued that the drop in marketing expenditures has led to almost half of Netflix’s profit growth.
| Metric | Fourth quarter of 2019 | Q4 2020 | change | % Change |
|---|---|---|---|---|
| recipe | $ 5.467 billion | $ 6.644 billion | $ 1.177 billion | 21.5% |
| Revenue cost | $ 3.466 billion | $ 4.165 billion | $ 699 million | 20.2% |
| Marketing | $ 879 million | $ 763 million | ($ 116 million) | (13.2%) |
| Technology and Development | $ 409 million | $ 487 million | $ 78 million | 18.9% |
| General and administrative | $ 255 million | $ 276 million | $ 21 million | 8.2% |
| Operating income | $ 458 million | $ 954 million | $ 496 million | 108.1% |
Data source: Netflix.
Maybe it doesn’t matter. As noted, Netflix still managed 8.5 million subscribers in the last quarter, bringing its annual gain to 36.6 million. The company is also already a market leader and may simply be facing headwinds of saturation.
However, Netflix seems to have paid a high price for not promoting its product as aggressively as in the past, and despite the clear increase in promotional spending from moderate levels in the second and third quarters.
Cause and effect
Market research firm Kantar explained earlier this month ATTHBO Max was the big winner in the fourth quarter in terms of new media streaming subscriptions in the U.S. In all, HBO Max gained 19.2% of total domestic video-on-demand subscriptions in the quarter. The next best platform was AmazonPrime, with 18.2% of new SVOD subscribers. Walt DisneyHulu and Disney + came in third and fourth, respectively, with 13.7% and 13%. Netflix’s fifth-place showing was a far-off 7.4% disappointment. In that sense, only 860,000 of the 8.5 million members that Netflix signed up for in the fourth quarter live in the United States or Canada.
There is nothing inherently wrong with that. Netflix’s streaming service has been available in the United States for more than a decade and there is a real possibility that it is close to market saturation here. That is why your international business has been a high priority for some time.
Still, Netflix has only 73.9 million Canadian and American subscriptions, against 135 million homes found in both countries. That represents 61 million potential families that Netflix could still bring.
Here’s another way to look at it: how the growth of Netflix members was so much weaker than the growth of rivals’ subscribers during the fourth quarter although Netflix is great sequential increase in marketing expenses?
Data source: Netflix. Author’s graphic. Dollar figures are in the thousands.
Investors may be wondering whether these results are related to the cutbacks in promotional spending that began in 2019. If the slowdown in growth in North America is a harbinger of similar issues that are mounting on the international stage, perhaps retreating in marketing spending now don’t be the ideal move.
it’s worth watching
Netflix is not doomed. The king of streaming is still profitable and is increasing its margins in ways other than through unsustainable spending cuts. Revenue grew by almost $ 1.2 billion year after year during the fourth quarter, for example, while its cost of revenue grew by only $ 700 million. The company’s letter to shareholders in the fourth quarter even mentioned its march toward sustained positive free cash flow, adding “we believe that we no longer need to raise external financing for our day-to-day operations”. This means that soon the company will be able to add revenue without spending as much or more on programming.
We cannot assume that part of Netflix’s margin growth rooted in reduced marketing spending is sustainable. Many people are still in quarantine and are looking for ways to relieve boredom. But with coronavirus vaccines being distributed now, it will be more difficult to get their attention. The advent of HBO Max in a competitive market that already includes Disney + means that Netflix may need to spend even more on marketing – not less – than in the past.
This is certainly something for current and future Netflix shareholders to keep an eye on.