What Netflix Costs

Last week, my column focused on the continuing dependence of many traditional pay TV players on advertising as a source of revenue. The day that column ran, Netflix reported its financial results for the second quarter and they highlighted just how good a business Netflix has built by eschewing that reliance on advertising and providing an ad-free service.

$5 per month per subscriber

That’s how much Netflix costs to run on a per-subscriber basis in the US. See the chart below, which shows Netflix’s monthly revenue per paid user in the US and its “cost of revenue” (essentially, the costs of content and content delivery) per subscriber on the same basis:

Increasing margins as a result

As you can see, that cost is actually steadily falling over time – it was about $5.70 three years ago, at the beginning of 2012, but has fallen by around 70 cents since then and is likely to continue to fall. Meanwhile, Netflix’s revenue per paid subscriber was very steady at $8 (its price was $7.99) for quite some time, but recently began rising slightly as it increased the standard price for monthly subscriptions by a dollar — it’s now about $8.40. The net result? An increase in profit margins, naturally. Bear in mind Netflix’s contribution profit metric also subtracts marketing costs, the other major service-specific cost it incurs, from revenue:

Netflix is the company with the most predictably rising margins of any tech company I follow – aside from a couple of blips, it’s marched steadily onwards up that line and in fact is currently slightly ahead of its own projections on margin too. It has a stated goal of 40% margins by 2020, but might actually get there earlier.

The international picture is different

Internationally, the story is quite different. It is profitable on a pure cost of revenue basis, though only barely:

However, the high costs of marketing in new countries Netflix enters puts the international business into the red, where it is likely to stay as the international expansion continues. Both domestically and overseas, Netflix spends around $50 on marketing for every net new subscriber it gains.

Netflix, Hulu, and others

Why do I mention all this? Well, to make this simple point: though we’re accustomed to paying $80-100 per month to a pay TV provider for a range of content to meet our needs, many of us are increasingly paying just $8-9 per month to Netflix for a service that costs just $5 to run and, for many people, provides much of the video content they consume. How long can this situation continue? And in a world where Netflix is able to do this so cheaply without showing any ads, how sustainable is the business model for traditional pay TV providers? It’s worth noting Hulu just began testing a concept for an ad-free Hulu subscription at $12-14 per month or well under double what it charges today for its offering with ads. I suspect Hulu and its owners are beginning to recognize the challenges associated with running a paid subscription service with ads in the face of Netflix’s success. But, as I pointed out last week, others need to do so as well, especially those that currently have far heavier ad loads than Hulu.