The Great Netflix Correction: loss of subscribers throws streaming business model into question

Netflix has stemmed the bleeding.

Last quarter, the streaming group shocked both Wall Street and Hollywood with an abrupt end to its decade-long growth spurt, triggering a dramatic fallout likened to the dotcom crash.

This quarter, Netflix won by setting expectations low, and exceeding them — with the help of a new season of the hit show Stranger Things.

Shares climbed more than 7 per cent in after-hours trade after Netflix said 970,000 subscribers cancelled their accounts in the second quarter. It was the worst subscriber loss in its history but as Netflix had forecast twice as many defections, investors were relieved.

“It’s tough . . . losing a million and calling it success,” cofounder and chief executive Reed Hastings said plainly on Tuesday. “We’re talking about losing 1mn instead of 2mn. Our excitement is tempered by the less bad results.” 

With a recession looming and inflation soaring to 40-year highs in the US, Netflix is grappling with a more cost-conscious consumer. While it previously lured people in as a cheap alternative to their pricey television bills, Netflix is now the most expensive option among a sea of copycat streaming services.

“The cost of living crisis [is] having a profound impact on all companies”, said Paolo Pescatore, analyst at PP Foresight. “No one is immune.” 

This spending squeeze is happening at the same time that the world’s largest media and tech companies have unleashed a gutsy, expensive effort at competing with Netflix.

“Competition has gotten to levels that are sort of absurd,” said Rich Greenfield, analyst at LightShed, referring to the steep spending commitments new entrants have made. “I don’t think there is anyone in the investment community who anticipated [Comcast’s] Peacock losing two and a half-billion dollars”. 

The impact has been harsh and sudden. As recently as January, analysts predicted Netflix would add 20mn subscribers in 2022. Now, Netflix is hoping to break even for the first nine months of it.

Netflix was the worst-performing stock in the S&P 500 for the first half of this year. Its market value has shrunk from more than $300bn in November, to $90bn.

The ‘Great Netflix Correction’, as it has become known in Hollywood, has triggered anxiety about the streaming business model and the future of entertainment. Netflix’s stumble has set off a sell-off across media stocks, wiping tens of billions in value from giants such as Disney and Warner Bros.

Morgan Stanley this week described the situation as the “first streaming recession”. “Streaming video revenues may prove more vulnerable than expected to a global recession and lower consumer spending levels,” warned analyst Ben Swinburne.

Bank of America cautioned that streaming has “very quickly become a commoditised product”. 

The question for both Wall Street and Hollywood is whether this downturn is temporary, or if the streaming business is fundamentally less attractive than executives had assumed.

Netflix’s second-quarter results provided lukewarm evidence supporting the former. The company is on a path back to growth, albeit by a hair — predicting it would sign up 1mn subscribers in the third quarter.

Cancellations have been most acute in the US and Canada, Netflix’s largest market, where nearly 2mn people ditched their accounts in the first half of this year.

At $15.49 a month for its most popular plan, Netflix costs more than its major competitors, including Disney Plus and HBO Max, which charge $8 and $15, respectively.

Netflix is also being challenged on its content. Co-chief Ted Sarandos on Tuesday described his company’s programming as “delivering hits on top of hits”. But the company has fallen behind HBO in Emmy nominations — one measurement of quality — with 105 to HBO’s 140 this year.

It is unclear how many streaming services households will pay for, particularly in a recession, and Netflix has lost its “bulletproof, must-have status”, said Michael Nathanson, analyst at MoffettNathanson.

Already there are more video streaming subscriptions than there are people in America, with 380mn subscribers to a population of 330mn, according to data company Ampere Analysis. Globally, Netflix has previously touted a pool of 1bn potential customers who have access to the internet. Now, Nathanson warns the potential market may be closer to 400mn. 

So far this year, Asia-Pacific is the only area where Netflix has been adding subscribers. The company signed up 2.2mn people in the region in the first half of 2022, while losing customers in the rest of the world.

Netflix executives this week appeared to be in damage control mode, taking shots at rivals and offering up data to prove its dominance.

One example: during the 2021-22 television season, Netflix drew more viewership than broadcasters CBS and NBC combined, according to Nielsen figures provided by Netflix. Other data points were less compelling, such as Twitter engagement for Stranger Things outpacing that of Paramount’s Top Gun Maverick — a movie that made more than $1bn at the box office.

Despite this year’s slump, Netflix remains far ahead of rivals, with 221mn subscribers to Disney Plus’s 138mn. Netflix also makes a profit on its streaming service, unlike its competitors, and expects to end the year with $1bn in free cash flow.

Nonetheless, Netflix management has announced sweeping changes to revive subscriber growth. It is working with Microsoft to offer a cheaper service that serves advertisements, and plans to limit password sharing, through which it estimates 100mn households are watching Netflix for free.

These moves won’t take place until 2023. For now, Netflix will depend on hits to carry it through the second half of the year. It will be helped by a new season of The Crown and the sequels to Knives Out and Enola Holmes. “We’re executing really well on the content side,” Hastings said.

But the streaming group still lacks its own Star Wars or Harry Potter. Ross Benes, analyst at Insider Intelligence, warned: “unless [Netflix] finds more franchises that resonate widely, it will eventually struggle to stay ahead of competitors that are after its crown”.