References: [1]Citi: Focus, Scale and the Long Tail[2] JPMorgan: To Rent or to Buy, That is the Question.[3] The Four Types of Netflix Originals[4]

This article is authorized to be reproduced from the official account: Zhiyi Finance (ID: foronefin), author: Jiang Hao Corli, title picture from: Visual China

Netflix Why did the subscription system be selected among the four business models? How does the subscription system form the core competitiveness of Netflix together with the old film strategy and recommendation mechanism? What role did Dali Miracle play in the growth story of Netflix ? Why doesn’t Netflix make a cheap version of “ Netflix SE” with advertisements?

April 16, 2020, a year later, the market value of Netflix once again surpassed Disney : 's stock price hit a record high, with a market value of 192.7 billion US dollars, nearly 10 billion higher than Disney . Netflix has never been so proud: the increase in three days is more than 18%, and all investment banks in Wall Street unanimously gave buy ratings.

What situation does Netflix face in half a year ago?

shares fell 30% in the third quarter of 2019, with a $70 billion market value wiped out.

Disney+ was downloaded more than 9.7 million times within ten days of its launch in November (it is now reported that the number of users has exceeded 50 million, and it took 11 years for Netflix to exceed 10 million users)

Apple's budget for Apple TV in the first year was US$5 billion. Even if Apple TV is only one-third the price of Netflix , Apple TV's current TV series production cost is the highest in human history (joining Game of Thrones) - $15 million per episode. Apple will directly give Apple TV bundled sales to users who buy new phones. The current good situation of

Netflix is, on the one hand, thanks to the outbreak of the stay-at-home economy, and on the other hand, it is due to the foundation that Netflix can survive in the unlimited games in the content industry for decades - subscription-made . During the epidemic, advertisers have cut their advertising volumes, but the subscription model of Netflix is not affected at all. Driven by the epidemic, it has been passively expanded its user base and further created possibilities for the future to create integrated content platforms for production + distribution + viewing.

Netfly Why did Netflix choose the subscription system among the four business models? How does the subscription system form the core competitiveness of Netflix together with the old film strategy and recommendation mechanism? What role did Dali Miracle play in the growth story of Netflix ? Why doesn’t Netflix make a cheap version of “ Netflix SE” with advertisements?

The focus of this article is not to describe the competitive history of Netflix , but the story of how Netflix uses subscription system and technology drive as the underlying productivity and vigorously achieves miracles in each business cycle to obtain large-scale returns.

Content industry is an unlimited game, and the business model is a limited game

( Netflix 's first revenue growth peak: the rental war in 2004; the second revenue peak, the streaming home entry battle in 2011; the third revenue peak: the 2018 World War")

Why is the content industry an unlimited game?

Since its launch in 2004, Netflix has never stopped fierce competition, even if the business model has changed again and again, even if the business model has changed again and again. : The "rental war" between Netflix , which was just launched in 2004, Walmart and Blockbuster, and the result was Walmart launched, and Blockbuster went bankrupt; the "streaming home entry battle" started in 2011, and the result was that Netflix gave up the "dual track system", and a member can enjoy DVD rental and streaming services at the same time; the "world war" of mobile streaming started in 2018, Netflix VS the whole world:

What players are there in the US streaming market today? Amazon Prime Video, Google's Youtube TV, Apple's Apple TV, century-old store Disney , HBO Max, the largest telecom operator in the United States (the copyright of "Friends" of ATT in 2020 has expired, and you can only watch it on HBO Max in the future), and Peacock, a subsidiary of Comcast, the largest cable TV operator in the United States.

Note: The basic package price, standard package and premium package of Netflix are $8.99, 12.99, and 15.99/month, but the basic package of Netflix does not support high-definition video playback. The financial report shows that the ARPPU of US users is $13.32. Therefore, it can be considered that the "basic package" of Netflix is $12.99/month

. However, among all streaming platforms, the price of Netflix is the highest (except HBO Max). Why can , Netflix, which seems to have no advantage in price and total content, break through the siege? Even if the impact of the epidemic is ruled out, the Viewing Per Membership (per-user viewing) of Netflix was still rising before the outbreak. Of course, it is not ruled out that the competitive effect has not yet been fully revealed, but the strong user growth truly reflects the competitiveness of Netflix .

First look at this screenshot, from the 2004 Citibank research report "Focus, Scale and the Long Tail (focus, scale and long-tail effect ) [1]":

The first sentence translated is: We believe that the main risk faced by Netflix is the irrational strategy of competitors - using "any possible price" to enter the market.

(In 2005, Walmart and Blockbuster's pricing were basically lower than Netflix )

Netflix did the right thing? Netflix 's change and unchanging

1. Summarize Netflix 's methodology is: uses subscription system and technology to drive unlimited games, and uses great efforts to deal with miracles to deal with cable games. What changes is the market, the business model, and the direction of vigorously producing miracles, but what remains unchanged is the value brought to users by subscription system and technological progress.

achieves stable cash flow expectations in the future through subscription system, and can make stable content investments in the future. Because the recommendation mechanism has a very high inventory utilization rate and the old film strategy makes the content cost extremely low, the return on investment is extremely high, and the unit economic model is established, so Netflix "makes miracles": spending money crazy in advertising to buy users, and spending money crazy in logistics to build a distribution center.

thus formed positive feedback: better services, more users, more revenue expectations, more content and logistics investment, better services... The core of all positive feedback is precisely the subscription system.

Fifteen years ago, why did Netflix choose the subscription system from four modes?

(2004-2018 Netflix Disney investment return comparison, left axis Netflix , unit 1000%, right axis Disney , unit 1%)

In May 2004, Netflix was listed with 1 million users. The year before, DVD just surpassed VHS and became the main format for American home entertainment content playback, with a market size of US$5.7 billion. The DVD rental market also has great prospects, and IDC expects the DVD rental market to grow by more than 20% each year in the next three years.

At that time, the giant in the videotape rental market was Blockbuster. At its peak, there were 50 million registered users, 20 million active users ( Netflix did not reach this number until 2011), and 9,000 stores, accounting for more than 54% of the market share (JPMorgan 2004). The main business model is offline leasing. A DVD can be rented for 3 days for USD 5, but if it is not paid back within the deadline, there will be a fine. After the launch of

Netflix , it became famous. Under pressure, Blockbuster also launched a subscription service in 2004, but giants always have big problems: Blockbuster's subscription members can only place orders online, and are not common with in-store rental services; in order to "flexibly" launch offline assets, Blockbuster did not build another distribution center but used the store's warehouse to ship online orders (specific analysis will be made later).

At that time, there were four main modes for movie screening: Blockbuster's offline rental model, PC-side MovieLink's PPV (Pay Per View, pay per movie) mode, wired broadband (VOD) and Netflix subscription model. Why did Netflix choose a subscription model that no one else did? In addition to the concerns that users do not have overdue fines and extremely high user satisfaction, what advantages does the subscription system bring to Netflix ?

First of all, the first point is to maximize cost savings: users who pay by will definitely find the latest and most popular movies. For Blockbuster and other channel providers, the cost of movies is always a hurdle, but for subscription users, it only needs to meet their "continuous and uninterrupted" viewing needs. This is also the reason why Netflix always adheres to the "old film strategy (back-catalog) ".

Boshida's cost of a videotape is even as high as US$90, but in 2004, the average purchase cost of a DVD of Netflix was only US$18 (of course, Netflix later adopted the content sharing system, with only US$1-2 in advance for each DVD, and the revenue of each DVD will be shared with the producer within 12 months, further reducing the cost of capital occupation). According to Credit Suisse's calculations, the purchase cost of new movies from DVDs on major content channels was US$16 per picture in 2009, but the cost of old movies was only US$7 per picture.

The following picture shows the proportion of new and old movies of Netflix and Blockbuster. It is not difficult to find that the proportion of new and old movies of the two is completely inverted. Within two months of the release of the new film, the number of DVDs purchased by Netflix is generally only 10% of that of Blockbuster. How do old movies meet user needs? The answer is the recommendation mechanism, which recommends related movies based on the user's rating history of viewing content. Unlike many people's impression, at that time, it was not the only one who made recommendation mechanisms in the market. Filmcaddy, an online leasing company under Blockbuster, also provided viewing suggestions for users. Why couldn't Filmcaddy make Netflix ?

recommendation mechanism + old film strategy = long tail effect

problem is that only the recommendation mechanism plus old film strategy can maximize the role of the long tail effect.

on the one hand, through the old film strategy, reduce the cost of content purchase, and maximize the enrichment of the content library under the same budget. On the other hand, through the recommendation mechanism, users will be recommended to watch "long-tail content" that would not have been paid attention to, maximizing the efficiency of inventory usage.

For Netflix , the most core fixed assets are also the most important fixed costs - DVD. Through the combination of old film strategy and recommendation mechanism, extremely high investment returns can be guaranteed and fixed costs can be quickly recovered. Netflix is also more confident in making large-scale investments. In the fierce market competition, facing Blockbuster, which has a larger scale and stronger financial resources, the strategy of Netflix is not only a differentiated layout, but also a lifeline for preserving funds. The

recommendation mechanism can also promote user activity and make up for the lack of content brought by the old film strategy: by early 2005, Netflix accumulated more than 400 million ratings, and at the end of 2005, the cumulative ratings exceeded 525 million. We conducted a simple calculation. The number of Netflix users is 3.5 million (average at the beginning of the year and at the end of the year), an increase of 125 million ratings in 11 months, which is equivalent to each user giving 3.3 movie ratings per month. According to financial report data, , Netflix, , each user watches an average of 6.6 movies per month. means that users will rate 50% of the movies.

In 2004, based on the recommendation mechanism, Netflix launched the "Friends" system. You can see movies recommended by friends, as well as the family party system, the minor and severe user priority system, etc., which are all manifestations of Netflix 's emphasis on technology-driven.

makes great efforts to achieve miracles: to achieve the extreme business model that seems to have no threshold

If subscription system and technology drive are the underlying methodology of Netflix , then in a specific business model, the operation methodology of Netflix must be a miracle. has low content costs due to the old film strategy and recommendation mechanism, and the unit economic model is established. Therefore, Netflix spends money at the same time on the revenue side and the expenditure side (Is it a slight similarity to the current APP factory strategy?), the revenue side is crazy buying and increasing users, and the expenditure side is crazy about building factories to increase delivery speed.

According to the calculations of consulting companies and investment banks at that time, the life cycle of Netflix users is 21 months multiplied by US$20 ARPU to get LTV=436, minus the basic cost of 246 yuan, fulfillment fee of 47 yuan, customer acquisition cost of 35 yuan, RD investment of 22 yuan, plus DA cost of 87 yuan, EBITDA can be 159 yuan, plus 36.6% margin, EBIT can be 73 yuan. The unit economic model is valid, so the cash flow of Netflix has always been positive. At the end of the first quarter of 2004, the company had 150 million yuan in cash on its accounts and had no liabilities.

It is not difficult to find that in the unit economic model, the cost of acquiring customers is even lower than the user's lifetime performance fee. Therefore, the decision of Netflix is: as long as the customer acquisition cost (SAC) is calculated to be less than US$30, how many advertisements are there to buy as many advertisements, the result of is that paying customers increased by 72% in 2003. In Q1 2004, TV advertising was added to part of media marketing, allowing customer acquisition costs to rise to around $35. In 2004, the number of paid customers increased by 84%, achieving the first leap in the number of users and revenue scale (a peak in the company's revenue and market capitalization chart above).

In June 2004, Netflix had 25 distribution centers (Walmart has only 6), and 80% of users could achieve next-day delivery; in August 2004, there were 27 distribution centers, and after half a year, they upgraded to 29, and 85% of users received next-day delivery; at the end of 2005, there were 37 distribution centers, and 92% of users achieved next-day delivery; in 2009, there were 50 distribution centers, and more than 97% of users achieved next-day delivery.

Baseda refused to build a distribution center when it launched online DVD rental business. On the one hand, it hopes to flexibly utilize the manpower and material resources of existing stores to improve the efficiency of asset use. On the other hand, the distribution center needs additional DVD inventory, which is another huge investment, and it is difficult to coordinate and manage the inventory of the store. In Blockbuster's eyes, Netflix is a delivery tool after all, and Blockbuster's entry threshold cannot be lower: just open a website and then ask the store employees to ship the goods.

But it turns out that Netflix successfully achieved a seemingly no threshold business: Blockbuster's SKUs in inventory are extremely limited, and it is difficult to compare with the distribution center whether it is the absolute number of single films or the total movie types. Baseda users often need to rush to order the movies they want. After all, there are only a few popular movies in a store, but there are endless treasures in the warehouse of Netflix .

At the same time, Blockbuster's store management system is far less advanced than the Netflix distribution center. Store employees take a lot of time to process online orders and users return DVDs. However, Netflix even developed a special automated logistics system , which can automatically identify which DVDs can be sent to the next user (because 85% of the returned DVDs will be sent directly to the next user), which can automatically identify which DVDs are damaged, automatically label the envelope (the DVD is installed in the envelope), automatically package the goods, and automatically classify the DVDs in the warehouse.

So everything forms a closed loop: can accurately calculate future income and cash flow through the subscription system, and on this basis, it makes corresponding content investment. Because the recommendation mechanism utilizes inventory very high and the old film strategy makes the content cost extremely low, the return on scale investment is extremely high. Therefore, Netflix can further invest in logistics and other infrastructure. After the service quality is improved, the number of subscription users of Netflix continues to rise, and the entire closed loop continues to .

Fifteen years later, how did Netflix achieve a closed loop?

Fifteen years later, there is no logistics and DVD inventory in the streaming business model, but the story of Netflix is still: the subscription model is moving towards global users, and the recommendation mechanism, customer acquisition, and infrastructure investment are combined into a strategy: localized self-made drama .

opens markets with completely different languages, cultures and customs. It relies on the Netflix self-produced drama filmed based on different cultures in various countries and regions. From the self-produced drama "Drug Lord" that truly opened the Latin American market in 2015, to the Portuguese TV series "3%", the French TV series "Marse City", the Japanese TV series "Nude Director", the Korean TV series "Itaewon", " Smart Doctor Life ", and the British TV series "Crown", they are all "fist products" that target various markets and establish brand image. The word-of-mouth effect brought by localized dramas is the best way to recommend and acquire customers. The Spanish-language TV series "Book House" launched last year attracted more than 45 million families to watch. There are four types of self-produced dramas by

Netflix : Netflix purchase scripts, select crews, and produce one-stop self-produced dramas, Netflix buy out self-produced dramas with exclusive global network broadcast rights, self-produced dramas jointly produced by Netflix and limited network TV stations, and the last one is self-produced dramas that were suspended before the resumption. [3]

For example, " House of Cards " and "Crown" are the first 100% authentic Netflix self-produced dramas, "Itaewon" is the second type: Netflix bought the global exclusive broadcast rights of more than 20 Korean TV series JTBC, and "Black Mirror" is the fourth type. Netflix CEO Hastings disclosed at the 2019 fourth quarter investor conference that Netflix localized dramas have exceeded 130

localized self-produced drama strategy. The last part of the strategy is the new infrastructure: the web and client design of Netflix can be used worldwide, and you can use it in another region as long as you change your language, but this is only the most basic. The subtitles, audio and even posters of Netflix can be set according to user needs:

(set as Chinese user interface, movie posters are all Chinese)

(subtitles are not embedded subtitles like iQiYouTeng, and can be switched directly with audio) The result of the new infrastructure of

is that one investment can be replicated to global users indefinitely, which is truly close to the ideal state of zero marginal cost of the Internet. Therefore, the unit economic model of self-produced dramas is also established, and Netflix is naturally willing to vigorously develop self-produced dramas. The results of localized self-produced dramas are very significant. On December 17, 2019, Netflix announced the number of subscribers in various regions of the world for the first time. European Middle East and Africa are the largest group, with doubled users in two years: there were 47.4 million subscribers in Q3 2019, and only 19.7 million (+140%) in Q1 2017; followed by Latin America, with doubled users: 29.4 million users (+90%) in Q3 2019; finally, the Asia-Pacific region, with tripled and 9 times revenue: 14.5 million users (+209%) in Q3 2019, and revenue increased from 116 million to 1 billion.

" Netflix SE" possibility: Why does Netflix insist on not advertising?

Finally, let’s look at a key issue in which Netflix “surpasses” other streaming media platforms during this epidemic. Why doesn’t Netflix advertise?

In all aspects, Netflix seems to have no reason not to advertise: the number of cable TV users is declining, but advertisers' demand (after the epidemic) is still there, and this part of the advertising budget must be invested. Netflix should not just give other channels and platforms to eat :

According to Bloomberg, the advertising revenue in the OTT market can triple in the next four years. Digital TV predicts that the market space of AVOD in 2024 is 36% larger than the SVOD model led by Netflix .

OTT: It can be understood as a channel other than traditional limited TV

AVOD: Ad-supported-Video-On-Demand, it can be understood as a content channel with advertising, such as Roku and hulu

SVOD: Subscription-Video-On-Demand, referring to a subscription-based content channel mainly Netflix

In addition, Netflix "originally" has a large amount of viewing data that can be used to analyze user needs. The data type, data model and data volume of streaming media platforms are unmatched by cable TV stations. also looks at the demand side, and there are also a large number of users who have free needs. All of this can be solved by launching a free ad-friendly Netflix -" Netflix SE".

Naihe Wall Street has analyzed the possibility of " Netflix SE" since 2005 (JPMorgan[2]) , Netflix is the unshakable route of subscription system. The main reason is Netflix 's confidence in the subscription system model and its clear positioning:

Netflix has no advantage in the advertising market, even if it is "massive" use User viewing data is also difficult to compare with the "huge amount" user data of Google, Amazon , and Facebook :

"Even if you want to obtain 5 billion advertising revenue from these three companies, the cost and competitive pressure to invest are still too great. In the next ten years, these three companies (Google Facebook Amazon ) will obtain unlimited data, and Netflix has no advantage and is unwilling to obtain too much data" [4].

From another perspective, the ambition of Netflix is definitely not limited by billions of advertising revenue. As mentioned above, Citi Securities suggested that Netflix advertise on envelopes and web pages in 2005, and used 500 million ratings accumulated at that time for data analysis. 's advertising revenue in 2006 can reach... 10 million US dollars. At any point in the past, if Netflix advertised, its revenue scale will be smaller than the member revenue volume of Netflix today.

The last angle is that Netflix 's market share in the global streaming media industry can far exceed its share in the advertising market, and the monopoly pricing benefits brought by monopoly positioning must be higher than the benefits brought by the fiercely competitive advertising market. Take the markets of China and the United States as an example. Every province and every city in China has basically a TV station, but how many long-term streaming video platforms are there in the country? iQiyi Youku Tencent three. There are so many wireless TV stations, cable free TV stations, and cable paid TV stations in the United States, and the streaming media platforms that survived are only two hands. Netfly is still smart.

From being born under the battle of giants at the beginning of its establishment, to today's global storm, the subscription system has been the foundation of Netflix . Today, Netflix can stand out among global streaming platforms, and it is also a reward for maintaining strategic determination in decades of unlimited games. Looking back at the Chinese market, which company do you think has the most Netflix temperament?

Reference:

[1] Citi(2004): Focus, Scale and the Long Tail

[2] JPMorgan(2004): To Rent or to Buy, That is the Question.

[3] The Four Types of Netflix Originals

[4] Netflix 2019Q4 Earnings Call

[5] Data source: Bloomberg, Wind database, Yahoo Finance, CSRP by Wharton Business School

[6] Some sources of view: Research reports from Jefferies, Lehman Brothers, Credit Suisse, Macquarie, Barclays, Deutsche Bank, etc.

[7] Netflix Culture Manual (2018)

[8] HBO's content strategy (2019)

[9] Yuanshou Jin Laohan: Video War 2020