Netflix: Disanchoring
Imagine all the margin, it's easy if you try
Netflix reported its fourth-quarter results on Thursday. Here’s the shareholder letter and the transcript.
The headlines focused on Reed Hastings stepping down as co-CEO. That is understandable. Certainly, he is a business legend, having co-founded a DVD-by-mail startup, vanquished larger competitors, and pivoted the business twice, first by pioneering into streaming and later into original content. Netflix now dominates the field with $32 billion of global streaming revenue from over 321 million global household users, including 231 million who are currently paying for it. There is no doubt him stepping down as co-CEO and up to executive chairman is newsworthy. He is on my Mount Rushmore of business leaders.
However, he is leaving the day-to-day in good hands. Ted Sarandos has been co-CEO since 2020 and had been essentially co-running the business for a decade before that. Reed had actually stepped back to focus on philanthropy and his book until he reasserted himself early last year when Netflix’s growth decelerated sharply. But he has relied heavily on Ted and new co-CEO (former COO) Greg Peters for a very long time. Greg spearheaded the creation of the brand new ad business, taking it from an idea to reality in about six months, which is completely absurd. And in any case, Reed will still be involved and available as executive chair and major shareholder. But he is 62 years old, has all the money in the world, and has strong leaders who are more than capable of being formally recognized for they’ve been doing for some time.
That’s why this is a silly question:
The answer to this question is almost always that it’s going to be business as usual. It wouldn’t be, “Yes, we are going to acquire theaters, abandon original content, and plow streaming profits back into the DVD business. Reed hated these ideas of ours, so naturally he put us in charge. And now we’re free to execute on them (even though he is executive chair).”
I think Reed, Ted, and Greg are very much on the same page strategically. While Greg alluded to the fact that others internally warmed up to advertising sooner than Reed did, the team got to the same place eventually. And they have been giving strong signals that they are very open-minded about strategies and tactics in the years ahead.
For example, live sports is on the table if they can figure out a monetization framework that works for Netflix. The current model is to amortize fixed cost content across a growing base of subscriber (and now ad) revenue, which drives margins up over time. Renting sports rights that reprice higher every few years prevents that. That’s behind Ted’s comment that they “are not anti-sports, they are pro-profits.” Renting sports rights would also be a missed opportunity because Netflix has the unique power to significantly boost fan interest and engagement in the sport through their docuseries projects, but it wouldn’t execute that plan if it would drive up its own content costs.
Look at Drive to Survive, Netflix’s F1 docuseries that completely blew up the sport. In 2019, before DtS, ESPN was paying $5 million per year for the F1 TV rights. Thanks largely to DtS, last year, it agreed to pay $75-$90 million per year. An astounding 53% of F1 fans said DtS played a role in them becoming fans of the sport. Of course, Netflix does not want to give the sports leagues these gifts for free. Naturally, it wants to maximize its own participation in the value it creates.
We don’t know the economic terms for DtS, Break Point, the new tennis docuseries, or the several other sports docuseries (golf, rugby, Tour de France, World Cup soccer) that are being released this year. But I would expect each of them to increase fan interest and engagement with the respective sports just as DtS has done for F1. So, and I’ve written about this a few times, I don’t think Netflix should be paying for this content. I think the leagues should be funding the content creation, giving Netflix the perpetual rights, and compensating Netflix for making it available to its roughly one billion global viewers. It is unbelievably effective advertising—roughly 10 hours of advertising per season to the millions of people who watch it—which increases live viewership, ticket sales, concession sales, and overall fan engagement. It is a proven model, in my view, driven by Netflix’s unprecedented scale and engagement. Even Queen’s Gambit completely blew up sales for chess sets and books:
Which party—F1 or Netflix—benefits more from DtS being on Netflix? Remember, 53% of F1 fans cited DtS as a reason they became fans. And the TV rights skyrocketed in value by 15-18x in three years. On the other hand, DtS almost certainly accounts for a fraction of 1% of Netflix viewing hours. It is one drop in the content bucket. So who needs this arrangement more? The answer should dictate who pays who.
Buying Leagues?
One very direct way for Netflix to participate in this value creation would be to own…