Netflix (NASDAQ: NFLX ) , one of the world's largest providers of on-demand Internet television with over 44 million members, released its earnings for the fourth quarter of 2013 on Jan. 22. It was definitely another great quarter for the company, which reported full year net income of $112.4 million, almost $10 million above the Street consensus. The company's $4.4 billion full year revenue figure was in line with expectations.
However, the most interesting news regarding Netflix's latest earnings is that the company added 2.33 million paying customers in the U.S., way above the Street consensus of 2 million customers. Moreover, Netflix also added 1.7 million international subscribers. Netflix's user base growth is simply amazing, specially if we consider that competition for the Internet television market is fierce, with Amazon.com's (NASDAQ: AMZN ) Prime service and Hulu also competing to capture market share. In this difficult context, how did Netflix manage to acquire almost four million customers worldwide in a single quarter?
It's all about differentiation
To continue growing its user base in a competitive environment, Netflix is trying to differentiate its service as much as possible. At first, Netflix's differentiation strategy was based on acquiring as much exclusive content as possible.
Eventually, Amazon and Hulu started bidding up the price on library content in order to avoid losing market share. As a result, it's getting more expensive to obtain great content, as it can be seen from Netflix's weak profitability. Despite seeing more than $1.1 billion in revenue in the last quarter, the company only managed to convert $5 million into free cash flow.
Aware of the urgent need of an extra edge to remain competitive, Netflix started creating its own content. And the results have been very impressive. So far, Netflix's series have received over 80 major award nominations and wins, including the Emmy and Golden Globe awards for House of Cards, Orange is the New Black, Arrested Development and Hemlock Grove.
The company is producing original documentaries -- The Short Game, rated 7.6 on Internet Movie Database -- and partnering with famous studios like DreamWorks Animation to develop original animated series for children, such as Turbo F.A.S.T, which is on track to become one of the most popular kids series ever on Netflix.
As a way of adding more value to its membership, Amazon is providing perks like free two-day shipping on all Amazon purchases, and the ability to rent selected books for Kindle for free. The service also allows users to download, rather than just stream, certain videos. However, in the long run, the ability to consistently create great content may become the best way to achieve differentiation.
From now on
Netflix still has plenty of room left for future growth, as over the coming decades Internet TV is expected to replace traditional TV, growing from millions to billions. Moreover, Internet penetration and broadband speed should continue to increase in emerging markets. This will expand Netflix's addressable market.
The company has been operating its business nearly at a loss, as it invested heavily in content, software improvements, and marketing. However, a shift from top-line performance to earnings is expected. To improve profitability, the company is getting ready to overhaul its pricing strategy. For example, early in 2013, the company started offering its members the option to stream to two additional devices at a time, for an extra $4 per month.
Final Foolish takeaway
Despite already being the world's largest subscription streaming service, Netflix continues delivering amazing user base growth figures, thanks to a well-thought differentiation strategy based on creating top-quality, original content, sometimes in cooperation with famous studios.
The company is a must-watch, as it could benefit enormously from a global shift to Internet TV, which is expected to replace traditional TV in the long run. However, it's also important to pay close attention to the effects of legislation changes and modifications of pricing strategy on user growth.
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