Netflix, Inc.'s Major European Expansion Is a Risky Move

Netflix,'s (NASDAQ: NFLX  ) plans for a major European expansion are now official. The company intends to launch service in 6 new European markets this fall. The "headliners" of the expansion are France and Germany, as has been widely rumored since late last year. Netflix will also enter Belgium, Luxembourg, Austria, and Switzerland.

In the past, I have highlighted the high short-term cost of Netflix's international expansion. While the existing Netflix international markets are likely to turn a profit by Q4, the 6 new markets could lose on the order of $100 million per quarter upon launch. This would cause earnings to decline temporarily, until Netflix offsets the increased costs with subscriber growth.

Netflix's new international expansion will be expensive, and it's also quite risky

However, that's just a short-term issue. The bigger concern for Netflix shareholders is execution risk. This is arguably Netflix's boldest international expansion ever, and if it doesn't live up to expectations, the cost of fixing it could be staggering.

A bold move
Netflix's recent international expansion projects have gone fairly smoothly. However, the last two expansions (the Netherlands in September, 2013 and the Nordic countries in the fall of 2012) were much smaller in scope. The countries Netflix will enter this fall are about 4 times as populous as the Netherlands and the Nordic countries combined!

Additionally, most of Netflix's international territories are either English-speaking (Canada, the U.K., and Ireland) or historically Anglophile (Netherlands and the Nordic countries). The only exceptions are the Latin American territories launched in late 2011.

The same can't be said for Netflix's newest markets. Whereas over 85% of the populations in Denmark, Norway, Sweden, and the Netherlands are fluent in English, just 56% of Germany's population is fluent in English. In France, that falls to just 39% of the population.

Overcoming the language barrier
Netflix will offer local language content in these countries in addition to American content. However, it still seems likely that Netflix will have to expend more effort to sign up subscribers in France, Germany, and some of its other new markets than was the case in its other recent launch markets.

Of all its international markets, Latin America has been by far the toughest for Netflix. Netflix's growth in Latin America has been plagued by a variety of issues, including broadband quality, low credit card usage, and a less-developed e-commerce landscape. However, the lack of an English-speaking population may also be a headwind to Netflix's growth there.

English-language content may have less appeal in some of Netflix's new markets

It's hard to tease out just how much the lower demand for English-language content might be affecting Netflix's performance in Latin America. In any case, between the lower proportion of English-speakers in France and Germany, the sheer size of this year's expansion, and regulatory issues related to financing local content in France and other markets, this year's expansion is far riskier than any of Netflix's other international launches since it entered Latin America.

Adding risk
European expansion is, without a doubt, a major opportunity for Netflix in the long run. That said, it's odd that after two years of very methodical expansion into "easy" markets with high English literacy, Netflix is suddenly pushing the pace with 6 new markets where only half of the population (on average) speaks English.

At a recent conference, CFO David Wells indicated that Netflix is willing to take big risks on new markets. For example, Netflix will enter new markets even if it can't get as much high-quality content as it would like. Netflix's management thinks that it can solve problems like that on the fly after entering the market.

My Foolish colleague Anders Bylund applauds that level of urgency. To me, it seems like an unnecessary level of risk. If Netflix wants to try its hand in a potentially tougher market like France, it would make more sense to launch that market alone, or in conjunction with small English-speaking markets like Australia and New Zealand.

That would minimize the cost of fixing any problems that arise. Instead, Netflix is entering 6 non-English speaking markets in Europe. Any setbacks could tie up management resources and cost hundreds of millions of dollars.

Bottom line
If Netflix's new international territories all reach breakeven within 2 years or so, its upcoming round of expansion will have been a smashing success. However, this is likely to be the toughest new market launch since the troubled Latin America launch from 2011. By undertaking such an ambitious expansion, Netflix's management is exposing shareholders to a lot of risk.

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Read/Post Comments (4) | Recommend This Article (3)

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  • Report this Comment On May 25, 2014, at 3:13 PM, AceInMySleeve wrote:

    It's all accounting but i imagine Netflix will launch mid Q3 so as to not sustain 100M in a single quarter. Expenses decline rapidly after the first marketing surge.

    Thanks for the data about english-speaking proportion. I didn't realize the Nordics were so much higher than the continent.

    I would point out that Netflix did quite well in the US, and they have a low proficiency at English.

  • Report this Comment On May 25, 2014, at 5:29 PM, duuude1 wrote:

    Good stuff Adam. Regarding languages, note the statistics in the following report:

    http://ec.europa.eu/public_opinion/archives/ebs/ebs_237.en.p...

    On page 6, notice that the younger age groups are more likely to speak additional languages other than their "mother" tongue than older folks - and although I don't have stats on the frequency with which that 2nd language is English - you can pretty well bet that English is one of the top additional languages that the kids are learning.

    When you travel to various European countries, you notice very quickly that older residents do not (or are reluctant) to converse in English, while younger residents speak English readily and easily.

    So I will bet that the younger age groups will be the English-speakers, first-adopters, and more tolerant of NFLX's language-learning stumbles. There will be stumbles. Always are. NFLX knows how to recover from stumbles :)

    And ultimately, it is the younger folks NFLX wants to target, and this is the long-term fast-growth demographic.

    I agree that NFLX needs to learn how to deliver content in various languages, but all the main Euro countries are actually a safe training ground due to the predominance of English among the young. Safer anyways compared to the middle east and asia.

    Finally, for your closing statement:

    "...this is likely to be the toughest new market launch since the troubled Latin America launch from 2011."

    ...do you know the reasons why LatAm was a tough market for NFLX? You can bet NFLX has done a deep dive on those markets and knows the reasons why it has had a tough time "down there". I believe NFLX has mentioned paucity of credit card transactions and sufficient bandwidth in LatAm. The Euro countries targeted for this fall are the exact opposite of LatAm in those regards.

    Duuude1

  • Report this Comment On May 26, 2014, at 7:34 PM, TMFGemHunter wrote:

    Yes, Netflix has definitely talked about the payments issue in particular with regard to Latin America. But that is just one variable, and I'm sure it's not the only one. I think even Netflix would have trouble quantifying the impact of various variables, e.g. local interest in American content, disposable income, comfort with e-commerce, credit card penetration, broadband availability/quality.

    I am also expecting a Q3 launch, probably in September, and it's possible that the launches will be slightly staggered. I think the expenses can be leveraged over time, but they won't actually go down. For one thing, Netflix wouldn't be paying for a full quarter of content in Q3. With such a big market, I think Netflix may invest in a lot of advertising over a fairly long period of time -- not just a few months around the launch date.

    It makes sense to invest in the advertising in order to grow the sub base as quickly as possible. The only reason not to do so is if Netflix will still be in "beta" form when it launches, i.e. not a lot of content compared to other international markets, or not fully featured in some way. In that case, I could see why Netflix might be worried about people signing up, getting frustrated and then quitting (and not coming back for a while or at all).

    Adam

  • Report this Comment On May 27, 2014, at 3:55 PM, Pete01810 wrote:

    I believe this is far less risky than you seem to think. It's not so much six new countries as two new languages; French and German. And French isn't completely new, given their agreements in Canada and the French language movies you can already get here in the USA.

    Also Lots of interest in English (as opposed to only American) content, although it needs to be dubbed. And the dubbing has in most cases already been done, they just need the rights to it.

    Also "Comfort with e-commerce, credit card penetration, broadband availability/quality" are all non problems for these markets, not at all like Latin America.

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