The numbers show Netflix's DVD-by-mail business is shrinking, but should the company embrace that reality? Source: Netflix.
For Netflix (NFLX 4.17%), the growth story continues. Right now, the company boasts nearly 65 million members in more than 50 countries. But next month, the company will add three countries to that list: Over the span of three days, Netflix will be coming to the European countries of Spain, Portugal, and Italy starting on Oct. 20. For those following the company, this is continued aggressive international expansion.
Of course, citizens there can only sign up for Netflix's streaming services, as the company only offers DVDs domestically. After essentially bankrupting Blockbuster with its DVD-by-delivery business, the company has moved on to its streaming operations. For perspective on how quickly Netflix's domestic DVD business has deteriorated, look no further than Netflix's financial statements that I've attached in appended form.
| Domestic DVD | 2013 | % of Total | 2014 | % of Total | 2015 H1 | % of Total |
|---|---|---|---|---|---|---|
| Revenues | $910,797 | 20.8% | $765,161 | 13.9% | $337,218 | 10.5% |
| Cost of revenues | $471,523 | 15.1% | $396,882 | 10.6% | $174,689 | 8.1% |
| Marketing | $292 | 0.1% | $- | 0% | $- | 0% |
| Contribution profit | $438,982 | 55.7% | $368,279 | 32.2% | $162,529 | 24.7% |
| Contribution margin | 48.2% | 48.1% | 48.2% |
Source: Netflix's quarterly report, segment info addendum. Numbers in thousands.
No. 1: Revenue as a percentage of total has fallen
While it's easy to note the 10-percentage-point drop in the percentage of total revenues domestic DVD now contributes, it's important to note how this is occurring. And domestic DVDs' drop is twofold: On one hand, total streaming-based revenues have gone from $3.5 billion in fiscal year 2013 to an estimated $6.8 billion in 2015, according to a sample of analysts compiled by Bloomberg. To maintain the same percentage to total revenue it contributed in 2013, domestic DVDs would have to book nearly $1.4 billion in business.
Instead, during the first two quarters Netflix has booked an anemic $337 million in domestic DVD revenue. At its current run-rate, the business would book nearly $675 million in domestic DVD revenue. And that's under the assumption Netflix's DVD business won't continue to shrink, something that has occurred every consecutive quarter since 2013.
No. 2: Contribution profit as a percentage of the total has fallen
For Netflix investors, perhaps the most heavily watched figure is contribution profit. The non-GAAP figure is simply calculated as revenue minus cost of revenue and marketing expense. And that makes sense. For bottom-line earnings figures, the company simply consolidates contribution profit, subtracts operating and over various expenses, and then takes out provision for income taxes to arrive at its net income figure.
And when it comes to that contribution margin, the figure has fallen as well, but not by as much as you'd probably expect, falling from 55.7% in 2013 to 24.7% in H1 2015. And that's because the DVD-by-mail business is shockingly high-margin when compared with streaming. Over the past two and a half years, the contribution margin percentage has been remarkably stable above 48%, as the company has essentially stopped marketing the product (spoiler alert: Rhis is No. 3).
Compare that with total streaming, which is expanding its contribution margin but only hovers in the 17% range, as international streaming hasn't been profitable on a contribution profit basis in any quarter over the past two and a half years among large marketing and other expansionary expenses.
No. 3: Netflix has essentially stopped marketing the service ... but should it?
As the aforementioned visual shows, Netflix has stopped spending money on the service. After spending a paltry $292,000 in marketing in 2013, Netflix hasn't recorded any marketing costs for its DVD business since. Compare that with streaming, in which Netflix has spent nearly $1 billion in marketing -- most of that in its currently unprofitable international profit segment.
But perhaps that's not the best strategy for the company. Because of its high contribution-margin profile, it stands to reason that Netflix could potentially get bigger marketing bang for its buck by apportioning some of its ad spend to the service. Merely slowing the rate of subscribers who are looking to leave the DVD business could pay immediate dividends until the International segment is ready to contribute to the company's bottom line.
