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Netflix Has an Opportunity to Use Technology Unlike Any Other Media Company

By Adam Levy – Apr 18, 2018 at 1:28PM

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Netflix can now use its competitive advantage to improve its original content spending.

Netflix (NFLX -0.09%) plans to spend $7.5 billion to $8 billion on content this year. It'll spend even more than that in cash, as a growing portion of that content spend comes from licensed and produced originals where Netflix pays upfront and amortizes expenses over time. Ultimately, Netflix says it wants 50% of the content on Netflix to be originals.

As Netflix's content budget shifts more toward original, it has an opportunity to use technology unlike any other media company. Chief Product Officer Greg Peters said the company is building new technology to support its content side -- "the programming choices that we make, how we can produce content more efficiently."

Peters' comments indicate there's a lot of room for improvement in terms of how Netflix uses AI to make content spending decisions. A couple of years ago, the company said its AI saves it $1 billion per year. As it improves upon its algorithms and uses them to reduce the need for human intervention in programming decisions, not just for content recommendation, Netflix could start saving a lot more.

Exterior of Netflix's office in LA.

Image source: Netflix.

Thinking like a technology company

The main idea behind any technology company is to remove marginal expenses. Anytime you can replace a human's job with a robot, there's an opportunity for leverage. Of course, if the robot costs more to create than the human costs to employ, it's not worth developing the technology. That may have been the case for Netflix for the past few years, as it still spent a relatively small portion of its content budget on originals.

But as that content budget balloons and shifts more toward original programming, Netflix has an opportunity to leverage technology to improve its margins, and Peters indicates that's exactly what it's doing.

Netflix spent an estimated $1.5 billion on original content last year. That number could easily double by next year.

Netflix plans to release 700 pieces of original content this year alone. And there are hundreds more films, series, and specials that Netflix turns down every year. That eats up a lot of human hours. And while they can use Netflix's data to inform their decisions, it ultimately comes down to humans. Implementing an algorithm to do most of the work -- just as it does for its individualized recommendation engine -- could reduce the need to hire people to support its original programming expansion.

Netflix is uniquely positioned to use technology in its programming decisions

No other media company fosters direct relationships with its viewers at the same scale as Netflix. Traditional media companies like Disney (DIS -1.58%) and Time Warner's (TWX) HBO are just starting to build momentum with direct-to-consumer relationships. Netflix has 20 years of its subscribers' data and thousands of hours of viewing for each one of its 125 million streaming subscribers.

What's more, Netflix's continually climbing content budget means it can generate significantly more leverage from investing in technology to make programming decisions than its traditional media competition. Again, Netflix's content budget for the year is about $8 billion. That's about the same amount Disney and Time Warner spent on non-sports content last year. HBO, perhaps Netflix's closest competitor on original content, spent around $1.1 billion per year on original programming in each of the last three years.

With more data to analyze and a bigger content budget to leverage, Netflix is better positioned than anyone to inform its original production decisions with AI.

Where it all shows up for investors

There are two potential paths to leveraging technology on the programming side for Netflix. The first is that Netflix lets the efficiencies driven by technology fall to the bottom line, resulting in an expanding operating margin.

More likely, Netflix will look to manage margin expansion and grow its total audience by getting more out of its content and marketing budgets. That's the long-term view of things. As CFO David Wells said during the company's first-quarter earnings call, "The bigger the business we are, the higher that [operating] margin could be."

So, the efficiencies might not show up in the income statement, but investors should see them in the net subscriber addition numbers, which are still growing year over year.

Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix and Walt Disney. The Motley Fool recommends Time Warner. The Motley Fool has a disclosure policy.

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