Netflix (NFLX 2.17%) investors were in for a rude shock after the company posted disappointing subscriber numbers for the second quarter. Netflix bulls point out that while the streaming giant's massive growth might have taken a short breather, the company did extremely well overall.
However, the company's 43% annual jump in streaming revenue was driven by recent price hikes, which led to a 14% jump in the average selling price. Now, Netflix positions itself as a premium online streaming company, and the fact that subscribers accepted the subscription hike hits that point home. But a closer look indicates that Netlflix's strategy isn't working in markets that will matter in the long run.
One size doesn't fit all
Netflix's subscriber growth has trailed off in recent quarters, despite its attempts to tap foreign markets.
The chart above clearly shows that Netflix's overseas growth has stalled after peaking at the end of the previous fiscal year. This is weighing on the company's overall subscriber growth, as the domestic market's subscriber additions have been tepid at best, growing in the single digits.
The bottom line is that Netflix needs its international subscriber growth to pick up pace to offset saturation in the U.S. But the company will need to change its approach to attract more subscribers in price-sensitive markets or it runs the risk of losing to local rivals and new entrants that are better-placed from pricing and content perspectives.
For instance, Netflix's ambition of eventually hitting 100 million subscribers in India looks like a long shot due to its pricing structure. The company reportedly had just over half a million paid subscribers in India at the end of last year. By comparison, local player Eros Now had nearly 8 million paid subscribers. Its most expensive plan costs just $1.50 per month, while Netflix's base plan costs just over $7 per month. Though this premium pricing structure has allowed Netflix to tap affluent Indian customers, it has limited reach in the mass market.
Netflix would have been better off taking a leaf from Amazon's (AMZN 4.11%) playbook. The e-commerce giant's Prime subscription service in India costs less than $2 per month -- and with a discount for an annual subscription, not even $15 per year -- giving users access to video, music, and many other benefits. By comparison, a Prime subscription in the U.S. costs nearly $13 per month, while a stand-alone monthly video subscription goes for $9.
Amazon's tailored pricing plan has allowed it to corner a bigger share of India's online video-streaming market, and the gap could increase thanks to the company's strategy of creating more local content. What's more, competition will continue in emerging markets; Alphabet's (GOOGL 1.77%) (GOOG 1.66%) YouTube will soon produce original shows for markets including Mexico, Japan, France, Germany, and India.
More importantly, YouTube will be deploying a strategy of offering more ad-free content and making low-budget original shows to boost the subscriber base of its premium service. Eight percent of India's internet population uses YouTube, so Alphabet has an opportunity to eclipse Netflix in critical markets such as India if it prices its subscription right.
But Netflix is flexible
Netflix runs the risk of missing out on the online video-streaming revolution in emerging markets due to a premium pricing structure. India, for instance, is expected to become one of the 10 largest video-streaming markets by 2022. It could generate nearly $800 million in annual online streaming revenue in the next five years, up from just $300 million at present, according to consulting firm PwC.
The good news for Netflix investors is that Netflix is open to changing its pricing structure. CFO David Wells said on the latest earnings conference call that the company is testing new pricing models to increase its addressable market in India, and it could replicate this in other emerging markets. More specifically, Wells pointed out that there are three or four different demographics in the Indian market that the company plans to address, saying:
We may have an issue where there's three or four different sort of growth patterns within India, in terms of different demographics, different segmented groups. As we address one segment and then we start addressing another, and so forth and so forth, each one has a specific set of challenges with it. We're in the early days of, sort of, that first segment. So, you know, expect more from us in terms of getting into segments 2, 3, and 4.
This is a remarkable about-face from Netflix. In April, CEO Reed Hastings had said that the company had no plans to change the pricing structure in the country. The change of stance clearly indicates it's now willing to take big steps to arrest slowing subscriber growth.
Netflix will be doing the right thing by introducing additional subscription plans in price-sensitive markets such as India. It can eventually sell those customers higher-priced plans as disposable incomes increase.