By now you've heard about the poor second-quarter results for Netflix (NFLX 4.17%). Net subscriber additions came in well below the expectations of both management and analysts. The streaming service actually lost subscribers in the United States -- the first time since the Qwikster debacle in 2011.
But the fact that Netflix subscriber additions disappointed isn't the biggest thing investors can take away from the company's second-quarter report. It's the reasons management gave for the miss and what they mean for the company.
Why management says it missed expectations
The main reason for the disappointing results, according to Netflix's letter to shareholders, is "Q2's content slate drove less growth in paid net adds than we anticipated."
In other words, there was a lack of a popular film or series that captured the cultural zeitgeist to drive subscription growth. It didn't help that recent price hikes in some regions led to higher-than-normal levels of churn. But the bigger long-term problem is an inconsistent "top of the funnel."
Talking about gross subscriber additions during the earnings call, CFO Spencer Neumann noted, "We saw that slowed down across the board, which indicates to us some level of seasonality and kind of the overall, as we say the kind of timing of the content slate."
There's good news and bad news here for investors. The good news is that it seems like Netflix's success with original content is a big driver of subscriber additions. So, despite upcoming loss of some of its most popular licensed content, it probably won't have a significant impact on gross additions. The bad news is that Netflix needs to keep pumping out new originals that can capture mass audiences in order to bring in new subscribers.
Image source: Netflix.
Creating the next Orange Is the New Black
To finish up the company's earnings call, content chief Ted Sarandos gave a shout-out to Orange is the New Black and creator Jenji Kohan. Netflix is releasing the final season of the series later this month.
That will certainly help gross additions this quarter, which Netflix expects to reach 7 million, but it also means the company is facing a big hole in its lineup next year. Orange is one of the most-loved series on Netflix.
Netflix has successfully pushed several new series into the limelight to succeed it. It received Emmy nominations for Russian Doll, Ozark, and Bodyguard. That's in addition to the ongoing success of Stranger Things and The Crown, which missed the cutoff for nomination this year, but were nominated last year. Netflix is sure to score another hit with critics over the next year with all its new originals.
But critically acclaimed content isn't enough to drive subscriptions. Netflix will have to increase awareness of its series through additional marketing spend. Marketing expenses increased just 1.9% year over year in the second quarter. That number might have to take another step up, even after the massive increase in the marketing budget last year.
Netflix's major focus on recurring series can create a flywheel effect. If it can create a few winners early in their run (season one or two), it can enjoy that success for several more years before a series runs its course.
Of course, this is all easier said than done. Netflix had a few big-budget releases last quarter, like Triple Frontier starring Ben Affleck, and it failed to attract attention for most. That may have been the impetus behind Sarandos' reported initiative to become more budget-conscious with original content. If Netflix is going to spend big, it wants to be sure it'll sign up a lot of new subscribers.
If investors take away one thing from Netflix's second quarter, it should be the importance of its original content -- and marketing that original content -- to the service's future subscriber growth.
