Following rumors that surfaced in May, Netflix (NASDAQ:NFLX) confirmed last week that it is jumping into video games. When the video-streaming leader reported second-quarter results, it outlined its plans to expand into games, starting with titles optimized for mobile devices. Netflix has previously dabbled in interactive content, releasing a handful of shows that allow viewers to make choices that impact how the story unfolds.

Will the strategy pay off?

Exterior of Netflix office in LA.

Image source: Netflix.

A new category

Netflix plans to include ad-free games in its membership at no additional cost, even as it will inevitably shoulder all the development costs of producing the games. That may sound financially risky, but keep in mind that Netflix already spends billions of dollars on original video content. Games are just another category for the company to jump into, in Netflix's view.

"We view gaming as another new content category for us, similar to our expansion into original films, animation and unscripted TV. Games will be included in members' Netflix subscription at no additional cost similar to films and series," the company wrote in its earnings letter to shareholders.

The video game industry is the biggest it has ever been, reaching nearly $180 billion in revenue last year due to the COVID-19 pandemic. With consumer interest in games at record levels, Netflix believes that this is the right time to enter the category.

Building a content flywheel

Since Netflix will not charge extra for games, investors can view the initiative as a method to bolster engagement. Netflix has realized that it has created incredible intellectual property (IP) franchises with its original content and has been exploring various ways to create a virtuous cycle of engagement with that IP. For example, Netflix finally opened an official merchandise store just last month.

Much like Disney's massive flywheel -- where it creates new IP and then monetizes that IP through merchandise, theme parks, licensing, and expansive media content -- Netflix has a similar opportunity to replicate that strategy with its own properties. Developing games that expand the ecosystem will play into that initiative.

"We are in the business of making these amazing worlds and great storylines and incredible characters. And we know the fans of those stories want to go deeper," COO Greg Peters commented on the conference call with analysts. "They want to engage further."

How Netflix will gauge success

In addition to engagement, Netflix will also seek to gather user data that informs many strategic decisions. Netflix is known as a data-centric company, leveraging its massive trove of information that feeds everything from its recommendation algorithms to content investments. That's partially why Netflix has never cared about critic reviews or traditional viewership ratings typically provided by third-party analytics companies.

Instead of directly measuring success with financial metrics, Netflix will simply focus on putting out compelling content that can expand the core subscription service in new ways that enhance the entertainment value members receive. "[U]ltimately, the success of this initiative is about great games fundamentally, and those can come from a variety of different sources," Peters said.

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