Along with announcing its fiscal second-quarter earnings results on July 20, Netflix (NFLX 9.71%) confirmed it would be entering the gaming market. The company said it would start with mobile games and expand from there.
The streaming content pioneer has little experience with gaming. In fact, the closest it came to games so far is interactive content. Therefore, expanding into the gaming market may come with added risks to shareholders. Admittedly, there is plenty of upside to the decision as well. However, whenever you add uncertainty to a business, it also adds risk.
Image source: Netflix.
Valid reasons for entry
Netflix has long considered gaming to be one of its key competitors. In Netflix's eyes, consumers have limited hours they can spend on entertaining themselves, and if they choose to play games, they are not spending that time on Netflix. From that perspective, the entry into gaming makes sense.
And if you are going to enter the gaming market, the mobile platform is the one you want to get into. In the U.S. alone, there were an estimated 136 million mobile gamers in 2019. That total is expected to grow to 156 million by 2025. The U.S. and Canada are Netflix's largest markets for streaming subscribers, so offering games on top of movies and other content strengthens its customer value proposition.
Investors may be nervous about the news, but subscribers are cheering it. The company said mobile games would initially be offered for free to paying members. Of course, few things come for free, and members will likely be asked to pay a higher subscription fee at a later time to compensate for the additional benefits.
It wouldn't be the first time Netflix has attempted that strategy. Recall, Netflix started as a DVD-by-mail service and only later started offering streaming as a free option. Eventually, management realized streaming content was the future and split the company between the DVD-by-mail service called Qwikster, and the streaming service, which remained Netflix. Before the split, the company was charging members $10 per month for both services. After the split, customers were charged $8 per month for each service. The move was a disaster, and the company shed millions of subscribers in the next few quarters. The switch to video streaming was clearly the right idea in the long run but Netflix could have handled it better. Yet, the company seems to have similar plans for the video game market.
CEO Reed Hastings has been thinking about the entry into video games for a long time and finally decided it was the right time:
We talked about video games for several years, writing up the pros and cons of the timing of entry. That has properties like film that you can own the IP. You're going to have these long franchises and very positive for us, kind of industry-structure wise, if we can master the skill set. And so really, it came down to us thinking that, that incremental money to fund games made sense relative to our other content investments.
Risks
The expansion into games will require investment from Netflix. That is money, time, and attention that could be spent on doing what it's proven to be excellent at, creating viewing content. To some degree, investing in games will stunt investing into its core content categories.
Netflix boasts 209 million paying subscribers, but not all of them play games. Those members may balk at the idea of paying more for membership as Netflix offers more high-quality games. The company will have to play a balancing act with spending on games and raising prices so it doesn't alienate existing members, a task that is not guaranteed to go well.
Investor takeaway
Netflix has proven it can create content and convenience for folks around the world. It's not only that Netflix is good at picking which movies and shows to offer its customers; it's also good at how it delivers them. Increasingly, people prefer to consume their content through streaming devices without being encumbered by advertisements.
There is reason to think that Netflix can learn to deliver the type of games people want, how they want it. Nevertheless, this move into gaming also presents added risk to the stock, as a positive outcome is not guaranteed.
