Big news reverberated across the entertainment industry in late 2021 when Netflix (NFLX -0.63%) announced it had started developing mobile games for its subscription service. Launched in November of last year, there are now five mobile games that subscribers can access on their phones as a part of the Netflix subscription bundle, with many more to come in future quarters.
Some investors celebrated this development as an opportunity for Netflix to enter a new, lucrative business line that could help the company grow for many years to come. But given the intricacies and technological limitations of the video game industry, it is hard to see how Netflix can get a strong return on these video game investments.
Is Netflix's foray into video games a giant misstep?
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Netflix's plans
Before getting into any analysis, let's get up to speed on what Netflix has done and said it will do. On Nov. 2, 2021, the company launched five mobile games for subscribers around the world, two of which focused on the Stranger Things franchise. The games are included for all subscribers and have no advertisements or in-app payment mechanisms (which is how most mobile games make money).
On its latest conference call on Jan. 20, many analysts asked about the new investments into video games. Executives said that they believe subscriptions could be a great model for video games and that the company plans to develop interactive experiences for its big titles (i.e. stuff like Stranger Things). On top of this, the company said it would be exploring licensing popular gaming intellectual property (IP), with some announcements potentially coming this year. It is unclear what this means, but it is likely that Netflix is reaching out to major video game publishers to see if they would want to bring their mobile games to Netflix.
Technology and business model limitations
At first, making moves into gaming seems logical for Netflix. But there are two problems that arise for Netflix and the video game market, one business model-related, the other technological.
From a technological perspective, the video game industry has not cracked cloud-based streaming, which is how Netflix and all other streaming services allow their users to watch shows without downloading the content. Except in rare circumstances or with older games, gamers download content directly to their devices. For Netflix, this is fine for mobile games, as it only creates a small amount of friction for users and is on the same hardware that people watch their shows. However, it will prevent the company from creating expansive, console/PC-level IP unless it is willing to go through hardware distributors like Microsoft, Sony, and Nintendo. Given that Netflix keeps everything behind its subscription paywall, this puts the company in between a rock and a hard place when deciding whether to make big-time games for its subscribers.
The bigger problem may be the business model, though. If Netflix is looking to license IP from other publishers, it will have to ask them to refigure their entire monetization strategies. Why? Because almost all of the popular mobile games in the world are free-to-play but make money through advertisements and in-app purchases of content. If the company is going to license games from other developers, it will likely need to be with fresh content built for a subscription paywall, which is antithetical to how the industry operates today.
Can games be a needle mover?
Given the roadblocks in front of it, I believe Netflix will mostly be limited to producing its own games if it is going to stick to keeping everything behind the subscription paywall. This is fine, but can it be a needle mover for Netflix? Investors need to ask themselves how many subscribers will join the service if it has a few dozen mobile games when thousands of games are free to download from the app store already.
One might argue that the games aren't about attracting new subscribers, but reducing churn for existing customers. That could definitely play out if the mobile games get lots of usage, but again you need to ask yourself whether the juice is worth the squeeze. Video games take tons of employees to make. For example, Electronic Arts has 11k employees, just as many as Netflix, but generates less than $10 billion in revenue, while Netflix does almost $30 billion. If Netflix hires 3,000 developers and all it does is reduce churn among its subscriber base, it is hard to see how the return on the investment would be worthwhile.
Is Netflix destined for failure in video games? At this point, it is hard to tell. The company has an impressive track record of succeeding with new businesses, and I don't think it is smart to count it out before the investments really get started. But given the dynamics of the video game industry and the technological limitations that keep gamers locked in to specialized hardware, it is tough to see how Netflix can make much of a dent in gaming with its current strategy.
