Last week's shock that Netflix (NFLX -0.51%) is losing subscribers is worth a bit of inspection by investors. This is one of the most popular products of all time, with over 200 million streaming subscribers and a presence in nearly every country in the world. If Netflix is losing subscribers, is there a bigger trend investors should be worried about?
I think there is reason to be concerned for at least some subscription companies. Over the last decade, subscriptions have proliferated across the business world and have been a favorite of Silicon Valley-backed start-ups. But there's a limit to how many subscriptions people will pay for, and eventually subscription fatigue will set in. Netflix may be telling us we're already there.
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Subscriptions everywhere
I think it's worth thinking about the concept of subscription fatigue in buckets. One is essential goods or services that people aren't likely to cut unless it's a last resort, another is subscriptions that can be substituted or downsized, and the final bucket is non-essentials. We should look at these very differently.
The essential bucket includes Amazon's (AMZN -1.14%) Prime, Chewy's (CHWY -2.54%) recurring purchases, and Costco (COST -0.55%) membership fees. These may not be 100% necessary expenses for most subscribers, but they're providing goods that will need to be purchased somewhere, and the subscription itself adds incremental value in the form of convenience or lower prices.
Substitutable subscriptions are where investors should start thinking about the risk to the downside. Netflix has shown that it can be replaced by Disney+ (DIS -0.45%), Warner Bros. Discovery (WBD 0.97%), and even Alphabet's (GOOG 0.37%) YouTube. Even if the streaming TV revenue pie is growing overall, it doesn't mean everyone's slice is growing.
I would put Spotify (SPOT -1.49%) in the same bucket, and it may even be non-essential. Apple's (AAPL -0.57%) music and gaming subscriptions are also in this category, but they're such a small piece of the company's revenue that it's not worth changing your investment thesis if there are a few lost subscribers.
Cable TV companies like Comcast (CMCSA 1.62%), Charter (CHTR 0.73%), and AT&T's (T 1.30%) DirecTV are under threat from streaming products like YouTube TV, but they're also becoming less essential altogether with the growth of streaming. Even in broadband, there's now competition from 5G providers for home broadband.
I think we will see some shuffling of substitutable subscriptions, with the leaders rising to the top and the weaker companies losing subscribers in the next few years. In this category, it's worth sticking with quality over taking risks on money-losing companies.
Non-essential companies are where I see the most risk if subscription fatigue sets in. This includes products like food delivery, bike rentals, rewards clubs, and similar optional services that are likely to get more scrutiny for consumers. The few companies in this category that made it to public markets haven't fared well in the last year, and I don't see a reason for a recovery now.
Inflation, stimulus, and wages
Underlying this potential subscription fatigue are the drivers of consumers scrutinizing purchases. Inflation has pulled more money into essential goods like food, fuel, and rent, leaving less discretionary income for subscriptions. At the same time, inflation increases costs for subscription companies, leading them to increase prices.
Stimulus payments and additional unemployment checks are also running out, leaving less money in many people's pockets than a year ago.
Then there are wages, which are going up, but not keeping up with inflation. Unless this changes, spending could get squeezed even further.
Who gets cut first?
Investors need to ask themselves if they're invested in companies that are providing an essential subscription service, or non-essential or replaceable subscriptions. With inflation and subscription fatigue setting in, it's likely more customers will be looking to cut marginal subscription fees, and that could have a big effect beyond Netflix.
