Netflix's (NFLX 2.47%) leadership team, led by co-founder and co-CEO Reed Hastings, used to be completely fine with accounts that shared passwords. The belief was that it would introduce more people to the service, who would then hopefully become paying members themselves. But now, amid slowing subscriber growth, they want this practice to end.
Here's why this objective won't be as fruitful as many are hoping for the streaming giant. Another strategy, however, could be a boon for the business.
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Netflix is chasing a one-time boost
In its Q1 2022 shareholder letter, Netflix management pointed out that there are roughly 100 million households globally sharing passwords with actual paying accounts. Given that Netflix counted 222 million subscribers as of March 31, there is a significant amount of potential revenue the business is missing out on.
There are some important reasons I don't think the focus of cracking down on these free users will help Netflix to boost its growth prospects. First, I'm not entirely sure how it will even be implemented successfully. Based on the company's progress thus far in the initial test markets (Chile, Costa Rica, and Peru), customers are confused with the whole process.
In Peru, for example, members found that if they simply called customer service and told them that someone from their household was using the service in a different location, they could access the account with a verification code, and they wouldn't have to pay extra. This workaround might be extremely difficult for Netflix to contain.
Furthermore, Netflix runs the risk of losing these password sharers for good. The burgeoning number of entertainment options out there makes it easier for them to not sign up for their own accounts and instead seek alternatives. Would the company rather have someone who doesn't pay for the service but still watches it? Or someone who doesn't watch the service at all? Because it costs virtually nothing to serve an additional customer, my belief is that Netflix would want to choose the former.
And lastly, even if Netflix is successful at converting the 100 million households that currently share passwords to paying accounts, which in my opinion is highly unlikely to happen all at once or maybe at all, it will only be a one-time bump to revenue growth. In subsequent periods, the business will still have to find ways to attract new subscribers at a similar rate as in the past. This has been a challenge in recent quarters and will continue to be because of heightened competition, a trend that has crushed the stock.
Introducing an ad-based tier will help
That said, providing consumers with a cheaper, ad-supported subscription tier could definitely drive demand for Netflix. Up to this point, management was all about giving its viewers a great experience, one they thought ads would undermine. But now, Hastings and his team want to offer customers more choice. Netflix could introduce this option by the end of this year.
A cheaper membership tier would make it easier for those password-sharing accounts to become paying members as opposed to being completely left off the platform. It can certainly attract a higher number of price-sensitive consumers. And Netflix's massive scale (222 million members) and far reach (in over 190 countries) would be incredibly valuable for advertisers looking to target a broad, worldwide audience.
"I think it's pretty clear that it's working for Hulu," Hastings mentioned on the Q1 2022 earnings call when discussing advertising. "Disney is doing it. HBO [part of Warner Bros. Discovery] did it. I don't think we have a lot of doubt that it works, that all those companies have figured it out."
From a financial standpoint, this is a smart move for Netflix and probably long overdue. The company's biggest advantage is that it is able to spend massive amounts of money (more than $17 billion in 2021) on content thanks to its huge user base. Therefore, growing accounts (and revenue) by introducing a lower-cost, ad-supported tier would keep the flywheel spinning.
And bringing on more subscribers, especially after a poor start to the year, is what shareholders desperately want right now.
