Netflix (NFLX 2.47%) doesn't think you have to spend more to get more.
The company built a reputation for outspending the competition for big-name licensing deals and its massive library of originals. But management is changing its tune a little bit. The question co-CEO and head of content Ted Sarandos is asking his team is, "Can you get more impact per million-dollar spend than anybody else?"
He thinks so, which could mean a substantial profit bump for the streaming leader over the next few years.
Three factors driving more efficient content spending
Netflix plans to keep its content budget around $17 billion for the next few years as it looks to increase the impact of its spending.
After ten years of creating originals, management thinks it's gotten much better at creating content people care about. Netflix has built up the partnerships and skills to create more consistent hits. It has also developed a reputation for all sorts of programming from prestige series and films or blockbusters to reality series and competition shows, which makes it more appealing to creators. Sarandos also said its creative output benefits from the scale of Netflix, which counts 223 million paid memberships.
On top of that, Netflix is still recovering from the production shutdowns, delays, and restrictions caused by the COVID-19 pandemic. "It will take several years to completely unwind the COVID logjam," Sarandos said during Netflix's third-quarter earnings call. "We're trying to be more and more aggressive about smoothing that out to make sure that the content is available when people are ready to watch it."
A smoother content cadence can be a more effective use of the content budget. When Netflix has a new exciting hit series or film coming out every month, members are more likely to keep their subscriptions. Churn is rising across the board in the industry as consumers hop from one streaming service to the next. Sarandos expects a smoother release schedule in 2023 and further improvements in 2024.
Additionally, Netflix benefits from its global scale and ability to make content from smaller markets popular worldwide. We saw this on a massive scale with the success of Squid Game last year. According to internal metrics, the Korean series cost just $21.4 million to produce, but generated nearly $900 million in value.
"When we move $1 from the English language to non-English production, that can have a lot of impact," Sarandos said at an investors conference earlier this month. Indeed, it's generally less expensive to produce films and series in smaller markets versus the United States. Netflix's ability to drive subscriber engagement with foreign-language series and films is one of its biggest competitive advantages as a global media company.
Growing profits and cash flows
Content is, by far, Netflix's biggest expense. Curbing the growth of content expenses should lead to substantial growth in profits and cash flow.
Netflix has seen the gap between content cost amortization and its cash outlays for new content shrink over the last few years as its production business matures. Through the first nine months of 2022, it spent about $13 billion of cash on content and amortized around $10 billion.
With continued revenue growth, albeit a bit slower than investors hoped for at the start of the year, management has produced free cash flow of $1.3 billion in the first nine months of 2022. Operating income has declined, however, to just $5 billion in the same period due to higher content amortization expenses. Nevertheless, investors should expect a return to operating income growth going forward as content expenses stabilize, following the decision to hold the cash content budget steady.
Of course, the company can only produce leverage in its cash and operating expenses if it can grow the top line without increasing its content budget. But given the factors Sarandos has pointed out, it looks like there's a path to improvement, which should pay off for subscribers over the next few years.
