Media companies have been hard-pressed to make a profit from streaming video. But there's one company in the space that's already immensely profitable and should see a substantial profit bump next year.
Netflix (NFLX 0.73%) generated $2.8 billion in net income through the first six months of 2023, while practically all of its peers are losing money. Its operating margin of 21.6% represents a step back from 2022, but its margins are set to see significant expansion next year, led by a planned price increase.
Netflix's price increase shows confidence from management that it can produce meaningful operating leverage in 2024, boosting its bottom line. Here's what it means for investors.
Accelerating revenue growth with multiple levers
Last year, Netflix moved away from forecasting its subscriber growth every quarter, choosing to focus on revenue growth instead. To that end, Netflix has several levers it's pulling all at once to grow revenue.
First, it introduced an ad-supported tier. The ad tier, priced extremely competitively with other streaming services, presents an opportunity to attract new subscribers. It makes the service more accessible to cost-conscious subscribers, including those who were sharing accounts previously. (More on that later.)
Over time, the ad-supported tier presents a major growth opportunity. That's because Netflix can increase revenue per member without increasing the price members pay. Higher ad prices or increasing the number of ads per minute streamed can produce a substantial bump in revenue. Netflix says the average revenue per ad-supported member is already comparable to its ad-free tier in the U.S.
That said, CFO Spence Neumann said advertising isn't a meaningful contributor to revenue or revenue growth yet. It could become much more important in 2024 and beyond as ad prices bounce back and membership grows.
NASDAQ: NFLX
Key Data Points
The second lever is mitigating account sharing. Netflix started cracking down on shared accounts earlier this year, pushing viewers on someone else's account to sign up for their own. Members can also pay an additional fee to share their membership outside of their home.
The paid sharing rollout wasn't completed until the second half of this year, which means the impact of the move will carry through well into 2024. Management expects to see accelerating revenue growth as a result of completing the rollout.
Finally, the last lever is to increase prices for ad-free viewers. Netflix has made periodic price increases over the last decade, but its last one was way back in January of 2022.
Now, it's considering another price increase as soon as the Screen Actors Guild strike is resolved. A price increase would add billions in additional annual revenue without any additional cost. Besides passing the increased costs of a new actor contract on to Netflix's customers, that could provide a bigger boost to Netflix's bottom line than either of the above factors.
What a price hike signals about Netflix
Not only would a price hike produce the biggest impact on Netflix's bottom line, but it would also send a strong signal that its ad-supported tier and account-sharing crackdown are working in its favor.
From a purely economic perspective, streaming service companies want to maintain parity between their ad-free and ad-supported tiers. The average customer lifetime value of an ad-supported subscriber should be equal to that of an ad-free subscriber. So when Netflix (or any other streaming service) increases the price of its paid tier, it's a signal to investors that the ad-supported tier is producing more revenue per user.
But a price hike also indicates that it's seeing good results from the account-sharing mitigation. Customers are either absorbing the cost of additional households or existing viewers are signing up for their own accounts at a rate better than Netflix expected. That means there's room for it to raise prices as it's providing better value to customers than it modeled.
In other words, a price hike would signal to investors that all three levers are working and profits are set to climb considerably over the next year.
At an investors conference last month, CFO Spence Neumann said Netflix isn't even close to reaching its profit potential.
We've got a bunch of benchmarks. You know them as well as I do. Networks at scale are well above 20% operating margin. So we think we've got a lot of headroom.
Investors should expect profit-margin expansion in 2024. Netflix will continue to reinvest in its product and service to maximize its top-line long term, but the profit potential is a lot higher than it is today. With shares pulling back in price during the recent market downturn and still down over 45% from their all-time high in 2021, it may be an opportune time to add Netflix shares to your portfolio.
