Earlier this month, Netflix (NASDAQ:NFLX) embarked on the next stage of its international expansion by launching in Japan. While the company has launched successfully on multiple continents, this was its first move into Asia.
A few days later, Netflix announced plans to expand its Asian presence further in early 2016, launching in South Korea, Singapore, Hong Kong, and Taiwan. These are sensible markets for Netflix to tackle. Nevertheless, with each set of new countries it enters, Netflix is delving into riskier and riskier territory.
Netflix has thrived in familiar markets
As Netflix has moved beyond its core U.S. market in the past five years, it has found vastly more success in the countries that look most like its home market.
For example, Netflix is dominant in Canada. It has gradually built up a strong presence in other Anglophone markets like the U.K. and Ireland. Netflix has also been extremely successful in the Nordic countries and the Netherlands: markets with high English literacy and high broadband penetration.
On the other hand, in Latin America -- where fewer people are fluent in English and broadband penetration is lower -- Netflix posted big losses initially and has faced a long slog toward profitability.
Netflix's new markets will look more and more like Latin America rather than Canada or the Nordic countries as it reaches the final stage of its global expansion project. The key question is whether Netflix has learned enough in the past few years to accelerate the process of reaching profitability in tougher markets.
Is fast Internet enough?
The Asian markets that Netflix is entering now have an interesting mix of positive and negative attributes. On the positive side, they all have relatively high GDP per capita, making a service like Netflix affordable, and they have high broadband penetration, making streaming video feasible.
English proficiency is a mixed bag. Territories like Singapore and Hong Kong also have very high levels of English fluency, which could make Netflix's English-language original series more valuable there. South Korea and Taiwan are middling in terms of English proficiency, while Japan is far behind the pack.
Cultural differences may represent an even bigger barrier to Netflix's expansion. At a high level, American TV content is less popular in these countries than in Netflix's most successful international markets.
In Japan -- by far the largest of Netflix's Asian markets -- Netflix confronts the additional headwind of the surprising popularity of old media. For example, physical media still represents 78% of music sales in Japan, whereas digital formats dominate music sales in most of the world.
Perhaps this makes the Japanese market ripe for disruption. That certainly wasn't the case for Hulu, though, which pulled out of Japan in 2014 after three unsuccessful years there. To make matters worse, a recent study by Parrot Analytics found that demand for Netflix's original series is much lower in Japan than in the European markets where Netflix is launching this fall.
To succeed in Japan -- and perhaps Asia more broadly -- Netflix may need to rely heavily on local content. If so, it would drive up Netflix's costs and increase the amount of time it takes for these markets to reach breakeven.
Expect some setbacks
Netflix's experience in Latin America shows that even when its service initially flops in a new market, the company can eventually turn things around.
That's going to be an important skill in the next few years. Japan, South Korea, Taiwan, Hong Kong, and Singapore all look like attractive markets due to their strong GDP per capita and high broadband penetration -- yet there are still plenty of pitfalls related to English literacy, consumer acceptance of streaming video, and local tastes.
Ultimately, Netflix is likely to figure these issues out, but it will take time. Furthermore, most of the markets remaining for Netflix to launch in 2016 will be even more like Latin America -- i.e., low in English proficiency, broadband penetration, and GDP per capita.
The net result is that investors should be prepared for some setbacks in the next year, compared to the consistently strong results Netflix has posted in 2015. That could increase Netflix stock's volatility next year. But as long as Netflix demonstrates continuous improvement in its more established markets, these dips could be buying opportunities rather than reasons to panic.