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How Netflix Inc. Plans to Spend $7 Billion Next Year

By Demitri Kalogeropoulos - Sep 22, 2015 at 7:20PM

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Rivals will have to write some huge checks if they expect to knock the global streaming giant off of its leadership perch in 2016.

Netflix's (NFLX 2.90%) management recently updated what it calls the company's "long-term view," a statement on the big-picture thinking of CEO Reed Hastings and his team about where the business is heading. This is their forecast at the broadest level: "Over the following decades, Internet TV will replace linear TV, and we hope to keep leading by offering an amazing entertainment experience."

The long-term view, published in July, is heavy on competitive strategies and industry dynamics — but light on numbers. Still, it does include 2016 spending estimates for Netflix's three biggest expense categories: content, marketing, and tech development. Together, these investments add up to a cool $7 billion. A shareholder could see that spending forecast as an expensive bet on highly uncertain future profits. But to me it looks more like one heck of a competitive moat. Either way, this is where that mountain of cash is going.

Content is king
Acquiring enough TV shows and movies to keep Netflix's 65 million subscribers entertained is projected to cost $5 billion in 2016, or close to double this year's outlay. But it isn't just the size of the checks that's changing around Netflix's surging content splurge.

Disney is one of the few big content owners that Netflix plans to keep a close relationship with. Source: Netflix.

The biggest difference lately is that management is focusing on originals and putting less money behind assembling a wide selection through deals with content owners like Epix and Starz.

Instead, Netflix is aiming to be more like HBO than a cable network. "We are actively curating our service rather than carrying as many titles as we can," according to the long-term view. Unfortunately for the business, this originals-focused approach consumes more upfront cash, which is why Netflix has had to take on signifiant debt over the last two years.

Disney is a big exception to the go-it-alone approach. In fact, next year will bring the two companies closer than ever as Netflix becomes the exclusive streaming distributor for first-run movies put out by The House of Mouse. This one deal probably cost in the neighborhood of $300 million, and investors shouldn't be surprised if the Netflix-Disney partnership grows over time.

Buying new members
Netflix plans to spend $1 billion on marketing and advertising next year, up 70% from 2015's projection. Most of that investment will happen in international markets like Japan, where the company hasn't yet established a strong brand or dominant market position.

The important thing to remember about the level of marketing spending is that it involves a simple trade off between membership growth and profits. Right now, management is choosing to prioritize subscriber gains internationally. That's why this business is suffering from a double-digit percentage loss at the moment. But within a few years Hastings expects those markets to approach the strong profitability Netflix enjoys in the U.S., with margins headed toward 40% of sales despite a decreasing marketing commitment.

Improving the service
At $700 million, Netflix plans hefty investments in improving the streaming experience next year. This involves initiatives like the June update to the TV app that added better title art and more detailed show information. These changes make it faster and easier for subscribers to find the stuff they want to watch.

The shift should also improve retention numbers, management believes. And innovations like these help Netflix keep rivals on their heels, stuck playing catch-up to Netflix's ever-improving TV-watching experience.

Source: Netflix.

Looking ahead
Netflix's "to do" list is much longer than it's "done" list. Engineers are working on adding many more languages in support of Netflix's spiking global growth. They are tweaking the recommendation engine to show more targeted and personalized content. And they're busy optimizing around the mobile devices that are the main Internet screens in many of the emerging markets that Netflix will be expanding into over the next year.

Netflix expects to be in every market around the world by the end of 2016. It hopes to control a uniquely deep catalog of original content by then, in addition to some of Disney's most popular theatrical hits. It also plans to pioneer major improvements to the way people experience TV along the way. Achieving those goals will cost nearly all of Netflix's profits next year. But management thinks that the business will be positioned for significant earnings growth from 2017 on.

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