Netflix marked subscriber growth in the second quarter as it rolled out paid sharing broadly in May, but executives on Wednesday emphasized they expect converting password sharers to paid subscribers – and the related business impacts – will happen gradually.
Although Netflix gained 5.9 million net subscribers globally in Q2 (including 1.2 million in the U.S. and Canada) on the back of the paid sharing rollout, it saw average revenue per member (or ARM, as Netflix terms ARPU) decline in nearly every region quarter over quarter. Total revenue of $8.2 billion was also slightly below expectations.
In its domestic market, Netflix reported ARM of $16.00, down from the $16.18 in Q1. It also marked ARM declines in EMEA (down 3% to $10.87), LATAM (down 1% to $8.58) and APAC (down 13% to $7.66).
Macquarie Research analyst Tim Nollen in a Thursday note to investors noted the U.S./Canada decline in ARM was surprising, “where the paid sharing launch presumably led to higher revenues, and ad tier subs also should have helped given they contribute to higher ARM than the standard ad-free plan.”
As Netflix prioritizes revenue growth, it’s pursued multiple avenues including shifts in plans, pricing and policies, all of which are expected to positively benefit the business over time.
The most recent effort is the password sharing crackdown through paid sharing launched in May. There Netflix can monetize unpaid users and grow revenue by either getting shares in different households to pay the extra member fee, enticing them to sign up for their own account on the nascent lower priced ad-supported tier, or pushing them to higher ARPU ad-free plans (the cheapest of which was just dropped for new or rejoining members, also potentially driving users to the plan with ads, or bringing in over $15 per month per user on the Standard commercial-free plan).
Netflix is charging $8 per extra member for users in different households in the U.S. It’s rolled out paid sharing in over 100 countries as it looks to monetize an estimated 100 million users globally that access a Netflix account without paying. The U.S. extra member charge is a price point and policy that other analysts have pointed out are designed to drive signups for the less expensive ad-supported tier (which at $6.99 per month is priced lower than an extra member) or pricier ad-free plans.
But as Nollen also noted, on the earnings call Wednesday Netflix leadership expressed confidence in the effort and told investors they expect a resulting uptick in both revenue and subscribers to be more of a slow build.
Engaged password sharers converting first
Speaking during the Q2 earnings call Wednesday, Netflix co-CEO Greg Peters noted that the company in the quarter was positive on revenue and subscribers relative to pre-launch of paid sharing in all of its regions.
“I also think it’s important to note that the business impacts of that product experience will roll in over several quarters,” Peters said. “So, it's not an overnight kind of thing because, in part, the interventions are applied gradually and, in part, because some borrowers won't immediately sign up for their own account but will do so…next month or three months or six months or maybe even longer down the line as we launch a title that they're particularly interested in.”
As to who is converting first, perhaps unsurprisingly, management said it’s the segment of password sharers that are most engaged with the SVOD, such as those who use it every day, that are very likely to sign up for their own account quickly.
“Some folks are less engaged, and it's going to take us a little bit longer to convince them to move over with great stories, great TV shows, and films,” Peters said.
He categorized the early cohort of conversions as “generally well-qualified members” – something Peters views as positive as they are choosing plans, engaging at rates and have retention characteristics that generally look like members who have subscribed to the service for a long time.
Another component of the gradual ramp for revenue and subscribers is Netflix rolling out mechanisms to prevent password sharing more broadly over time (with Bank of America analyst Jessica Ehrlich noting on the call anecdotal instances such as where some people on mobile haven’t yet been blocked from accessing Netflix accounts shared with people outside the household).
“We'll see those interventions broaden to more of those cohorts over a period of time,” Peters said.
Subscriber growth primary revenue driver in 2023
Netflix guided for global ARM to be flat or down in Q3, with revenue expected to grow 7% year over year to $8.5 billion and accelerate further in Q4 on the back of subscriber growth.
Netflix CFO Spencer Neumann, speaking to the around 1% global decline in ARM and Q3 forecast, noted it’s nearly a year out since Netflix raised prices in major markets in advance of paid sharing, citing that as the primary factor. Movement in the plan and country mix shift is also at play, he said, as much of the company’s subscriber growth in the past year has been international, with lower ARM countries impacting trends. But over the medium to longer term, Netflix believes ARM will get a boost from price changes, ads and extra members – though both of the latter are still in the early days.
“We’re really early in terms of paid sharing impacts, including extra member…that’s going to build up over multiple quarters and as they do, we’ll see all of that demonstrate itself in growth in ARM overtime, we’d expect,” Nuemann commented.
That said, the finance chief noted most of Netflix’s revenue growth this year is going to come from subscriber volume through new paid memberships – driven by the paid sharing rollout (though not the extra member fee itself). The U.S./Canada is also getting a little more benefit from ads thanks to the larger advertising market. But while Netflix’s plan with ads saw subscribers double since Q1 the base remains limited, and Neumann said the impact of ads on revenue, even in the U.S., is still very small overall and nascent to the business.
Peters also commented on Netflix’s move this week to drop its cheapest commercial-free plan (Basic plan, usually priced at $9.99 per month) for new members in the U.S. and U.K., as it did recently in Canada, which could also potentially help drive ARM higher.
The change in plans was made with two goals in mind, according to Peters. One is to offer consumers a wide range of price points. The other is to optimize long-term revenue, including factors such as signups, conversion, take rate, and retention.
“Just as we evolve from a single plan years ago and have adjusted our offering over time, this latest move reflects what we think will best achieve those goals in the countries that we launched it in,” Peters commented. He added the entry price points on plans with ads in those markets is accessible and those plans are “attracting a healthy share of sign-ups.”
And when Netflix drops the basic tier, he said they’re seeing consumers sort into two groups: One that takes the plan with ads (helping to grow that base to bring in more ad revenue), or those that move into the standard plan, which at $15.49 per month is priced more than $5 higher than the now defunct Basic plan.
“Netflix has now removed its US & UK basic ad-free tiers for new/rejoining members - another step to drive users to the ad tier where despite a large member base Netflix still has far to go to achieve the reach that advertisers want,” Macquarie’s Nollen wrote to investors. The firm said it’s “optimistic on the upside potential to subs, revenue and earnings from paid sharing efforts and its ad tier, but are conscious of the time it will take for these to contribute.”