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Friday, August 22, 2014

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  • Netflix's Q3 Subscriber Loss Could be Churn AND Acquisition Related

    With Netflix today lowering its Q3 U.S. forecast by 1 million subscribers to 24 million, many observers are focused on the culprit being higher churn induced by the company's recent pricing change. Churn could well be the big driver here, but the cause could also be the other side of the equation: a slowdown in new subscriber acquisitions, particularly for those just wanting the DVD-only plan. Until we get the actual breakdown with the Q3 results, we won't know for sure, but if it's both factors, then Netflix might be finding itself at the beginning of a very different chapter in its evolution.

    By extrapolating from prior quarters, I had previously estimated that Netflix could have around 6.9 gross subscriber acquisitions in the U.S. in Q3. Since the company originally forecast to end Q3 with 25 million subscribers, that would imply net growth from Q2 of around 410K subscribers, which in turn would mean churning out 6.5 million subscribers. That level of churn would be at least 2.5-3 million higher than expected given prior history.

    Now, with a new Q3 target of 1 million fewer U.S. subscribers, is Netflix experiencing even higher churn? Or having a harder time attracting new subscribers than planned? Or both? A key part of Netflix's impressive stock run-up over the past 2 years is due to its ability to add millions of subscribers each quarter. With the stock nose-diving almost 20% today, investors are surely wondering whether the subscriber growth engine - in the U.S. at least - is sputtering.

    With exit barriers to the streaming service so low, it's to be expected that churn will be a fact of life for Netflix. But to stay a step ahead means having strong new additions. It's too early to know, but the combination of multiple online entertainment options (e.g. Hulu, Amazon, free, pay-TV, etc.) and diminished content appeal (Netflix recently lost the Sony movies due to a usage cap in their Starz deal) could well be starting to have an impact on Netflix's growth rate. With the Disney movies going away in March when the Starz deal expires, Netflix's streaming content will come in for even greater scrutiny.

    Netflix has made no secret of its desire to morph into a full-fledged streaming company. But I continue to maintain it split streaming and DVDs too early. The combination delivered both choice and convenience, in a package no other competitor could match. I still don't fully understand the rationale for why Netflix felt compelled to split the services now and hike the entry price of streaming plus 1 DVD to $16/mo (about halfway into this interview today there's another explanation). Having made the move though, it looks like the company is starting to pay the price. Over the next few quarters we'll get a better handle on both churn and subscriber acquisition performance which will reveal just how disruptive the service and price changes were.