Netflix released its Q2 ’15 earnings late yesterday, adding 3.28 million subscribers globally, almost twice as many as the 1.69 million it added in Q2 ’14. Everyone knows that Netflix has been expanding fast internationally, but what was most intriguing about the Q2 report was that Netflix added 900K subscribers in the U.S. vs. its forecast of 600K. The 900K compares with 570K U.S. adds in Q2 ’14, 630K in Q2 ’13 and 530K in Q2 ’12.
In other words, in Q2 ’15 Netflix significantly broke out of a relatively narrow growth range it had been in over the past 3 years in the seasonally-weak second quarter. The 900K add is even more noteworthy because Netflix has almost twice as many U.S. subscribers (42.3 million) now than it did 3 years ago (23.9 million). The law of large numbers suggests the bigger a company gets, the harder it is to achieve even comparable unit growth, much less greater growth.
All of this raises the question of whether Netflix may have bent its “S curve” in the U.S. in Q2 ’15, which could portend a significant change in the video market’s dynamics. For those not familiar, the S curve basically describes the rate of a new technology’s adoption over time. Is Netflix’s heightened growth in Q2 an indication that U.S. consumers have accelerated their adoption of Netflix (and SVOD generally), or was it an outlier quarter, with growth returning to historical levels next quarter and beyond?
Why is all of this important? Because, if you believe as I do that eventually for many consumers Netflix and other OTT services will become a substitute, not an augment, to pay-TV services, then faster adoption could mean accelerated rates of cord-cutting and cord-nevering. Simply put, as more and more people spend more and more time watching an inexpensive service like Netflix, eventually more and more of them won’t see the need to subscribe to pay-TV.
In fact, I’d assert this dynamic is already well underway among young millennials. Talk to the average 23 year-old setting up an apartment and I’ll bet you’ll hear that their smartphone and landline broadband are essential, but pay-TV and landline phone are not. Consider that according to one recent study, just 18% of young millennials’ viewing time is now spent on traditional broadcast and cable TV.
Pay-TV operators recognize this shift, which is why we’re seeing services like Sling TV from Dish, a “cord-cutter” service from Cablevision, the new Stream service from Comcast, a forthcoming mobile video service from Verizon, among others.
On the earnings call yesterday, Netflix executives attributed the Q2 U.S. subscriber breakout primarily to improved original content, which included premiers of “Marvel’s Daredevil,” “Sense8,” “Dragons: Race to the Edge” and “Grace and Frankie,” plus the season 3 debut of “Orange is the New Black.” They also described higher-than-ever viewing times, improved use of the service via a new UI and their extensive use of data to drive original content decision-making.
With Netflix planning to spend $5-6 billion per year on content (leaning toward originals, many of which will have subsequent seasons released), subscriber engagement should increase further going forward. That will in turn put even more pressure on pay-TV.
Recent data from The Diffusion Group indicated a relatively small 3 percentage point drop-off in pay-TV subscriptions among Netflix subscribers. But the Q1 subscriber numbers for big U.S. pay-TV operators was soft and if Q2 numbers are as well, then I think there’s ample reason to believe we are indeed seeing underlying cord-cutting and cord-nevering increasing due to Netflix’s and others’ success. This would certainly tip the debate to Netflix being a foe to the pay-TV industry.
Netflix has always emphatically said that it can co-exist with pay-TV (see CEO Reed Hastings’ famous analogy of people using both a bike and a car). That may be true for some consumers, but Netflix’s Q2 growth spike, pay-TV’s declines and fundamental changes in consumer preferences all suggest tradeoffs are already being made by some, with pay-TV getting the boot.
While Netflix’s international expansion has gained huge attention, the disruption starting to play out the U.S. market is perhaps more consequential.