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[Author's Note: An editing error in last Thursday's essay resulted in a sub-header title repeated for the last two sections. The last section has been renamed "Beyond Walled Gardens". I regret the error.]
Wall Street did not like Netflix’s announcement in its Q1 2024 letter to shareholders—released last Thursday—that it will stop reporting its quarterly subscriber data membership (average revenue per member or ARM) in 2025. The stock dropped 12% on the news, with analysts speculating that subscriber growth may have peaked.
If we assume Netflix is a tech company, the move mirrored tech companies like Meta and Apple which have reduced disclosures to investors as they have matured and growth has slowed. For example, we know Apple’s Services business generated $85 billion in net sales in 2023—up 9% year-over-year—but the company offers little insight into which services drive growth. Apple has yet to disclose to investors how many TV+ subscribers there are worldwide.
But, if we assume Netflix is a media and entertainment company, the move was unusual: All public media companies break out revenues according to distribution channel (e.g., theatrical, linear, direct-to-consumer). Its move means its streaming competitors will be discussing declining linear affiliate and advertising revenues while Netflix will be reporting a broadly framed story of “very substantial profit and free cash flow” from an opaque mix of subscription and advertising revenues.
Of course, Netflix is neither only a media and entertainment company nor only a technology company. It is a mix of the two and more the latter. As it moves further into gaming, streaming and advertising, the move is a simple answer to two difficult questions that I highlighted in last May’s “The ARPU of Storytelling”:
How does a media business go about redefining ARPU in the streaming era?
And, once they have redefined it, how will they sell it to investors?
Netflix’s answer to both questions seems to be, quite simply, a pivot into a story for investors that is more technology company than media company.
Key Takeaway
Netflix has forced its competitors into telling multiple stories of inevitable defeat in streaming. Those competitors now face a stronger rationale for their IP to be monetized outside the walls of their respective walled gardens.
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Total time reading: 5 minutes
Redefining ARPU in the streaming era?
I wrote in “The ARPU of Storytelling” that Warner Bros. Discovery could tell a story of gaming ARPU and streaming ARPU if they wanted to. “Hogwarts Legacy”, an immersive, open-world action role-playing game set in the world first introduced in the Harry Potter books, had been a big success. But, back then Warner Bros. Discovery management was not selling investors on gaming.
This changed last November in their Q3 2023 earnings call, where management delivered a sales pitch to investors that “sketched a future for Warner Bros. Discovery in which growth and profitability from gaming and streaming provide a cushion for the decline of the company’s linear networks” (NOTE: I wrote about this last December in “Media Executives Covet Games, but Are Ill-Suited to Run Them). But, there was no change in how direct-to-consumer ARPU was reported despite the new sales pitch. In its Q4 2023 earnings call, it shared that “Suicide Squad, one of our key video game releases in 2024, has fallen short of our expectations.” In other words, the execution has yet to meet the sales pitch.
Notably, Netflix does not yet seem to have a gaming sales pitch to investors, either. There was no discussion of individual games or any metrics offered from Q1 2024. Rather, Netflix’s value proposition to consumers as framed by CEO Ted Sarandos was “this consistent and dependable and expected drumbeat of hit shows, films and games, that's the business that we're in.” The implication is the ARM metric no longer reflects the complete story of Netflix’s business model. Engagement is probably the best metric, and a story for which they prefer to tell internally.
How to sell it to investors?
Netflix management explained in its letter to shareholders why it will stop reporting quarterly membership numbers and ARM:
In our early days, when we had little revenue or profit, membership growth was a strong indicator of our future potential. But now we’re generating very substantial profit and free cash flow (FCF). We are also developing new revenue streams like advertising and our extra member feature, so memberships are just one component of our growth. In addition, as we’ve evolved our pricing and plans from a single to multiple tiers with different price points depending on the country, each incremental paid membership has a very different business impact.
The framing of this point reflects an argument I made two years ago in my (ultimately very wrong) prediction, “Mark My Words, We Must Imagine Other Business Models for Netflix Than Advertising”:
Netflix may indeed need more than streaming to drive growth in its business model. But, understanding what they will end up doing relies less on looking to media's past, and rather forcing ourselves to imagine which business models Netflix executives believe its software makes possible.
Two years later, those business models appear to be games, livestreaming and now ad-supported streaming, to date. In that essay I was skeptical about advertising because “Adding advertising to Netflix adds complexity to a business that is already unusually complex for a media business.” Reading the explanation from management, above, Netflix’s business model had evolved to the point where the attempt to explain ARM across those different business models on a single platform would likely confuse investors and employees, alike.
The Occam’s Razor solution seems to be refocusing the story around revenue and operating margin as its primary financial metrics, and engagement (i.e. time spent) as “our best proxy for customer satisfaction”. Engagement has been a tightly controlled story, to date, and management promised “progressively more information on engagement, starting with our Top 10 weekly and most popular lists and more recently our bi-annual report into viewing on Netflix (which covers ~99% of all video watch time on our service).”
The New ARPU of Storytelling
“The ARPU of Storytelling” highlighted how WarnerMedia and Disney under former CEO Bob Chapek had struggled to convince investors that ARPU would be able to capture multiple user behaviors. The New York Times has succeeded with a story that includes both Total digital-only ARPU ($9.18 in 2023, up 2.6% year-over-year) and an ARPU broken out across digital verticals (Bundle and multiproduct ($13.05), News-only ($9.54), Other single-product ($3.57)). Its stock price is up 7% over the past year but down 11% year-to-date.
Netflix is up 18.47% year-to-date and 69% over the past year. The price drop last Thursday and Friday was in response to management dropping the ARM/ARPU story. How the story will play out in the long term remains to be seen. Netflix’s management seems to believe it has made the right decision.
Normally the question in this instance is “Will any of its legacy media competition follow?” But, the reality is that none have proven they have the technical chops to scale to, much less compete at, Netflix’s level. So, the question is really “Will any of its legacy media competition be able to follow?”
The answer is clearly No, suggesting Netflix has positioned its competitors into telling multiple stories of inevitable defeat in streaming. Not because they cannot compete on ARPU—both Warner Bros. Discovery’s Max ($11.65) and Disney’s Hulu ($12.29) have ARPU that is competitive with Netflix ($17.30) in the domestic U.S.—but rather because they are not in a position to build or tell any story to investors other than streaming, theatrical and linear.
The timing is rather wicked: As I argued in last Thursday’s essay, the economic rationale for media conglomerates controlling enormous libraries of intellectual property (IP) under the protection of copyright law is beginning to weaken. The implication is that if Netflix’s competition can no longer tell a story to investors of competing with Netflix, the stronger the rationale will be off their IP to be monetized outside the walls of their respective walled gardens. As both a competitor and a licensor, Netflix stands to benefit both ways.