The Netflix Crisis Isn’t What It Seems

In the following excerpt, Derek and Matt Belloni discuss the streaming wars, Netflix’s engagement, and whether Netflix is a media company or a tech company.

Derek Thompson: So we have about an hour, but let’s say we only had two minutes and we were at a cocktail party or something, and you really wanted to scurry away to get a shrimp or a rye cocktail. And I said, “Just give me two minutes. What’s the matter with Netflix?” What’s your answer?

Matt Belloni: Well, the short answer is that not much is actually the matter, if you look at their financials, because they’re going to have $15 billion in profit this year. They won the streaming wars when you look at the broader picture through Hollywood. They came, disrupted, kicked everybody’s butt and remade the industry in their own image. But … They have a problem with Wall Street. They were the darling of the media industry, because they were not a media company, they were a tech company. And the growth trajectory of Netflix was based on engagement numbers, that’s their fancy word for viewership, that kept going up, up, up, and the engagement on Netflix has slowed down. Why has it slowed down?

That is the billions and billions dollar question, because if you ask a lot of people at Netflix, especially those who work in the L.A. operation, the content people, they would say, that it’s the Silicon Valley people fault. The user interface got too cluttered. It was hard to find what you wanted. They have 100 percent belief in the algorithm to match the content you want to watch with the content that the Netflix people are making and licensing, and that there are serious problems on the tech side.

Now, what the co-CEO of the company, Ted Sarandos, believes is that the content is not good enough, especially in the U.S. and Canada, which is what generates about 70 percent of the viewership. The content that is made in English language, primarily for the U.S. and Canada, has become cluttered, they have lost their way. And that’s why they completely remade their executive suite this past week with a new head of content and they’re going to bring in a new head of film. And they believe they have to get better at the content that they produce, that’s the short answer.

Thompson: And see, this is why you’re the best, because I think if I brought on 10 people, nine of them would’ve said, “Oh, the company’s broken. Something deeply, deeply is rotting inside of the company.” If you just look at the numbers, if you’re just a boring ass accountant and you look at the numbers, Netflix has a higher operating margin than it’s ever had. It has the lowest churn number of any of the streamers. It’s obviously bigger than all of its streaming competitors. It’s obviously won the streaming wars. A Netflix premium customer has a lifetime value that is significantly more than the next best offering from HBO or Paramount. It is the industry leader in practically every single metric you could possibly name. But then there’s this word that you used, engagement. What is the number here? What is the number that is stagnating or going down that is causing Wall Street, and even causing some people inside the company to freak out if all of these other numbers, revenue, profit, operating margin are all going up?

Belloni: We know from the first half of the year that engagement was up 2 percent, which not down, it’s still growing, but-

Thompson: Just quickly, what does that mean? What is engagement?

Belloni: That means that the hours watched on Netflix were up 2 percent from the previous year in the first half of the year. And that’s fine, but it’s not good enough. It’s not what they have been used to. And most importantly, it’s not what Wall Street is used to. Because the Netflix stock price is a real factor here of what’s driving all the change. Netflix has lost about 40 percent of its value in the past year. And the reason is, like I said, the tech moniker over Netflix, that halo that allowed them to be valued like a tech company and not a media company, people are waking up and they are realizing that Netflix is basically a fancy media company. They’re not diversified, they don’t use content to sell baby formula like Amazon. They don’t pursue content just for the heck of it, and they are marketing halo like Apple. They are not user-generated and a passive utility like YouTube. They are a media company that depends on the frequency and quality of the product that they are creating, and that’s a real factor here.

Now, the fact that they also tried to buy Warner Brothers last year, I think was the big wake up moment for a lot of investors. When Netflix decided … Now this is a company that for 20 years has said, “We are a grower. We’re not a buyer. We don’t need to buy anything because we are growing, growing, growing.” When they announced to the world that they thought they needed to buy Warner Brothers and HBO and all of the IP, intellectual property that comes along with that studio, people said, “Wait a minute, they know something we don’t.” And in fact, there’s some reporting that’s come out via Bloomberg in the past week or two that says that internally they’re looking at metrics that show fewer people are opening the app, and when they are there, they are spending less time. And to Netflix, that is, that can’t happen. More people need to be opening the app and they need to figure out how to do that.

This excerpt has been edited and condensed.

Host: Derek Thompson
Guest: Matt Belloni
Producer: Devon Baroldi
Additional Production Support: Ben Glicksman