On Wednesday, The Walt Disney Co (DIS, Financial) reported earnings results for its fiscal second quarter of 2022, which included strong subscriber gains for its streaming service. Disney+ ended the quarter with 137.7 million subscribers, higher than the forecasted 135 million and marking a 7.9 million increase from the first quarter.
This marks a sharp contrast to the incumbent top streaming giant, Netflix Inc. (NFLX, Financial), which lost 200,000 subscribers in the first quarter of 2022 and expects that it could lose as many as 2 million in the second quarter.
Disney+ isn’t the only streaming service picking up new customers despite Netflix's troubles. Warner Bros. Discovery’s (WBD, Financial) streaming services, which include HBO, gained subscribers in the first quarter as well.
So why are Netflix’s subscribers down even as competitors like Disney+ and HBO are gaining new subscribers, and can we expect the trend to continue? In order to answer these questions, we need to look at these businesses’ strategies for attracting and retaining customers.
The honeymoon stage
Disney+, HBO and most other streaming services that are not currently the top dog in the industry (i.e., not Netflix) still consider themselves to be in a growth stage.
This means they are also still at the “honeymoon stage” with customers. Since gaining more subscribers is their top goal, they are more solicitous towards customers, focusing on things like improving content, building marketing strategies and encouraging people to watch and talk about their content.
The ability of new players to bring about a honeymoon phase is a key reason why more established companies can end up losing to younger competitors. This is especially true with businesses that follow a subscription model, since recurring revenue from loyal subscribers adds up enormously in the long run, increasing the incentive to sacrifice short-term profits in order to gain more subscribers.
Asking more for less
In contrast to its competitors that seem to be cropping up left and right, Netflix has reached a stage of market saturation where it’s incredibly difficult to gain more subscribers. At this point, just about anyone in the U.S. that’s going to subscribe to Netflix already has.
International growth is being countered by the fact that more streaming services has resulted in a rise in the number of people who only subscribe in the short term to watch just the shows they want before cancelling and moving on to the next subscription service. After all, most people can afford one streaming subscription, but that doesn’t mean they can afford 10 streaming subscriptions.
To make matters worse, Netflix is responding badly to its slowing growth by lashing out at customers. The company blames account-sharing for lost revenue and has thus begun policing accounts that have logins from more than one location, charging extra fees for multi-household accounts. You can read more about why I believe this is a terrible strategy here. The short version is, I think the higher costs combined with the antagonism toward customers and the fact that competition is fierce is a recipe for disaster. Also, Netflix is trying to sqeeze customers at a time when many are already finding it difficult to pay their bills.
Will streaming be profitable in the long run?
Netflix has been profitable on a per-share basis since 2003, but that doesn’t necessarily mean competitors will have it so easy, since they are trying to compete with a company that has been building itself up for decades.
Disney expects that Disney+ will be profitable by fiscal 2024. If it is, then this would be a truly commendable feat, since it would mean overtaking Netflix’s decades of progress in just a few years.
HBO and HBO Max’s lack of profitability is a major reason why AT&T (T, Financial) decided to spin off WarnerMedia so that it could merge with Discovery. AT&T already operates in an incredibly capital-intensive industry, so it really felt the pain of losing money on an operation that is likely years away from exiting the red.
Once the major players have been competing for a while, they will likely settle down into an oligopoly, at which point they can focus on profitability but will lose any growth stock multiples they might have previously benefitted from.
Disney’s playbook
Disney is in a unique position because it might not necessarily need streaming itself to be profitable in order to make money off of it, which is part of what makes it a dangerous competitor for Netflix.
Sure, Disney’s main competitive advantage comes from its vast library of intellectual property, but the company hasn’t built up that IP library by being nice. Part of its playbook is to aggressively take down successful competitors in the entertainment industry, even if it needs to burn money in order to do so.
This approach pays off because it increases Disney’s “share of mind” among consumers, making them more likely to become habitual buyers of Disney products and consumers of Disney media.
An example of this strategy in action is when Disney saw the success of Mattel Inc.’s (MAT) Ever After High dolls, a line of dolls based on characters that are the teenage children of fairy tale figures, and created its own Disney Descendants dolls to directly compete. Disney Descendants are based on – you guessed it – characters that are the teenage children of popular Disney characters.
Thanks to Disney’s deep pockets and overwhelming prevalence in entertainment media, it was able to produce and sell its Disney Descendants dolls at a far lower profit margin than Mattel could ever hope to achieve. Eventually, Mattel had to lower its manufacturing budget for Ever After High, resulting in lower-quality dolls, and this was what finally killed the franchise.
There’s not really anything stopping Disney from adopting this same strategy in a bid to take market share away from Netflix. Perhaps the only real way Netflix could combat this would be to create superior original content, since it could never hope to compete with Disney on price, but that’s clearly not the route Netflix is taking as it slashes its production budget.
Takeaway
As Netflix loses subscribers, its competitors are gaining subscribers. The company seems content to let this happen as it focuses on squeezing more money from its existing customers, but to me, this strategy seems akin to just handing its lunch over the moment Disney and other competitors try to eat it. Netflix is focusing on all the wrong things in an attempt to return to growth as it turns its ire on customers, which creates an ideal opportunity for competitors to swoop in and take market share.
