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How should Netflix's product strategy change, given its recent earnings chaos?

Two weeks ago, Netflix reported its first subscriber loss in ten years. They forecasted two million new subscribers in Q1 but lost 200,000 members and then predicted a loss of two million members in Q2. Wall Street responded quickly, driving Netflix’s stock price from $350 to $200 per share. What should Netflix do?

I’ll answer this question in three parts:

Netflix’s 2022 Product Strategy
What Happened?
How should Netflix’s Product Strategy change?

The punchline: Netflix doesn’t need to change its strategy, but it will accelerate three important tactics to re-accelerate growth:

a new ad-based $5/month plan,
paid account sharing, and
the ability to transfer sub-profiles to paid accounts.

Here goes.

1. Netflix’s 2022 Product Strategy

Over the last ten years, Netflix’s approach has been very consistent:

Create a great customer experience focusing on personalized merchandising and a simple, compelling viewing experience.
Deliver lots of TV shows and movies, with increased investment in original content.
Test to find the optimal balance between price and value.

I’ll do my best to infer Netflix’s product strategy. (It has been twelve years since I worked at Netflix.)

Product Vision

Netflix’s product vision outlines a series of step-function innovations that propelled it forward over two decades. Think of each of these steps as 3-5 year periods:

This illustrates the GLEe model for forming a product vision. Get big…Lead…Expand…

Like product strategies, each of these steps is a hypothesis. Today, Netflix focuses on original content, and its next big bet is games. The vision is that games will be a significant part of Netflix’s subscription service in five to ten years.

Games may feel like a stretch, but recall that in January 2007, Netflix launched three hundred mediocre streaming titles to complement its DVD by mail service. Today, the company is an original content powerhouse and is one of the biggest studios in the world. These step-function innovations take time.

Force-rank Growth, Engagement, and Monetization

Using the GEM Model, here’s how Netflix likely prioritizes growth, engagement, and monetization:

The GEM model requires that teams force rank Growth, Engagement, and Monetization to build cross-functional alignment.

Over the last five years, in anticipation of Disney+’s launch, Netflix focused on growth, enabling the company to build a hard-to-copy advantage through economies of scale. This year, Netflix can amortize its content investment across 222 million members allowing it to invest $18B in content — twice as much as Disney+. As a second priority, Netflix focuses on monetization so it can invest incremental profits in even more original content. The third priority is engagement, as measured by retention, given that the product’s 2% monthly churn is so low.

Product Strategy: The SMT model

A good product strategy answers the question, “How will your product delight customers in hard to copy, margin-enhancing ways?” Below are five high-level hypotheses — product strategies — outlining how Netflix plans to continue doing this. While their high-level engagement metric is retention, I listed a proxy metric for each product strategy to assess short-term progress. I’ve also added sample tactics against each strategy.

My work below is highly speculative and is not comprehensive. It attempts to craft a story using several product strategy models and observations from Netflix’s blog, earnings statements, and the product itself.

The SMT lockup combines strategy, metrics, and tactics.

Note the last “Price, plan, and margin-enhancement” strategy. Focus on this area to restart growth will be critical for Netflix over the next few years.

To illustrate the DHM model, I detail how two of the product strategies above delight customers in hard to copy, margin-enhancing ways:

Personalization delights members by making it easy to find movies they’ll love. Executing personalization at scale is very hard to copy. Personalization also helps Netflix to generate profits. They have taste data for 222 million members and use it to “right-size” their content investment. Netflix spends more on potential blockbusters like “Stranger Things” and less on niche content like “Dawn Wall” based on forecasts derived from their personalization algorithms.
Viewing experience. Netflix encodes titles hundreds of times for different devices and bandwidths. They also partner with over a thousand Internet Service Providers to localize traffic with their Open Connect Appliance embedded deployments, enabling movies to be viewed in high resolution nearly instantly. Open Connect also creates a hard-to-copy network effect via this ISP network. High-quality video and audio that “just works” delight customers.

The point of the DHM model: pursue strategies that delight customers, are hard to copy, and improve the business. That’s how companies create both long-term customer and shareholder value.

A Rolling Four-quarter Roadmap

Below is a sample roadmap. I completed this exercise to illustrate how to transform the SMT framework into a rolling, four-quarter roadmap to tell a story of how each strategy might play out over time:

This rolling four-quarter roadmap begins with Q2 2022, given I am writing this at the beginning of the Q2 quarter.

These product strategy models illustrate how I think about product strategy, what Netflix’s plan is today, and where they hope to be in the future.

2. What happened?

Netflix released its Q1 2022 earnings detailing a loss of 200,000 customers against a forecast of 2.2M new subscribers. It was the first quarter in ten years with no growth. Worse, Netflix forecasted a 2 million subscriber loss in Q2.

Here’s the resulting stock drop:

Why did growth stop? In Q2 of 2020, Netflix exceeded its forecast by 8M subscribers, delivering nearly 16M net new subscribers. As the pandemic began, COVID “pulled forward” lots of subscriber growth, given theaters were closed, and folks had lots of free time at home. Think of these extra eight million subscribers as fence-sitters that COVID pulled over the fence. These new subscribers might have joined in the next two years, but COVID inspired them to join early 2020. How long will these new members stay? Should Netflix expect more new subscribers over the next year, given this rapid influx? As COVID receded, would these fence-sitters cancel?

In 2021, Netflix's growth was slightly slower than expected, but they believed it was because growth had been pulled forward into 2020. However, by the 2022 Q1 earnings call, the answer was apparent— there was underlying weakness in the business. During the call, the Netflix exec team explained four factors:

Slower than expected rate of broadband & smart TV adoption. Netflix’s potential audience is households with broadband Internet and smart TVs. With slower adoption, the migration from cable TV to streaming was slower than expected.
Widespread account sharing. Netflix is very customer friendly as they make it easy for customers to set up multiple profiles and watch up to four simultaneous streams from one account. Worldwide, Netflix reported 100 million “sharers” across 222 million paid memberships due to this customer-friendly approach.
Macro factors include the war in Ukraine, the decision to cancel 700K Russian subscribers, continued COVID ambiguity, and the specter of both worldwide inflation and recession.

Netflix believes that all three factors grew over the last two years, slowing their growth. But it was hard to detect the issues because of accelerated member growth due to COVID.

In its earnings letter, Netflix highlighted a fourth factor: more competition from other streaming services:

Note the growth of Disney+ and other Subscription Video on Demand services (Peacock, Apple TV+ and HBO Max).

The big winner? Disney+ grew to 100 million members in 18 months, and it took Netflix eighteen years to hit this same milestone.

In the earnings call, Netflix outlined five other issues:

Effect of price increases. Netflix has slowly raised its prices as AB tests determined they were revenue positive. There’s slight, expected churn with each price increase, and Netflix works to win these customers back through continual service improvement.
It’s more about cancels than customer acquisition. The main surprise was slightly escalated churn in Eastern and Central Europe — both connected to uncertainty caused by the war in Ukraine. There’s also higher churn than expected in Latin America. Netflix will dig deep to figure out what’s going on in both regions to forecast more accurately and address the underlying issues.
Performance in India is below par. Netflix lowered prices in India and is still working to understand how to compete there. Compared to the US, where households pay $100/month for cable TV, cable TV costs $3/month in India. The value equation for streaming services in India is very different from the US.
Content is critical, but its impact is hard to forecast. Ted Sarandos, Netflix’s co-CEO and head of content, described the rich, upcoming slate of TV shows and movies. However, predicting how much new content will drive growth is still more art than science. Whether a show will be a “Squid Game” or “Cooking With Paris” requires a well-calibrated Ouija board.
Games are a long-term bet. While Netflix is making a significant investment in games, it’s clear they won’t impact 2022 growth.

In its Q1 earnings report, Netflix did what investors hate: surprise them. But the miss was mainly caused by COVID, which clouded many underlying issues.

3. How will Netflix’s Product Strategy Change?

The product team will likely ramp up work in two areas to re-accelerate growth: advertising and shared accounts. They’ll also continue to invest in games as their next big thing.

Advertising

In 2005 Netflix struggled to deliver profits with its DVD by mail service and launched an advertising business to try to generate profits. They displayed ad banners on the site and printed ads on their DVD envelopes. They even executed an A/B test to see if there was a negative impact. The surprise: no retention impact. And for three years, advertising delivered meaningful profits.

But in 2008, as Netflix’s core DVD by mail business became profitable, Reed Hastings, the CEO, decided to kill advertising. The rationale was that Netflix needed to stay focused on personalization and maintain a simple experience. When Reed relayed his decision to me (I was VP of Product), he asked two questions:

Reed: “Gib, who is going to be best in the world at advertising?
Me: “Google.”
Reed: “What do we need to be best in the world at?”
Me: “Personalization.”

At that same time, three broad business strategies— each with a clear leader— emerged:

Hulu’s ad-supported model
Apple’s new release “pay as you go” downloads, and
Netflix’s subscription.

There was pressure from both Netflix employees and consumers to offer more, but Reed felt it was essential to keep the service as simple as possible and for each of the three companies to stick to their “lanes.” We were careful not to force members to make additional choices about whether they wanted to pay more for a new release download or pay less for an ad-supported plan. This approach worked well for fifteen years.

Fast forward to today

With slowing growth, Reed acknowledged in the Q1 earnings call his changing perspective on advertising:

Those who have followed Netflix know that I have been against the complexity of advertising and a big fan of the simplicity of subscription. But as much as I am a fan of that, I’m an even bigger fan of consumer choice.”

Reed believes that today many potential customers are ad tolerant and will appreciate a lower-priced option.

If you look at Netflix’s plan choice page, it’s easy to imagine a fourth choice to the left — an ad-supported plan for $4.99 a month:

An ad-supported program could support a $4.99 plan, giving ad-tolerant customers a lower-priced choice.

The other change in Netflix’s business: no free trials. The one-month trial was an easy on-ramp for customers, and nearly 90% of subscribers converted from the trial to a paid membership. But as Netflix grew, the content costs for the trial period increased, and more customers canceled and rejoined (as new series came and went), so Netflix eliminated the free trial. Today, there’s a chance that a $4.99/month ad-based plan will serve as an easy on-ramp. Regardless, an ad-supported program will provide four clear choices for customers ranging from $4.99 to $19.99– a wide price spread that offers something for everyone.

During the earnings call, Reed also acknowledged the many companies Netflix can partner with to sell and execute advertising — it shouldn’t distract the product team too much from its current focus.

My read on the earnings call was that Netflix would move forward with advertising. Said Reed, “It’s not a matter of whether or not advertising will work. It works for Hulu, it works for Disney, and it worked for HBO.” I think we’ll see advertising on Netflix in a year or two.

Shift from multiple streams to resolution focus

There’s one crucial change in the most recent price and plan screen. Until recently, one row on the plan page detailed the number of streams a subscriber could watch simultaneously: one stream for the Basic plan, two streams for Standard, and four streams for Premium. More simultaneous streams motivated customers to choose higher-priced plans, which led to more account sharing. When Netflix was growing fast, they didn’t worry about account sharing as having multiple profiles for one account provided more taste data and likely improved retention. But with slowing growth, it’s time for Netflix to address sharing.

Today, a row describing the resolution/audio quality available at each price level (480p, 1080p, and 4K + HDR) replaces the simultaneous streams row. Netflix now buries the stream limit at the bottom of the screen and clarifies, “Only people who live with you may use your account.” This distinction is essential as Netflix sets up payment systems for shared accounts.

Shared accounts

Netflix is already exploring two concepts in Chile, Costa Rica, and Peru:

“Add Extra Member” allows subscribers to pay for account sharing for a friend or family member outside the household.
“Transfer Profile to Paid Account” upgrades a profile that’s currently sharing someone else’s account to an independent, paid account.

Like advertising, Netflix believes that it will take a year to figure out the best approach. Netflix also acknowledged that account sharing exists because of their customer-friendly policy; they made it easy for members to set up multiple profiles and watch many movies simultaneously. It will take a while to reset expectations for account sharing among Netflix members.

How will it go? For many, having the ability to share accounts outside their household creates more value, so some members will cancel when Netflix limits sharing. But Netflix hopes that a healthy percentage of the 100M “sharers” will eventually convert to a paid account. These potential customers enjoy the service and have broadband Internet and smart TVs, so shared account use resembles a free trial. There should be reasonable conversion to paid accounts.

Games are a long-term bet

While I outlined the five steps in Netflix’s evolving product vision very linearly, in reality, it was a very circuitous path. Netflix tested originals in 2008 during the DVD era but failed. Then in 2013, Netflix launched “House of Cards” and finally proved the original content hypothesis. Since then, Netflix has ramped up its original content investment, enjoying the ability to quickly translate its content into 40 languages in 190 countries and build a hard-to-copy advantage through its economies of scale.

In recent years, Netflix experimented with interactive storytelling for both kids (“Captain Underpant’s Epic Choice-O-Rama”) and adults (“Bandersnatch”). I assume interactive stories didn’t deliver enough delight to warrant aggressive investment as we haven’t seen many interactive stories in the past year. So Netflix shifted to broader gaming, with an initial focus on mobile games.

Netflix began experimenting with interactive stories with children’s titles like “Captain Underpants.”

It will take years to demonstrate success with games, so Netflix is careful not to talk about this new category as a way to jumpstart growth in 2022. Games are a long-term bet.

If games don’t succeed, Netflix will move on to its next big hypothesis. Someday, Netflix will even experiment with the holy grail of cable TV — live sports and news. There will always be a hypothesis for the next big thing at Netflix; meaningful step-function innovation is a big part of Netflix’s continued success.

Conclusion: Blending Strategy, Consumer Science, & Culture

For twenty-five years, Netflix successfully combined three elements:

Strategy: A plan for how the company hopes to delight customers in hard to copy, margin-enhancing ways.
Consumer Science: Testing to expose the plan to the reality of consumers’ whims and the competitive business environment.
Culture: The ability to create an environment that embraces risk, experimentation, and values that serve as an “operating system” for an organization to help employees make great decisions about people, products, and the business.

How will Netflix’s product strategy change this year? Not much, though there will be lots of detective work to understand the factors that made it hard to forecast the business in the past two years. And Netflix will accelerate growth tactics like advertising and paid shared accounts.

During the earnings call, Reed said, “We’re all really geared up — this is our moment to shine. This is when it all matters.” Reed’s comment reminded me of the Qwikster debacle in 2011 when Netflix lost 800,000 customers as they announced a plan to split the company in two — a DVD by mail service called Qwikster and a Netflix streaming service. After the announcement, Netflix stock fell by 35%.

In 2011, when Reed stood in front of the company to address Qwikster, he acknowledged his error. But on a hopeful front, he reiterated that the strategy was right, the A/B test systems were working, and Netflix’s culture was very healthy. To his mind, Qwikster was a recoverable error.

Reed closed out the meeting with just four words, enunciating each word very slowly:

“Just keep getting better.”

Netflix’s recovery was complete within a year, initiating its run to become a streaming behemoth worth $500 billion at its most recent peak.

I’m sure things will play out the same this time around.

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