What Netflix’s Bad Quarter Means

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Netflix was riding higher than ever a year ago. Inevitably, that momentum has slowed as competition heats up and the pandemic recedes in the U.S. On the latest episode of the Pivot podcast, Kara Swisher and Scott Galloway discuss the company’s near-term future in a crowded streaming landscape.

Kara Swisher: Netflix released its quarterly earnings report and it was not pretty. The company saw a huge slowdown in their subscriber numbers — probably not a surprise since they had experienced a huge upsurge. They added about 3 million versus the 6 million they had expected. Shares for the company fell 11 percent following the news. In a shareholder letter, the company said, “We believe paid membership growth slowed due to the big COVID-19 pull forward in 2020 and a light content slate in the first half of this year due to COVID-19 production delays” — even though they pumped out more content than anyone else, really. Flash back to this time last year when Netflix was having its biggest quarter ever. Here’s what we said back then:

[Editor’s note: The italicized section below is an excerpt from a 2020 Pivot episode.]

Swisher: I got to say, Reed Hastings is flawless as far as I can tell, in everything.

Scott Galloway: Incredible. Incredible.

Swisher: Including his weird little bedroom. So tell me. Tell me what you think of this. And what do you think is going to happen?

Galloway: Well, it’s not surprising. Right? Netflix, I believe, is up 28 percent year-to-date. So they’re obviously accelerating through the crisis. What do they do? This is a company now worth more than Disney. What they do is say they either buy Spotify or they start making these massive, super interesting investments as they did in Madrid, where they have hired 10,000 creatives and they’re creating content that can be morphed into German and Norwegian and Ukrainian content really easily. They just slip in into the same sets or the same scripts, different — you know — the hot star from Kiev and they make it a Ukrainian version. They’re the only company, other than Amazon —

Swisher: Yeah. They’re the Amazon of entertainment. That’s what I was just thinking.

Galloway: A hundred percent. As long as they manage that incredible story they have — that’s the peanut butter. The chocolate is access to the cheapest capital in the history of entertainment, and they can keep making these forward-leaning investments. And then the wind of corona will eventually subside and people will hopefully be spending less time in their homes, but they’re still going to spend more time in their homes than they did pre-corona. And you have one company that is just going out and making such incredible investments. If you’re making triple the CapEx of anybody else and you’re just as good or better, which Netflix is, you kind of can’t compete. 

Swisher: They’re really good.

Swisher: So they are very good. I still think they’re very good, but some analysts thought that future growth prospects were problematic once COVID ended, when people were not inside. They got an enormous boost from COVID, and, of course, have spent a lot of money. They’re ahead of people. But they also got an enormous amount of competition from HBO, from Disney, from all over the place. They sort of have been lapping all the other competition and now the other competition has met them.

Galloway: That was like — did you see the movie Defending Your Life? I feel like we’re in heaven, looking at ourselves.

Swisher: I love that movie.

Galloway: I’m Albert Brooks. You’re Glenn Close.

Swisher: No, Meryl Streep.

Galloway: Oh, that’s right. Same, same. Tomato, tomahto. Both amazing actresses.

Look, the thing that’s catching up, I think, to Netflix, is that the novel coronavirus has slowed production and I think the most interesting thing here is Disney’s progress against Netflix. I think Netflix has almost a quarter of a billion subscribers, but Disney has breached 100 million. What Disney has that plays to their advantage in an era of crisis where production has slowed, if not halted, is that they just have the biggest bank of content.

Swisher: Let’s not leave out Peacock. It’s not doing badly.

Galloway: With Friends and Star Trek — I mean, they do have a lot. But nothing matches the franchise value of Star Wars or of Marvel or of the animation or the kids. The novel coronavirus has been a fantastic wind in the sails of all streaming, but it’s been especially, but the catamaran here, if you will, or the one that’s just able to leap out ahead relative to the rest — a little bit of a sailing metaphor from the dog — is Disney. If it’s about capital and new production, Netflix wins, because they have access to the cheaper capital. But if it’s about a base of content that you have to draw on, because production has been slowed, then Disney makes more progress against any of them. If you look at what’s happened over the last 12 months, Disney has basically gone from zero to 60 in like two seconds. But you said this before. You don’t want to bet against Reed Hastings and Netflix.

Swisher: I never do.

Here’s an interesting quote from this guy, Nat Schindler, from Bank of America. He said, “People aren’t talking about the fact that they beat revenue. People aren’t talking about the fact that they crushed EPS [earnings per share] estimates. People are talking about the fact that they missed net subscriber additions in the quarter over last quarter. Not year-over-year growth, not even total subscribers — which was off by less than one percent. So this is really a tertiary metric, and it makes it extremely volatile. It’s incredibly difficult to predict what’s going to happen in a given quarter. I look at this as a buying opportunity largely because if you look at what has happened in the past, in the times that Netflix has missed in the past on this really hard-to-predict number … the stock has rebounded immensely.”

That’s a fair point. I would say, unlike those previous times, they have competitors. You have COVID ending and summer happening, and they don’t have quite enough content and everyone else has some really good content. I’ve noticed what I’ve been watching and it’s not only on Netflix, and it used to be only on Netflix. I love Netflix. Let me just underscore, I think they’ve run circles around all these companies.

Galloway: They’re great at what they do.

Swisher: They’ve figured out their tricks, I think. That’s really going to be hard, especially as streaming wars heat up overseas, and they’re competing for talent in a way they weren’t before. They need to keep feeding the beast of consumers’ expectations.

Galloway: Netflix really benefited from the fact that they effectively had no competition. Amazon Prime came in, but I think relative to the amount of capital they spent, I would argue that Amazon … Amazon was spending $350 million for every Emmy to HBO’s, like, 60. They just didn’t have the culture punching out creativity at the same efficiency as everybody else. HBO was caught a little bit flat-footed, and Netflix came in, and arguably, given how much they grew this space, didn’t have a lot of competition, and then competition exploded three years ago with all these people coming in with half-baked efforts to protect their legacy assets.

I think the thing you take away … when I talk to companies who do subscriptions, everyone says, okay, it’s a better economic model. But it’s more than that. When you’re in a transactional model, all you’re focused on is how do I get the next consumer in the door tomorrow. Your best and brightest are focused on creating more traffic.

Whereas, when you enter into this what I call long-term monogamous relationship, you’re really focused on the relationship and pulsing value to the end consumer. You just end up with a more product-consumer-focused organization and you end up — when you think about it, Netflix and HBO, they just have better content.

Swisher: They do.

Galloway: There’s no logical reason why they should have better content than ad-supported media, except ad-supported media takes its best and brightest and sends them to Procter & Gamble to talk about new ad packages and doing whatever they can in the short term to juice viewership the next week.

Swisher: Yep, yep. They’re just not as creative. They’re not as creative. You can just feel it.

Galloway: They can’t invest for the long term. They can’t say, okay, this show needs time to marinate, or this show is not about a huge audience. It’s about extreme quality, because that pulses value to a smaller segment.

Swisher: Harry and Meghan to the rescue — they have their first series on Netflix.

Galloway: Harry and Meghan, oh, that’s right, they did a deal with Netflix. Do you know what her greatest accomplishment to date is?

Swisher: What?

Galloway: She has accomplished what every spouse wants to accomplish —

Swisher: Which is?

Galloway: — and that is, she has convinced her spouse that their family are total assholes. I think that’s a huge accomplishment. That’s what we all try to do. We all try to convince our spouse, “Hey, your family, let’s be honest, they’re total assholes.” She’s done that. She’s convinced him.

Swisher: Anyway, Disney has other businesses. Theme parks, Baby Yoda dolls, etc., etc., ESPN, Comcast has … Amazon obviously has all the toilet paper it sells. Warner has its other businesses. Netflix only has its Netflix, and so that’s one of the problems, is can it get into other businesses? They were suggesting ad-supported Netflix possibly, or other things they could buy. You had talked again in that quote about buying Spotify and whatever, and so you wonder.

Galloway: They need a dumb hardware device. They’ve got to go vertical.

Swisher: I don’t know.

Galloway: This is Disney’s Achilles’ heel. It’s very hard to get past a quarter of a trillion dollars without investing in and owning the rails, because at some point, Apple can come in and start … it’s just amazing. If you look at Apple across … Do you realize Apple gets somewhere between 3 and 12 percent of the top-line revenue of every streaming service? They really are the toll keeper.

Swisher: They are the toll keeper.

Galloway: Because if you want access to their app store, which you have to have, you got to pay the tax.

Swisher: That’s right.

Galloway: Netflix at the end of the day and Disney to a lesser extent, because I guess they have some vertical with ABC, but I got to think these guys are going to get into some sort of dumb device — and that’s why Roku’s so powerful.

Swisher: You keep pushing the Roku thing. I think you’re right.

Galloway: Roku is the most innovative company that gets the least amount of press.

Swisher: Although, here’s a quote from Reed Hastings when asked about Netflix’s second act: “We do want to expand. We used to do that shipping DVDs, and luckily, we didn’t get stuck with that. We didn’t define that as the main thing, we define entertainment as the main thing.”

So he’s sticking with his plan. I think I would never count out Reed Hastings ever, not once.

Galloway: That guy’s a genius.

Pivot is produced by Rebecca Sananes.

This transcript has been edited for length and clarity.

What Netflix’s Bad Quarter Means