Last week, Netflix (NFLX 9.69%) reported another quarter of stellar growth. The company grew its streaming subscriber base by more than 5 million during Q3. Its domestic contribution margin remained very strong, while its international business posted a quarterly profit for just the second time in Netflix's history.
Not surprisingly, Netflix's management team was thrilled with this performance. During the quarterly earnings interview that followed the earnings release, Netflix executives pointed to several reasons why the streaming video pioneer still has a long runway for growth.
1. Content investments are paying off
[I]f you look at the long-term trend in our business, we've grown the content budget, we've grown the content library and made it better, but revenues have grown faster, which is what's driven the profit improvement and the margin improvement over the years.
-- VP of Investor Relations Spencer Wang
In recent years, Netflix has been increasing its content budget by $1 billion or more annually. Last year, its "cost of revenues" -- a rough proxy for content spending -- increased by more than $1.4 billion year over year. The 2017 increase is on pace to be even larger.
Netflix is investing heavily in its content library. Image soure: Netflix.
This content spending is necessary for driving long-term subscriber growth at Netflix. However, it would be problematic if it were coming at the cost of profitability. Fortunately, despite the rapid growth in Netflix's content spending, revenue is rising at an even faster clip. The company grew its revenue 30% -- or more than $2 billion -- in 2016. It is on track for even faster growth in 2017, and should add nearly $3 billion to the top line this year.
2. Netflix has a sustainable content advantage
I think we've created a place where people want to come and create. They've heard from their friends, they've seen it from their peers that they've been able to come and do the best work of their lives.
-- Chief Content Officer Ted Sarandos
As Netflix has become a force in the media market, some competitors have grown wary of licensing their content to it. So far, this hasn't been a problem, as Netflix has seamlessly moved into creating compelling original content. Indeed, the company has become a perennial No. 2 behind HBO in terms of Emmy nominations.
It would be natural to wonder whether Netflix can sustain this level of quality in its original programming. Ted Sarandos, the company's content chief, certainly thinks it's possible. He noted that Netflix gives content creators more freedom to carry out their vision than traditional TV networks. This helps draw talent to the Netflix platform and encourages them to do their best work.
3. Still optimizing in Asia
There are specific lessons we have to learn about which content, how to get that developed, that we're working on. ... It's just going to take some time to iterate on the content as we did in Latin America five years ago.
-- CEO Reed Hastings
Netflix has huge ambitions for growth in Asia. After all, the continent is home to well over half of the global population. However, the company's subscriber base there remains modest thus far.
CEO Reed Hastings is confident that Netflix is on the right path, though. He pointed investors to its considerable success in Latin America. It took a while to figure out what content would play well in places like Mexico and Brazil and how to overcome infrastructure hurdles there. Yet Netflix eventually cracked the code in Latin America -- and it will take the same patient approach in Asia.
4. Mobile can be a big growth driver
So as you mentioned, one of the things that we're working very hard on is making sure that the encodes that we're using are super-efficient so that we can provide a really, really high-quality video experience, and with lesser and less bits.
-- Chief Product Officer Greg Peters
Creating a more mobile-friendly product is one thing that could drive faster growth in Asia and other developing markets. For many people, a smartphone is their only internet connection. However, data limits are common, as is inadequate bandwidth.
That's why Netflix continually invests in improving its encoding technology. Efficient encoding allows it to deliver high-quality video content while using less bandwidth. As it becomes more feasible to take advantage of streaming video without having a home broadband connection, Netflix's total addressable market will expand. (Being more mobile-friendly could also increase member engagement in developed markets, supporting further growth.)
5. Investing in marketing
I think I've indicated in the past that U.S. marketing has gone up on an absolute basis as we see the benefits ... of promoting our original content. I think you'll see that increase again in '18.
-- CFO David Wells
While Netflix is achieving its fastest growth abroad, management still sees plenty of room to grow in the U.S. (Netflix ended September with about 53 million domestic streaming subscribers, compared to its long-term target of 60 million-90 million.)
In recent years, Netflix has found that promoting its award-winning original content is the best way to drive continued subscriber growth in the U.S. As a result, the company has started to aggressively ramp up its domestic marketing spending again, after a period of steadier spending a couple of years ago. Year to date, domestic marketing spending is up 29% year over year. That investment is paying off, as domestic revenue has risen 23%.
