A Brief History of Netflix

Netflix was founded in 1997 as a DVD-by-mail service.  In 2007, Netflix began offering streaming and the company’s focus shifted.  By 2013, three-quarters of Netflix’s domestic revenue came from streaming.  Streaming is now clearly Netflix’s focus, with 97% of its 7,100 employees working on streaming and 95% of domestic revenue coming from streaming in 2018.

In 2014, Netflix stopped marketing its DVD-by-mail service, which it calls its “legacy” business.  The number of DVD subscribers has fallen by two-thirds since that time.  Meanwhile, Netflix has significantly increased its marketing budget for domestic streaming.

This has led to robust growth, with the number of domestic streaming subscribers nearly doubling (from 33 million to 58 million) between 2013 and 2018.

Why does Netflix still offer a DVD-by-mail plan? 

There are two reasons:

  • Netflix tried and failed to jettison the service in 2011
  • The DVD-by-mail segment makes money

Not long after it began offering streaming, Netflix executives saw the writing on the wall and announced that Netflix would be split into two companies: (1) Qwikster, which would handle the DVD-by-mail business, and (2) Netflix, which would solely stream content.  Netflix subscribers became livid, as they were being asked to maintain two different membership accounts and absorb a 60% price increase.  Netflix quickly pulled the Qwikster idea (but kept the price increase) but not before 800,000 subscribers ditched Netflix in a single quarter.  The DVD-by-mail service has stayed with Netflix ever since.

DVD-by-mail may be a declining business, but it did generate $212 million in profit in 2018.  There were still 2.7 million DVD-by-mail subscribers at the end of 2018, so this part of Netflix’s business is likely to hang around for a few more years.

In 2013, the DVD-by-mail profit margin was more than twice the profit margin for streaming.  The gap has narrowed since that time, but DVD-by-mail consistently has a higher profit margin.  This is largely because the cost of revenue is much higher (as a percentage of revenue) for streaming than it is for DVD-by-mail.

Cost of revenue is the cost to license and produce Netflix programming, which Netflix capitalizes (makes an asset) and expenses over time.  Netflix’s streaming business loses a higher percentage of sales dollars to cost of revenue than its DVD-by-mail business because it is more expensive to acquire streaming content than it is to purchase DVDs.

What is the future of Netflix and DVD-by-mail?

Netflix would have been happy if streaming never became a thing; as the pre-streaming Netflix was cash-flow positive with no debt.  The rise of streaming led Netflix to borrow heavily in order to obtain content, which created a cash crunch that I discussed in a different article.

But streaming offers Netflix a tremendous opportunity:  economies of scale.  Cost of revenue is primarily a fixed cost; thus, it costs Netflix almost nothing when a new subscriber signs up for streaming.  This isn’t the case for DVD-by-mail, as millions of subscribers can’t use the same DVD at the same time.

Thus, if Netflix can continue its impressive subscriber growth while managing to keep cost of revenue down, it is possible that the company could become cash-flow positive in the long run.  But until that time, Netflix will be grateful to maintain its dwindling DVD-by-mail service as the company needs all the cash it can get.

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