Netflix (NASDAQ: NFLX) lost another 970,000 subscribers in the second quarter, after 200,000 ditched the service in the first three months of the year. That result is actually better than expected. In April, management called for it to lose 2 million subscribers in the second quarter.
Indeed, Netflix has been having a tough time holding onto existing subscribers, but management says that's getting better. "Retention improved over the course of the quarter and, while churn remains slightly elevated, it is now back near pre-price change levels," it wrote in its letter to shareholders. And there's reason to believe churn levels will continue to improve in the back half of the year and in 2023.
Nothing out of the ordinary
There may have been a lot of noise in Netflix's first-quarter results. On top of instituting a price hike in several major markets at the end of 2021 and in early 2022, the industry was also dealing with the hangover from the COVID-19 pandemic, which led to more in-home entertainment. That was especially the case in the winter as cases swelled amid the rise of the omicron variant.
It was unclear whether churn was a response to the price hike or if other factors outside of Netflix's control were pushing churn higher. Management says the second quarter was much clearer. "We've seen pretty much the standard response that we've seen historically over the last five years or so," COO Greg Peters said on the second-quarter earnings call. While a price hike will lead to higher churn levels temporarily, management expects those levels to return to their typical rate over time.
That's extremely important for Netflix, which counts 220 million subscribers worldwide. Even a 10-basis-point jump in churn translates into a drag of 660,000 subscribers every quarter. And when you're already nearly saturated in some of the most valuable markets, it's a lot harder to find new gross additions to offset those losses.
Churn will continue to improve
There are a few reasons to believe Netflix will see continued improvements in retention over the next few quarters.
First of all, it's moving further away from the price increase in most markets where it implemented them. The price hike was likely a catalyst for some subscribers to cancel their service.
Additionally, Netflix is still recovering from COVID-19 production shutdowns and delays, and its content slate will continue to improve in the back half of the year. While a single show, like Stranger Things, won't be enough to keep customers engaged throughout the year, a steady stream of hits will keep viewers turning to Netflix month after month.
Importantly, Netflix is shifting more of its marketing toward promoting individual titles. While Netflix historically relied heavily on its recommendation algorithm and the built-in billboard at the top of the Netflix home screen, it's now using more traditional marketing channels to promote specific titles. CEO Ted Sarandos pointed to the marketing campaigns for Stranger Things 4 and The Gray Man as examples of title-centric marketing. This kind of marketing is essential to improving the perception of Netflix as providing top quality content and value for subscribers.
Management also expects that the forthcoming ad-supported tier, which it will begin rolling out in 2023, will also help improve subscriber churn. Including ads in the streaming service will allow Netflix to retain more price-sensitive customers.
Management is only forecasting for 1 million net subscriber additions in the third quarter, a drop from 4.4 million in the third quarter last year. While there's still a lot of uncertainty, the declining churn levels should push Netflix well into positive full-year net addition territory by the end of the year and into 2023.
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Adam Levy has positions in Netflix. The Motley Fool has positions in and recommends Netflix. The Motley Fool has a disclosure policy.
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