Netflix Still Committed to DVD-by-Mail Business to Offset Expansion Costs

Netflix lost 1.3 million DVD subscribers in 2013, compared with a loss of three million DVD subscribers the prior year, bringing the total number of disc-by-mail subscribers to 6.93 million on Dec. 31, the company said in a 10-Q SEC filing. DVD revenue fell 20 percent to $911 million, Netflix said.

As the number of DVD-by-mail subscriptions continues to spiral downward, Netflix expects the domestic DVD business to continue to generate “significant contribution profit” that will help offset losses from its expansion into international markets with its streaming-only service. The company believes the number of DVD memberships will continue to drop and doesn’t anticipate an increase in spending on its DVD operations and technology, it said. The DVD segment had a contribution margin of 48 percent for the year ended Dec. 31, relatively flat compared with the prior year, it said.

The number of subscribers to Netflix’s domestic streaming service grew by 6.3 million, or 15 percent, to 33.4 million, the company said. Domestic streaming revenue jumped 26 percent, or $566.5 million, to $2.75 billion on membership additions, it said. Netflix has retained its $7.99 per month domestic streaming membership plan, but it added an $11.99 plan late last year that allows members to stream content on up to four devices concurrently, it noted. The number of new member additions related to the $11.99 plan wasn’t material for the year, it said.

Cost of revenue in Netflix’s domestic streaming segment grew 19 percent to $1.84 billion in 2013 largely due to a $226.3 million jump in content licensing expenses with existing and new streaming content, including original programming, the company said. Content delivery costs grew by $31 million, and payment processing fees and customer service call centers added $33 million in costs as a result of the growing member base, Netflix said.

Netflix expects a “substantial European expansion in 2014,” it said, having added the Netherlands in September to join the U.K., Ireland, Finland, Denmark, Sweden and Norway. Netflix also offers its streaming service in Canada and Latin America. The company ended 2013 with 10.9 million international subscriptions, a 79 percent increase over 2012, it said. International revenue grew 148 percent to $712 million, it said. The prices of international memberships range from $7 to $14 per month (in U.S. dollars).

Netflix ended 2013 with 2,022 full-time employees along with 305 part-time and temporary employees used primarily in DVD fulfillment operations that have “fluctuating demand.”

On risk factors, Netflix cited the possibility of introduction of net neutrality legislation that could “decrease the demand for our service and increase our cost of doing business.” It said it is unclear how the FCC will respond to U.S. Court of Appeals for the D.C. Circuit’s reversal of FCC net neutrality rules last month and how network operators will attempt to benefit from that decision.

If network operators “attempt to use this ruling to extract fees from us to deliver our traffic or otherwise engage in discriminatory practices, our business could be adversely impacted,” Netflix said. Internationally, government regulation concerning the Internet along with “potentially significant political and economic power of local network operators” could result in “discriminatory or anti-competitive practices that could impede our growth, cause us to incur additional expense or otherwise negatively affect our business,” it said.

Usage-based pricing and “meaningful bandwidth caps” -- or other ways network operators could try to monetize access to the their networks -- could result in higher operating expenses that in turn could hurt member acquisition and retention, Netflix said. If network operators were to create tiers of Internet access -- and “either charge us for or prohibit us from being available through these tiers” -- that could also hurt Netflix revenue, it said.

Netflix highlighted the competitive relationship it has with Internet service providers that offer pay TV programming and so have “an incentive to use their network infrastructure in a manner adverse to our continued growth and success.” It said Comcast “exempted certain of its own Internet video traffic (e.g., Streampix videos to the Xbox 360) from a bandwidth cap that applies to all unaffiliated Internet video traffic (e.g., Netflix videos to the Xbox 360).” Netflix expressed the hope that consumer demand, regulatory oversight and competition “will help check these incentives” so that network operators aren’t able to provide “preferential treatment to their data” and not to Netflix content.