Netflix and Network Effects
In mid-July 2020, if you were to browse the latest news on the Internet, one of the major headlines you would quickly see is as follows: “Netflix adds a total of approximately twenty-six million new subscribers in the first two quarters.” When COVID-19 first started spreading and state officials began implementing economy lockdowns, innumerable individuals were forced to stay home. No cinemas were open, concerts were cancelled, stadiums were jarringly silent, etc. The result? People had to seek other forms of entertainment, and they did so through one particular online television service: Netflix. As a result, Netflix experienced huge increases in new subscriber growth and unimaginable profit gain. However, not all remained the same for long. In October 2020, Netflix reported an addition of approximately two million more subscribers in the third quarter, which was smaller than its prediction of two and a half million new subscribers. Also, the addition of two million subscribers in the third quarter was very low in comparison to the addition of ten million subscribers in the second quarter. While Netflix currently remains confident in its ability to generate content for its viewers, it is skeptical about new subscriber growth in the fourth quarter. Specifically, Netflix is predicting an addition of approximately six million new subscribers in the fourth quarter in contrast to the roughly nine million subscribers it added last year during the same period. A key question that arises is as follows: what has happened to Netflix’s subscriber and profit growth? Why was subscriber and profit growth very high in the first half of 2020 but very low for the remainder of 2020?
In order to answer this question, we can analyze the concept of network effects. Put simply, network effects occur when increased numbers of people enhance a good or service’s value. When people were at home due to state lockdowns, they turned to Netflix as a source of entertainment. In fact, creating a membership account on Netflix became a proliferating trend, which resulted in the addition of millions of new subscribers and incredible profit gain. This is known as a positive network effect: as a rapid number of people began subscribing to Netflix, its value exponentially increased. However, when state officials began lifting lockdowns and the doors to entertainment venues like movie theaters were opened, fewer people subscribed to Netflix. In addition, Netflix began facing increased competition from other television streaming services like Disney+, HBO Max, etc. Hence, Netflix experienced a negative network effect: as the number of new subscribers decreased, the value of Netflix decreased as well. Moreover, a few weeks ago, Netflix increased the prices of its standard plan (the most popular plan among consumers) and premium plan. Consequently, this resulted in another negative network effect as even fewer individuals did not wish to become new subscribers, thus decreasing the value of Netflix as a whole.