When they released fourth quarter earnings data last week Netflix broke out their streaming and DVD businesses for the first time. A quick analysis of the data reveals that in the US the revenue and profit per month for each streaming customer was $21.94 and $2.40, whilst the average DVD subscriber paid $33.04, which yielded a profit of $17.32. Lower revenues are combined with lower margins with the result that the 34% less revenue per streaming sub translates into 86% less profit. Netflix hopes to make up for the lower amounts per sub by growing the digital business fast enough to more than offset the declining physical business, and by increasing margins.
Results out from Amazon yesterday tell a similar story in their books division. The worlds largest retailer provides much less information than Netflix about the performance of its different business units. However, we know that digital books rose to 19% of the US publishing market in the first 11 months of 2011, up from 8% in the same period of 2010, and that at 8% the Q4 growth rate for Amazon’s North American media sales, which include books, music, movies and video games, was below expectations. The explanation for the disappointing growth is most likely digital books, which typically cost less than physical books and on which Amazon only recognises 30% of the cover price as revenue. From the Financial Times:
Analysts said the explanation most probably lay in digital books. The Seattle-based retailer has stimulated the spread of ebooks via its Kindle devices but the shift from print is altering the fundamentals of its business as well as the publishing industry.
It is likely, however, that Amazon makes more profit on e-books than on the physical books, so whilst the trend to digital is shrinking revenues their profits should be ok. In this sense, which is the most important sense, it is better off than Netflix.
Financial analysts worry when there is a decline in any top line or bottom line metric and it is hard for management to keep Wall Street happy through transitions of the kind described above. In Reed Hastings and Jeff Bezos Netflix and Amazon have two of the most respected tech CEOs in the world, but their stock prices have still whipsawed wildly. Amazon was down 11% after their results this week and Netflix had a terrible time last year when Wall Street rejected its attempt to bring absolute clarity to its physical to digital transition by splitting the streaming and DVD businesses. So far Netflix has had the harder time of it, but streaming is now over half their business in the US, so they are over the hump. Amazon is much earlier in the transition, and has music, movies and games to worry about as well as books. That said, Amazon is a much more diversified business and is therefore more resilient to shocks in individual business units.
It will be interesting to see how the next year plays out for both these companies. Digital is the only way to go, but Wall Street may punish them for going there. If it does, then the implication is that the companies are over-valued today, not that they are getting worse.