Netflix Adds Fewer Subs Than Expected as HBO Readies Rival

Not as Many Americans Signing up for Netflix as a Year ago

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Kevin Spacey as the manipulative Frank Underwood on 'House of Cards.'
Kevin Spacey as the manipulative Frank Underwood on 'House of Cards.' Credit: Netflix
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Netflix has had better days.

On the same day that HBO announced plans to more directly rival Netflix, the streaming video service reported that it had failed to attract as many new subscribers as it had anticipated three months ago.

Three months ago Netflix projected that it would end the third quarter with 50.9 million people paying to subscribe to its streaming service around the world. But when the company reported its third-quarter earnings on Wednesday, it fell short at 50.7 million people. In the U.S. -- Netflix's largest subscriber base -- Netflix had projected 36.5 million paid subscribers by the end of the third quarter, but fell short with 36.3 million.

Netflix is beginning to have a hard time attracting completely new customers. Not only did the company fail to add as many new-to-Netflix streaming-service subscribers in the U.S. as anticipated, but it didn't add as many it had a year ago. Netflix holds that it has not hit the domestic subscriber ceiling, but rather attributed the slowdown to its decision earlier this year to raise prices for new customers.

"As best we can tell, the primary cause [for the net additions decline] is the slightly higher prices we now have compared to a year ago. Slightly higher prices result in slightly less growth, other things being equal, and this is manifested more clearly in higher adoption markets such as the U.S.," the company said in its earnings statement.

That suggests Netflix faces a steeper climb to its stated goal of one day notching 60 to 90 million U.S. subscribers, which CEO Reed Hastings said in April would be "two to three times larger than domestic HBO."

Marketing game plan
Whether Netflix needs to reconsider its marketing game plan remains to be seen. In April Netflix said that it was switching its marketing strategy from going after subscriber sign-ups with direct-response campaigns to spending its budget on more brand advertising. For example, during the second quarter, Netflix rolled out what the company described as its "largest content-marketing push to date" to promote original series "Orange Is the New Black."

Netflix increased its overall third-quarter marketing budget by 35% year-over-year to $145.7 million. But the marketing budget for its U.S. streaming service only inched up by 1% year-over-year to $61 million.

If Netflix is already having a hard time attracting new U.S. subscribers, its struggles may be compounded next year when HBO rolls out a streaming version of its service that wouldn't require people to have a cable TV subscription. Netflix has called HBO its primary long-term competitor since 2011, but now the two will contend more directly -- and especially for so-called cord-cutter or cord-never households who don't subscribe to cable or satellite TV.

"We and HBO have completely different content, so I don't think it will be a significant impact at the consumer level," Mr. Hastings said during the company's earnings webcast on Wednesday.

Wall Street doesn't appear to be so bullish on Netflix's prospects. The company's stock price took a 3% tumble Wednesday morning after HBO announced its streaming-service plans. Then the price plummeted by 25% in after-hours trading following its earnings release.

In addition to competing with HBO for subscribers, Netflix may face increased competition from HBO for content if the TV network opts to expand its video library beyond its own shows and Hollywood films.

"HBO is another buyer in the market if they do choose to start licensing even from their sister companies [at Time Warner]," said Netflix chief content officer Ted Sarandos during Wednesday's earnings webcast.

If HBO does begin to compete against Netflix for content, that could shoot up content prices and therefore Netflix's already large content-acquisition costs. Netflix doesn't disclose how much it spends specifically on content, but the figure is considered to account for the majority of its "cost of revenues" figure, especially as Netflix begins producing original films like the upcoming "Crouching Tiger, Hidden Dragon" sequel and a slate of Adam Sandler movies.

Netflix's costs totaled $954.4 million in the third quarter, up 19% from last year. And the cost of revenues for Netflix's U.S. streaming business alone was up 19% to $565.3 million.

Despite the soft subscriber numbers, Netflix's business continues to grow. The company generated $1.4 billion in overall revenue during the third quarter, a 27% increase from last year to meet analysts' estimates. Revenue from its U.S. streaming service rose by 25% year-over-year to $877.2 million. And the company banked a $59.3 million profit.