Subscription Revenue Model (Netflix) (17:37)

Table of Contents:

1:16 – Part 1: Key Drivers of a Subscription Revenue Business

5:09 – Part 2: Where to Find the Required Information

10:08 – Part 3: How to Put It Together in Excel + Add Scenarios

15:32 – Recap and Summary

Part 1: Key Drivers of a Subscription Revenue Business

The key revenue drivers for subscription-based businesses include:

1) Existing Subscribers and the Renewal Rate – MOST revenue depends on the existing subscriber base unless the business is growing like a beast.

2) New Subscribers and Their Renewal Rates – As a % of existing subscribers, how many new ones is the company adding each year?

3) Monthly Fees and Pricing Increases – How much will these increase by over time? How much *can* the company can increase fees before driving away members?

The renewal rates often differ for existing vs. new subscribers because new customers tend to cancel more quickly; once someone has been around for a few years, he/she is more likely to stay subscribed.

You should also look at different scenarios – What happens with higher growth, renewal rates, and fee growth and with lower growth, renewal rates, and fee growth?

Part 2: Where to Find the Required Information

Some companies disclose these figures in their filings, but Netflix does not – they only give us the Net Additions, Revenue, and Average Monthly Fees in each business segment.

However, if you run the numbers yourself, you’ll see that the Churn Rate, or Cancellation Rate, can’t possibly be that high because Net Additions have been 17-25% of Subscribers historically.

So with a 30% cancellation rate, the company would have to replenish its subscriber base by 50% with new subscribers each year – not likely!

Also, industry sources like Parks Associates point to a fairly low cancellation rate of ~9% for the company.

So we choose to use a 94% renewal rate for existing subscribers and an 88% renewal rate for new subscribers (the 91% rate in the middle corresponds to the 9% cancellation rate).

We go 2% higher in the Upside Case, 2% lower in the Downside Case, and 2% lower than that in the “Extreme Downside” Case.

Subscriber Additions as a % of Base Subscribers will be higher than the historical numbers but decline over time. Monthly Fee increases will range between the average historical increases.

Part 3: How to Put It Together in Excel + Add Scenarios

1. Set up the Renewal Rate Schedule for New vs. Existing
2. Multiply the Existing Subscribers by the Renewal Rate each year
3. Factor in New Additions each year as a % of Base Subscribers
4. Apply the New or Existing Renewal Rate each year
5. Sum the Total Subscribers and take the yearly average
6. Grow the Monthly Fees and multiply to get Total Revenue

What’s Next?

After setting up the basic schedule, you could check and refine your numbers to make sure the scenarios and capitalized annual growth rates (CAGR) all make sense.

You could also consult other sources, like equity research, and see how your views compare with the consensus estimates for the company.

And then you could build the rest of the model by projecting expenses, Working Capital, CapEx, and other line items required for the full financial statement projections.

About Brian DeChesare

Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street. In his spare time, he enjoys lifting weights, running, traveling, obsessively watching TV shows, and defeating Sauron.