Does Netflix’s Q3 earnings beat undermine tech’s macro narrative?

Netflix reported its Q3 earnings yesterday: the company beat expected revenue and subscriber growth, with its global subscriber base jumping by 2.41MM. This compares to quarter-over-quarter contractions of roughly one million subscribers last quarter and 200,000 in Q1. The company’s revenue increased by 6% year-over-year, of which Netflix attributes 5% to subscriber growth and 1% to an increase in Average Revenue per Membership (ARM). The company’s revenue decreased sequentially from Q2, which the shareholder letter indicates as being “entirely due to F/X,” or the strengthening of the US dollar. Note that subscriber growth was mostly flat in the US and Canada for the quarter.

Netflix provided guidance of 4.5MM net subscriber additions for Q4, which is roughly 15% above the consensus expectation of 3.9MM; the next quarter will reflect the launch of Netflix’s new cheaper, ad-supported subscription tier. The broader economy is mentioned just once in Netflix’s Q3 shareholder letter, as a force that might countervail against the usual boost of holiday seasonality and a strong content slate.

In my three-part series on the Mobile Marketing Winter, I’ve discussed how three factors have coalesced to engender an exceptionally challenging operating environment for consumer technology companies, but especially those companies dependent on advertising for revenue generation:

  1. Persistent inflation and macroeconomic uncertainty;
  2. A reversion to pre-COVID consumer engagement norms;
  3. Apple’s App Tracking Transparency (ATT) privacy policy.

I make the point in that series that parsing apart the individual magnitude of impact for each of these factors is impossible. But in a piece titled Spotify’s Q2 results suggest ATT outweighs macroeconomic weakness, I argue that Spotify serves as a suitable (if imperfect) company to juxtapose against advertising-dependent businesses in an attempt to isolate the effects of the three aforementioned factors. This is because Spotify isn’t totally dependent on advertising for growth and because Spotify’s advertising product utilizes contextual, not user-level behavioral, targeting. And Spotify’s Q2 results show no sign of macroeconomic weakness; just the opposite, sequential quarterly growth in Spotify’s premium subscriber base was greater than that of its advertising-supported tier, and from a higher baseline. From the piece:

If macroeconomic weakness was the primary driver of a slowdown in consumer tech, a reasonable expectation is that advertising and premium subscription revenues would decrease across the board in response to a pullback in consumer spend. One might also expect premium subscribers to churn in favor of ad-supported product tiers for the same reason. This is not what is exemplified by Spotify’s Q2 results, which prompted a 14% jump in the company’s stock price on revenue and subscriber beats.

Spotify’s management did mention potential forthcoming macroeconomic headwinds in its earnings call last quarter, and its Q3 results will be reported next week. But the general outlook from Spotify related to the economy was only tentatively tepid. From Spotify’s Q2 earnings call:

So, looking at Q3 and beyond, as Daniel said, we continue to monitor the global macro outlook, but to-date, have seen no real impact on our user or subscriber outlook. Specifically, we expect to see another quarter of accelerating MAU net adds and expect subscriber net additions similar to Q3 of last year. On the premium side, which is still the majority of our revenue, we expect ARPU to be up in the mid single-digits. And for advertising, we did see some softening in trends over the last 2 weeks of June, but with that as context, we still expect solid growth in Q3, albeit slower than we might have forecast earlier in the year.

And Spotify’s CFO, responding to an analyst question about churn:

And just in general, just as a macro question, which I think we addressed earlier, but we haven’t seen any impact at all in churn, either with respect to some of the questions we are getting about the macro uncertainty.

This is relevant because, as I point out in my Advertising strategy in a recession presentation, a critical consideration for advertisers during a recession is increased churn — or any general aberration from predicted behavior — of existing users.

Contrast Spotify’s tone about the macroeconomic outlook with Meta’s. From Sheryl Sandberg’s prepared remarks in Meta’s Q2 2022 earnings call:

These continue to be turbulent times for the global economy. Many of the macro factors having an
impact on our revenue are continuations of things we’ve seen in previous quarters, such as the
continued impact of the war in Ukraine and the normalization of e-commerce after the pandemic peak. But there are also new challenges with rising inflation and uncertainty around a looming recession.

And Meta’s outgoing CFO, Dave Wehner, in response to an analyst question about the macroeconomic environment:

And then finally, just the signals headwinds and the challenges that advertisers are facing on a second order basis may be affecting some spend. But at least on the first order, we think it’s largely a macro environment that is offsetting the benefit that we would otherwise be getting from lapping the iOS 14 rollout last year.

Snap’s comments on the impact of the macroeconomic slowdown in its Q2 2022 earnings call were even more pointed. Derek Andersen, Snap’s CFO, from the call:

And then beginning — later in Q4 and certainly through the first half of this year, we’ve seen macroeconomic challenges have built…While there have been lingering supply chain and labor supply issues impacting certain segments that began during the pandemic, more recently, we’ve seen the impact of persistently high inflation, then rising interest rates, and rising geopolitical risks associated with the war in Ukraine. Those macro headwinds have disrupted many of the industry segments that have been most critical to the growing demand for advertising solutions over prior years.

And Jeremi Gorman, Snap’s Chief Business Officer at the time who recently decamped to Netflix:

So as things start to rebound for some of these advertisers in the areas where the macro pressures are a little bit more transitory, it’s also the first thing to get turned back on. So we remain optimistic that as things hopefully start to improve in the macro that we can capture that opportunity by remaining focused on the three key priorities that we’ve articulated in the call earlier.

To be fair, both Snap and Meta did cite ATT in their Q2 earnings calls as imposing headwinds on their businesses. But these four companies — two of which are advertising platforms, and two of which are consumer subscription businesses — present two very different commercial narratives. Snap and Meta speak to a currently deteriorated macroeconomic environment that is causing pain presently. And Spotify and Netflix speak to the possibility of macroeconomic headwinds on their businesses.

One possible explanation for this divergence is that advertising revenues and consumer subscription revenues react on different timelines to potential macroeconomic weakness. It’s not unreasonable to expect that advertisers might reduce ad expenditure ahead of a looming recession whereas consumers react with much more immediate sensitivity: a multi-million dollar ad strategy takes more time to unwind than a $10 monthly subscription that can be canceled at will.

Another explanation is that Spotify and Netflix are both inferior goods that benefit from a recession: consumers shift their preferences to streaming services from more expensive forms of entertainment when their spending power is diminished. But Netflix went public in 2002, and so data exists related to its performance during the global financial crisis of 2008-2009. And while Netflix was a very different company at the time, primarily generating revenue from home-DVD rentals, the company didn’t exhibit counter-cyclical characteristics. In its Q3 earnings release from October 2008, which took place just one month after Lehman Brothers failed, Netflix missed its guidance on subscriber growth and revised its Q4 guidance down for the second time that month.

But a third explanation for the difference in emphasis between these threats and risks is that ad platforms are keen to highlight macroeconomic weakness, and not ATT, as the primary impediment to their businesses. The business cycle is just that — a cycle that ebbs and flows. ATT is a systemic change to the operating environment that can’t easily be surmounted. The economy will improve at some point; ATT represents a permanent degradation of the efficacy of digital advertising targeting and therefore the revenue potential of any ad platform.

Dave Wehner speaks to this dynamic in Meta’s Q2 2022 earnings call (emphasis mine):

So we do think there is a cyclical component of this. We know that advertising can be especially subject to these cyclical pressures. We do think that long term, digital within advertising continues to have a very positive future. And we think that we are positioned to continue to grow engagement nicely and build the best products in digital in the market. So we’re quite confident that as the market conditions improve, we’ll continue to be able to return to nice levels of growth.

If the business cycle is mostly responsible for changes in commercial trajectory in a worsening economy, then a recovery can be expected at some point in the future. But if a systemic, permanent degradation of the operating environment has structurally weakened a business, no such recovery or positive correction can be expected as a matter of destiny.

Note that my contention here is simply that ATT may be playing a larger role in the commercial slowdowns of ad-dependent businesses than macroeconomic weakness — I am not arguing that macroeconomic weakness plays no role. Furthermore, and critically, the enormous caveat to this argument is that these are but four companies within a large and complex technology ecosystem, and a deeply-convicted conclusion can’t be drawn from such a small sample. And finally: Netflix reports earnings early in the cycle, and the rest of the companies cited here may perform similarly (or not) in Q3.

Photo by DCL “650” on Unsplash