Are Netflix's Best Days Behind It?
Are Netflix's Best Days Behind It?

If the record industry wants music subscription services to become mainstream products, it should pay close attention to the factors behind growth at Netflix. In the first quarter of 2011, the online video rental service added 3.6 million subscribers, to finish with 23.6 million.

To put it another way, the company's subscriber numbers increased 69% in a single year. It's the kind of explosive growth normally seen in a company's formative years, even though Netflix is a mature company. Check out the year-over-year subscriber growth starting with Q1 2009 and ending with Q1 2011: 25%, 26%, 28%, 31%, 35%, 42%, 52%, 63% and 69%.

With Netflix consumers have proven they will rent content - even re-run content - and stream it from the cloud. They will pay for digital content they could get for free through illegal means. They will pay if the service allows streaming through multiple devices - including mobile.

So what is Netflix doing that music subscription services could emulate? The price has to be right for the product: Netflix costs $7.99 for unlimited streaming and it's a price point that clearly resonates. Music services that include mobile options cost $10, a price point that is clearly not attractive for current music services (add auto and living room functionality and that could change). Netflix obtains only content that allows it to charge its desired prices instead of licensing everything and charging more. It's the other way around in music, and allowing content owners to dictate pricing has not worked. And the product has to deliver enough value to the customer. Price and features are functions of licensing deals with content owners, so subscription services can't just act unilaterally.

But much of what makes Netflix successful has nothing to do with licensing deals: It's a strong product that's easy to use, with saincredibly helpful recommendations and constant improvement based on customer feedback. Music services can do all these things, plus add features more unique to music such as social and sharing functions and a "lean back" radio feature that requires little effort other than hitting the "play" button.

Of course, Netflix also operates a DVD rental service. But its biggest growth has come in the last year as customers have been attracted to its streaming service. In November 2010, the company offered for the first time a streaming-only price point, in which all subscribers to DVD plans get free, unlimited streaming.

Revenues rose to $718 million, a 46% increase from the first quarter of 2010. Gross profit rose 50% to $280 million and net income was up 87% to $60 million.

The company's shares were down 6.2% to $236.07 in midday trading Tuesday in spite of excellent first-quarter earnings. Some analysts worried increasing customer acquisition costs foreshadow lower subscriber growth. Others noted that international expansion and content acquisition costs would eat into the company's healthy margins. All are problems any music subscription service would be glad to have.

If a music service can reach the scale of Netflix, it too can pay rights holders handsomely while continuously improving the product and giving subscribers a high level of service. In the first quarter, Netflix shelled out $192 million for the acquisition of streaming rights on top of the $377 million it paid to rights holders related to its subscription revenue.

What would music subscriptions look like with Netflix's first quarter numbers? At $10 a month for unlimited access on PC and mobile devices, the service would generate $2.8 billion per year from 23.6 million subscribers. If that many subscribers were evenly split between two monthly plans that cost $5 and $10, annual revenue would be $2.1 billion.

But the question remains: Can - and will - the music business follow Netflix's lead?