Netflix recently posted surprising US subscriber growth of 2 million in the last quarter, which has caused the stock to nearly double since the beginning of the year. It puts Netflix at 5-6 million subscribers since its infamous price increase.
The narrative appears to be simple — as Netflix successfully raised prices, it could afford to add more quality content, which in turn leads to subscriber growth. This can continue as long as untapped demand still exists. But how much growth is truly left? This confounding question is the reason why the Netflix stock has yo-yoed over the last 12 months.
On one hand, our previous media study suggested current demand for online streaming to be 40 million households. So there is still room to grow. But as they come closer to the potential 40 million, one expects life to get harder. Competition will increase as Redbox and Verizon enter streaming. Even HBO has acknowledged that a streaming-only option may need consideration. They'll all spend money to fight over an increasingly smaller piece of the pie, driving acquisition costs per user very high. There is an opportunity for international growth, but life will still be difficult if the US market matures quickly.
On the other hand, if you look into the future 25 years, wouldn't you be surprised if anyone did not have some kind of digital streaming service? The question to solve for is: is it 25 or 5 years from now?
This is the challenge of latent demand — unmet needs unarticulated by current consumers (pre-Starbucks, no one was asking to pay $4 for a cup of coffee). Or demand from an unexpected population of consumers (like Xbox drawing in women and kids via Kinect). By definition unmet, unarticulated needs from unexpected consumers is hard to measure.
It is possible to quantify latent demand, but the real challenge is estimating when the dam will break. Investing in latent demand requires as much faith as it does fact, as there is a risk of being perceived as over-investing if the upside doesn't materialize soon.
One proven way of quantifying latent demand is looking at generational demand. In particular, looking younger is a very effective latent demand strategy. Some companies try to influence the point of entry into the category, which is much earlier than the point of entry into a specific brand. In particular, looking at the teen market can prove very fruitful. Several recent moves suggest Netflix is betting on teens and young adults an untapped source of consumers to come their way.
There are roughly 42 million 15- to 24-year-olds in the US. According to Nielsen's 2012 Cross Platform Media report, 36% of total minutes for 18- to 24-year-olds are via streaming (game console, internet/PC, mobile) which is the highest of any age cohort. For simplicity's sake, let's assume share of minutes translates into penetration. So let's say 15 million teens/young adults who actively stream. These 15 million consumers aren't paying customers now, but could eventually become so. And this would grow the US streaming market potential nearly 40%. And each decade would add even more.
Netflix has quietly been sowing the seeds of latent demand with this group via smart sampling, habituation, and content. By charging a single price per household and allowing multiple users per household to use Netflix for free, they have let millions of teens and young adults enjoy the benefits of Netflix on their parents' dime.
After some point in time, these young consumers will be habituated to the benefits of Netflix. My high-school-aged nieces, Emily and Kaitlin, are watching The West Wing with me on Netflix. It's one of my favorite shows and I've gotten them hooked. As we talk about the show, I also ask them questions about their feelings about Netflix. My unscientific research with them and their friends yields some startling results. The vast majority of their media consumption is via streaming. The vast majority of their friends have Netflix. And the ones who don't are sheepish about not having it. And while they can imagine sharing an account with friends, they prefer the privacy of an individual account. So, the thought of paying $8/month when they are on their own doesn't faze them a bit.
Netflix also has the first part of latent demand going for them, which is the idea of unarticulated, unmet needs. The beauty of the media business is that great content has an amazing shelf life. The West Wing started the year my younger niece Kaitlin was born, yet 14 years later she found it. A business model that brings ever growing user base to evergreen content is great one.
Netflix's content moves to create a Just For Kids section and their exclusive Disney deal suggests that they are trying to ensure habituation starts even earlier. If Netflix can win with latent demand, they may have a competitive advantage that HBO and even Amazon Prime may find hard to compete with.