Netflix Plays New Role: Budget-Conscious

In early June, Netflix content chief Ted Sarandos met with several dozen of his middle-ranking and senior film and TV executives and delivered a blunt message: Be more careful with money.

Mr. Sarandos told the group that spending on film and TV projects, particularly big budget movies, needed to be more cost-effective, according to people familiar with the meeting. Netflix has long measured the efficiency of its TV shows and movies using a ratio of their cost to a measure of viewership that gives more weight to new subscribers and those viewed at risk of canceling, say former employees. Mr. Sarandos made clear that in the future big-budget projects should bring in lots of viewers, a shift from the past when they might have gotten a pass if they were expected to get buzz and build industry credibility. 

The Takeaway
• Sarandos calls for more efficiency in creating shows and movies
• Streamer eyes Hollywood tactics like paying for performance
• Netflix has asked for some pilots of unscripted shows

That doesn’t mean Netflix won’t make programs appealing to a narrow niche. But every show should pay for itself, was the message, according to one person familiar with the meeting.

In the meeting, Mr. Sarandos cited “Triple Frontier”—a Netflix-made action drama starring Ben Affleck—as a film that was too expensive given how many viewers it attracted, according to people familiar with the meeting. The film cost $115 million. 

His edict is the clearest sign yet that Netflix is trying to be more disciplined about its spending as it confronts the biggest competitive threat since it launched its streaming service just over a decade ago. Late this year, Disney is scheduled to launch its own streaming service, Disney+, offering an array of iconic Disney-owned movies including “Star Wars,” TV shows such as “The Simpsons” as well as specially made originals. Priced at $6.99 a month, the service will undercut Netflix, which has gradually raised its prices to between $8.99 and $15.99. Also waiting in the wings to launch their own services are AT&T’s WarnerMedia, Apple and Comcast’s NBCUniversal. 

A Netflix spokesperson declined to comment on specifics about its internal metrics, but said the company uses viewing relative to cost as one measure of success and is always looking for ways to get better. “There’s been no change to our content budgets, nor any big shifts in the sorts of projects we’re investing in, or the way we greenlight them," the spokesperson said. Netflix wasn't cutting spending, the spokesman emphasized.

The impact of the new competition is increased because companies like Disney, NBCUniversal and WarnerMedia used to be major program suppliers to Netflix. But that is changing, as they start to retain their programs for their own services. Just last week, Comcast’s NBCUniversal revealed it would move “The Office” off Netflix for its own service at the end of next year. Netflix has anticipated the competition by ramping up production of its own shows over the past few years, fueling an explosion in its programming spending to $12 billion last year from $4.6 billion in 2015. Netflix still spends less than many traditional companies: Disney spent $13.3 billion on film and TV shows in fiscal 2018 while NBCUniversal spent $16.6 billion on programming and production last year, corporate filings show.

Along the way, Netflix has also become a producer of major films, making some at budgets that are big even by the standards of a traditional Hollywood studio. Netflix reportedly spent more than $150 million to make Martin Scorsese’s upcoming film “The Irishman,” for instance. Its latest Adam Sandler movie “Murder Mystery,” which filmed in locations like Italy’s Lake Como, is also said to have cost nearly $100 million, according to a former Netflix employee. In comparison, Disney’s latest Spider-Man movie that came out this month reportedly had a budget of $160 million. (A Netflix spokesman declined to comment on the cost of individual movies.)

To be sure, Netflix is still spending actively. Last week it unveiled plans to make “Prom” directed by Ryan Murphy, the big-name TV producer it struck a high-priced deal with last year. It also announced a deal with writer/producer Janet Mock. (A person with knowledge of the situation also noted that Netflix was prepared to pay several hundred million dollars to keep “The Office.”) 

This kind of programming blitz has helped Netflix maintain subscriber growth—it hit 149 million global subscribers in the first quarter, up 25% on a year earlier. But it has also kept the company spending more money than it brings in, requiring it to continue borrowing money. Last year, for instance, Netflix had a cash shortfall of $3 billion and has projected that will increase to $3.5 billion this year. Netflix has said it expects this cash burn to decline starting next year.

Mr. Sarandos’ message to his content staff suggests the company is being more careful. In the past, some in Hollywood say, Netflix executives appeared willing to spend more than was necessary on productions. One former employee recalled that when they were working on a production set in five countries, someone suggested shooting in only two countries and using alternative locations for the other three to save money. “They didn’t like it,” the former employee recalled. 

Netflix doesn’t need to be as aggressive anymore, due to the lead it has on everyone else, said Michael Nathanson, an analyst with Wall Street research firm MoffettNathanson. “They are the leading game in town and were probably overspending relative to what they need,” said Mr. Nathanson. “Now that they are in a strong position, they probably want to allocate more of that spending overseas.” 

Maturing Giant

At the same time, Netflix has evolved to be more like a traditional Hollywood company. It has hired heavily from entertainment companies like NBCUniversal, Fox and Disney. As a result, it has begun adopting more conventional Hollywood tactics.

“The attitude that has always prevailed at Netflix is ‘Hollywood is broken and we’re going to fix it,’” said one former employee. Over time, though, executives at the company began to realize that “yes, we can fix things, but not everything has to go by the wayside.”

For instance, Netflix executives are discussing whether to make a portion of a producer’s compensation for a film contingent on its performance, according to two former employees. This type of compensation is common in the traditional movie industry, where some producers are paid based on a percentage of the box office proceeds after certain costs are covered. But this idea, which hasn’t previously been reported, would be radical for Netflix, requiring it to be more open about viewership so profit participants like producers could track what they were owed. But it could help Netflix spend less on films that bomb.

Meanwhile, the company in some cases has asked producers of unscripted projects to put together a full or partial test episode, known in Hollywood as a “pilot,” a standard request by TV networks. For example, Netflix recently ordered a pilot of an unscripted restaurant show from Vox Studios, the entertainment arm of publishing company Vox Media, that it ended up not moving forward with, according to people familiar with the situation. A Vox spokeswoman declined to comment.

Netflix hasn’t asked for pilots in the past and instead would order a full season of a show from the initial pitch, according to studio executives and agents. That previous practice had helped Netflix move faster than traditional networks in getting new series ready, but it also meant Netflix was ordering shows with less idea of the audience reaction. A person close to Netflix said the company has only asked for pilots in a small number of cases with unscripted projects. Usually the request is made to ensure characters gel on camera, rather than for cost reasons, the person said.

Viewing Numbers

“They are the leading game in town and were probably overspending relative to what they need.”

Even as it embraces aspects of conventional Hollywood culture, Netflix’s tech roots still drive how it assesses the value of individual programs. What is changing is that Netflix is applying that cost assessment approach across a wider range of programs.

While Netflix releases very little information publicly about viewership for its shows and movies, its staff knows every detail about the audience, according to former employees. Every day,  members of the content team get an email showing the previous day’s most viewed shows by region. But Netflix tracks the value of each show, in terms of bringing in new subscribers and keeping existing subscribers from canceling, through another metric. 

That is one based in part on a number Netflix internally refers to as a show’s Adjusted Viewer Share. It isn’t a straight number of viewers. Instead, it is adjusted to give more weight to viewers who watch a show within 24 hours of subscribing, or those viewers who hadn’t otherwise watched a Netflix show in several weeks—and thus were deemed to be in danger of canceling. Someone who watches hours of Netflix regularly is given less weight. The adjusted viewing figure is calculated over a 28-day cycle. (One person familiar with the situation said Netflix tinkers with the formula occasionally.)

That number is then combined with the budget of the show to come up with a second, closely watched statistic, the show’s “efficiency score.” Current and former Netflix employees say it’s among the most important internal statistics to assess the success of a project. 

Despite its importance to Netflix employees, the score is not something the company discusses with outsiders. Studio executives and Hollywood agents who work with Netflix say the streaming company’s staffers don’t use the word “efficiency” in discussions, but the point can be clear anyway.

For instance, producers behind the popular drama “Ozark” were recently told by Netflix executives that while the show was very popular, it was approaching a “tipping out” point where its cost was too high relative to its value. 

Two Seasons and Out

Netflix’s metrics-driven approach shows up in other ways. For instance, it now routinely ends shows after their second season, even when they’re still popular. Netflix has learned that the first two seasons of a show are key to bringing in subscribers—but the third and later seasons don’t do much to retain or win new subscribers. Ending a show after the second season saves money, because showrunners who oversee production tend to negotiate a boost in pay after two years. 

Many producers are turned off by the two-season limit, a number of creators told The Information. “It’s really hard to get them to put money into a third season,” said one creator whose show was canceled after two seasons, who wished to remain anonymous as to not upset Netflix. “For a creator, you want to be able to reward your audience with more seasons.”

A person close to Netflix noted that Netflix is making so many shows now that it would be natural to cancel certain shows after the second season if the viewership weren’t continuing to grow. The person added that the company does not have a policy to cancel shows after the second season. There are exceptions for monster hits: “Stranger Things,” for instance, is about to debut its third season.

Not everyone in Hollywood is complaining about Netflix’s shift in approach. One producer notes that Netflix makes far more shows than its tech rival Amazon. An agent notes that Netflix can afford to be more cautious as it has been so aggressive in buying and developing shows and movies in recent years, putting it ahead of its competitors who are just about to launch their streaming services. 

“Before it was a content acquisition race,” said one agent. “But now Netflix has the luxury of time since they have programming slated for the next two years, so they can take time and get stuff right.” 

UPDATE: On July 8, Netflix issued this statement about "Triple Frontier": "We're incredibly proud of Triple Frontier, one of our most popular original films. 63 million member households have now watched the movie since it launched in March, and we look forward to working on more projects with this talented cast, producers and writer/director J.C. Chandor,” said Ted Sarandos, Chief Content Officer, Netflix. 

The story has been updated to include a comment from a person close to Netflix that the company does not have a policy to cancel shows after their second season.

Jessica Toonkel is a New York-based reporter for The Information covering media and how the industry is being disrupted by technology. Before that, she spent seven years at Reuters covering a range of topics including media, mergers and acquisitions and financial services. She can be found on Twitter @jtoonkel.
Tom Dotan joined the Information in 2014 covering the media, advertising and streaming video businesses. He is based in San Francisco and can be found on Twitter at @cityofthetown.