Accounting practices at Netflix

Accounting

The trend in Netflix's contribution margin ratio over the past three years is as follows. The costs are the COGS plus 30% of other expenses. The remaining 70% of expenses are assumed to be fixed.

Netflix

Revenue

Costs

Contribution

Contribution Margin

The contribution margin for Netflix is therefore lower than it was a couple of years ago. The long-term trend is tough to determine, but it seems that Netflix saw its contribution margin take a hit in 2012, only to begin the process of building it back in 2013. Or alternately, this new level is basically a "new normal" level for the company, with the higher level from 2011 unlikely to be reached again for the foreseeable future. Either is possible without knowing the reason why the contribution margin declined so much in 2012.

The breakeven point for Netflix given this is as follows:

Breakeven

Variable Costs

Fixed Costs

Breakeven Revenue

What this means is that the company's breakeven revenue point has increased over the past three years. The fixed costs continue to increase and the result of that is that Netflix needs to earn more money each year in order to break even.

Margin of Safety

Revenue

Breakeven Revenue

MoS

For Netflix the margin of safety has fluctuated. The company definitely had a rough year in 2012, when the margin of safety declined, but it has built is margin of safety back up a bit for 2013.

If the fixed expenses were 60% of operating expenses, the results do not change much. The contribution margin changes, of course, as it gets lower, but the breakeven revenue and the margin of safety do not change. When fixed expenses are 80% instead of 70%, the contribution margin gets higher but again there are no changes to the breakeven revenue or margin of safety because the change to the contribution margin is offset by a corresponding adjustment to the fixed costs.

If the total dollar amount of fixed costs remains the same as under the 70% scenario, the effect of a 10% reduction in revenue on operating revenue would be that operating revenue would decline. The past two years would have seen a loss for the company:

Netflix

2013

2012

2011

Revenue

Costs

Contribution

Contribution Margin

14%

11%

21%

less FC

Operating Revenue

-209

-310

56

If sales increase, obviously this is a good thing:

Netflix

2013

2012

2011

Revenue

Costs

Contribution

Contribution Margin

29%

27%

35%

less FC

Operating Revenue

All years look good under this scenario, and the gap between 2011 and 2013 shrinks considerably.