Vertical Analysis Discussion:
COGS ( Cost of Goods Sold):
Netflix's cost of goods sold (COGS) as a percentage of revenue has remained relatively stable in the 61-63% range over the 2018-2022 period. Specifically, COGS was 63% of revenue in 2018, 62% in 2019, 61% in 2020, 58% in 2021, and rebounded to 61% in 2022. The consistency demonstrates that despite significant subscriber growth over this period, which saw subscribers double from 139 million to 220 million, Netflix has managed to maintain control over content licensing costs.
COGS primarily consists of amortization of the content library and content licensing fees paid to studios and other content providers. As a streaming platform, content is the core product for Netflix, and securing rights to premium movies and shows requires sizable investments. However, scale has likely afforded some pricing leverage with the major studios. The dip in COGS as a percentage of revenue in 2021 can be attributed to two factors - first, a pullback in content spending during the early months of the pandemic when production was halted, reducing cash content acquires. Second, the staying-at-home boost Netflix's subscriber growth in 2020 and 2021, spreading costs over a wider member base. The rebound in 2022 may reflect an unwinding of the above pandemic impacts alongside continued competition among streamers bidding up licensing costs.
Overall, maintaining COGS as a steady proportion of revenue will be critical for scaling a profitable streaming business model going forward. Even minor increases in licensing fees can pressure already thin margins, so Netflix will need to balance growing its vast content catalogue to attract new subscribers with squeezing efficiencies out of negotiated content deals wherever possible. Savvy licensing agreements and increased investment in owned original programming, which offers more predictable cost structures than third-party content, should be priorities. As the streaming landscape grows more competitive, retaining Netflix’s position as the content quality leader consumers are willing to pay a premium for will hinge significantly on strategic COGS management.
R&D (Research's and Development):
Netflix's research & development (R&D) expenses have shown an upward trend as a percentage of revenue from 2018-2022. Specifically, R&D spend rose from 19% of revenue in 2018 to 23% in 2019, dipped slightly to 21% in 2020 likely due to pandemic impacts, before resuming its climb to 25% in 2021 and 26% in 2022. In absolute terms, this reflects an increase in R&D spending from around $1.2 billion in 2018 to over $2.6 billion in 2022.
The mounting R&D intensity indicates Netflix's strategic investments focused on strengthening its tech infrastructure and innovating new platform features to propel future growth in a maturing market. Major areas of investment span personalized recommendation algorithms leveraging artificial intelligence, targeted marketing capabilities, localization efforts to drive international growth, improvements to streaming quality and efficiency, innovations in interactive and immersive content formats, and crucially - early-stage R&D of next-generation content experiences through virtual and augmented reality.
While these growth-oriented technology investments weigh on profitability in the near term due to expensing R&D costs as occurred, the long-term payoff for subscribers and revenue could be substantial if Netflix can cement itself as the undisputed platform innovation leader in entertainment. Investing aggressively during a period of slowing subscriber growth makes strategic sense to position Netflix to capture the next waves of platform disruption. For example, perfecting shoppable video capabilities now allows Netflix to monetize its original shows in new ways when integrated virtual shopping becomes mainstream entertainment in the coming years. Dominating future content technologies while incubating them during an earlier developmental stage is wise.
Overall, Netflix's willingness to devote an ever-increasing share of its revenues to high-risk, high-reward R&D investments in new technologies signals a forward-thinking innovation culture that extends beyond streaming into the greater transformation of entertainment ahead. While it squeezes profit margins today, technological leadership in both consumer-facing breakthroughs and next-generation content capabilities could become Netflix's competitive moat to fend off rivals in an otherwise commoditized market. The R&D priority indicates Netflix is playing a long-game - technological innovation will be the key strategic leverage ensuring the platform stays culturally relevant amid ever-evolving digital disruption.
Selling & Administrative:
Netflix's selling and administrative expenses as a percentage of revenue demonstrate a steady upward climb over the 2018-2022 period, increasing from 8% in 2018 to 17% in 2022. The bulk of growth in Netflix’s sales & marketing spend stems from increased investment in advertising and promotional activity as competition in the streaming market intensifies. With virtually every major media company from Paramount to Comcast launching direct-to-consumer platforms, Netflix has turned to higher marketing expenditures defending its market leadership position. Areas of focus include social media campaigns, TV ads, billboards, sponsorships and other brand-building efforts raising awareness of new and returning Netflix originals. However, the 17% of revenue dedicated to marketing in 2022 is disproportionately high, suggesting Netflix overspent chasing marginal subscriber growth. This likely contributed to the first subscriber loss in over a decade reported in 2022.
Meanwhile, general & administrative costs ticked up supporting international expansion in 190+ countries as Netflix rolls out localization efforts. Investments include translation of platform interfaces and subtitles, licensing of foreign-language content, as well as back-office and compliance costs of operating globally. Netflix also continues beefing up headcount particularly in tech/product to facilitate ongoing platform innovation and data analytics optimizing the consumer experience.
While strong subscriber growth over 2018-2021 supported heavier spending, the pullback in 2022 amidst rising inflation and slowing demand provides an opportunity to refine efficiency of sales and marketing efforts. As penetration plateaus in core Western markets, acquiring customers becomes more expensive, suggesting a rebalancing of promotional expenditures toward retaining existing subscribers in a choppy economic climate may have better payoff. Rightsizing headcount and administrative bloat also offer cost savings that can be redirected toward content and product.
Overall, Netflix’s skyrocketing selling & administrative costs reflect necessary investments in brand equity and infrastructure to orient operations toward global scale; however, overspending by misjudging demand leaves opportunity to refine operational strategy to optimize returns as market maturity exposes the limits of user growth potential. The path toward sustained profitability requires implementing more nuanced leveraging of sales and marketing tactics.
Comparison with Paramount:
When comparing core operating expenses between entertainment streaming rivals Netflix and Paramount over the 2018-2022 period, the most pronounced divergence emerges in research & development spend, content cost structure, and overall expense escalation trends.
Specifically, Paramount's cost of goods sold as a percentage of revenue ranged between 56-75% over the time period, peaking at 75% in 2022, whereas Netflix held steadier in the 58-63% range through 2021 before matching Paramount’s 75% in 2022. The escalation of content costs indicates both companies doubled down on investments in original programming and licensed catalog expansion to vie for market share - however Paramount+, as a relative underdog entrant launching in 2021, needed to grow content library from zero to competitive scale at steep upfront cost. Meanwhile R&D expenditure sees the starkest difference; Paramount has yet to dedicate meaningful investment to streaming-focused R&D with tech product innovation not yet a strategic priority, whereas Netflix’s escalating R&D spend hit 26% of revenue in 2022 as it morphs into a tech platform beyond just content distribution.
Marketing costs tell a similar story of the insurgent spending aggressively to play catch up; Paramount’s jump from 19% of revenue spent on selling & marketing functions in 2018 to 27% in 2022 aims to rapidly attract streaming subscribers through advertising, promotions and brand awareness campaigns. By contrast, Netflix, having enjoyed years as the subscription leader, saw selling costs rise gradually from 8% to 17% over the period. However, 2022 proved Netflix did overspend chasing marginal subscriber gains, presenting an opportunity to streamline sales and marketing optimization.
In summary, as the established market pioneer, Netflix enjoys advantages of innovation leadership and global brand equity, while still working to refine operational efficiencies amidst maturation; whereas Paramount+ has assumed the role of hungry disruptor playing aggressive catch-up in both content and marketing investment at wider loss tolerance, though risks overextending budgets during the scaling sprint. Both companies face risks of rising content licensing costs eroding profitability goals in the years ahead, suggesting original IP development becomes even more critical retaining subscriber loyalty at favorable margins relative to licensed shows.
Why Interest Expense wasn't Covered for both companies:
The interest expense line item tracks costs associated with debt financing and capital raised. However, in the media entertainment industry, interest costs tend to play a secondary role compared to the labor, marketing, tech innovation and content amortization-related expenses that more directly shape streaming platforms' product experience and subscriber acquisition capabilities. Both Netflix and Paramount have raised considerable debt and equity capital to fund their streaming ventures - however, assessing the efficiency and return on those cash investments is better reflected in the growth, engagement and retention trends of their streaming services, not mere interest payments on debt. The core operating expenses like R&D, S&A and COGS offer clearer windows into the platform experience itself - the technical product innovations, the marketing messaging and content breadth + quality that ultimately drive subscriber growth and satisfaction. Interest expense meanwhile is more peripheral, showing capital costs but not the operating visibility.
In summary, while financing costs enable these companies’ ambitious investments, the success of those investments manifests in core operating spending efficiency, not interest payments alone. Evaluating product experience quality and subscriber metrics provides a clearer mirror into the return on capital invested based on strategic operating expenses taken.
Sources:
https://ir.netflix.net/ir-overview/top-investor-questions/default.aspx
https://www.wsj.com/articles/netflix-pitches-advertisers-as-ad-tier-trails-smaller-rivals-dd394ffb
https://www.wsj.com/articles/netflix-seeking-top-dollar-for-brands-to-advertise-on-its-service-11661980078
Excel Source: Post 4.xlsx
