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How Netflix’s Bet on Originals Is Already Paying Off

Series like ‘House of Cards’ and ‘Orange Is the New Black’ are a key factor in cutting subscriber churn, RBC survey finds

Netflix original series like “House of Cards” and “Orange Is the New Black” aren’t great for attracting new subscribers — but they’ve become a key way for the No. 1 streaming service to retain them.

That’s according to a new consumer survey by RBC Capital Markets. In a survey of 1,078 U.S. Internet users, the Wall Street firm found that 43% of Netflix customers said original content was a “moderately” to “extremely” important factor influencing their decision to keep the service.

In addition, 64% of Netflix subs said they had viewed original content over the last three months, with approximately 20% of those surveyed saying original content made up at least half of their Netflix viewing, according to the RBC study, published Thursday.

The survey results “show tentative evidence that original content is a customer retention tool…or an anticipatory anti-churn factor,” RBC analyst Mark Mahaney and associate Brian Peak wrote in the report. “And this is a new element to Netflix that may not be adequately appreciated by the financial markets.”

In their research note, the RBC analysts reiterated their “outperform” rating on Netflix and raised their price target from $280 to $330 per share. Netflix shares opened at $296.43 per share Thursday, up more than threefold since the start of 2013.

However, Netflix could end up paying more up-front than it expected for original content, because of its binge-viewing model of releasing all episodes at once. The company may need to accelerate spending initially deferred a few years down the road, it disclosed in its most recent quarterly filing. The company has projected spending $150 million on original content in 2013.

SEE ALSO: How Binge-Viewing Could Rock Netflix Stock

In the long term, according to RBC’s analysis, Netflix’s originals will help it cut churn by establishing expectations about future potential offerings, a strategy borrowed from premium cable networks like HBO.

“Subscribers may not have liked the current ‘hot’ series on HBO, but they retained their subscription because they ‘knew’ that HBO was likely to produce other series in the future that they would likely like and that would only be available on HBO,” the analysts wrote. “With its original content offerings, Netflix for the first time now also shares this characteristic.” That in turn will boost Netflix’s financial results via lower churn, higher net sub adds, higher revenue, less marketing expenses and higher profits, according to their thesis.

Netflix previously disclosed subscriber churn rates but does not report that metric now.

“(W)e believe that Netflix’s ability to successfully generate original content has been proven. Now the question is whether it can sustainably generate original content,” Mahaney and Peak wrote.

As a customer-acquisition tool, originals fare poorly, according to RBC’s survey. When asked how important original content was to their decision to sign up for Netflix, 74% responded that original content “did not influence my decision at all,” with only 7% saying originals “influenced my decision a great deal.” Netflix execs touted a modest subscriber boost after bringing back “Arrested Development” for a fourth season, but acknowledged “House of Cards” had a negligible effect earlier in the year.

Meanwhile, other Wall Street analysts are less bullish on Netflix’s ability to sustain its aggressive growth targets.

In a June report, Bernstein Research analysts downgraded their rating on Netflix from “market perform” to “underperform,” saying the current stock price reflects “unrealistic expectations” for subscriber growth. By 2020, Netflix will reach a “steady state” of 43 million U.S. users with streaming contribution margins to expand to 32%, Bernstein analysts Carlos Kirjner and Ram Parameswaran predicted. But they said the current stock price reflects an expectation of at least 50 million domestic streaming subscribers with contribution margins closer to 40%.

Netflix, if it continues to expand content offering and increase user satisfaction, will have the ability to modestly raise pricing over time, depending on the competitive landscape, the RBC analysts said.

Even though Netflix customers are very price-sensitive, just 16% of subscribers said they would be “extremely likely” or “very likely” to cancel Netflix following a $1 monthly price hike above the current $7.99, with 61% saying they were “slightly likely” or “not at all likely” to. Those are similar to RBC’s findings in a May 2013 survey.

“We believe that these results may suggest meaningful price flexibility on the part of Netflix subscribers,” Mahaney and Peak wrote.

SEE ALSO: Netflix Could Feel Safe Raising Streaming Pricing Soon: Analysts

Overall, RBC found that 63% of current Netflix subscribers are either “extremely satisfied” or “very satisfied” with the service, a slight improvement from 57% in the firm’s May 2013 survey and the highest level since Netflix’s marketing fumble on price hikes and rebranding in the second half of 2011. In addition, 68% of current Netflix subscribers are “not at all likely” to cancel their subscriptions in the next three months, with just 2% “extremely likely” to do so, the best customer satisfaction ratings in more than two years, according to RBC.

RBC conducted the latest U.S. survey of 1,078 consumers about Netflix, its eighth to date, over the last two weeks of August using online website SurveyMonkey. Of those surveyed, 43% were current Netflix subscribers and 18% had been subscribers in the past but were not at the time of the survey.

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