Is Netflix’s foray into video games a giant misstep?

Big news rippled through the entertainment industry at the end of 2021 when netflix ( NFLX -1.72% ) announced that it had started developing mobile games for its subscription service. Launched in November last year, there are now five mobile games subscribers can access on their phones as part of the Netflix subscription package, with more to come in the coming quarters.

Some investors celebrated the development as an opportunity for Netflix to enter a lucrative new line of business that could help the company grow for many years to come. But given the complexities and technological limitations of the video game industry, it’s hard to see how Netflix can get a strong return on these video game investments.

Is Netflix’s foray into video games a giant misstep?

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Netflix projects

Before we get into any analysis, let’s get acquainted with what Netflix has done and says it will do. On November 2, 2021, the company launched five mobile games for subscribers worldwide, two of which focused on the stranger things franchise. The games are included for all subscribers and have no ads or built-in payment mechanisms (which is how most mobile games make money).

During its last conference call on January 20, many analysts asked about new investments in video games. Executives said they think subscriptions could be a great model for video games, and the company plans to develop interactive experiences for its big titles (i.e. stuff like stranger things). On top of that, the company said it will explore licensing intellectual property (IP) of popular games, with announcements potentially coming this year. It’s unclear what that means, but it’s likely that Netflix will reach out to major video game publishers to see if they’d like to bring their mobile games to Netflix.

Technology and business model limitations

At first, getting into the game seems logical for Netflix. But two problems arise for Netflix and the video game market, one related to the business model, the other technological.

From a technological point of view, the video game industry has not cracked cloud-based streaming, this is how Netflix and all other streaming services allow their users to watch shows without downloading the contents. Except in rare circumstances or with older games, players download content directly to their devices. For Netflix, this is suitable for mobile gaming, as it only creates a small amount of friction for users and is on the same hardware that people watch their shows. However, this will prevent the company from creating an extended console/PC level IP address unless they are willing to go through hardware distributors such as Microsoft, sonyand nintendo. Since Netflix keeps everything behind its subscription paywall, this puts the company between a rock and a hard place when it decides to create high-profile games for its subscribers.

The biggest problem, however, may be the business model. If Netflix seeks to license IP from other publishers, it will have to ask them to rethink all of their monetization strategies. Why? Because almost all popular mobile games in the world are free to play, but make money from ads and in-app content purchases. If the company is going to license games from other developers, it will likely have to be with new content designed for a subscription paywall, which is contrary to the way the industry operates today.

Can games be a needle mover?

Given the hurdles in front of it, I think Netflix will mostly stick to producing its own games if it sticks to keeping everything behind the subscription wall. That’s good, but could it be a needle mover for Netflix? Investors must wonder how many subscribers will join the service if it contains a few dozen mobile games when thousands of games are already free to download from the App Store.

You could say that the games are not about attracting new subscribers, but about reducing the churn rate of existing customers. This could certainly happen if mobile games are used a lot, but again you have to ask yourself if the juice is worth it. Video games require tons of employees to be created. For example, electronic arts has 11,000 employees, as many as Netflix, but generates less than $10 billion in revenue, while Netflix makes nearly $30 billion. If Netflix hires 3,000 developers and only reduces churn among its subscriber base, it’s hard to see how the ROI would be worth it.

Is Netflix doomed in video games? At this point, it’s hard to say. The company has an impressive track record of success with new ventures, and I don’t think it’s a good idea to count it down until the investments really start. But given the dynamics of the video game industry and the technological limitations that keep gamers locked into specialized hardware, it’s hard to see how much difference Netflix can make in gaming with its current strategy.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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