Netflix (NASDAQ: NFLX) held off on in-app subscriptions for a long time. Its key point of contention is that Apple (NASDAQ: AAPL) and Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google app stores take a 30% cut of in-app subscriptions right off the top every month. If a Netflix customer signs up for the $11-per-month plan through their smartphone app store, Netflix keeps only $7.70. However, Netflix keeps all of it if a user signs up on its website and logs into his or her account through the app later.
Netflix finally relented and agreed to pay the Apple tax about three years ago, but now it looks like it wants to walk back on that decision. The streaming giant is testing a workaround that directs users to its mobile website from the app when users attempt to sign up for a new account or change to direct billing. The test is currently live in 33 countries, according to a report from TechCrunch.
In May, Netflix stopped allowing Android subscribers to sign up in app, cutting the Alphabet company out of the loop. However, it still allowed existing users to continue billing through Google Play.
Why Netflix wants to cut out the middlemen
Netflix is planning to spend $2 billion on marketing this year, an increase of more than 50% from last year. It's grown to 68 million paid members internationally, up from 24 million when it first decided to work with Apple in 2015. It's also managed to increase U.S. subscribers substantially despite increasing market saturation and a series of price increases.
Netflix has considerably more weight to throw around today than it did even three years ago, especially internationally where mobile is a dominant computing platform in some markets. The company is running tests to see if it can afford to increase the amount of friction in the sign-up process without losing too many potential subscribers. If Netflix's plan to circumvent app store fees succeeds, it could cut Netflix's costs substantially.
Coming off a poor showing in the second quarter where revenue and subscriber additions fell short of expectations, Netflix could use a boost in operating profits. Further, additional revenue could help offset the company's $700 million increase in marketing spending this year.
In any event, cutting out Apple and Google is likely to face less backlash than yet another price increase. Netflix has made several price increases over the last few years, and it's faced challenges with regard to subscriber retention as a result. The company's long-term prospects remain fine, but management may want to search for other options aside from price increases. If working around in-app subscriptions can open up access to significant untapped revenue, Netflix may be able to delay the next price increase for customers.
Picking its distribution partners
While Apple and Google are Netflix's among biggest distributors (it's a top-grossing app in iTunes), the company is also beginning to work with newer companies to reach more customers. Netflix agreed to terms with Comcast (NASDAQ: CMCSA) to allow it to distribute Netflix on its X1 platform. In addition, Comcast now is selling a package that includes Netflix alongside traditional cable networks. In exchange, Comcast gets to keep a percentage of subscription fees, just like the Apple and Google app stores.
However, Comcast arguably helps Netflix reach an audience it otherwise wouldn't have by putting Netflix in front of cable customers. By contrast, Apple and Google aren't promoting Netflix. In fact, they each currently offer or plan to soon offer a video service to compete with Netflix.
What does this mean for Netflix?
As the company's Comcast tie-up shows, Netflix is willing to pay for help with discovery, but it's not willing to pay for help with billing. The company likely has the brand and scale to overcome any additional friction caused by routing users around in-app payments and doing so could help Netflix manage its budget a lot better. It remains to be seen whether Netflix will go through with ditching Apple after completing its test at the end of next month. The move wouldn't be terribly damaging to Apple or Alphabet, but for Netflix, it could be a huge deal.
Find out why Netflix is one of the 10 best stocks to buy now
Motley Fool co-founders Tom and David Gardner have spent more than a decade beating the market. (In fact, the newsletter they run, Motley Fool Stock Advisor, has tripled the market!*)
Tom and David just revealed their ten top stock picks for investors to buy right now. Netflix is on the list -- but there are nine others you may be overlooking.
*Stock Advisor returns as of August 6, 2018
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Alphabet (C shares) and Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, and Netflix. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.