August 28, 2014
Peer Group Impact: How Netflix Mixed Retail and Content to Become a Media Darling
Looking at Netflix by the numbers is impressive. This summer, the streaming video service reached the 50-million subscriber mark, reporting more than 1.3 billion in second-quarter revenue. That’s up nearly 40 percent from the same period last year, garnering tremendous attention from the business press. It’s clear that Netflix has arrived. Behind the scenes, the company has quietly restructured its peer group and its CEO compensation to reflect its new business strategy and success.
Witnessing Netflix’s rise is to witness the evolution of a brand. Netflix initially built itself as a retailer by providing DVD-by-mail rentals, later adding online streaming media. Five years ago, it was much closer to Blockbuster than HBO. However, when you think about Netflix now, it’s more likely you’ll know it by its Emmy-winning show, “House of Cards,” or its other hit program, “Orange Is the New Black.” Its recent acquisition and development of original content signal a business strategy shift from distribution channel to content provider – a role traditionally held by the media industry.
In becoming a content creator, Netflix has gained greater strategic control, using content to help grow its subscriber base. This, in turn, has driven superior performance, as evidenced by the company’s increasing Total Shareholder Return (TSR) – up threefold in 2013 alone.
Moving On – A New Peer Group
As a result of this evolution of business strategy, Netflix has restructured its peer group to focus on companies in the software and services, retail, and media industries. To create its 2014 peer group, Netflix dropped nine hardware and semiconductor companies and replaced them with seven media and five software companies. That means companies like AMC Networks, Discovery Communications and Virgin Media are in while others, including Advanced Micro Devices and Echostar, are out.
A New Peer Group Prompts Rise in CEO Compensation
The change in peer group has immediate impact, particularly when it comes to CEO compensation. According to analysis by my firm, Farient Advisors, the median target Total Direct Compensation (TDC), for Netflix’s new peer group is $9.3 million, a significant increase from the previous group’s median of $4.4 million. Within this context, Netflix made several changes to its CEO compensation in 2014, including a $1 million increase in salary (from $2 million to $3 million) and a 50 percent increase in stock option awards.
According to Farient’s Performance Alignment Reports (PARs), Netflix’s new CEO compensation package is aligned with shareholder interests compared to its new peer group. However, its new CEO compensation package is not aligned with shareholder interests compared to its old peer group. This is because the new peer group pays higher than the old group.
- The Alignment Zone highlights the acceptable range of pay given the size, industry and performance of the company
- Netflix’s range of forecasted 2016 compensation (target line in red below) compares favorably to its new peer group as it is well within the 2014 Alignment Zone
- Netflix’s new CEO pay would have been excessive relative to its former peer group-however it is now aligned with the company’s higher paying peers
Conclusion – Fair Pay
Netflix’s new pay positioning is driven by its new business strategy, new peer group and impressive growth. Within this context, Netflix’s new pay positioning makes sense. The increase in CEO pay is warranted and shareholders agree – Netflix received a 97percent Say on Pay vote in approval of its 2014 compensation strategy.
So, what’s next for Netflix? The fall television season. Eyeing global streaming domination, the brand has announced a cavalcade of original shows to premier this fall, and is anxiously awaiting the next round of Emmy nominations this month. Yes, Netflix has become a true media darling.
This article originally appeared on Forbes.com.