Pricing Pressure: Did Netflix Screw Up?

Netflix announced a significant change to its subscription policies which for many people involves either a major price hike or a change in the way they use the service.

Given the state of the economy and the inherent human resentment of any cost increase whose effects people feel powerless to fight, there was, predictably, outrage. Remember that tea party in Boston a couple of centuries ago?

There are alternatives for those who are intent on fighting, but evidence suggests the company recognized the threat, considered alternatives, measured the options - and went ahead anyway. That may well have been the sensible strategy: do your research and stick to your guns. However, business history is replete with well-studied choices gone wrong. Anyone recall New Coke, the most heavily researched product launch ever? How about the reaction to the Murdoch phone hacking scandal? Timing, communication, lack of sensitivity to cultural nuances and a host of other factors can play havoc with the best-laid plans. So, watch to see if the outrage abates - or heats up. Netflix may soldier on - or admit a mistake and retrench. And that will tell us a lot about how much consumers are willing to put up with, even from companies they like. JL

Alex Wagner reports in the Huffington Post:

With the announcement on Tuesday that Netflix would raise its subscription prices -- separating its DVD and streaming services into two separate plans, each priced at $7.99 per month and increasing its combo package by a whopping 60 percent -- Netflix customers took to the internet to vent their collective rage.

But for a company that, according to industry analysts, is known to rigorously consider every decision it makes, the move was likely a calculated bid to strengthen the company's longer-term position -- including managing increasingly high content costs.

Michael Pachter, an analyst with Wedbush Securities, told The Huffington Post, "Netflix did not do this lightly. They raised prices because they're being forced to do so. "

Eric Wold, a director of research at Merriman Holdings, estimated that the company paid roughly $600 million to license content last year. But with as 94% increase in the number of new Netflix customers over the last year, the cost of content is on the rise -- dramatically.

As an indicator, Netflix's licensing agreement with the Starz Network is predicted to increase to $300-350 million a year in 2012, a considerable uptick from its present estimated $30 million agreement. By 2012, Wold estimates, the company will have to start paying close to $1.5 billion for content.

Pachter surmised that, by raising the cost of a hybrid package by nearly 60 percent and splitting DVD rentals from streaming subscriptions, Netflix is "trying to price the hybrid plan so high that people have to [choose] streaming-only or DVD-only."

In the immediate future, Pachter reasoned that "the nearly 25 million subscribers that are available for streaming now would drop to 18 to 20 million." By reducing the number of streaming customers -- however cosmetically -- Pachter reasons that Netflix would be better positioned to "negotiate with content providers, who are clearly squeezing them and driving their costs up."

The downside of such a strategy, he told HuffPost, was that it remained unclear if the benefit of controlling content costs would be offset by a decline in revenue and an increase in customer turnover due to a dissatisfied base.

Other industry experts looked at the situation differently. Justin Patterson, an analyst with Morgan Keegan Equity Research, saw the company's move as a net positive. According to his analysis, splitting services into DVD and streaming would, in the long term, nudge more users towards streaming.

As proof, he said, "Over 90 percent of Netflix subscribers are on the streaming only, 1-out, or 2-out DVD plans. And DVD usage per subscriber declined by over 20 percent in 2010." Ultimately, Patterson views a move to streaming "as a long term positive for subscriber growth, retention and free cash flow."

Wold, however, cautioned that forsaking DVD subscriptions in the near term could prove problematic for the company. Netflix is "still making a lot of money on DVDs," he said. "They already have distribution costs -- and they have indicated they have no intention of closing those distribution centers. Closing any centers at all would diminish the value proposition -- you couldn't get a DVD in a day or two."

For the moment, it remains unclear to what degree the company's latest decision will alienate customers and push them over to competitors like Hulu Plus and Apple, or simply compel them to choose one delivery format over the other.

At the very least, Netflix seems to have tackled the very basic problem of monetizing its individual subscription streams. "Remember, when they started [the streaming option], it was an experiment," said Crawl Howe, director of consumer research at the Yankee Group. "This is evidence of the market maturing. And it's a way to segment the market and to try to deliver more of what the customer wants."

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