Netflix and the art of raising prices

NFLIX, from  afar

I don’t know NFLX well, other than as a user of its products.  I’m still annoyed at myself for not having bought it two years ago.  But I haven’t been motivated to do the work I’d need to own it, so I mostly just watch the price as a barometer of the market’s feelings about growthy, techy consumer stocks.

Clearly, the recent plunge from the $300+ high to the current $130 runs sharply counter to the experience of most consumer-oriented secular growth names (more about this tomorrow).

the recent price increase…I know that the company has other issues.  I have no opinion, positive or negative, about the stock.  I just want to make a comment about the mess that the company made about the price increases it recently announced.  My take is that the move is actually a good thing.  The way NFLX went about it, however, shows a stunning lack of basic management skill.

…is a good thing…

Why good?  Yes, there are some cases where consumers actually want to pay more for an item–like buying an $8,000 Hermès handbag– to display their wealth or sophistication.  This isn’t one of them.  So for NFLX raising prices inevitably means losing customers.  There’s no way around that.

If the early returns are reliable, however, upping prices by 15% has lost the company 4% of its subscribers.  Revenues are still at least 10% higher than they would otherwise have been.  And NFLX can presumably build from there. Also, customer defections, relative to the company’s expectations, have been concentrated in users of DVDs only, the segment that NFLX wants to de-emphasize.

…done in awful fashion

Top management of most consumer companies spend a great deal of time thinking about prices.

They know that there are tipping points where regular customers of the products/services may dramatically slow down usage if the price exceeds a certain level.  They also know that these points are virtually impossible to predict in advance.  In the casual restaurant business, for example, a venue with a $17 per person average check may have diners lining up all around the block.  An $18 per person check-less than a 6% difference, on the other hand, may translate into lots of empty tables.

They also know that any really visible price rise–one that forces the consumer to think about how much he’s actually paying in total–is particularly perilous.  As NFLX has found out the hard way, $8-$10 a month isn’t that significant for its customers.  An extra $2, or the choice of remaining at the old price for a lower level of service, is.  It focuses attention on the fact that NFLX can cost $150 or more a year.  And, of course, there are probably a certain number of people who don’t use the service but have forgotten to remove the fee from the recurring payments on their credit cards.

As well, higher prices not only can spur customers to look for substitutes; they can provide a pricing umbrella under which rivals can prosper.

Also, techy things typically don’t go up in price.  They either stay the same for a new model that’s a lot better, or they go down.  As a result, for NFLX  any price rise comes as a shock.

NFLX appears to have been completely clueless.

what could NFLX have done instead?

Remember, I haven’t studied NFLX closely, but there are a at least a couple of tried-and-true marketing tactics that companies use to raise prices.  For example:

new and improved.  Companies often offer additional features–better content, preferred access, faster access, a wider selection, other stuff you may not need/want–as at least a psychological justification for customers paying more.

a program of small but steady price rises.  To eliminate sticker shock.

a public relations campaign in advance, interviews in the media, or communication with customers, to explain the economic necessity for raising prices.

–more conservative guidance.  This may simply have transferred the negative Wall Street reaction to the earlier point in time when NFLX gave guidance, rather than when the company lowered it.  But it would have suggested that NFLX has a better feel for its customer reaction to higher pricing.

where to from here?

The Wall Street analysts’ earnings consensus for NFLX for 2011 is about $4.50 a share, meaning that the stock is trading at slightly under 30x current profits.  While the stock doesn’t appear cheap to me, the company does appear to be growing at a pace much faster than 30%, even after its current stumble.

I think a buyer has to believe two things:

–that NFLX will continue to grow profits at 30%+ for as far as the eye can see, and

–either that management has made an isolated mistake, or that having sharp people at the top isn’t crucial to the company’s success.

The company is presenting at a conference today.  We may get more input from that.

3 responses

  1. It’s possible Netflix doesn’t want to make an easy transition to the new model, as that assumes that Netflix wants to keep distributing DVDs, which I don’t think they do. I would bet they’ve hit a tipping point, where the majority if their subscribers are only actively using streaming and Netflix is just throwing money away by keeping a cache of DVDs on hand (and paying staff to stuff envelopes).

    With clear numbers showing that a negligible and dwindling number of people are renting DVDs or even subscribing to that distribution channel anymore, Netflix can argue that they can’t pay for content if it’s only going to be available on DVD, and strong arm production companies and movie studios into making their content available on the streaming platform.

    By adding video games to Quickster they can effectively drive GameFly–the only real player in this style of video game rental–out of business. The barriers to entry (registering at another website and paying yet another fee) are eliminated for those who already have a Netflix account and who don’t want to deal with GameFly’s notoriously slow deliveries. Eventually they’ll just let the DVD business die and make Quickster a quick game delivery system.

  2. I wasn’t certain how else to ask a question so I’m doing so here.
    Please forgive me since my question/request is not about Netflix.
    Here goes:
    I listened to a debate recently on the merits of small commodity companies
    acquiring larger ones. The company in question was Alpha Natural Resources purchasing much larger Massie Coal.
    Can a smaller commodity company like ANR actually make the investment finacially feasible when they bought a company that was already foundering?
    I enjoy your blog greatly!

  3. Pingback: question from a reader: the merger of Alpha Natural Resources and Massey Energy « PRACTICAL STOCK INVESTING

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