Tag Archives: internet

Netflix and the art of raising prices

September 21, 2011 By in Entertainment, Industry Analysis, internet, Stock ideas, Technology Tags: , , , , , , , , , 3 Comments

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.

Boston Consulting Group: traditional money management industry in long-term decline

July 13, 2011 By in Constructing a Portfolio, Getting financial advice, Industry Analysis, internet, Investment firms, Portfolio management Tags: , , , , , , Leave a comment

the BCG report

The Boston Consulting Group just released its ninth in a series of analyses of the global asset management industry.  This year’s is called Building on Success: Global Asset Management 2011.

BCG’s conclusion:  the industry is in long-term decline, despite a bounceback in profitability during 2010 caused by rising markets and an investor shift out of low-fee money market funds into more expensive products.

Reasons:

–the industry is mature everywhere except in emerging markets, so growth isn’t going to come from finding new customers.

–existing products aren’t good enough, with active managers typically offering one-size-fits-all products that don’t beat their benchmarks.

–competition is intensifying.  It takes two forms–price competition among industry participants; and the development of competing offerings, like hedge funds or private equity, that siphon assets under management away from the industry.

–there’s a steady flow of money away from high-fee active and equity products  and toward  lower-fee passive and fixed-income ones.

–in both the US and Europe, a small number of firms have established extremely large relative market shares.  This gives them economy of scale advantages that let them lower prices and still maintain their own income.  In US equities, for example, 5% of the funds took in 53% of the new money in 2010.  The bottom 50% of the market took in only 4%.  The European equity business is even more concentrated than that, as is the US fixed income sector.  In European fixed income, where concentration is somewhat less, the top 5% took “only” 38% of the new money.

my thoughts

I agree with BCG that we’re seeing a sea change in the asset management business.  I’d put the situation slightly differently, though.

Before Black Monday in 1987, investors tended to buy individual stocks rather than packaged products and to rely for advice on savvy registered reps employed by traditional (read: high cost) brokerage houses.  The market crash changed all that.  The antiquated NYSE system of having monopoly market makers (good for their profits, not ours) froze up; volume disappeared and bid-asked spreads became very wide.  Put in a market order and your execution could differ by 5% from the last price you saw on a screen.  And it seemed that the 5% was always in an unfavorable direction.

This experience, and the sense that the world was getting to be too complex for non-specialists to decipher, sparked a change in investor preference away from individual stockpicking toward buying professionally-run mutual funds.  At the same time, 401ks were becoming more in vogue.  Brokerage houses decided to limit their legal liability by turning their reps into marketers of computer-generated financial planning advice and mutual funds. The Baby Boom was just coming into its peak earning years.

I think the Great Recession and the accompanying sharp decline in world stock markets have triggered another sea change.  This time it’s a return to do-it-yourself for individuals, based on the assessment (right in most cases, In think, but wrong in some) that brokers are professional marketers, not trained investors, and add little value.  In any event, their firms limit what they can say and do.

The Baby Boom is starting to enter retirement.  Investment results are more critical than they were before; losses are more painful.  So boomers are dialing down their risk profiles by selecting passive products–through ETFs–and fixed income.  On top of this, on retirement Boomers are becoming their own Chief Investment Officers as they take charge of managing their 401ks or other defined contribution pension plans.

For institutions, which have long known that their favorite active managers underperform, it’s a switch to “alternative investments,” despite evidence that for the past decade managers of the latter have performed worse than traditional active managers.

For both classes of investors, it seems to me the change has the character of rejecting the devil you do know, figuring the one you don’t can’t be that much worse.

 

There are obvious issues with this change, assuming I’m correct.  Personally, I think pension sponsors are crazy to be building up their allocation to alternative investments.  The risks are high, the reported numbers aren’t that great, and there’s lots of anecdotal evidence that some of the reported numbers don’t stand up under more than cursory scrutiny.

For individuals, which is my main focus in writing this blog, the issues are somewhat different.  They’re how to get the information you need to make intelligent decisions, and who do you trust. Personally, I think that the investment management industry will follow the same pattern as traditional bricks-and-mortar retailing.  It, too, will morph (is morphing) into diffuse internet-connected collections of professional investors working in small groups and selling research or advice at reasonable prices.

 

 

 

states casting about for new revenue sources

July 12, 2011 By in economics, Industry Analysis, internet Tags: , , , , , , Leave a comment

States in the US are trying to repair tattered balance sheets.  In addition to laying off workers and trying to reduce compensation to remaining employees, they are also working hard to develop new revenue sources.  Here are two of the most recent developments:

1. California just passed a law taxing sales over the internet.  It applies to purchases made by California residents from online companies that have a presence in the state.  You’d think that “presence” means factories, warehouses, sales offices, or bricks-and-mortar retail outlets–and it does.  But the new law also says that if a shopping comparison or coupon site located in California refers a customer to an online retailer, and the customer buys something, the fact that the comparison site is in California counts as a presence of the online retailer in the state.

According to the Los Angeles Times, Sacramento figured this new wrinkle to the sales tax would raise $317 million a year in new revenue.  What could they have been thinking?

What’s happened instead is that online retailers from Amazon and Blue Nile to Overstock and Zappos (yes, it’s cheating.  Zappos is part of Amazon, but I needed another end-of-the-alphabet site) have severed relations with the 25,000 or so comparison sites (oh, those wildly entrepreneurial Californians!) the Golden Sate has spawned.  Amazon has apparently sent its (former) affiliates a letter advising them to move out of state if they want to reestablish themselves with the online superstore.

According to the Financial Times, some couponing sites have lost up to 30% of their business since the new law went into effect.  More specialized sites appear to have seen the majority of their revenues evaporate.

Let’s assume that the 25,000 referral sites average four employees each (I’m making these number up, just to try to get a sense of the impact of the new tax).  That’s 100,000 jobs.  If half of the industry either relocates to other states or goes out of business, the new tax will have quickly generated a loss of 50,000 positions.  If each worker had been paying $5,000 yearly to California in sales, income property and other taxes, then the legislation would cause an annual loss of $250 million in state and local revenue.  And that’s without calculating unemployment benefits for laid-off workers.

…not exactly what the doctor ordered.

By the way, Amazon is urging a referendum on the tax, according to the FT.

2.  New York is redefining–“clarifying” might be the word the state would use–what it means to be a resident of the state for income tax purposes.  Details of two recent court cases that bear on this issue, the Barkers and John Gaied, can be found at taxdood.com.

Resident vs. non-resident–what’s the tax difference?  Non-residents pay income tax on income earned in New York;  residents pay income tax on all their income, including investment income.

The Barkers live in Connecticut, Mr. Gaied in New Jersey.  That’s where they vote, where they have their driver licenses, where their cars are registered, where they serve on juries, where their mail gets delivered (Mr. Gaied has some delivered to Staten Island, as well), where their kids go to school.

But,

1.  Mr. Barker works in Manhattan as an investment manager ; Mr. Gaied operates a gas station on Staten Island. Because of their work, both spend more than 183 days a year in New York State.

2. The Barkers own a vacation home on Long Island that Mrs. Barker’s parents use and they visit rarely;  Mr. Gaied owns a house on Staten Island that he bought for his parents to live in.

That’s enough to make them both residents of New York for tax purposes.  The facts that neither party spends much time at their New York houses, and that their primary residences are elsewhere, make no difference.  Owning and maintaining a residential property in New York State that looks like it could be lived in year-round is the essential thing.

Of course, the Barkers are also residents of Connecticut for tax purposes–so they’re taxed twice;  Mr. Gaied is similarly a resident of New Jersey.

According to the tax authorities, the Barkers owe an extra $608,000 in taxes to NYS for the years 2002-04.  After penalties and interest, the total bill is $1.055 million (an aside:  the tax bill implies the Barkers had over $6 million in investment income during the three years.  Wow!).

In the Gaied case, taxdood.com says the courts initially ruled in favor of Mr. Gaied, but political armtwisting got the matter reheard.  In round two, Mr. Gaied lost.

I think this effort by New York State bears watching.  My guess is that NYS is starting small, and will be aiming for bigger fish as the file of precedents gets bigger.  The tax authorities may end up raking in a pile of money.

It would be interesting to know what percentage of house/apartment owners in the Hamptons, or the Adirondacks, or the Catskills or the five boroughs of NYC are out-of-staters.  If it’s over 10%, these tax rulings can’t be good either for the construction industry in these areas, or for property values.

It seems to me that anyone who might be affected should either turn the property into rental real estate–so the property can’t be construed as a residence–or sell, in order to stop from running up additional tax liabilities.  And the news is certain to make vacation home seekers think more fondly of the Jersey shore or eastern Pennsylvania.

Stay tuned.


 

a Gree (3632:JP) listing in the US?

July 7, 2011 By in Industry Analysis, internet, Japanese development, Recent Market Action, Stock ideas Tags: , , , , , , , , , , Leave a comment

…possibly, according to Bloomberg.  The move makes sense to me.  But we’ll have to wait and see.

The social networking business is almost entirely cellphone-based in Japan.  It’s dominated by a small number of companies, including Gree and DeNA (2432:JP) (I own them both).  It’s also maturing, which is why Japanese firms are expanding in to China and the US.  They are also starting to buy mobile game companies in the West as a way of getting exclusive content for their networks.

Why list in the US?

Two reasons, both related to merger and acquisition opportunities:

–right now, the only real option either company has in approaching, say, a US game company is to offer cash.  Shares listed on an exchange that’s still less than a third the high-water mark the main indices reached 23 years ago, and linked to an economy that’s been moribund for the same period, aen’t going to be very attractive.

–a US listing would likely raise Gree’s profile (or DeNA’s, for that matter).  My experience is that the internet sector in Japan is not well understood by investors.  I’m not sure why.  Despite the fact that Gree is profitable, cash-generative and growing extremely rapidly, it’s trading at under 20x earnings.  That’s less than YHOO or EBAY in the US, and about 40% of the multiple of its (slow-growing) personal computer-oriented rival, mixi (2121:JP).

A US listing might also boost Gree’s PE–it certainly can’t depress the current mid-teens value–and increase prospects for price appreciation.  The former would make the stock more attractive to management to use as acquisition currency, the latter would make it more attractive to shareholders of potential targets.

are the financials reliable?

In many ways, financial disclosure in Japan is more detailed than in the US, and at least as reliable.  It’s certainly way better than anything you’ll find in Europe, or elsewhere in the Pacific.  The one drawback for a foreign analyst is that it’s all in Japanese.

the Google-Verizon plan unveiled yesterday

August 10, 2010 By in Current Market Thoughts, Industry Analysis, internet, Stock ideas, Technology, Wireless Tags: , , , , , , , , Leave a comment

GOOG and VZN made their new internet plan public yesterday.  An explanation is available on the GOOG public policy blog, which links to the proposal’s text on Scribd.  (I searched without success to find the proposal on the VZN website.)

the plan

It has some straightforward features, followed by a couple of curve balls.  First, the plain vanilla–

fixed-line internet

The proposal has five points that deal with the fixed-line internet as it exists today.  They are:

1.  Service providers can’t prevent lawful activity, including sending and receiving content, running applications and using services, and connecting devices to the network.

By implication, service providers would be able to stop unlawful activity or actions that harm the network or users.

2.  Service providers wouldn’t be able to engage in “undue” discrimination against lawful activity in a manner that causes”meaningful” harm.

3.  Service providers would have to disclose terms of service and network management practices “in plain language” and in enough detail that users can make informed choices.

4.  Providers can do “reasonable” network management, including measures to reduce congestion, ensure security and eliminate unwanted or harmful traffic.

5. The FCC would enforce consumer protection and nondiscrimination requirements, not by general rulemaking, but by case-by-case actions against violators.

This leaves the FCC relatively toothless, but that’s basically where Congress and te courts have the agency now.

the eyebrow-raising ideas

These have generally drawn the most unfavorable comment in the blogosphere so far.

1.  Wireless would be exempted from all the fixed-line rules, except for #3, transparency in terms of service.  In other words, service providers could deny access to users if it wanted and prioritize content.  Very convenient for Android-based phones on the VZN network.

2.  “additional or differentiated services” could be offered by any service provider who also runs a broadband internet service governed by the plain-vanilla rules.  On this “differentiated” network, which could make use of internet content, the service provider would be able to prioritize traffic.  On its blog, GOOG offers the examples of online gaming/gambling, education (distance learning?), entertainment (movies, concerts?), and health care monitoring as examples of possible additional services.

my thoughts

It sounds to me like GOOG and VZN want to make very large capital investments in wireless and fixed-line internet service networks and want to setle the ownership issue before they do so.

Up until now, the cable and telephone companies that have built out multi-billion dollar internet networks have been compelled–rightly or wrongly–by their semi-monopoly status to accept the rules of “net neutrality.”  If DIS, for example, wants to offer an internet on-demand movie download service over, say, the Comcast network, in direct competition with Comcast’s own cable on-demand service, net neutrality says Comcast has no choice but to allow this to happen.  More than this, Comcast has to make every effort to ensure DIS has enough bandwidth that its service will be successful.

In some sense, then, content providers own the network just as much as the firms who built it, who are relegated to being nothing more than “dumb pipes” that deliver content to consumers.  I’m not trying to make judgments about what should or should not be the case.  I’m simply trying to describe the current state of affairs.

GOOG and VZN, it seems to me, are content (resigned?) to this being the case with capital investments made to date.  But before they commit new money to build new network infrastructure (GOOG, I think) or enhance an existing one (VZN Wireless) they want to make sure they own the network in the strongest possible sense.

Yes, if GOOG and VZN are permitted to build on their own terms, there’s a chance that the existing fixed-line internet–already a laggard in world terms–will develop more slowly than it would otherwise.  On the other hand, without some assurance that they will own the resulting network, I don’t think a non-utility like GOOG will build anything.  Also, there may be more competition in private networks than one might initially think.  Where GOOG treads can AAPL be far behind?