Commentary

More On The Success Conundrum At Netflix

I wrote about the dilemma of being Netflix in an earlier post; this is a sequel.

This week Netflix's announcement of pricing changes has created a stir in the industry.  Netflix issued a seemingly reasonable explanation for the increase.  That is what PR is for. 

However, one has to look at this move in the context of a simultaneously complicated playing field and dynamic industry environment within which Netflix is trying to both survive and shape the future.  In that sense, this price increase should not come as a surprise to anyone, other than those who think that everything on the Internet should be either free or subsidized.  At the end of the day, when most media (if not everything) moves to the Internet, expect more price parity between traditional pay TV services and emerging Internet video services than was typical before. 

Netflix was a flush-with-cash, successful company based on its DVD business.  Its explanation that this recent price increase is due to the high cost of mailing physical DVDs suggests that the DVD-by-mail model is broken.  Since Netflix has done well with this model for more than a decade and a not insignificant number of DVD customers underutilize the service (myself included) -- i.e., go weeks if not months between swapping DVDs -- there is more to this picture than a cost-plus pricing scheme.

Netflix is clearly taking a portfolio approach to managing its business.  The (mature) DVD-by-mail is the cash cow funding the (emerging) streaming business. It's not a stretch to see how a profitable, unique service (DVD-by-mail) with a limited future runway should be able to fund the nascent but promising streaming future of Netflix.  Within this pricing change is a tacit testament that the DVD-by-mail service still holds value for subscribers, and that they will not abandon the service en masse.  For one the streaming selection is dwarfed by what is available on DVD as well as the timing of available titles on DVD.  Secondly, if these users were price-sensitive, they would have switched to services like RedBox when the appeared (only the most heaviest user of Netflix makes out better price-wise than (s)he would with renting kiosk DVDs).  As I wrote in the earlier post, Netflix has no direct competitor for its DVD-by-mail service.  Not so for its streaming service, where substitutes and direct competitors abound.

I surmise that Netflix has assessed that the DVD-by-mail users are its least-price sensitive users, and are therefore going to be subsidizing its streaming service.  After all, increasing its streaming pricing is going to throw a big monkey wrench in its subscriber acquisition strategy as well as its competitive position in the streaming market. 

What started out as basically a "free" service for its DVD-by-mail subscribers, is now being charged and in effect, DVD-by-mail subscribers are expected to pay the difference to keep this service.  While this is strikes me as bait-and-switch, I also wonder why Netflix did not simply offer its DVD-by-mail subscribers the option to either sign up for a paid streaming service or discontinue it. 

A few possible explanations: one, that the number of DVD-by-mail subscribers who may have opted out of streaming may not be insignificant.  Two, the streaming subscribers count is really important to Netflix.  Three, it is easier to hit subscribers with a price increase and have them take it than to give them an option to choose and risk them opting out. 

The last of these sounds a lot like how price increases are implemented by existing pay TV subscribers, doesn't  it? 

It is obvious that Netflix's business model is going to be driven by content licensing costs.  As content providers are waking up to the reality of the value of the content in online streaming, expect the early largesse enjoyed by Netflix and others such as Hulu to be over, and greater parity in the cost structures of video services (online streaming and traditional pay TV) vis-à-vis content licensing.  Consequently, the pricing across different types of services will also start converging.  Expect online video services trending upwards and traditional pay TV services downwards with market forces at work. 

The halcyon days are coming to an end for everyone - traditional pay TV services, online streaming services and streaming video subscribers.   Traditional pay TV has enjoyed pricing power for most of its existence; early online services caught incredible licensing deals that allowed them to ratchet growth rapidly with disruptive pricing, and consumers got a cord cutting option for the first time.   Netflix's new pricing scheme is just one indicator of the level-setting underway.  That Netflix has chosen to hit up  its DVD subscribers first is a good calculated decision on their part, but the way it was done is also an indicator of the high-stakes game in online video where market dominance is still up for grabs by anyone. 

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4 comments about "More On The Success Conundrum At Netflix".
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  1. Peter Herring from TTW Systems, July 15, 2011 at 1:19 p.m.

    It's rare that I get to be both a marketer and customer, a situation that allows me to get past the statistics and concepts and into the feelings that drive consumers. The problem with Netflix's move has nothing to do with people expecting everything for free on the web. It is not even - necessarily - a classic price raise issue. The problem is that old fashioned marketing equation that doesn't seem to get discussed much anymore: value proposition. I had a beer with my son last night - I'm 56 and he's 31, so here's a rare generational consensus. Netflix's streaming content sucks. (That's normal consumer parlance.) Neither of us ever saw the streaming as a great value. I had the 1 DVD a month add on to make up for the deplorable lack of streaming content. I still recall my first reaction on getting a Roku and signing up for streaming - there's nothing here! No decent new content, and a lot of old movies are unavailable too. So the problem is not simply a price raise on a service seen as valuable - the problem is a price raise on a service seen as mediocre at best. We used to call this a poor value proposition, and it comes into play at that magic point where the customer "feels" that the service is not worth the cost. I don't know what that point would have been for Netflix, but I'm betting that, for a lot of customers, it's wasn't a 60% raise, which felt higher because the online service was already perceived as a low value add on. For me, it probably won't be worth it - there are too many other choices out there - including a red box three blocks away. And I am a loooong term customer. (It also didn't help that when I called Netflix I was told to call later, due to increased call volume. You'd think they might have staffed for this one.)
    I am highly aware of the churn in the online video ecosystem, and I don't envy Netflix. This is a systemic problem that the majors will be working out - meanwhile, the online experience is Balkanized for consumers and, as a result, if you want the kind of choice offered by cable (all those channels, one price) the cost of getting it is already on a parity.

  2. Donna Zelzer from Midwifery Today, July 15, 2011 at 1:31 p.m.

    "I surmise that Netflix has assessed that the DVD-by-mail users are its least-price sensitive users, and are therefore going to be subsidizing its streaming service."

    I don't understand this statement. I'm a person who can't stream and when I change to the 3-DVD no streaming plan, I'll be saving $4/month. I don't see how this is subsidizing the streaming service or hitting the DVD subscribers first. The only people who get price increases are those who want both services.

    To me, it seems like what they're doing is changing it so people are paying for what they actually use.

  3. Gary milner from The Simpler Way, July 15, 2011 at 1:47 p.m.

    I have just resubscribed to Dish and quite frankly was blown away by the quality and depth of content on its online service, way better than the on demand component of the business. Add to that the high quality of HOB go and the whole library that they have and you have a compelling model. There are a lot of satellite subscribers out there that will not drop their sports content, combine the compelling online and the odd redbox visit , then why do I need Netflix? Oh yeah to watch all the old TV shows.

  4. Sam Vasisht from Independent, July 15, 2011 at 2:41 p.m.

    Donna, a simple way to slice this statement is that if you were a streaming only subscriber, nothing changes. But if you are a DVD + streaming subscriber, then you are paying a higher price than before. Netflix had added streaming as a 'free' add on to DVD by mail subscribers earlier. They could have removed the 'free' service, but instead chose to apply part of the subscriber fee to the streaming component and have subscribers pay additional for the DVD by mail component. The math is the same if you keep both services, but as a pricing model it was a calculated move.

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