Netflix: Rolling up the Red Envelope (the “Logic” behind the Price Increase)

The 60% Netflix price increase announced yesterday was handled surprisingly ineptly for a company beloved by its customers.  While the extent of final damage to the brand is unknown, subscribers are upset and the Netflix halo has been dimmed considerably.

Many have been asking why the price increase?  The reason for the price increase was not because Reed Hastings wants customers to switch to streaming so that the DVD-By-Mail plan can be phased out, as this AllThingsD post argues.  That must clearly be wrong. Because of the limited available content, streaming is just not a compelling enough product yet for Netflix to hang its hat on.  There are a number of emerging competitors in that business including Amazon, Apple, and Google, and, in addition, Netflix does not control its destiny because it needs to negotiate with content providers for streaming.  By contrast, the mail part of the business and Netflix’s superior logistics in executing that business are what distinguishes Netflix, in particular as the video rental stores have been boarded up.  My guess is that Netflix will be quite happy for the mail business to continue given the strong defensible position it has there regardless of the infrastructure and postage costs, while it further develops the streaming business into an experience that resembles the original mail offering instead of resembling it’s less interesting and less capable step brother.

So then why?  By clearly separating the two products and establishing a $7.99 price to the streaming component (regardless of whether you take no DVDs by mail or 1, 2, or 3), the offering looks more and more like a premium movie channel a la Starz, Encore, or Showtime. This is another step in that direction for streaming as Netflix has been long signalling to the world.  (See here and here, for example.) Netflix gains precise subscriber counts useful for negotiating deals with the studios, many of which may be on a per subscriber basis. The $9.99 plan muddled the ability to do this, as some of that plan’s subscribers valued streaming, while others valued the mail option. This disadvantaged Netflix in negotiating deals if studios demanded payment for all subscribers on plans with access to streaming.  By more clearly delineating its subscribers between streaming and no streaming, Netflix has more firepower in the wallet on a per subscriber basis to negotiate better content deals.  And the more it looks like a premium channel on top of the core cable offering, the less threatening it is to studios and the more willing they are to negotiate in good faith. Given many of the premium movie channels on the rung beneath HBO are around the $7.99/price, Netflix should be able to put together something that resembles one of them, an improvement on the current streaming package.

The logic is sound if Netflix had stepped out like this from the very beginning.  The problem is that it did not.  A 60% price increase is unheard of for any product, and like in any other industry, customers are going to run for the pitchforks in response.  Netflix has to perform some damage control quickly or otherwise risk looking like just one of the customer-unfriendly players on whose back Netflix has built an amazing business disrupting.

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