Netflix's pricing backlash: Follow the money, churn rates

Netflix's pricing backlash: Follow the money, churn rates

Summary: Netflix swapped out its pricing plans, angered customers and effectively separated its streaming movie and DVD rental businesses. Why? Here's the math behind the pricing decision.

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Netflix swapped out its pricing plans, angered customers and effectively separated its streaming movie and DVD rental businesses. Why? Netflix is betting that it has pricing power since it will have to pay higher content costs going forward.

On the surface, the math makes sense. Netflix basically raised prices. An option to get streaming video and DVD rentals in a bundle for $9.99 a month is now $15.98. In other words, one DVD rental out at a time is $7.99 a month. And the streaming service is $7.99 a month.

Following Netflix's blog post officially confirming the price changes, the customer backlash ensued. We won't recap all the comments here, but folks weren't happy. The Wall Street Journal summed it up best and noted that Netflix customers were subscribing to unlimited screaming.

The big question here is whether this screaming amounts to real damage to Netflix's brand or financials. Clearly, Netflix thinks it has the risk-reward balance on its side. Here's a look at the calculus behind the pricing decision.

It's about the revenue stupid

Netflix's pricing move is all about the money. By unbundling DVD and streaming services, Netflix is reflecting its costs better. Unfortunately for customers a bundled plan is now 60 percent higher. What's galling to customers is that they can even get a bundle discount from the cable giants---you know the companies Netflix was going to unseat.

The backdrop here is content costs. Netflix has to renegotiate its Starz deal and content costs are only going up. The company knows it. Wall Street knows it. And consumers will now know it. Netflix is passing along some costs upfront.

Depending on the analyst, Netflix's price changes will boost average revenue per subscriber at a nice clip. Jefferies analyst Youssef Squali said that Netflix's average revenue per unit could jump to anywhere from $12.59 to $13.98 depending on the churn increase. Today's estimate is $11.80.

Here's the model:

Piper Jaffray analyst Michael Olson has a similar scenario. "Despite potential for higher churn, our analysis leads us to expect these changes to result in higher ARPU and profitability over the next several quarters," said Olson.

Here's Olson's take:

In either case, Netflix's price changes are all about the dollars. If subscribers get the 1 DVD at a time plan and the streaming service for $15.98 instead of $9.99 Netflix comes out way ahead.

Well then there's the churn

The linchpin to this equation is whether folks drop the DVD shipping service en masse. Olson noted:

If customers choose to abandon DVD-by-mail and downgrade to the streaming-only plans, ARPU would fall, but profitability would rise and Netflix would more quickly accomplish its goal of becoming an internet streaming service. If subscribers maintain both DVD-by-mail and streaming, then ARPU will rise, and the profitability of the DVD service will also rise to be more in-line with that of streaming.

Following the money leads you to conclude that Netflix isn't going to complain if you dump the DVD plan because of costs. Officially, Netflix is committed to DVD shipments.

Netflix's churn levels, historically about 4 percent, are likely to increase. Why? There's a direct substitute for Netflix's DVD service---CoinStar's Redbox. Merriman Capital analyst Eric Wold said:

For those Netflix subscribers who still utilize DVDs, we would expect this price increase to force them to re-evaluate their subscriptions - with a potentially meaningful percentage of them canceling their subscriptions altogether. While Netflix has not detailed the number of DVD-using subscribers, management has noted that there has not been any significant number of subscribers downgrading to streaming-only plans and between 1/3 and 1/2 of new subscribers during 4Q and 1Q chose streaming-only plans - indicating that most subscribers are still choosing plans with a DVD option. With limited choices now for DVD rentals (especially with Blockbuster and other chains closing), we believe Redbox would experience a significant share of any defecting DVD-rental demand.

The catch is that Netflix's first quarter churn fell to 2.8 percent from that historical 3.5 percent to 4 percent range. In other words, Netflix can afford to let churn levels creep higher. For my economics, Redbox is the choice. The kids like the kiosk and it's $1 a movie unless you forget to return the disk. I'll keep streaming only for a bit, but the selection is lacking. A substitute for Netflix may be Amazon streaming via the Prime subscription. In either case, Netflix has forced a lot of customers to check out new options.

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Topics: Mobility, Hardware

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  • RE: Netflix's pricing backlash: Follow the money, churn rates

    Content providers will raise the cost until NetFlix is ruined ... just the way cable, then satellite was ....
    BrentRBrian
    • I'm going after the content providers (in a small 1 man way)!

      @BrentRBrian
      If enough of us REFUSE to pay higher prices EVERYWHERE, not just NetFlix, "they" will start to feel real pain (not just blah quarterly aches).
      I don't think it will happen! Just my 2 cents worth.
      kd5auq
      • RE: Netflix's pricing backlash: Follow the money, churn rates

        @kd5auq <br>Yep, and we should demand the same of our politicians, and get our country back from financial collapse from the Obama regime, and no GW Bush hasn't been president for almost 4 years now so stop blaming him please!!!!!!!!!!!!!!!!!!!!!! Obviously socialism doesn't work, everywhere it's tried it eventually runs out of the peoples money to spend, rendering it a collapsed system.
        mikroland
      • WTH?

        @mikroland NT
        Joe McPlumber
      • RE: Netflix's pricing backlash: Follow the money, churn rates

        @kd5auq Yeah, the will NEVER happen!
        markpringle
      • RE: Netflix's pricing backlash: Follow the money, churn rates

        @kd5auq I quit cable and satellite 8 years ago, and I will quit Netflix too for this. I'm not paying more than $8 (maybe $10) per month for this. Otherwise they can kiss off. I cut Starz loose 8 years ago and apparently Netflix wants to cram them down my throat. Wrong answer. I'll cut Netflix loose in a heartbeat.
        blueskip
      • Content creation is expensive.

        @kd5auq

        This is often lost of people. Transformer: Dark Side of the Moon cost a cool 200 million to make. A single film.

        In this case, it looks like it will gross about 1 billion over its life but for every winner like this, there are 3 losers.

        I have always been amazed NetFlix was able to turn a profit at these rates.
        Bruizer
      • RE: Netflix's pricing backlash: Follow the money, churn rates

        @mikroland

        //offtopic - Dubya had destroyed what took Clinton nearly 8 years to accomplish in less than 1 - that is, a national budget surplus. If John Boehner and Eric Cantor understood the only way you can truly go from in the red to in the black is to cut costs AND increase revenue (e.i. start taxing the "haves" and the "have mores", as Bush called them), then maybe we'd be on the way out of being in the red.

        //offtopic
        Champ_Kind
      • RE: Netflix's pricing backlash: Follow the money, churn rates

        @kd5auq Not going to happen. Content providers will keep charging more for shoddy content, no matter what we do. Just like how most every manufactured product we buy these days is lower quality than the equivalent product from several decades ago (cars are even designed to be completely disposable these days, instead of being built to last forever).
        Champ_Kind
      • Content creation costs?!?

        Bruiser, the production studios recover their costs first. They put up the cash to make the movie and they get the first bite of the income apple. By the time the blockbuster movies hit the online distribution houses such as Netflix, production costs are out of the way. The production companies could not afford to release the films to Netflix and their competitors otherwise. Netflix streaming can provide a high viewing volume, but at a lower-per view revenue.
        nkfro
      • RE: Netflix's pricing backlash: Follow the money, churn rates

        @kd5auq, the article to which we are commenting indicates my monthly Netflix bill will be reduced by $2/mo. since I choose to stream movies. Where are the higher prices you want me to protest? When common sense dictates ones actions, most of the easily solved problems can be sidestepped.
        nkfro
      • If your going to change topic, at least make an effort to talk sane

        @mikroland
        Are you completely out of your mind????

        You talk like a simpleton who's political leanings vastly out way your grip on simple logic. What I am talking about is this blathering nonsense you said:
        "get our country back from financial collapse from the Obama regime, and no GW Bush hasn't been president for almost 4 years now so stop blaming him please!!!!!!!!!!!!!!!!!!!!!! Obviously socialism doesn't work"

        If you truly believe any of that nonsense then you and your ilk are doomed to relive the follies of your past literally for as long as you live and are making decisions based on crap like that.

        This recession is not some recent shallow problem, haven't you noticed that???

        Who was in power and set the stage and created the environment where this recession started?? Was that Obama??? Did Dub'ya have such a sloppy weak grip on the wheel that Obama was doing the steering of the nation years before he was voted in???

        You sir are the prime example of why nothing good ever seems to come out of politics. Its because of dolts who would rather bury their heads in the sand up to their shoulders about what is and has really gone on in the world to save their precious love for a political party as opposed to facing some blatant realities and except facts for being facts.

        It was Bush's policies and political practices that lead the U.S. financial institutes down the road to ruin and it was Bush who shuffled off into the sunset leaving the financial landscape of the world in ruins, ruins so deep no leader around the world has been able to completely extricate their country form the mess completely. And the fact remains that despite the fact that much of this economic strife around the would came out of the U.S. situation created by the Bush government that Obama has done better then some leaders around the world at tackling the problem.

        And this drivel about socialism is pure nonsense itself in the extreme. The U.S. is about as close to a socialist regime as Bush was a smart communist. The U.S. is not socialist and nothing really like socialist at all. Your pure ignorance of what socialism is, reveals the plain and simple fact that you are completely uneducated in politics and are spouting off based on nothing more then a blunt and mindless hatred for democrats.

        People around the world bust a gut laughing when they read or hear of some twit in the U.S. who simply hates the democrats and evokes the socialist complaint to bolster the reasons for their hate. Everyone around the world who knows so much as a whiff of what politics is about knows full well that the U.S. on many levels represents much of what is the antithesis of socialism and it remains that way today.

        For those who think that brow beating the the poor and downtrodden and less fortunate is the way to build a stable economy and the Republican party is the only party capable of doing that, well, my hats are off to you for taking such an outlandish stance with such pride, but I would have to say that your attitude in life hardly seems to represent what the forefathers of America had in mind of what makes for a great American citizen.
        Cayble
      • RE: Netflix's pricing backlash: Follow the money, churn rates

        @mikroland
        Shouldn't you be watching Faux Noise?
        Chiatzu
      • RE: Netflix's pricing backlash: Follow the money, churn rates

        @mikroland you lose credibility. Obama hasn't been president even 3 years yet...a long ways from "almost 4 years". And yes, GW was in a big way responsible for the collapse and a huge deficit increase. That doesn't remove Obama's ineffectual leadership, but he was not the instigator of the mess.
        dabble53
    • RE: Netflix's pricing backlash: Follow the money, churn rates

      @BrentRBrian Yeah, if anyone is to blame here, it is Hollywood. The MPAA are a bunch of greedy lawyers and accountants with zero concern for customer satisfaction. The fact that Starz experienced huge revenue growth courtesy of Netflix and then pulled their content to demand more money is just one more example. Netflix knows that the same thing is about to happen with other content providers. I long for the day when the greedy studios are finally replaced by nimble, efficient, consumer service-oriented companies.
      BillDem
      • RE: Netflix's pricing backlash: Follow the money, churn rates

        @BillDem Good luck with that
        nbkz81f
      • RE: Netflix's pricing backlash: Follow the money, churn rates

        @BillDem Absolutely. The studios are looking to squeeze Netflix out of the "all you can eat" subscription model for the per-view payment model that's been so profitable for the motion picture industry.

        Too bad that the studios let the Netflix genie out of the bottle. Trying to throttle Netflix by restricting access to the latest films, while at the same time offering advantages to rival streaming services that will conform to the studios' per-view pricing model, will be like grabbing smoke.

        The studios' problem is that the public <i>likes</i> the subscription model, and there'sl no benefit offered to consumers to give Netflix up for something else. Even at higher prices, a Netflix subscription is a screaming deal compared to paying $4-$8 to view each individual film.

        Short of anti-trust violations, I don't see any way the studios will win out over Netflix on this one.
        Randy Hagan
      • RE: Netflix's pricing backlash: Follow the money, churn rates

        @Randy Hagan What are you smoking? No offense but they've already won if they're forcing Netflix to raise prices.
        blueskip
    • RE: Netflix's pricing backlash: Follow the money, churn rates

      @BrentRBrian
      You got that right. Screw Netflix I'd rather pay a dam cable company for at least a recent movie. I used to think netflix was great and maybe giving something back to the people. Crazy I should have know it was to good to be true. Churn this Netflix.I held off for years going to netflix then with all the video stores closing I decided what the hell. I knew it.
      futuregu@...
      • Know your enemy

        @futuregu
        Netflix has by far been the leader in low cost media! @Randy Hagan is right. The real slime balls here are the production studios. They have continued to have strong quarterly numbers yet they are not satisfied with doing well. They want the same revenue for mobile/internet viewing as theaters. This will end the same it did with the music industry. DRM free music (iTunes) is the precursor to DRM free everything. In the mean time smart people will just wait it out, or turn to untraceable forms of piracy. Studios may be big, but they can't withstand the strength of world wide popular demand.
        scubashnurpel