Netflix betting on subscriber fallout in Q3, everyone over it in Q4

Netflix posted solid Q2 earnings on Monday, but naturally, all of the attention was focused on the recent price hikes. Nevertheless, Netflix execs feel confident that all the complaining is just hype.
Written by Rachel King, Contributor

Netflix posted solid Q2 earnings on Monday, but naturally, all of the attention was focused on the recent price hikes. Nevertheless, Netflix execs feel confident that all the complaining is just hype.

See also: Netflix makes case for its price moves, but cuts Q3 outlook

Speaking during the company's quarterly conference call for investors on Monday, CEO Reed Hastings reiterated that Netflix regrets that customers are upset, but recognizes that most of these angry emotions will likely taper off within a few months:

Because of the timing, we announced it at the very beginning of a quarter, we'll see the negative effects of it in Q3. That is, the elevated churn and lower revenue growth than we would otherwise have. Then the price increase takes effect essentially mid-September, on average. So we get a little bit of benefit at the end of the quarter and then the real benefit comes in the following quarters, Q4 and beyond. But in terms of tracking where we are and our expectations, we're feeling very good.

Although the most obvious reasons as to why Netflix is raising its rates (i.e. having to pay more to Hollywood studios for licensing fees), execs spoke a little more about the jump in subscription rates. And even if subscriber numbers drop off, Hastings still boasts that Netflix is the number one spot for DVD rentals:

We feel great when you think about it with our DVD service at $7.99. It's an incredible value. It's the lowest priced offer in the marketplace. It's the best service levels in the marketplace. So if a customer wants DVD rental by mail, we're definitely the place to go. And then in terms of streaming, we've gained increasing confidence over the last two years about the viability and strength of a pure streaming plan. We gained some confidence when we launched in Canada and that blew away our expectations with the response. We gained some confidence when we led on our nonmember home page with streaming only and as we put in our shareholder letter, in Q2, about 75% of subscribers chose streaming only. In other words, even though DVD was only $2 more, 75% [were] stuck with streaming only.

Although there is Redbox and Blockbuster, Netflix still does lead the way in DVD sales. The real competition really is in streaming, with Hulu Plus and sites from cable providers like Xfinity from Comcast. Thus, Netflix actually does have a need to step up pricing in order to build that digital streaming library to stave off its competitors and have a chance to retain the majority of its customers base, which it likely will.

In a recent study conducted by Morgan Stanley's AlphaWise on July 15 --- just days after Netflix rates skyrocketed --- found that subscriber churn and initial responses were fueled by "too much emotion," which is likely to die down by the time the new prices go into effect for new subscribers this September:

Since Netflix’s July 12 price increase announcement, we have seen the ad-hoc polls’ churn results gradually come down; we anticipate the true churn rate will prove to be much lower and the that fulcrum point for sub churn will be at the legacy, 1-disc out, streaming plan.

Another survey reported by equity research firm Wedbush backs up those assertions with a report published on July 24. After finding that 31.4 percent of subscribers with the $9.99 plan (roughly 4.2 million subscribers) would drop their Netflix subscriptions entirely, Wedbush still believes that such estimates are actually just overdramatic:

In our view, respondents are more emotional and, in general, angrier following a price increase that is not accompanied by a meaningful addition to the value provided by the current services. Many appear to have viewed the price changes as a “takeaway”, and we believe that the large percentage who stated an intention to discontinue the service will reconsider their decision as they evaluate their alternatives to obtain streaming content elsewhere at a reasonable price. As such, we expect defections at perhaps half the rate indicated by the survey, and expect no more than half of the 5.5 million current subscribers who said they would discontinue Netflix service to actually do so.


Editorial standards