Tuesday, October 25, 2011

Did Netflix Raise Price Enough?

Netflix has been getting hammered in the press for its missteps from raising prices, starting Qwikster and then killing Qwikster. Now its stocks tank on its most recent earnings report. But lets look a little closer at the effects of the price change. Its $9.99 monthly plan went to $15.98 and the earnings report indicates that they lost 800,000 subscribers during the quarter (from 24.6 million to 23.8 million). This would imply an elasticity of less that 0.1, pretty inelastic.

They will surely lose more over the coming month due to the price change and they would have gained subscribers simply through "natural growth." But how much could this account for? For example, suppose natural growth would have put subscribers at 30 million. Then the price change would have had to cause 5 million subscribers to stop service over the long-run just to get an elasticity greater than 1.0, in the elastic range where profits are maximized. This is six times the 800,000 lost subscribers so far.

As a result,
Netflix earned $62.5 million in the quarter compared to $38 million the same quarter last year. On this news, the stock price plummeted 37%, wiping out $2.3 billion in market capitalization. Stock market analysts claim that the stock price is warranted despite the good earnings news because they expect much lower future earnings.

10 comments:

  1. Interesting evaluation Michael.

    As a Netflix subscriber myself my reaction to the price increase was to reduce my subscription from a higher priced plan to a lower one. Also, I have developed a strategy to use less of their service in the long run. These decisions make me more profitable for Netflix in the short term, but less profitable in the long run. This fear may be what is driving investors to revalue the stock.

    Also, Netflix's current strength is its CD distribution infrastructure. Upper management appears to be over-looking that. A streaming only business model has a much lower cost of entry and an uncertain, developing future cost structure as the hollywood studios are still working out ways to maximize this new revenue stream.

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  2. Very helpful information for an econ major in dire need of extra credit papper. Thanks for showing me the way to my thesis buddy. :)

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  3. i calculated for thoes who want to know Elasticity=0.072

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  6. Reduce the elasticity of demand, command a higher price.

    Looking back on the netflix decision, we can see that raising the price due to the inelasticity of demand was a good decision. The initial announcement of the price increase caused a shock to consumers that led to an initial decrease in subscriptions. It also adjusted the stock price (retracement) due to trader sentiment on the news. CEO Reed Hastings even had to apologize publicly for raising prices. Once the shock of the change in price wore off and became stable, netflix increased its subscriptions at the higher price.

    From Damon's post above, we infer that Netflix also anticipated the different price elasticities and adjusted their subscriber plans to take advantage of different consumer markets. For example, it introduced a streaming only option for $7.99. Now, Netflix is adjusting prices again using a tiered model.

    http://www.huffingtonpost.com/2014/04/21/netflix-price-increase_n_5187461.html

    Of note, when this blog was originally posted, NFLX was trading at $117.21. As of the close on Friday (8-14-14), it is trading at $459.09.

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  7. It's also interesting seeing how Netflix is responding to a more competitive market by trying a product differentiation strategy that is more difficult to imitate: original Netlix shows available only on Netflix. The popularity of these programs, such as House of Cards, has helped them avoid falling victim to a completely elastic demand curve.

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  8. Product differentiation strategy was the helpful tactic applied by Netflix, and this has shown the enthusiasm Netflix has for growing more.

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  9. An alternative to purely and simply increasing prices, Netflix, could create as an alternative a price band that would allow segmenting customers by levels of prices and services according to their capacities of payment, whether as their tastes and entertainment needs.
    The creation of price bands would increase the flexibility of services, positively impacting the growth volume of the customer base of the Corporation.
    These price bands can be created in matrixes that are adapted to the specificities and complexities of each market, according to their geographical, socio-cultural, individual’s income levels, as well as schooling.
    Alternatively other options could be considered to be created such as payment for services by demand for certain areas of geopolitics, averaging costs for use toward certain segment of the population, whose resource availability is more limited than other social groups.
    Netflix, could explore markets that have other languages as base, as well as other interests such as soap operas, Hispanic, especially the Brazilian, Colombian and Mexican which tends to be very popular in the Spanish-speaking community

    References: Froeb, McCann, Ward, Shor: (2014) Managerial Econonics. A Problem Solving Approach, Ohio: South Western Cengage Learning

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  10. I subscribe to Netflix but I am not a frequent user of it because I have cable with paid channels such as Starz and Cinemax. Since I am able to view movies on Demand, I rarely pay attention to Netflix. But when it comes to my daughter wanting to see the most popular movie at the theater, which costs me almost $40 plus, including snacks, I opt for Netflix instead. I know many people who do not have cable but use Netflix as their main source of entertainment. So the raise in price is contingent on each individual’s usage.

    Before Netflix caught on their $7.99 price was catchy when advertising and marketing for new customers but they didn’t understand the concept of simple pricing. A dollar or two increase would indeed affect those on a tight budget but those counting the opportunity cost of a theater wouldn’t complain much.
    Netflix could offset the increase by providing more movie and TV show options, whether it’s an original or purchased shows. I also think the restriction of password sharing would streamline growth. They could implement a limit of how many people can log on using a single password. As of now, many simply give their password to individuals in multiple households or multiple people within one household on several devices.

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