Netflix has been getting hammered in the press for its missteps from raising prices, starting Qwikster and then killing Qwikster, and now for raising price (see earnings report). But lets look a little closer at the effects of the price change. Its $9.99 monthly plan went to $15.98 (an increase of 60%) and the earnings report indicates that they lost 800,000 subscribers during the quarter (from 24.6 million to 23.8 million, a loss of 3%). This would imply an elasticity of 0.05, pretty inelastic.
When you increase price with an inelastic demand, revenue goes up. Indeed, 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.
Interesting evaluation Michael.
ReplyDeleteAs 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.
Very helpful information for an econ major in dire need of extra credit papper. Thanks for showing me the way to my thesis buddy. :)
ReplyDeletei calculated for thoes who want to know Elasticity=0.072
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ReplyDeleteReduce the elasticity of demand, command a higher price.
ReplyDeleteLooking 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.
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.
ReplyDeleteProduct differentiation strategy was the helpful tactic applied by Netflix, and this has shown the enthusiasm Netflix has for growing more.
ReplyDeleteAn 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.
ReplyDeleteThe 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
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.
ReplyDeleteBefore 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.
Netflix customer service
ReplyDeleteThe demand curve for on demand media consumption is changing rapidly enough that I think it could be difficult to predict the ideal pricing strategy until hindsight sheds light on Netflix's strategy. As Walt Disney creates its own on demand streaming service, content is quickly leaving the vaults of Netflix, which will surely have some impact on the satisfaction of Netflix subscribers. Additionally, the online streaming services have only begun to tap into the sports broadcasting arena as well as gaming services that are moving away from purchasable consoles and onto internet based streaming services. As content is bundled, new shows are released with varying degrees of success, games and live sports broadcasting shift to on demand services and broadcasting rights are determined, the amount of elasticity that any one service provider has is yet to be determined.
ReplyDeletePerhaps investors were predicting that demand was inelastic up to a certain point - and increasingly elastic after the "loyalists" and "Early adopters" had been saturated.
ReplyDeleteMaybe Netflix's stock price precesses around its long term future growth, namely subscription base. Investors may be more concerned with the longer term sustainability of Netflix, rather than the short term revenue fluctuations -- therefore, weighing a positive subscription growth more favorably than immediately earnings releases. This idea may be attribute to the stock price's declination as Netflix shed its subscribers, while increasing revenue.
ReplyDeleteI think this is an interesting trend to track. The short-term elasticity may be very inelastic, but in the long-term I think this could change. There are a lot of substitutes entering the market (Disney+, NBC etc) that could change the Cross-Price Elasticity of demand for this. This will be a good topic to revisit in a couple of years when this market settles out a bit with the large changes.
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