4 Lessons from Netflix's Price Hike

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Was Netflix’s decision to increase prices wise?

Company execs say, “yes.” Industry analysts say, “no.”

No matter what you think about the wisdom of the price increase, the move is bold. Less than a year ago, the company raised its base price for DVD + Streaming to $8.99 per month. Now, Netflix is changing its pricing structure so that this option now costs $15.98. At the same time, the company is introducing a DVD-only rate of $7.99 along with a streaming-only price of $7.99.

Drawing on statements of Netflix’s CEO Reed Hastings and chief service and operations officer Andy Rendich along with reactions of industry analysts and subscribers, here are four key things to consider when plotting a change in pricing.

1. Market Positioning

From a marketing perspective, the price increase moved Netflix from a low-cost provider of movies and entertainment to, well, a nebulous, yet-to-be-defined position.

Before the change, at $8.99 per month for DVD + Streaming, subscribing to the service was a no-brainer for many customers. The expense was comparable to viewing a movie in the theatres, renting a DVD on a monthly or more frequent basis, or subscribing to basic cable.

At the new price points, perceptions change. Customers are more likely to scrutinize their options in order to get access to a fresher and broader selection of content and/or reduce expenses for entertainment. They may opt to rent the occasional DVD from Redbox, or sign up for premium movie channels offered by cable companies.

However, price increases can succeed if synced with a redefinition or clarification of the brand and market position. For example, a stationery and gift retailer raised its prices at the same time that the company moved to luxury level of products, retail interiors, and virtual presence. Owner Heidi Kallett said that the change helped her business thrive as a premier brand.

Bottom Line

Be aware of the price schemes offered by your competitors, both direct (e.g., streaming businesses) and indirect (e.g., cable companies). Make sure your price points are aligned with a viable market position. Match price increases with brand elevation.

2. Cost Control

According to an article in the Los Angeles Times, “Netflix's chief service and operations officer, Andy Rendich, said the new prices ‘better reflect … the underlying costs’ and represent a better value for people who want only DVDs.” The implication, then, is that the old pricing did not absorb costs. Plus, the company needed more money to improve quality and volume of streaming selections. Bloomberg.com reports that CEO Reed Hastings stated that the price increase will enable Netflix to license “amazing new content.”

Customers expect good cost control from their merchants and vendors. They want to see businesses holding prices steady by instituting process improvements and leveraging assets, that is increasing sales volume based on existing resources (such as DVDs and digital content). They also believe that smart execs can predict growth in customer demand, anticipate increases in operational costs, and set prices appropriately.

So, frequent, erratically-timed price increases make customers question how expertly the company is making decisions. Well-spaced, periodic changes in prices or regularly timed price increases make more sense to customers as even the savviest of businesses can’t keep expenses down forever.

Bottom Line

Be discreet about how much information you share about your costs. Introduce price increases at regular intervals to demonstrate a command of your cost structure. Tie price increases to value associated with immediate, rather than anticipated, product innovations.

3. Market Segmentation

Netflix seems to have delineated its customer base into three distinct groups:

1. DVD only;
2. Streaming only;
3. DVD + Streaming.

If the company considers historical consumption, then these segments seem reasonable.

What complicates this picture is that customers opt for the best choice offered at the time, rather than enjoying the optimal solution. That is, many customers prefer the convenience of streaming but want the title selection offered by the DVD plan.

Bottom Line

Acknowledge that there are many factors affecting customer behavior including how you have structured pricing and deals in the past. Know your customers, and design products and set pricing to serve customers in well-defined market segments.

4. Customer Value

The thought process in favor of raising prices is that:

1. higher revenue per subscriber will offset loss in subscribers;
2. new subscriber growth will continue, adding to the bottom line.

Certainly, there are scenarios in which prices can be increased with little or no change in the number of customers. But this calculation should not be made in a vacuum, ignoring subscriber reaction. Profitability rests on being able to determine how many customers will leave and how many customers will sign on as well as the cost of new customer acquisition.

Bottom Line

Be certain that some customers will opt out when you raise prices. Be realistic rather than optimistic when predicting how many customers will stay and how easily you will be able to attract new customers at the higher rate.