Netflix Price Change: What does it mean for Netflix?

On July 12, Netflix made a big announcement on its blog: separation of its streaming and DVD rental plans (http://blog.netflix.com/2011/07/netflix-introduces-new-plans-and.html) and new pricing effective September with no grandfather clause (the only exception is the limited plan). Within hours of this announcement, blogosphere resounded with strong protests from current subscribers and cries of “Netflix gone evil”. Netflix is clearly trying to move away from physical DVD rental business and the new pricing is going to do exactly that. Let take a look at some data from the 10k (2010 data):

• Average number of paid subscribers = 14.786m
• Average revenue per subscriber per month= $12.19
• Total revenues = $2162.625m

Since 85% of subscribers have either:  streaming only (S + 0D),  streaming + 1 DVD (S + 1D) or  streaming + 2 DVD (S + 2D) plan, let us focus on these customers.  Let us reference these customers collectively as the S+nD segment.

	Old Plan	New Plan	% Increase
Streaming only	$7.99	$7.99	0.00%
Streaming + 1 DVD	$9.99	$15.98	59.96%
Streaming + 2 DVD	$14.99	$19.98	33.29%

Why the Outcry? The Role of Reference Price

With the new plan, the marginal costs of adding a DVD to streaming only plan went up substantially:

	Old Plan	New Plan
Add 1 DVD	$2.00	$7.99
Add 2 DVDs	$7.00	$11.99

It used to cost only $2 to add 1 DVD to the streaming only plan. That cost shot up to $7.99 in the new pricing plan. As a reference, the cheapest alternative is to rent a DVD from RedBox (or equivalent) for $1 a day. If the average 1 DVD subscriber watches 4 movies in a month, Netflix price comes out to be $1.99 per DVD.  99 cent is the price of convenience (home delivery + you can keep the DVD longer) which in my opinion is still a very good deal. However, a 60% jump in price ($9.99 to $15.98) is a huge psychological barrier for most people.

What does this mean for Netflix?

  

• Streaming + 1 DVD customers are likely to switch to streaming only plan

The 60% price jump is going to be a big barrier for customers in this segment and they are likely to switch to the cheaper streaming only plan for $7.99 which is $2.00 less than what they pay today.

•  Streaming + 2 DVD customers are likely to swallow the price hike

For this segment, the price jump is relatively small compared to the streaming + 1 DVD plan. Given the fact that these customers are already paying $14.99, an increase to $19.98 is more likely to be accepted.As we will see later, Netflix is counting on this!

• There is a significant % of  streaming + 2 DVD subscribers

If we assume that the remaining 15% of the customer base (other than the S+nD segment) pays an average of $15.99 per month (the least of other pricing plans), the average revenue per user in the S+nD segment is about $11.52 per month. 

If at least 10% of the S+nD segment is streaming only, then about we have 4.40 million streaming +2 D customers (a good 35% of the S+nD segment), 6.91 million streaming + 1D customers and 1.26 million streaming only customers.  

The total annual revenue from S+nD segment is $1.74b . Revenues from other customer segments is about $425m.

Post-price Increase Scenario

So we have the following segments of customers (well, at least 85% of them):

                Old Pricing

Segment	Number of Customers (million)
Streaming Only	1.26
Streaming + 1 DVD	6.91
Streaming + 2 DVD	4.40

Total Annual Revenues = $1.74b

• Scenario 1

After the price increase if all streaming + 1 DVD customers drop to streaming only option and Streaming + 2 DVD customers stay put, then we have:

Segment	Number of Customers (million)
Streaming Only	8.17
Streaming + 1 DVD	0.00
Streaming + 2 DVD	4.40

Total Annual Revenues = $1.83b, an increase of 5.17%

• Scenario 2

If 50% of the streaming + 1 DVD customers drop to streaming only option and 50% leave Netflix while streaming +2 DVD customers stay, then we have:

Segment	Number of Customers (million)
Streaming Only	4.71
Streaming + 1 DVD	0.00
Streaming + 2 DVD	4.40

Total Annual Revenues= $1.50b, a decrease of 13.79%

• Scenario 3

50% of the streaming + 1 DVD customers drop to streaming only option and 50% leave Netflix; 50% of streaming + 2 DVD leave as well, we have:

Segment	Number of Customers (million)
Streaming Only	4.71
Streaming + 1 DVD	0.00
Streaming + 2 DVD	2.20

Total Annual Revenues= $979m, a decrease of 43.74%

Netflix is hoping that the streaming + 2 DVD customers will not leave or drop to a lower price plan for the new pricing to make sense in the short run.