Why I'm Happy to Pay a 60% Premium for Netflix

Will some customers run out on Netflix (Nasdaq: NFLX  ) now that the company has created separate plans for streaming and disc rental? A poll run yesterday here at Fool.com says yes, but I'm not so sure. Between Hollywood's inattentiveness and cable channels' idiocy, an entertainment gap has formed that, increasingly, consumers turn to Netflix to fill.

Call it the TV gap, wherein disappointed consumers are turning to a combination of discs and the Web to make (ahem) "on-demand programming" live up to its name.

The rubes running the tube
Sound harsh? I suppose it is, but I'm not the only one who's seen the ruse of on-demand in action. Foolish colleague Travis Hoium also subscribes to Comcast's (Nasdaq: CMCSA  ) XFINITY TV service and has found it to be ... well, here, judge for yourself:

Last week the upgrade to XFINITY made its sweep through my local market. After, I couldn't decide if I had been upgraded or sent 20 years into the past. It's great to have on-demand access to TV shows I've missed recently, and I even came across a few I didn't know existed. But I couldn't help but think Comcast was trying to bring DOS back from the dead. Menus are grainy and difficult to navigate and I have no idea what will be available when. One of my best hopes of competing with Netflix fell flat on its face on my television.

He's right. The best thing about XFINITY is the online service that allows me to set the DVR to record. Of course, if that sounds like TiVo (Nasdaq: TIVO  ) circa 2006, you're right. Therein lies the problem with so-called on-demand services. Few are modern, and none allow me to choose what to watch, whenever I want to watch it, on my terms.

Even the good features have serious flaws. XFINITY's brand of on-demand stores recently aired shows, so my wife and I can catch up on USA Network shows we like but missed. Trouble is that using the service means suffering through ads I could've skipped through by recording the show. This is what counts for innovation?

Still more programs simply aren't offered via the on-demand model, but that's also understandable. Creators and studios are smart to get as much as possible from their intellectual property, and networks are in the business of making a profit. Negotiating a fair deal can get tricky. But again, if the shows aren't there, this also isn't "on-demand." True "on-demand" would be comprehensive and instant. In at least one of these areas -- comprehensiveness -- only Netflix gets close, and that's because of the dual nature of its service. Doesn't that deserve a premium?

With comprehensiveness comes cost
Interestingly, despite its many holes, the on-demand strategy is working for the likes of Comcast, DISH Network (Nasdaq: DISH  ) , and DIRECTV (NYSE: DTV  ) . In a study published last month, media researcher Nielsen found that Americans are watching 22 more minutes of TV per month than they were a year ago. Internet viewing was up 34%, mobile device viewing rose 20%, while couch potatoes spent 0.2% more time planted in front of the tube.

In short, giving consumers a taste of what on-demand programming could be like has enticed consumers to add roughly one half-hour sitcom's worth of viewing each month. I know that doesn't seem like much. But with each 30-second ad spot comes hundreds of thousands of dollars in ad revenue. Hollywood has a lot at stake in making on-demand work.

Merits of taking the low (cost) road
By contrast, Netflix isn't a network and thereby has the freedom to pursue on-demand differently. And it has. Instead of building Watch Instantly as a tease -- with only a few, if highly desired, titles -- CEO Reed Hastings chose instead to build a massive database of lesser-known titles that had just enough appeal to be useful, all the while keeping a DVD-by-mail business capable of filling gaps. The result? Hastings' company is the closest thing as there is to a one-stop shop for movie and TV programming rentals.

Unfortunately, none of this comes cheap. As my Foolish colleague Rick Munarriz rightly points out here, Netflix pays substantial fees to keep discs flowing to those who want them. Comprehensiveness, meet cost. That's why Netflix earns a 38% gross margin on what, effectively, is an Internet business. Amazon.com (Nasdaq: AMZN  ) has the same problem. Distribution is never, ever cheap -- especially when you commit to doing it well.

Looking back to look forward
We've seen this sort of thing before. Remember when Apple (Nasdaq: AAPL  ) cut the price of the iPhone just weeks after release? Early buyers were outraged. Some may have even left the platform for other devices. But today, nearly four years later, there's little doubt CEO Steve Jobs made the right call, even if it meant losing some customers at the time.

So while I get that some are angry over the price hikes -- more than 30,000 have expressed their displeasure on Netflix's Facebook page -- investors should be thrilled. Netflix is charging what it should for a need that, right now, it fills better than alternatives. There's also historical precedent for losing some customers in the short term to preserve the health of the business over the long term. I can't think of a more Foolish thing to do. Bravo, Mr. Hastings.

Fool contributor Tim Beyers is keeping his DVD-plus-streaming plan, thank you very much. He's also a member of the Motley Fool Rule Breakers stock-picking team and owned shares of Apple at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.

The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Netflix, Amazon.com, and Apple. They have also recommended creating a bull call spread position in Apple and buying puts in Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 13, 2011, at 1:51 PM, siggie71 wrote:

    If you use and enjoy Netflix, and you give it up to save ~$6.00 per month, you'll be sorry.

  • Report this Comment On July 13, 2011, at 2:41 PM, TheeMadCatte wrote:

    It's not about them charging $6 more. It's about how they did it.

    - killed the competition and then changed the pricing model

    - tried to sell this new price hike as somehow being a better value

    - disabled comments on their blog for the first hour and deleted posted from that and FB

    The truth might be that content providers are raising their fees considerably, as I've heard. Why not raise and say that they have to do this in order to keep going rather than treating us all like idiots? Maybe it makes great financial sense to do this, but it is a real problem the way they went about it.

  • Report this Comment On July 13, 2011, at 4:13 PM, richleaves wrote:

    Well your actually going to pay 7.99 +7.99+2.00 for blue ray for a total of 17.98.

    I'd rather pay 11.99 from blockbuster and get movies 28 days earlier and rent games as well as 5 in store exchanges as well as free blueray. But thats just me, if Netflix had releases 28 days earlier and free blueray, I would go with Netflix.

  • Report this Comment On July 13, 2011, at 4:41 PM, TMFMileHigh wrote:

    @richleaves,

    >>Well your actually going to pay 7.99 +7.99+2.00 for blue ray for a total of 17.98.

    You're right and wrong. While those are the a la carte prices, the combined plan -- DVD + streaming -- is discounted to $16. We won't be adding Blu-Ray since we don't have a compatible player. (I know, I know.)

    Thanks for the comment and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On July 13, 2011, at 9:45 PM, TheeMadCatte wrote:

    This is not the first time that I've seen/heard this comment. Could someone please explain to me how $16 can be considered "discounted"? 8+8=16 last I checked...

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