What if Netflix Hadn't Raised Its Rates?

Today is a bittersweet anniversary for Netflix (Nasdaq: NFLX  ) shareholders.

It was a year ago today that the company announced plans to begin charging customers on its unlimited DVD plans for its streaming service. It shaved $2 a month off its DVD plans, but the media rallied around the $7.99 a month that they would have to start paying if they wanted to continue to receive the growing catalog of streaming titles.

The most extreme case -- customers who were previously paying $9.99 a month for unlimited DVDs with one disc out at a time -- would now be paying $15.98 if they wanted to continue to receive both optical discs and streams. It was this 60% increase that became a rallying cry for consumers, leading to the unrest that dealt the company back-to-back quarters of net declines in domestic subscribers.

Investors, on the other hand, loved the news initially. A 60% rate hike? Sweet! It was a day after the announcement that Netflix shares hit its all-time peak of $304.79.

We know who got the last laugh. The stock was trading 73% lower as of yesterday's close.

Unhappy anniversary
Is Netflix a fourth of the company that it used to be? Its market cap may suggest that, but its metrics tell a different story.

After all, Netflix had 25.6 million subscribers at the end of June last year -- just two weeks before the decision that turned Fortune's Businessperson of the Year in 2010 into a popular pick on many worst CEO of 2011 lists. There were nearly 29 million subscribers as of the end of this year's first quarter.

Average revenue per user is declining -- probably stumping the once-bullish analysts that figured the rate increase would boost revenue per subscriber -- but that's the nature of many Netflix customers choosing streaming at $7.99 a month and either canceling their DVD plans or trading down to a cheaper plan with fewer mailed discs.

A metric that isn't going the company's way is profitability.

When Netflix reports its second-quarter results in two weeks, analysts see revenue climbing 13% as the byproduct of greater subscriber growth held back by lower revenue per member. However, analysts expect the company to be barely profitable this time, entirely the result of steep losses from its fledgling international services.

Still, is Netflix really a sliver of the company that it was a year ago?

The untold story
We will obviously never know how things would've played out if last summer's rate hike -- and the short-lived Qwikster fiasco that followed -- had never taken place.

However, even before the announcement, there were signs that business was slowing. Both its domestic and international subscriber growth during the second quarter was its slowest in nearly a year.

It's easy to see Coinstar's (Nasdaq: CSTR  ) Redbox growing its business and even successfully implementing a 20% rate hike last October. Meanwhile we have Netflix shedding disc-based subscribers in each of the past few quarters. If Netflix hadn't made subscribers choose between the two plans -- or perhaps even offered a discount for buying into both offerings -- maybe it wouldn't have lost as many of its high-margin DVD customers.

However, Redbox is the exception to the rule here. DISH Network (Nasdaq: DISH  ) continues to close Blockbuster stores. NCR (NYSE: NCR  ) cashed out of the DVD kiosk business. Studios are suffering from sluggish DVD sales.

The streaming revolution is a slow roller
Netflix was right about streaming being the future, but just as Redbox is the exception to the DVD rule, it seems as if Netflix is the exception to the streaming market.

Plenty of big names are jumping into the market that Netflix has been cultivating since 2007. Cable providers, wireless carriers, and dot-com legends either have streaming video services on the market or are about to launch them. Even DVD rental standout Redbox -- in cahoots with Verizon (NYSE: VZ  ) -- is planning to introduce a digital video service later this year.

No one can match Netflix and the catalog that it's been able to amass because it was early and recently vocal about making streaming its top priority.

Making streaming a premium product was the right decision. Studios no longer have to feel that they're handing licensing rights to a company that is belittling the product as a door prize freebie to DVD renters. It's not a coincidence that Netflix has been able to nab some juicy original programming since making the split.

Netflix's strategy is resonating with customers, as all but 2 million of its premium members are on the streaming plan.

Maybe the company was unfashionably early, but you can't be a disruptor -- even when you're disrupting yourself -- if you err on the side of being fashionably late.  

Stream on
Motley Fool co-founder David Gardner has been a fan of Netflix as a disruptor for nearly a decade, but there are other technology up-and-comers. Learn more in a free report that you can check out right now.

The Motley Fool owns shares of Netflix. Motley Fool newsletter services have recommended buying shares of Netflix and Coinstar. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz has been a Netflix subscriber and shareholder since 2002. He does not own shares in any of the other stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.


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  • Report this Comment On July 12, 2012, at 6:35 PM, jrusselll wrote:

    "If Netflix hadn't made subscribers choose between the two plans -- or perhaps even offered a discount for buying into both offerings -- maybe it wouldn't have lost as many of its high-margin DVD customers."

    they weren't high margin customers when they were only paying $10 for streaming and DVD.

  • Report this Comment On July 13, 2012, at 6:08 AM, JakeFromDenmark wrote:

    What I still don´t understand is this: How a man as brilliant as Reed Hastings couldn´t see the dissatisfaction coming when raising the prices 60% for some. Or maybe he just didn´t care.

    I wish, as a share holder, that they had done the price change incrementally at least for existing subscribers. $8 for each service and $12 for both then later raising prices again. A price increase that small wouldn´t have created much of a splash.

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