What Does Netflix's New Pricing Test Mean?

Streaming video leader Netflix (NASDAQ: NFLX  ) recently began testing a new pricing scheme for visitors to its website. One of the highlights is a plan that allows users to stream Netflix content on only one device at a time for $6.99 per month. (By contrast, the standard $7.99 plan allows streaming on two devices simultaneously.)

Is Netflix worried about competition from Prime Instant Video?

Netflix's new pricing scheme may be no more than a test that will never be widely implemented. However, it could also be a sign that the company is worried about Amazon (NASDAQ: AMZN  ) Prime as a competitor. While Amazon's video content library is not quite as good as Netflix's, it has been improving rapidly -- and Prime is cheaper than its rival.

Branching out
Until 2013, Netflix's streaming service was a "one-size-fits-all" offering. For $7.99 per month, users received unlimited access to Netflix's content, with the ability to watch up to two content offerings at once with a single account (a feature designed to appeal to families).

However, Netflix found that a few customers -- particularly families with diverse tastes and plenty of Internet bandwidth -- wanted to watch more than two streams simultaneously. In April, Netflix announced that it would create a plan allowing those customers to stream up to four video offerings at once for $11.99 per month. My Foolish colleague Tim Beyers has been one of the Netflix subscribers to take advantage of this upgrade offer.

The recently announced pricing scheme builds further on this differentiation. In addition to the two-stream and four-stream plans, Netflix is now offering some new U.S. customers one-stream and three-stream plans for $6.99 and $9.99, respectively.

The Amazon Prime "threat"
The most obvious rationale for Netflix adding a lower price tier would be a desire to remain competitive with Amazon's Prime service. Prime's regular price is $79 per year, which works out to less than $7 per month. That includes free two-day shipping on most Amazon items, as well as a large streaming video library and other perks.

So far, Amazon Prime has not been much of an impediment to growth at Netflix, which added 6 million streaming subscribers in the U.S. during the 12 months ending in September.

That said, Netflix has about 33 million domestic users and its potential market is finite, though large -- there were about 88 million U.S. households with broadband connections as of June. Meanwhile, Amazon Prime seems to be growing by leaps and bounds. Amazon boasted about adding "millions" of Prime members in the third quarter, and adding more than 1 million new members in the third week of December alone. (Both of these figures include international markets.)

While some people subscribe to both Netflix and Amazon Prime, others are choosing between the two services. As a result, it makes sense for Netflix to grab as much market share as it can before the streaming market nears saturation. Getting a little closer to Amazon on pricing with a "value offering" at $6.99 could help Netflix win some incremental subscribers.

Forget about price increases
If there's one thing this pricing test shows, it's that Netflix subscribers probably don't need to worry about facing a rate increase anytime soon. Netflix is still in growth mode, and as long as that remains the case, the company will not have much of an appetite for price increases.

With Amazon offering Prime subscriptions for $79 per year, it would be unwise for Netflix to push the envelope on pricing. Indeed, if this new Netflix pricing scheme is rolled out more broadly, it will allow people who never need two simultaneous streams to get an even lower monthly price.

Even with some people taking the lower-price plan, Netflix should be able to grow earnings at an impressive rate over the next several years. However, earnings growth is still unlikely to meet the expectations of the most ardent bulls, who are counting on an eventual price increase to turbocharge Netflix's earnings.

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Read/Post Comments (7) | Recommend This Article (3)

Comments from our Foolish Readers

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  • Report this Comment On January 02, 2014, at 6:45 PM, The1MAGE wrote:

    I don't think this has anything to do with Amazon Prime.

    This has to do with how many people are bootlegging their service. Limiting to one device means the person will not be able to share the service.

    The more expensive one, that has been out, was to add an option that charges to practically allow sharing the service, though I doubt they will officially say this.

    If they can get the bootleggers to pay for the service, in some way, shape, or form, their profits will skyrocket.

  • Report this Comment On January 02, 2014, at 6:52 PM, The1MAGE wrote:

    Quick typing, sorry. I meant the $11.99 plan they had announced previously when I was talking about the "more expensive one, that had been out..."

  • Report this Comment On January 03, 2014, at 1:15 AM, dinopontino1 wrote:

    This was 100% driven by amazon competition. Also, they didn't have 33 million domestic users, it was ~29 million paid at the end of q3 so they're basically going to eat $29,000,000 a month to compete with amazon.

    I have both services, I've been using amazon for vod over redbox. Netflix is a great deal at $7/month but I don't think they'll make any money at that rate.

  • Report this Comment On January 03, 2014, at 3:20 AM, duuude1 wrote:

    My opinion is that this is *not* an Amazon-driven pricing strategy. For Netflix to compete effectively on price alone would require a much lower price - since the streaming in Prime is almost free - the value-add for the vast majority of Prime subs is in the free shipping. Sure the streaming helps, but is a minor benefit for Prime users. The evidence is in the network traffic:

    http://gigaom.com/2013/11/11/netflix-youtube-sandvine-traffi...

    Look at the first table - Amazon video accounts for 1/20th of Netflix's network traffic - and that is BOTH the paid VOD and the free Prime videos!!! So no, I don't think that Amazon is the reason for the pricing experiment.

    The basic strength of Netflix's existing pricing and value proposition for consumers is that they easily beat the network traffic from major FREE video providers - Youtube and BitTorrent.

    As for making money at $7/mo - they are clearly raking in the bucks hand over fist. When they are not expanding internationally, the earnings are easy. The reason is due to their growth - every new sub's $7/mo goes straight to the bottom line. Since Netflix has a great handle on their growth rate (they have been amazingly accurate on their growth predictions) they can also easily plan how much of each additional sub's free cash will go to pay for new content.

    And despite all this easy money flowing into Netflix, where is the competition? It's so easy, isn't it, to just throw up a website and load up a few cheesy 1980's videos and become Starzflix, right? So where the heck are the competition - it's been over a decade that Netflix has been around - and where are the barbarian hordes of competitors?

    http://gigaom.com/2013/12/27/rdios-would-be-netflix-killer-t...

    Oh gee, another competitor (by Skype founder, Janus Friis, not a tech lightweight) bites the dust.

    So I don't believe competition in general is the reason for Netflix's price experiment. I lean more to 1MAGE's thoughts that Netflix is scraping up the freeloaders off the sides of the system and maximizing the cash flowing in from as many users as possible.

    Duuude1

  • Report this Comment On January 03, 2014, at 8:04 AM, dinopontino1 wrote:

    Ha, u cited metrics that came out in November before alpha house and betas were launched and the December free trials. Those amazon usage numbers are only going to go up at the expense of netflix growth. Everyone I know is now a prime member but not all of them stream instant because they haven't put 2 and 2 together. And international growth where, didn't amazon already beat netflix to Japan and is rolling in Australia?

    I see instant's weakness in that it's not on chromecast and they're only advertising on Viacom channels (that I've seen). Better marketing would really help the cause.

    So netflix made a wise move by lowering their price to fend off the price threat. But most people I've asked plan to switch to the cheaper plan if given the chance which eats millions/month.

    I don't have blinders on, I know the bull argument but it's fun watching amazon and hulu give it a go.

  • Report this Comment On January 03, 2014, at 8:51 AM, duuude1 wrote:

    Hey dino duuude, you bring up a bunch of good points. Amazon's a great competitor in general, and I'm long both NFLX and AMZN.

    But what usually happens when you have a head-to-head competition between a Pro and a Joe? Someone who doesn't make money at a particular profession, who is perhaps a talented amateur, is just not going to do well against someone who lives and breathes and is paid well doing only one job, who has beat out all the others striving to also be a Pro, who's talented, driven, tough, and jacked to boot. Netflix is a Pro - they do nothing else but make their money streaming video content. Amazon is a very talented Joe - they do a bunch of different things and on the side they play around with streaming because it's fun.

    I'll bet you when the post-holiday network traffic reports come out, the results will be essentially the same. Why? Is the november traffic results because AMZN didn't have the right content? Or is it because their UI is clunky to use and the viewing experience is poor? If it is because of content, and if their new releases are good, then perhaps we'll see increased AMZN traffic at the expense of NFLX. But if it is because of other issues such as poor UI, then we should see a similar beat-down.

    The whole point of an experiment is to see how people in aggregate will behave given these choices - a cheaper single-user lower resolution stream versus a series of multiple-user higher resolution streams at higher prices. If the business case is not favorable, if they lose money because most people make the choice you suggest, then they will ditch the cheaper plan.

    I'm also enjoying watching the competition, mostly because it highlights how beautifully NFLX has positioned itself in most cases over the past few years. They've crushed other aspiring Pros (Blockbuster, Vudu, Hulu, Redbox...) and kept the Joes (Amazon) on the sidelines.

    The question is - will Amazon make a run at being a Pro and make streaming a standalone product. That would be real competition. That would make me nervous. But I would still bet on NFLX in the end.

    Duuude1

  • Report this Comment On January 03, 2014, at 5:23 PM, The1MAGE wrote:

    I have never seen Amazon's plan as being a competition for Netflix. Prime members spend more then the non members do, so they want more members. Adding in streaming videos, and free kindle books is simple marketing strategy to get more members. Then they get the extra sales, and movie rentals.

    The whole idea of competition in this case is quite faulty really. You buy cable for multiple channels, not just one. Many people have had both HBO and Showtime, plus Starz, and other pay movie channels, I don't get this idea that people can only have a single source of streaming.

    I don't choose a single restaurant, and then shun all others because "that is not the restaurant I eat at."

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