Should Netflix, Inc. Charge $8.99 or $9.99 a Month?

Netflix hit new highs last week, but keeping the good times going may be a challenge.

Jan 27, 2014 at 4:05PM

Last week was a great one for Netflix (NASDAQ:NFLX) shareholders. The leading video service bucked the market's decline, soaring 17% on the week after posting blowout quarterly results. However, perhaps the biggest reason for the pop in price came from suggesting that it will eventually increase the monthly rate for its stateside subscribers, a move that it pulled off earlier this month in Ireland. 

This is a pretty big deal. Netflix now has more than 44 million subscribers, a figure that should top 48 million by the end of March. Even a modest uptick from the current $7.99 a month could lead to dramatic bottom-line results. After all, Netflix prefers to structure its content licensing deals based on established payments. If Netflix is able to grow its subscriber base or milk more revenue out of its users, the incremental revenue flows mostly down to pre-tax profitability.

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Until April of last year, the market was worried that Netflix's average revenue per user would be gradually working its way down to $7.99 a month as more of its DVD-based customers paying more than that downgrade their plans or move on as optical discs fade in popularity. However, in April Netflix rolled out a plan through which a family could stream four devices at the same time for $11.99 a month, double the rate allowed on the standard $7.99-a-month plan.

"That's met our expectations in terms of the family take rate," CEO Reed Hastings disclosed during last week's earnings call.

However, it's not just the wider plan that's leading investors to get excited about Netflix's revenue-generating prospects. It revealed in its letter to shareholders that it's testing pricing to eventually arrive at three tiers. It also went on to explain that existing members will be grandfathered into the old rate on generous terms, a move that implies that the new rates will be higher.

The question now becomes how high Netflix can go before the increase is wiped out by subscriber defections. Netflix has never tested its pricing elasticity, and it remains to be seen if Netflix is too cheap at its current rate. There's no point in going cheaper. Amazon.com is Netflix's closest rival when it comes to streaming smorgabords, and it makes its catalog available at no additional cost to anyone paying $79 a year for Amazon Prime. That's cheaper than Netflix, but it hasn't been enough to slow the leading platform down. After all, in a few months Netflix will likely cross 50 million global subscribers.

However, this doesn't mean that Netflix can spring a double-digit price on its user base. As valuable and addictive as Netflix might be, it would be hard to justify at $12, $15, or $20 a month. It would work for most guests, but too many would simply cancel the service every few months after binge-viewing the content that they wanted. The beauty of $7.99 a month is that it's a rounding error in most family budgets. There's no point in cancelling Netflix for February because the Winter Olympics are coming. This is why Netflix will likely want to keep the increase in the single digits for the basic plan. It could probably charge $9.99 a month and stick with it there for a few years. It can also go for the more modest increase to $8.99 a month, setting the stage for more periodic dollar increases. What do you think? Share your pricing thoughts in the comments box below.

It won't happen overnight. Netflix argued last week that it's in no hurry to roll out new pricing, but now that the cat is out of the bag, let's hope it doesn't sit on the increase for too much longer. With the stock hitting a new all-time high last week, patience isn't going to be Mr. Market's best virtue in assessing what Netflix is worth.

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Longtime Fool contributor Rick Munarriz owns shares of Netflix. The Motley Fool recommends and owns shares of Amazon.com and 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.

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