After announcing earnings that were largely in-line, Netflix (NFLX -8.54%) announced a small price increase intended to offset the rising cost of content acquisition and creation. Is the subscription increase enough to keep the share price moving upward? Amazon.com (AMZN -2.21%) and Google (GOOG -1.03%) are aggressively pursuing Netflix's customer base, and they can draw resources from multiple lines of business. What does this mean for you as an investor and as a subscriber?
The price increase will have a small impact on subscribers
Netflix learned from its past experience in trying to raise prices. The last time Netflix raised prices, it also tried to separate its DVD rental plan from its streaming plan. Customers faced a dramatic increase in prices of as much as 60%, as those who wanted to continue to receive DVDs would now be paying for two services instead of one. Cancellations skyrocketed, unsurprisingly. This time, the company is taking a much more gradual approach, initially raising prices by only $1-$2 and only on new customers.
A small hit to subscribers means a huge benefit to the company
Over the past year, Netflix added 11.8 million total streaming subscribers. If you estimate that the subs were paying for an average of six months of service in the first year and that they each would have paid an additional $1.50, the increase would amount to $99 million in revenue for Netflix. However, this doubles to $198 million when customers are paying the higher rate for a full year in the second year.
Netflix needs the capital to compete
Netflix is taking a big chance by developing its own content, but it needs to differentiate itself from Amazon.com and Google's YouTube. Today, each of these competitors offers a quick and easy video rental service that flows through to the content creators, but they have gone beyond the flow-through model by beginning to produce their own content.
In 2011, Google began funding ventures intended to feed an over-the-top programming service. It reportedly funded ventures from big-name talent like Tom Hanks and Amy Poehler, and got Madonna and Jay-Z to curate content on YouTube channels. Google retains the rights to insert advertising into the content for a specific period of time in deals that are reportedly much less onerous than those offered by traditional television stations.
Amazon is following suit with its own production of content, and it recently green-lighted six additional shows. One of those, Alpha House, is up for its second season, which indicates that Amazon hit its mark with an internal success and it likely has a model to replicate now.
The high cost of premium content offsets the benefit
House of Cards is estimated to have cost Netflix as much as $100 million for the first two seasons and a portion of the $400 million debt it recently took on is likely funding the third. The debt offering funded the development of the series with room to spare, but this isn't a reasonable long-term method of funding the growth of a content library. We don't know exactly how much season three will cost, but based on the widely discussed estimate of $100 million for two seasons, season three will likely cost between $65 million and $100 million. Why the increase? Now that the company is locked into a course of action, the price for premium talent will likely go up as well.
Prices will rise across the board but appreciate the benefits
If there is $100 million coming in from price increases and possibly $100 million going out for the development of new content, this may seem like a wash. However, the company can't maintain a price difference between new and old customers, so it is likely that existing customer prices will increase as well.
Investors will celebrate the price increase and subscribers should bear the small increase with a smile. Investors now have an explanation for how Netflix plans to pay for the coming increases in content creation costs and subscribers can still watch a month of content for less than the price of a premium ticket to the movies.
