Grandpa May Be Netflix's Secret to Growth

Netflix's May rate hike may have helped more than it hurt in terms of user growth.

Jul 22, 2014 at 6:04PM

The market wasn't exactly impressed with Netflix's (NASDAQ:NFLX) report, judging by the stock moving lower Tuesday. However, one area where the leading premium video streaming service rocked was in its ability to grow its subscriber base. 

Netflix closed out the second quarter with 50.05 million streaming accounts worldwide, 1.69 million more than it had three months earlier. This may not seem like a big number in light of the net additions of 4 million and 4.07 million that it had scored in its two most recent quarters, but 1.69 million is a pretty good number in light of the seasonality of the business. Netflix only tacked on 1.24 million net additions during last year's second quarter, and its forecast back in late April was only calling for a gain of 1.46 million additional members for the period.

Some pros were concerned that growing its user base by 1.46 million through the three months ending in June would be a challenge. JPMorgan's Doug Anmuth warned Monday, ahead of the report, that U.S. subscriber additions could come in soft since it was pitted against the hype of the Arrested Development revival and the introduction of Orange Is the New Black last year. He was right about stateside subscriber growth decelerating from last year's level, but Netflix's 0.57 million in domestic net additions for the quarter was a better metric than the 0.522 million that he was forecasting.

Perhaps the most impressive aspect of the 1.69 million net additions during the quarter -- and the 3.69 million that it's projecting for the current quarter -- is that this follows May's move to boost its monthly rate by $1 to $8.99. This was only kicking in for new subscribers, and that could've resulted in potential new members slamming on the brakes. What kind of person would realize in May or June that he or she wanted to join Netflix, knowing that everyone else that came in before were only paying $7.99 a month? Clearly a lot of people didn't flinch at the prospect of just missing the cutoff. 

However, there's another part of the net additions math. It's not just about gross additions. We also have to subtract the folks who cancel the service. Netflix doesn't provide us with gross additions. It's been a couple of years since it stopped providing its churn rate. Canceling Netflix is easy -- too easy -- and that is perhaps why it stopped furnishing investors with member turnover ratios. This leaves us with having to guess if defections are on the rise or if lower cancellations helped pad the quarter's net additions.

Why would cancellations be lower than historical averages? Well, May's price hike didn't just make it more expensive to sign up. Netflix's decision to grandfather in existing members at $7.99 a month for up to two years likely played a major role in keeping members around. Netflix is beefing up its digital vault and increasing the frequency of fresh original content. Why cancel if it means paying $8.99 a month or two later?

"There was minimal impact on membership growth from this price change," reads Netflix's shareholder letter. This suggests that the new price wasn't a deterrent, but did grandfathering in the more than 48 million members it had at the time of the increase keep more people than usual from calling it quits? We may never know, or at the very least have to wait two years for everybody to be paying $8.99 a month to get a better read on the situation.

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Rick Munarriz owns shares of Netflix. The Motley Fool recommends and owns shares of 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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