Lower Price Points

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By AceInMySleeve
November 22, 2005

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Netflix is testing lower price points. This decision would be, in my opinion, one of the most significant decisions in their history. While it is superficially nothing more complicated then slashing 2$ off their plan prices, the impact on various business dynamics would be tremendous.

What Netflix has said, which is quite curious, is that they will only make the move if they can maintain the 50M-60M$ profit guidance for 2006. But a price cut is a move that hurts the short-term in favor of the long-term. That is, it is a growth-inducing decision. Profit per sub declines, but the total number of subs increases, and there is a theoretical crossover point in the future where the decision becomes accretive. However, a 2$ price cut next year immediately cuts out 120M$ in revenue (and potential profit) off the model. That the crossover could occur within 12 months with this large a number is flat out amazing to me.

I think if they implement this plan the stock will be treated harshly on Wall Street. The risk associated with the profit estimate will skyrocket, and it will be easy to paint it negatively.

If I was more of a trader, or I had better insight into the probability of this move I might exit my position right now. However, I WOULD MOST DEFINATELY RE-ENTER AFTER THE DROP. I am quite certain that it is a good move in the long term. Reasons:

1) Most importantly, I have grown to have great faith in Netflix management to carefully measure and model their decisions prior to making them. Frankly, I trust them now (and this took a long time for me.)

2) One can basically reduce the chances of an Amazon entry to nil. The risk/reward equation for them is more or less blown out of the water.

3) Video Stores will feel the pain and rapidly. If Blockbuster and Movie Gallery get hit with another -10% in-store rental year it's game over.

4) The appeal of online subscription compared to VOD and piracy is further improved.

5) A larger subscriber base gives Netflix more power to become HBO-like with content acquisition and production.

6) A larger subscriber base is more valuable for acquiring companies who might be more interested in finding new ways to monetize the subscriber relationships themselves rather then the profits thrown off from the actual online rental model.

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