Netflix's Price War - Strategy and Tactics
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By SteppenWulf
July 24, 2007

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I think Netflix dropping the price on its plans is a smart idea. Netflix should have dropped the price a while ago, once it saw that Total Access was starting to get traction - I posted back in December that it was in a war to the death with Blockbuster and Netflix needed to act like it. Unfortunately Netflix had to see subscriber contraction before it started really fighting.

Dropping the price now makes sense from both a strategic and a tactical sense.

Strategically, Netflix has come up with a plan to dominate digital video rental with WatchNow. This plan involves converting (over time) its current subscribers to digital video users, to create the largest mass of digital video users. In order to work, Netflix needs to have the largest set of subscribers that it will convert. The value of every subscriber right now is greater than a discounted cash flow analysis would suggest - because of the strategic value of owning the digital rental space.

Tactically, this is the time to kick Blockbuster, when it has huge debt. Blockbuster is closing stores, which will slowly improve its cash flow, but every store closing incurs one time costs. A price war now hurts Blockbuster the most. Either Blockbuster will follow suit, reducing its prices and cash flow even as it pays for existing stores, pays for closing stores, and pays interest on its debt, putting it in danger of a cash flow crisis. Or Blockbuster will not follow suit, meaning that its subscriber growth slows, churn increases, while Netflix subscriber growth jumps.

Blockbuster has been playing the price war cleverly so far, decreasing the price of its online only product, from which it gets very little revenue. This puts the pressure on Netflix's online only product, and also lets Blockbuster differentiate and get more money for its Total Access hybrid product.

I think this is one of the reasons that Blockbuster's stock increased on a price war, while Netflix's stock decreased - Blockbusters first move was smart, hurting Netflix while limiting damage to itself. The other reason is different expectations built into the stock price (Netflix stockholders are looking to win, Blockbuster stockholders are looking to survive and turn around).

I wish Netflix had gone even further, and dropped the price more. If Blockbuster feels pressured to lower its Total Access product, they are in a bind. This is exactly a Walmart like strategy, and Netflix putting Blockbuster into a crisis would be a great long term way of building value in Netflix.

I am glad they have finally started this war, which seemed to be obviously necessary since Blockbuster created TotalAccess.

I will be looking forward to some good buying opportunities in the next week or so.

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