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What's Behind Netflix's Price Increases

By Motley Fool Staff - Updated Oct 22, 2017 at 2:48AM

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A few dollars doesn’t seem like much, but it’s going to make a nice difference for Netflix’s top and bottom lines.

Netflix (NFLX 1.56%) announced plans to raise prices for most of its services, and the market is reacting fantastically to the news. In this Industry Focus clip, we explain exactly what Netflix is changing, how long it'll take to roll the changes out, what the $1 to $3 changes are likely to mean for the company's bottom line, how customers are reacting -- or not reacting -- to the increases, and more.

A full transcript follows the video.

This video was recorded on Oct. 13, 2017.

Dylan Lewis: Why don't we first start talking about what's going on with the price hikes? Like I said, the market was very happy to see this news. And for them, it's a really easy lever to pull to boost revenue, so I think that's probably why we saw this positive reaction. Why don't we run through what people will be expecting with their next couple of billing cycles?

Danny Vena: I think Netflix has already rolled out, on their website, the new prices. So, for new customers, those prices are already going to start immediately. For existing customers, for those that have the lowest plan, $7.99 for one stream, that will not change. The most popular plan, which is the concurrent two-streams plan with the HD option, that's the most popular one. That will be going from $9.99 to $10.99, so up $1. And the higher-option plan, the one that has HD, ultra HD, four concurrent streams, the price of that plan will be going from $11.99 to $13.99.

Lewis: So we're seeing an increase for most subscribers of either $1 or $2 a month. For folks who are already using the service, I believe this is something that might start hitting existing subscribers mid- to late October, but they'll really be rolling out the increases over the next couple of months, and I think they're going to be giving all their customers about 30 days' notice ahead of being hit with anything on the billing side, right?

Vena: That's my understanding. They're supposed to roll out, the notifications should go out to customers sometime in the next week or two, and then it will give them 30 days from their next billing cycle to make a decision. Frankly, for $1, I don't think many people are going to care.

Lewis: And I think that's kind of what the company is banking on. You look at what they're offering people -- the fact that it's the primary media consumption location for a lot of people, and only paying $11 or $13 a month, it doesn't really seem like that much, given how many hours people spend streaming content on the service.

Vena: Exactly. If you look at your average cable bill, the lower ones run $70 a month; the higher ones can run over $100. There's definitely a lot of benefit to a $10.99-$13.99 plan.

Lewis: So this doesn't seem like the kind of thing that will really meaningfully irritate consumers. You might lose a couple of people here and there. But it seems like something that investors are really cheering, and I think the reason for that is, you look at the company's average revenue per user over the last couple of years, and that has steadily climbed both in the domestic market and the international streaming market. You go back to Q2 of 2017, their most recently reported quarter was $10 ARPU in the U.S., just under $8 internationally, and those numbers are based on paid subscribers, not total subscribers. It seems like kind of a false number if you base it off folks who are also enjoying the free trial. You go back a year prior, it was $8.80 in the United States and $7.46 internationally. So they're showing nice growth there.

Then, think about the fact that the average prices that most of these people are going to be paying is probably going up at least $1-$2. That's probably going to steadily climb in the coming quarters and over the course of the next year.

Vena: I think that's true. Trying to get an idea of how that's going to affect their top and bottom line, we got a little help from RBC Capital's Mark Mahaney. He estimates that this increase will create incremental revenue of about $650 million for fiscal 2018, and an additional contribution margin of about $274 million.

Lewis: And I put together some numbers myself before the show, just ballparking what this might look like. If you take their most recent quarter and say we're going to assume average revenue per user goes up by $1 domestically, that's going to be an extra $600 million, roughly, that they're going to be pulling in, which is basically a 10% lift in revenue without any user growth.

So think about the levers that they have here, for them to increase their revenue. It's either going to become something where they add more people to their services, more end users on those services, or they're charging people more for using the services. Unless we see some crazy exodus because they're charging $1 or $2 more, I think this pricing move is a great move. And also it might show that there's room even higher for them to continue to expand prices in the future.

Vena: I'm a Netflix customer, and for full disclosure I should say that I'm a Netflix bull. I bought my first Netflix stock back in 2007 and have ridden it the entire way without selling. So, staunch believer in the model that they use. It represents about 15% of my portfolio right now, having grown there.

Lewis: A lot of people would kill to have that cost basis, Danny. [laughs]

Vena: [laughs] You know, it's one of those, every investor makes one really good decision. The old saying goes, even a blind squirrel will occasionally find a nut. This is mine.

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