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Netflix Still Has Room to Raise Prices, but It Won't Happen This Year

By Adam Levy - Feb 26, 2020 at 11:30AM

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Netflix would be smart to see how the competition performs first.

Netflix (NFLX 1.56%) is facing a lot of new competition, all at varying price points. From the free (ad-supported) Peacock by Comcast's (CMCSA -0.02%) NBCUniversal to the premium-priced HBO Max by AT&T's (T 0.94%) WarnerMedia, there'll be a streaming service that fits into any budget. 

So, where does Netflix fall in that spectrum, in terms of value from free to ultra-premium? Starting at just $9 per month, Netflix is still exceptionally affordable. Especially when you compare it against the forthcoming HBO Max and its $15 per month price point. 

When asked, consumers seem willing to pay prices closer to HBO Max than to Peacock. A survey from Piper Sandler analyst Michael Olson found that the average Netflix subscriber was willing to absorb a price hike of $2.40 per month. Netflix's last price hike was an average of nearly $2 per month and produced a noticeable impact on subscribers. But the two new competitors could inform Netflix's next price hike to help it make a better decision.

Exterior of Netflix offices in LA

Image source: Netflix.

Wait and see how the competition fares

Even if the average consumer says they'll accept another price hike from Netflix, it's smart for Netflix to wait and see how consumers respond to both HBO Max and Peacock as they enter the market over the next few months.

WarnerMedia expects HBO Max to attract an additional 16 million domestic subscribers on top of existing HBO subscribers over the next five years. That would bring its total to 50 million, getting closer to Netflix's 61 million U.S. subscribers.

HBO will also launch HBO Max internationally at a comparable price point to the U.S., and it expects the service to attract an additional 25 million to 40 million subscribers. While the HBO brand is well known internationally, consumers typically pay far less than in the U.S. as HBO usually licenses its brand and content.

Ironically, if HBO Max succeeds at its $15 per month price point, it may be a good thing for Netflix. It indicates strong demand for premium content and a strong willingness to pay for it. That's the green light for Netflix to raise prices.

On the other side of the coin, Comcast is launching Peacock with the intention of driving revenue through ad sales. Management commentary at its investor day earlier this year suggested it would be willing to provide Peacock for free to other pay-TV distributors and their customers in order to reach a broader audience. By comparison, WarnerMedia seems intent on raising its wholesale price for HBO with the introduction of HBO Max.

Ad revenue is a function of streaming hours, so if ad sales for Peacock are better than expected over the first few quarters, it may indicate consumers aren't willing to increase their budgets for paid streaming services. That said, there could still be room for Netflix to increase prices, just not as much as Olson's survey might suggest.

Expect another price hike in 2021

Olson expects Netflix to raise its pricing sometime in the next 12 to 24 months. That'll give Netflix enough time to digest the results from the competition and determine how much of a price hike its subscribers will absorb. 

After the last round of price increases, management noted, "There's a little more [price] sensitivity" compared to previous rate hikes, and it experienced elevated levels of churn. Nonetheless, investors should expect Netflix to raise prices in certain markets such as the U.S. and Canada again in the near future. With subscriber growth slowing considerably, the net impact of a price increase on the company's top line should be greater than if it kept pricing stable.

Olson estimates that if Netflix increased average revenue per user in the UCAN region by the $2.40 his survey suggests, it would add over $1 in earnings per share in 2021. Even with a 10% churn rate for subscribers (Olson's estimate), it could produce a top-line growth rate near between 15% and 20% in the region (my estimate) even as gross additions continue to slow. Those estimates could even be conservative, as churn wasn't nearly as bad when Netflix last increased prices by a similar percentage. If Netflix keeps pricing stable, it should produce UCAN revenue growth in the low to mid single-digits.

Moreover, the impact on Netflix's free cash flow could be even more significant. The company is finally moving back toward neutral cash flow after years of burning increasing amounts of cash to fuel its expanding slate of originals to appeal to its global subscriber base. The biggest input in the cash-flow equation is how much cash is coming in through the top of the funnel -- i.e., revenue. 

Raising prices in developed markets is the most effective way for Netflix to grow revenue over the next few years. Investors should keep a close eye on the results of the video streaming competition to inform how big of a price increase Netflix will make in 2021.

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