Please ensure Javascript is enabled for purposes of website accessibility
Free Article Join Over 1 Million Premium Members And Get More In-Depth Stock Guidance and Research

Why Netflix Isn't About to Raise Prices

By Anders Bylund - Mar 11, 2014 at 4:00PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Netflix is allegedly about to raise prices, "as content creation, distribution, and licensing costs increase." Here's what's wrong with that argument.

Relax. It's Netflix.

Fellow Fool David Eller recently penned an article on Netflix ( NFLX -2.33% ) and its rising costs, which will force the company to raise prices for its customers.

David's story was well-received and made it into USA Today . Unfortunately, it could also use some debunking.

Plan tiering
David rightly noted that Netflix is considering a change to its pricing plans. This much is incontrovertibly true. In the fourth-quarter letter to shareholders, Netflix talked about generous grandfathering of current pricing plans in case it decides to change anything.

But David may have missed a couple of details in that letter:

  • "We are in no rush to implement such new member plans and are still researching the best way to proceed."

  • "Eventually, we hope to be able to offer new members a selection of three simple options to fit everyone's taste."

In other words, Netflix isn't in a hurry to launch new pricing plans -- and even if it does, we won't get a bewildering array of choices. Moreover, it isn't clear at all that Netflix even thought about raising the price for today's basic all-you-can-stream plan.

The direct connection deal with Comcast ( CMCSA 0.54% ) kept coming up as a driver of price increases, because David believes that Comcast is fleecing the video service with incredibly high costs.

First, that idea doesn't pass the smell test. Netflix is cutting out middleman Cogent ( CCOI -1.49% ) from its content flow to Comcast subscribers. In doing so, it ensures a higher-quality connection that Cogent couldn't deliver.

The higher-quality link would be enough to justify higher costs here -- but slapping away Cogent's hand from collecting its profit margins is likely to keep Netflix's total service bill stable at worst. See a fuller discussion of this topic in an earlier story on this very topic.

Moreover, Netflix would be silly to accept a higher bill in the first place. Comcast doesn't hold all the cards here. Netflix could also choose to route its Comcast traffic via third-party content delivery services like Akamai Technologies ( AKAM 0.17% ), which already have high-quality connections to every major network out there.

Netflix is weaning itself off Akamai and friends in order to save some money and have more control over the data flow, but it's always a last-ditch option if some ISP plays hardball at the negotiating table.

And if you're still not convinced, Netflix CFO David Wells is on the record as saying that the Comcast deal doesn't change his margin guidance for 2014.

Long story short, Comcast is most certainly not charging Netflix an arm and a leg for this higher-quality connection.

Why so desperate?
Finally, David offered this chilling nugget: "What we do know is that Netflix has its back to the wall as half of its $3 billion in content liabilities are coming due in the next 12 months, so it will do anything it can to reduce or stabilize costs."

In other words, content costs are skyrocketing so Netflix must cut corners wherever possible just to stay afloat.

Except that scary $3 billion liability is simply an estimate of the upcoming year's operating costs.

At the end of 2012, Netflix had $2.2 billion in content costs coming due within 12 months. The company ended up spending $1.8 billion on domestic "cost of revenues," and another $800,000 in international costs. This metric lumps content costs together with video delivery expenses, payment processing fees, and customer service operations. I think it's fair to say that the $2.2 billion content cost estimate ended up in the right ballpark.

Data taken from three years of Netflix SEC filings.

So content costs are soaring 36% higher in 2014. The company doesn't offer full-year guidance this early, but forecasts for the first quarter came up with a 24% year-over-year sales boost domestically and an 88% international surge.

Think it's unreasonable to assume that these skyrocketing revenues will cover Netflix's increased content costs? I don't.

The battle of the big takeaways
David's big takeaway is that Netflix is sure to raise prices -- and soon.

That conclusion seems based on several problematic assumptions, as discussed above. On top of that, the alarm fades away when you consider that the $8 monthly bill hasn't increased since 2011. Has your cable company ever gone three years without a price hike?

And a recent price hike in Ireland came with a two-year grandfathering option. Two years. The extra euro per month may or may not affect Netflix's Irish growth, but I'd be shocked if Irish subscribers panicked over a price change 24 months away. Netflix is likely to adopt a similar approach to whatever changes might happen stateside.

Long story short, Netflix is not "about to raise prices." It may give subscribers some new plan choices, but even that isn't necessarily just around the corner. And there's no crushing liability load waiting to smash the balance sheet into smithereens.

My big takeaway? We Netflix investors (and customers) shouldn't worry. The company is doing just fine.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Netflix, Inc. Stock Quote
Netflix, Inc.
$602.13 (-2.33%) $-14.34
Comcast Corporation Stock Quote
Comcast Corporation
$51.78 (0.54%) $0.28
Akamai Technologies, Inc. Stock Quote
Akamai Technologies, Inc.
$111.14 (0.17%) $0.19
Cogent Communications Holdings, Inc. Stock Quote
Cogent Communications Holdings, Inc.
$74.22 (-1.49%) $-1.12

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/06/2021.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Our Most Popular Articles

Premium Investing Services

Invest better with the Motley Fool. Get stock recommendations, portfolio guidance, and more from the Motley Fool's premium services.