Why Netflix, Inc Raising Prices Is the Right Move

Netflix is experiencing higher costs as it grows internationally and builds out its original programming. Here's why a modest price increase is the right strategy.

Bob Ciura
Bob Ciura
Apr 28, 2014 at 11:00AM
Consumer Goods

Streaming movie, television, and DVD service Netflix (NASDAQ:NFLX) is growing like a weed. The company is quickly racking up subscribers both domestically and abroad, which has given it solid presence in the war for your living room. Netflix represents a major threat to existing cable providers like Comcast (NASDAQ:CMCSA). To be exact, Netflix added more than 4 million streaming subscribers in the most recent quarter, which represented a higher growth rate than the first quarter the previous year.

After its latest earnings announcement, though, Netflix caused a stir by revealing it would raise prices for new members in certain markets. Some might disagree with this strategy, the last time Netflix raised prices it caused a massive subscriber flight and an ensuing stock sell-off.

You'll recall that in 2011, Netflix planned a stiff price increase for its then-combo service of DVDs by mail and online streaming. At that time, Netflix announced it would increase its membership cost from $10 per month to $16 per month. This caused Netflix to lose approximately 800,000 subscribers over the next few quarters and the company's stock price collapsed by nearly 80%.

Even though the price increase may upset some, it won't have as big of an impact as last time. Here's why I think raising prices is the right move.

This time is different
'This time is different' are the four most dangerous words in the English language, but when applied to Netflix's pricing strategy, it's true. Netflix had little choice but to raise prices on new members. It's busily developing proprietary content in an attempt to lure new subscribers, based on the massive popularity of its shows like House of Cards. Moreover, existing members will be grandfathered in and allowed to stay at current pricing for what the company terms an 'extended time period'.

In addition, Netflix is only raising prices by $1 to $2 per month. That's a far cry from the 60% price increase the company experimented with three years ago. If anything, Netflix could increase prices even more. It's encountering significantly higher costs in its dual efforts to create original content and expand overseas.

Its most recent earnings report barely met expectations. Revenue matched consensus, with earnings per share coming in $0.03 better than estimates. In the current quarter, Netflix expects revenue of $1.14 billion, falling short of analyst estimates, which call for $1.31 billion.

It seems that most consumers flock to Netflix in a 'cord-cutting' move to save money. A typical monthly bill from a cable provider will be much higher than Netflix, even when incorporating Netflix's planned price increase. It's reasonable to assume most Netflix subscribers will stay with the service and accept paying an extra dollar or two, rather than go back to a cable subscription, and pay much higher prices for a great deal of content they don't want or need.

This is why Netflix is such a ground-breaking service, one that poses a huge threat to the cable industry. Netflix is a serious competitor to cable providers like Comcast(NASDAQ:CMCSA), which explains the recent deal struck between the two. Netflix and Comcast recently reached an agreement that gives Netflix a direct connection to Comcast. Going forward, Netflix will provide its services to Comcast's broadband network and pay Comcast for the privilege. This deal represents the first of its kind for Netflix.

Profitability matters
Netflix is doing well to add subscribers every quarter, but costs are increasing as the company gets more ambitious with original content and overseas expansion. As a result, it no longer made sense for Netflix to keep its prices at such low levels. Profitability is a concern for any company and Netflix is no exception.

Netflix is by no means repeating the same mistake it made in 2011, when it tried to pass through a sharp increase on members, and caused a mass exodus of subscribers. A very modest price increase will retain the vast majority of subscribers and allow Netflix to continue providing the quality of services and content that its customers have come to expect. As a result, its price increase strategy makes a lot of sense.