If you're a Netflix (NASDAQ:NFLX) subscriber, you can probably expect to pay more at some point in the future. During the company's second-quarter earnings call on July 15, CEO Reed Hastings indicated that the company will start providing incentives for users to move up to higher-priced tiers.
Over the past year, Netflix has increased its average subscription price by 5% in the U.S. and abroad, excluding foreign exchange changes. That was helped by Netflix's price increase for its standard two-stream subscription to $8.99 per month, but it credits its cheaper ($7.99) single-stream subscription for a significant amount of its subscriber growth. Hastings says the price increases will be more subtle going forward, and the value of the service will remain excellent.
Room for higher prices
The average Netflix subscriber streams around two hours of video per day. That makes it one of the most popular networks in subscribing households, surpassed only by broadcast networks.
Time Warner's HBO, comparatively, averages around half the time spent watching Netflix. Even so, HBO's new streaming service, HBO Now, costs $15 per month. It allows up to three simultaneous streams, but it doesn't support 4K video. Comparatively, Netflix's $11.99-per-month plan allows up to four simultaneous streams and supports 4K video for subscribers with a fast enough Internet connection.
Netflix is betting big on 4K video. With 4K television sets becoming much more affordable recently, Netflix is ready for widespread adoption of ultra-high definition. It purchased the rights to Breaking Bad and House of Cards in 4K, and it's already streaming them to top-tier subscribers. Hastings predicted that widespread adoption of 4K TV sets will occur before the 2018 World Cup (and people will stream the World Cup in ultra-HD over the Internet).
Buying up more 4K content will give subscribers more incentive to increase their plans from $8.99 per month to $11.99 per month. Hastings indicated this is part of the plan. He noted the company is focused on adding more content and the structure of the price tiering is unlikely to change.
How Netflix can get away with charging less than HBO
Netflix and HBO have never been more similar for consumers, but their business models remain drastically different. HBO relies on pay-TV providers for marketing, customer service, billing, and distribution. With HBO Now, Time Warner is partnering with tech companies to support it like pay-TV providers. For that support, the standard cut is a 30% commission.
That commission takes a chunk out of HBO's take home, but it still leaves it with about $10.50 in revenue per subscription. HBO could probably make more revenue at a lower price, but its relationship with pay-TV providers is preventing it from offering consumers a less expensive over-the-top option. Pay-TV providers take a much bigger cut -- 50% -- putting HBO's share more in line with Netflix's average subscription price.
Comparatively, Netflix takes care of all of its marketing, customer service, distribution, and billing. Most of those categories produce margin expansion as the subscriber count grows. HBO's costs, on the other hand, remain a constant percentage of gross revenue because of its split with distribution partners. Therefore, reaching massive scale will allow Netflix to produce strong operating margins. Its cost of content could still hold it back, but its expansion of original programming is as good a hedge as any against content costs.
For now, HBO still produces significantly higher profits than Netflix because of the costs it offloads to other companies. HBO also benefits from selling its original content via home video. As Netflix gives subscribers incentive to move to higher tiers through things such as higher-quality video, it stands to manage higher subscription revenue than HBO and significant profit expansion.
Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.