It was not that long ago when even the rumor of a Netflix (NASDAQ:NFLX) price increase led to legitimate speculation that consumers would balk at paying more for the streaming service.
You can trace those fears back to the company's ill-fated 2011 decision to split its DVD-by-mail service from its streaming product. For customers who used both services, that effectively resulted in a fairly major price increase, and people reacted in a negative fashion. Because of the outpouring of subscriber outrage, the company not only quickly reversed that decision, it actually froze prices until May of 2014.
When it finally did raise the cost of its most popular subscription in the United States from $7.99 to $8.99 for new customers (with existing subscribers getting a full year's grace period at the old price), analysts were legitimately concerned that it might slow down growth. At first, that appeared to happen, and the company even mentioned it in its Q3 2014 earnings report:
Separate from forecast variability, year on year net additions in the U.S. were down (1.3 million in Q3 2013 to 1 million in Q3 2014). As best we can tell, the primary cause is the slightly higher prices we now have compared to a year ago. Slightly higher prices result in slightly less growth, other things being equal, and this is manifested more clearly in higher adoption markets such as the U.S.
Three months later, however, in its Q4 2014 earnings report, the company reversed course, saying the drop was not related to the price increase:
In October, we judged the leading factor of the similar decline in Q3 y/y net adds to be our May price change. Since then, with additional research, we now think that the decline in y/y net adds would have largely taken place independent of the price change. We've found our growth in net adds is strongest in the lower income areas of the U.S., which would not be the case if there was material price sensitivity. Additionally, we implemented a similar price change in Mexico during Q4, and saw no detectable change in net additions.
The price change turned out not to matter, and if you look at the streaming leader's growth since then -- from 36.27 million paid members in Q3 2014 to 41.06 in Q2 2015 -- it's hard to see any negative impact. Now, the company has quietly raised prices by another dollar for new customers, and it's hard to imagine that impacting the company's growth.
What the price increase means
The latest price increase comes after the company raised its prices in Europe by a similar amount in August. Existing customers are being given a grace period this time as well, though it's not quite a year. In my case, the company has guaranteed I will pay the older rate until "at least May 9, 2016."
Still, the new rates will add significant money to the streaming service's bottom line, which is needed because "the company has $4.3 billion in programming costs over the next year, and almost $5 billion more for the following three years," according to Bloomberg.
Between the end of Q2 2014 and the close of Q2 2015, Netflix added just under 6 million U.S. subscribers, with about half of those coming in Q1, 2015. If we assume the same pattern for the current year, the price increase will bring in the following revenue from new customers over the next 12 months:
- Q3 2015: $3 million
- Q4 2015: $6 million
- Q1 2016: $15 million
- Q2 2015: $18 million
Those are relatively trivial numbers, but the math gets really interesting when the grace period ends for existing customers. When that happens, the company will add roughly another $123 million per quarter in U.S. subscriber revenue. Assume a similar increase for the company's 21.65 million global paid subscribers as of Q2 2015 and you add another $64.95 million each quarter.
In addition, global subscriptions grew by nearly 9 million customers between the end of Q2 2014 and the close of Q2 2015. If you assume a similar breakdown in subscribers as in the U.S., that would mean about 1.75 million new customers paying the higher rate in Q3 and Q4, 2015 and Q2, 2016 and about 4.75 million in Q1, 2015 bringing in the following revenue:
- Q3 2015: $5.25 million
- Q4 2015: $10.5 million
- Q1 2016: $24.75 million
- Q2 2016: $30 million
These are very raw calculations that don't account for currency differences or the fact that the new pricing may not hit all territories, but roughly, the change will bring Netflix an additional $864 million per year once it has been fully implemented.
Netflix is a good value
The difference between paying $8.99 for Netflix and $9.99 is likely irrelevant for most, if not nearly all existing and potential Netflix subscribers. Both are effectively $10, and since customers have a wide variety of payment options, few current subscribers are likely to even notice.
Netflix is treating existing customers well by offering a grace period before the price increase kicks in. It's also doing the right thing for shareholders by recouping at least some of the expanded investment it's making in content.
There might be a ceiling as to how high Netflix can raise its prices, but $9.99 a month is not it. As long as the company moves slowly and continues to justify higher prices by investing in top-tier content, it should be able to take in more revenue from new and existing customers without slowing its growth.
Daniel Kline has no position in any stocks mentioned. His wife is watching Breaking Bad on Netflix. The Motley Fool owns shares of and recommends Netflix and PayPal Holdings. 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.