Neflix (NASDAQ:NFLX) recently announced a price increase. The online streaming leader is raising the price of its standard streaming service by a dollar, to $9.99 monthly. This has some important implications for investors, not only when it comes to the direct financial impact of the price increase, but also in terms of evaluating Netflix and its long-term fundamental quality as an investment.
What Warren Buffett knows about pricing power
Warren Buffett is one of the richest men on earth, and also one of the most extraordinary investors of all time. The Oracle of Omaha has built his massive fortune by investing in top-quality companies with rock-solid competitive strengths, and he considers pricing power one of the most relevant factors to watch when making investment decisions. In Buffett's own words:
The single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business. And if you have to have a prayer session before raising the price by 10%, then you've got a terrible business.
Pricing power typically means higher profit margins for investors, and it also speaks well about the company's competitive strengths. If customers are willing to stick with a company's products or services in spite of a higher price, this shows that the business is offering something better, or at least different, in comparison to other players in the industry.
Does Netflix have enough pricing power?
While an 11% increase can sound important, it´s still only $1 extra monthly, so it will not have much of an impact on consumers' pockets. Besides, the company is actively building a valuable library of highly popular exclusive content, and this makes the subscription more valuable over time.
This decision from management is probably reflecting confidence on the fact that Netflix can raise prices without hurting subscriber growth by much. The company would hardly be thinking about increasing prices if subscriber growth were below expectations.
Netflix hiked prices from $7.99 to $8.99 in 2014, and the business continued to grow at full speed after that. More recently, it increased prices in Europe by 1 euro in August 2015. Management seems to be testing the waters and carefully evaluating if there is enough room to raise prices, so this decision is probably reflecting encouraging customer feedback.
Also, Netflix remains competitively priced in comparison to other alternatives in the industry. Management has always pointed toward Time Warner's (NYSE:TWX.DL) HBO as Netflix's most relevant competitor. This makes a lot of sense considering that HBO is arguably the top industry player when it comes to content quality. Also, Time Warner has recently announced that it will be launching HBO Go as a stand-alone online subscription service in Latin America, which is clearly an attempt to steal market share away from Netflix in the region.
On the other hand, Time Warner's HBO Now service is selling for $14.99 monthly, a 50% premium over the cost of a typical Netflix subscription, even after the latest increase. I'm not saying that Time Warner is necessarily charging too much for HBO Now, only that Netflix is still competitively priced in comparison.
Amazon.com (NASDAQ:AMZN) is another relevant player in streaming. The company offers its Prime Video service as part of its Prime membership program. For $99 per year, Amazon Prime members get free two-day shipping, Prime Video, Prime Music streaming, and access to Amazon Kindle Owner's Lending Library, among other benefits.
Amazon Prime Video has over 40,000 titles available, and the company is also venturing into original programming with successful launches such as Transparent, which recently won five Emmy awards, so Amazon is not a competitor to overlook. Still, even after the latest increase, Netflix remains reasonably priced in comparison to both Time Warner's HBO and Amazon Prime Video.
Considering that Netflix is adding a lot of value to the service via more and better content over time, it looks like the company has the pricing power to get away with the recently announced price hike. This is a big positive for investors in its stock. Don't take my word for it. Just ask Warren Buffett.