[In terms of Netflix’s current stock price I believe we’re entering rarefied air. In my previous Netflix-related post I predicted a continued upward price movement while also articulating my concerns for continued growth of the company. And as we begin to test the 300 level this week amid the negative news of a subscription price increase one has to wonder how long the current trend can last. Below is a excellently written summary of some of the main reasons why, although it was necessary, Netflix handled the rate increase poorly.]
*Courtesy of Daniel Indiviglio
1. It Amounts to a Giant Price Hike
This new strategy by Netflix will not be perceived by consumers as a way to empower them to decide whether they need streaming or not. To accomplish that result, Netflix should have left the total price for by-mail plus streaming unchanged, but broke the two out and allowed customers to stop paying for one or the other. Instead, it will slightly decrease the cost of its by-mail service and will require customers who want to keep streaming as well to pay a significant premium. As a result, the move will be interpreted by customers as a rate hike, not a move meant to provide them more flexibility.
2. No Value Added
If you’re on the one DVD-by-mail plan, then you currently pay $9.99 per month and enjoy streaming as part of the deal. To continue to stream, you’ll now have to pay $15.98. That’s a 60% increase! Now if Netflix was suddenly offering its entire library via stream or providing some other additional service, then customers might be able to stomach this rate hike. It isn’t. They’re getting the same services they got before, but now Netflix is charging much more money for them.
3. Streaming Isn’t There Yet
A time might come when it would make sense for Netflix to charge a significant premium for its streaming, but the service has not yet reached that point. Although its streaming library has grown significantly over the past few years, a huge portion of desirable movie and television titles remain unavailable by stream. Using my own Netflix queue as an example, just 3% of my selections are available by stream — and less than one-third of my queue’s titles were released in 2010 or later. If Netflix wants customers to pay a lot more for streaming, then it needs the quality of its service to better reflect its cost.
4. Netflix Doesn’t Need the Money
The oddest part about this rate hike is that Netflix doesn’t really need the money. It recently increased its fees (announced last November) by between 7% and 17%. Moreover, its profits have been strong over the past couple of years. And in the first quarter its profit soared 28%. It may want additional revenue to acquire more licensing to stream more titles, but a big rate hike like this may do more harm than good.
[I actually disagree with this point in that Netflix DOES in fact need the money. For further explanation check out this fascinating blog post by Andrew Schneck.]
5. Netflix May Lose Money
In fact, this pricing change could easily cause a decline in Netflix’s revenue. Last night, when I got home from work I told my wife about the rate hike. She was coincidentally watching an old Diane Lane movie she found scouring the Netflix streaming library. But without taking a beat, she said, “Oh, we can cancel streaming. It isn’t that good.” If you don’t think a service is worth its price at the moment you’re using it, that’s a pretty bad sign. Many subscribers will agree that streaming isn’t worth the extra money at this time.
How much could Netflix lose? Let’s do a quick analysis. According to one estimate, about 80% of Netflix subscribers currently have by-mail service that includes free streaming. Of that portion, let’s say half cancel streaming but keep by-mail service. Remember, many people don’t use streaming at all. In particular, if you don’t have an Internet-ready device connected to your television with a Netflix widget, then streaming is far less attractive. Through Netflix’s new pricing, by-mail only service will be about 20% cheaper than the current rate that includes free streaming.
If you assume that all of its revenue comes from subscribers, then its first quarter revenue would decline by 8% to $661.1 million from $718.6 million. This would reduce its profit of $60.2 million by $57.5 million, or by 95%! Netflix will have some subscriber growth as well, but the assumptions above aren’t crazy. If a large portion of subscribers shed their streaming, then Netflix could see a huge hit to its profits. And remember, this assumes that no subscribers cancel altogether. Some will.
6. Terrible Timing
Let’s imagine for a moment that Netflix’s streaming service is robust enough to warrant a big rate hike. Even then, putting that rate hike in place now is a pretty bad idea. The economy remains weak, as Americans are still nervous about the future. Inflation has also been squeezing Americans’ budgets. As they look for ways to save money, Netflix just gave them an easy one: don’t pay more for video streaming unless you really can’t live without it. By dumping the service, not only will you escape the big fee hike, but you’ll actually save money on your by-mail subscription service under the new plan.
7. Investors May Suddenly Begin to Question Netflix’s Strategy
Netflix has been a darling of investors for some time now. In just the past year, its stock price has increased by an amazing 144%. But Wall Street might begin to question its strategy. The company has said that streaming is the future. It’s right. But the future isn’t here yet. If its streaming subscriber base suddenly plummets by 50% or even by a smaller margin like 30%, then investors might worry about whether consumers are really ready to embrace the service on which Netflix has been investing a huge portion of its revenue. And if its profits dive as a result of the rate hike, then investors will be even more concerned with Netflix’s vision.
So what should Netflix have done? It should have increased its rates slightly, maybe by a dollar or two, and broke out streaming and by-mail service. For example, the company could have increased the cost of its basic plan from $9.99 to $11.98 for streaming plus by-mail service. If you wanted the two a la carte, it could have charged $4.99 for streaming and $6.99 for one DVD-by-mail. Although customers wouldn’t love the rate increase, they’d be better able to stomach it. It would also give Netflix the ability to up its fees in future years gradually, to hit the target that it believes is appropriate. But putting the hike in place immediately may do the company more harm than good.
Technical Analysis: [Finally, let’s take a quick look at the SwamiChart. As you can tell, the SwamiPredict indicator is still giving a green “buy” signal. However, it should be noted that it’s strength is diminished because it is not emerging from a different signal. Also, the SwingWave indicator is giving an orange “peaking” signal that could be very telling…. especially considering that it is coming a couple of bars off an outside day to the downside.]