The pricing decision has to be seen in the context of this long game that they’re playing, and winning at. Pricing decisions are always serious because they flow almost directly to the bottom line, so their CEO, Reed Hastings must have concluded that the short-term loss of income from cancelled subscriptions will be outweighed by the longer term gain in new subscribers who do not take the DVD-by-mail option. Netflix is signalling to these customers that streaming is a better option; DVD-by-mail becomes a niche offering for them.
TRANSFORMING TO STREAMING SERVICE
One of the functions of price is as a signalling mechanism. You can make all sorts of signals with price. For instance, you can with your prices signal to customers that you are a premium provider, or you can make price changes ahead of a market shift to signal to competitors that you are moving aggressively.
Netflix, with this price increase, is signalling that they are not focused on the DVD-by-mail business and with their prices they will try to drive customers away from that offering.
They’re used smart pricing to bring their customers along with them. When streaming was first offered as an option, it didn’t cost extra. As long as you had one of their DVD-by-mail subscriptions, you could get streaming video for free. That’s a great offer. I think we immediately moved from a three DVD subscription to a cheaper one DVD subscription, because the streaming option gave us so many options. We watch Netflix movies on our big television with a Roku box, but also on an iPad and on our computers. This range of options is really impressive: I can start watching a movie on our big screen and continue it — in bed with headphones — on an iPad. In a pinch, I’ve even watched movies on my iPhone.
However there is another sales model that competitors and substitutes are implementing: freemium. Hulu is a competitor of Netflix and subscription cable, which uses a freemium model. According to Vineet Kumar of the Harvard Business Review, a freemium model is a combination of “free”, and “premium”…[where] users get basic features at no cost and can access richer functionality for a subscription fee.
Numerous elements contribute to the attractiveness of a freemium business model. Because free is a powerful marketing tool, new users are easily attracted to the service. Freemium has been proven more successful than free trials or other limited-term offers. Customers have become cautious and mistrustful of cumbersome cancellation procedures. Indefinite free access is far more attractive.
Pricing Strategies and Profit
Netflix’s average monthly revenue per subscriber in the U.S. stood at $7.57 in 2013, or 95% of the actual price of $7.99. The average realized price differs from the actual because of promotional discounts and free trials. This implies that $1 increase in monthly price will result in average monthly revenue per subscriber going up by $0.95. Assuming that this price increase takes effect in mid 2014, and current subscribers are shifted to new price plan after two years (mid 2016), we conclude that Netflix will generate additional revenues of $18 million, $60 million, $310 million and $549 million in 2014, 2015, 2016 and 2017 respectively. The table below summarizes these findings which are based on the assumption that the subscriber base will grow from 33.4 million at the end of 2013 to 49.4 million by the end of 2017. Additionally, we expect Netflix to gain roughly $200-$250 million in incremental revenues from price changes in international markets, taking the global total to more than $750 million by in 2017.
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Forbes.com. (2014). Forbes Welcome. [online] Available at: http://www.forbes.com/sites/greatspeculations/2014/05/15/the-impact-of-netflixs-price-rise/#5a1b4c2262cd [Accessed 1 May 2016].
Blogs.harvard.edu. (2011). Netflix pricing strategy | CQ2 | Ed Murphy. [online] Available at: https://blogs.harvard.edu/cqtwo/2011/07/14/netflix-pricing-strategy/ [Accessed 1 May 2016].
Barbera Solutions. (2015). Barbera Solutions. [online] Available at: http://www.barberasolutions.com/#!Your-premium-business-model-will-fail-go-freemium/c196w/55719f690cf2312d796ebfd5 [Accessed 1 May 2016].