What Makes Netflix’s Pricing Model Amazing?

These days, there are many options for streaming services, and they grow exponentially year over year, but you might be curious, which streaming service costs the most? Which costs the least?

There’s already plenty to choose from, but Netflix, one of the pioneers of this streaming services and developing digital content has set the stage for how streaming services approach pricing.

Netflix Competition

Throughout 2013, though Netflix’s stock price history had been solid, the streaming service giant saw significant issues with their domestic consumption.

Increased Competition

Hulu stock was rising and Amazon’s market share was skyrocketing as they began to offer differentiated services.

High Content Costs

Consumers in the video streaming space want content—and lots of it. Content can retain customers and differentiate service. The problem is that content is expensive, and in past years, content costs were over 50% of Netflix’s streaming revenue.

Decrease in Average Price

In 2013, Netflix began offering a premium or family service for $11.99 ($4 more than their standard service). Consumers were not attracted to the premium service. They opted for the standard service instead of the average price per user began to quickly decrease to $7.74 from a peak of $7.81 shortly after the service was introduced. This represents a $20M decrease in annual revenue.

Declining Subscription Growth

Quarter over quarter, Netflix’s subscription growth had plateaued. To grow profitability, Netflix had to cut costs or increase their top line. To retain customers, Netflix had to invest in content. The only card Netflix had to grow profitably was to increase its price, a risky move given the circumstances.

Netflix’s Revenue
Management Techniques

Netflix used two revenue management techniques to increase the price, introducing more subscription tiers and a phased approach:

Increased Subscription Tiers

Netflix took a page from the airline industry and offered a “No Frills” tier. This allowed self-driven customer segmentation, engaging with the customer to pick the offer they wanted. The majority of customers opted for the increase in price since the value offering matched their willingness to pay.

Phased Approach

Netflix used different phases for current and new subscriptions

Current: Netflix introduced a “grandfathered” system where the current user’s price increase would be delayed. This was meant to create and sustain loyalty. The decision also gave current customers time to become accustomed to the new tiered product offering before having to pay more.

New: Instead of a one-time increase, Netflix opted for two smaller one dollar price increases, which had two positive effects:

i) One dollar seemed marginal to customers, meaning they would easily accept the change in price

ii) Allowed Netflix to gauge and monitor reaction to their price increase

Throughout implementation, from May 2014 to October 2016, the average Netflix account price increase was 17%, or $1.39 per user. The results of the increase became evident in the fourth quarter of 2016, where revenue growth hit a three-year high. Price increases allowed Netflix to increase domestic annual revenue by $800M or 44% of its domestic margin.

Netflix’s price increase was undoubtedly a success; however, did they leave money on the table? There are a handful of additional revenue opportunities that were overlooked:

Subscription Tier Differentiation

Currently, the value proposition between the three tiers are minimal. Netflix could add more features to the premium offering (i.e. current weekly content) or add revenue-generating activities (advertisements) to the basic package to motivate upselling.

Subscription Add-ons

If customers are not inclined to take the leap to the next tier, add-ons allow customers to choose upgrades on an ad hoc basis. For Netflix, this could entail having add-ons to each of the tiers (e.g. add a screen or increase stream quality for one dollar). This must be carefully done so as not to cannibalize current offerings (i.e. maximum number of users).

Mix of Netflix Offerings

This involves understanding how the Netflix offerings interact with one another and how that impacts the bottom line. Netflix can focus on moving users “up the premium ladder” into higher-margin offerings by offering free tier upgrades for a limited time.

Although many people despise Netflix for their price increases over the past few years, only three percent of customers cancelled their subscription, and many of them came back! The fact that a company can issue a 17% price increase within 18 months and still grow subscriptions, and the top line is what revenue management is all about. There is an excellent possibility that Netflix is aware of the money left on the table and have decided against capturing it until their next price increase. Watch out!

ABOUT THE AUTHOR Marc Carias is a Consultant at Revenue Management Labs. Revenue Management Labs helps companies develop and execute practical solutions to maximize long-term revenue and profitability. Learn more about what we do at Revenue Management Labs.

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