How Does Rate Hike Impact Netflix?

 
on July 13 2011 10:17 AM
Netflix Subscription
Why gift DVDs when you can give unlimited access to movies and shows with a Netflix subscription? For $7.99 a month, your special one can view streaming content on a computer or TV. The plan does not include DVD’s though. However, if you think your movie-buff does want access to a DVD title, Netflix does offer that option at different rates. Reuters

Netflix is changing its pricing plans in the US market - eliminating the bundling of streaming with DVD by mail programs.

We are separating unlimited DVDs by mail and unlimited streaming in to two separate plans to better reflect the costs of each. Now, our members have a choice: a streaming only plan, a DVD only plan, or both, Netflix said in an email to subscribers.

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As a result, the current $9.99 a month membership for unlimited streaming and unlimited DVDs will be split into 2 distinct plans:

Plan 1: Unlimited streaming (no DVDs) for $7.99 a month

Plan 2: Unlimited DVDs, 1 out at-a-time (no streaming) for $7.99 a month

This is the second time Netflix has raised prices in the past 8 months.

The separation of the unlimited streaming plan (still $7.99/month) from the unlimited DVDs by mail plans (previously viewed as an add on to the streaming plan) has raised prices significantly for each of the combination plans.

Here is a gist of the plan:

* One DVD out at-a-time now costs $15.98/month (up from $9.99/month). Two DVDs out at-a-time costs $19.98/month, up from $14.99/month. Three DVDs out at-a-time costs $23.98/month, up from $19.99.

* Unlimited DVDs by mail-only plans, previously available until the introduction of streaming in 2007, will cost $7.99/month for 1 DVD out at-a-time, $11.99/month for 2 DVDs out at-a-time, and $15.99/month for 3 DVDs out at-a-time.

In other words, Netflix will no longer be offering plans that include both unlimited streaming and DVDs by mail. Netflix's streaming remains at $7.99/month, but unlimited streaming plus 1 DVD will now cost $16/month (up 60 percent) and unlimited plus 2 DVDs will cost $20/month (up 33 percent).

The plan changes will be effective immediately for new subscribers, and the new prices for existing members will start for charges on or after September 1.

On Netflix' blog, the company noted that the change will separate the plans to better reflect the costs of each, helping ensure a long life for DVDs by mail. The site further noted that treating DVDs as a $2/month add-on to unlimited plans didn't make much financial sense given shipping/postage costs.

Impact:

The new pricing plans will result in substantially higher ARPU from subscribers who choose to keep streaming and DVD by mail, while resulting in lower ARPU for subscribers who only use DVD by mail or streaming services.

We illustrate 6 scenarios with higher average revenue per user (ARPU), partially offset by increased churn resulting in a price range of $220-$330. Our analysis assumes that monthly ARPU increases to $12.60 or $14.00 (from $11.80 currently) from the price hike, tempered somewhat from a mix shift toward streaming only plans, said Youssef Squali, an analyst at Jefferies.

Squali said this impact is partially offset by a 20 basis points, 35 basis points, or 50 basis points increase in churn in third quarter/fourth quarter, resulting in a total of 6 scenarios.

As a starting point Squali assumed that currently 25 percent of subscribers are streaming only ($7.99/month), 25 percent streaming plus 1 DVD out ($9.99/month), and 50 percent other higher priced plans (about $14.60) for current ARPU of $11.80. Assuming a mass exodus does not occur, he sees upside to estimates.

While $7.99/month or $9.99/month plans often flew under the radar on subscribers credit card bills, Squali believes it's important to point out that $15.98/month or $19.98/month could make many subscribers flinch, or at least be more aware of it.

Further, downgrading a plan to streaming only may not provide enough new content to satisfy many subscribers. As such, it is possible that churn could pick up more meaningfully than Squali has assumed in third quarter/fourth quarter, eating into subscriber growth and valuation.

We believe this is a positive for the company. The new pricing should provide greater flexibility for subscribers that wish to make greater use of either DVD or streaming, and could also expand the total number of subscribers as households with multiple users may subscribe to separate plans, BMO analyst Edward Williams wrote in a note to clients.

Williams said Netflix is poised to continue executing effectively as it expands its streaming capabilities and enters new markets, including Latin America later this year.

The new pricing structure should have tangible long-term benefits in terms of subscribers, as untethered members of a household potentially opt for a personal plan, and as the expanding reach of mobile devices creates a larger potential opportunity

Analyst Pachter said although average revenue per user would normally be expected to rise due to higher prices for the combination plans, he expects many subscribers to change to a lower-priced plan that includes only the options they use regularly (streaming-only or DVD-only).

We expect limited impact on postage expense, which is included in cost of revenues, as any savings from subscribers seeking a cheaper combination plan with a lower DVD amount may be offset by subscribers that adopt DVD-only plans (potentially at higher DVD usage rates), Pachter said.

Why?

Let's take a look at the possible reasons why Netflix may have opted for the change in plans.

In our view, the company is facing increasing pressure from content providers to base streaming content costs on the number of overall subscribers, Wedbush Securities analyst Michael Pachter wrote in a note to clients.

By bifurcating its subscriber base into streaming and non-streaming plans, the company may be able to successfully argue that a lesser number of subscribers access streaming content, and may be able to control growth in streaming content costs.

Our central thesis has been that the company's streaming content costs are rising faster than its revenues; today's move reinforces our conviction that this thesis is correct, Pachter wrote.

The analyst had earlier estimated that Netflix' streaming costs could rise to between $1.6 - 2.2 billion in 2012 and now believes that content costs are tracking closer to $2.2 billion to $2.5 billion, perhaps providing the catalyst for today's action.

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