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Netflix Braces Customers for the Next IP Shakedown

July 13, 2011

Yesterday Netflix announced changes to its subscription plans. Instead of offering a $9.99/month plan that covers unlimited DVD-by-mail rentals (one at a time) and unlimited Internet streaming, Netflix will now sell each service separately for $7.99/month. In other words, to get unlimited DVDs and streaming will now cost $15.98/month, 60% more than it did previously.

Netflix claims the move is designed to bolster the long-term prospects for its DVD business. The previous price system treated DVDs as a $2.00 add-on to the $7.99 streaming charge. The risk is that some customers might switch to the streaming-only plan and rely on other providers, such as Redbox or Blockbuster kiosks, for DVDs. But the real question is whether Netflix can expand its streaming library, which lags well behind its DVD catalogue. As Thom Forbes writes at MediaPost,

Netflix founder Reed Hastings decided some time ago that the future of his business was in streaming, most stories point out. Initially, the company was able to cut favorable streaming deals with several Hollywood studios but everyone expects negotiations in the future to be tougher. At the same time, perhaps because of the scarcity of recent blockbuster releases through streaming, the DVD business has evidently remained stronger than the company anticipated. So it has reassessed its position of offering the mail service for about a $2 per month “premium.”

The International Business Times adds that splitting the subscriptions may be a prelude to those “tougher” negotiations:

“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 – 2.5 billion, perhaps providing the catalyst for today’s action.

Netfix customers, of course, have taken to the virtual barricades to complain about the price increase for an unlimited DVD-and-streaming plan. The phrase “price gouging” has no doubt come up a few times. (Josh Zerkle throws some necessary cold water on that argument.) What’s interesting is that it won’t occur to most people to direct their anger at the Hollywood studios that are actually making it more difficult — thanks largely to the their dependence on the government’s copyright regime — to open up more content to online streaming. Once you get past the knee-jerk emotional reaction to the price increase — the notion that somehow Netflix is violating your “right” to a certain price level — you can start to see how prices reflect changing economic realities.

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