Netflix (NASDAQ:NFLX) is a movie rental company that makes film and TV programming available to customers on a monthly subscription basis via mailed DVDs and online streaming. A leading factor in Netflix’s success has been its low prices and value for money.
In the past, the average Netflix subscription fee has trended downwards due to rising free trial subscriptions, which Netflix uses to drive subscriber growth. Also, the company has experienced great demand for its low-priced $8.99 plan, which includes unlimited DVD rentals (one at a time) and unlimited streaming service.
Although we expect this trend to continue for the foreseeable future, below we explore factors that could drive Netflix’s subscription fee upward. Rising fees would create a 15% upside to our $82.26 price estimate for Netflix’s stock. (One caveat: In a recent article, we noted that rising subscription rates could also hurt Netflix’s competitive position vis-a-vis Comcast (NASDAQ:CMCSA) and other cable providers, which could put downward pressure on the stock.)
Rising demand for online content
With increased broadband penetration and improved speeds, demand for online video is on the rise. Broadband is increasingly becoming a one-stop destination for entertainment. According to an online poll commissioned by RealNetworks, 46% of 18 to 25-year-olds surveyed said that they spend the same amount of time viewing online videos as they do watching traditional TV. About 32% indicated that the computer is now their preferred platform for consuming on-demand video.
Netflix can potentially take advantage of this demand shift to raise its subscription prices. Netflix’s prices have room to rise because they are substantially cheaper than rates charged by on-demand competitors like Comcast. However, Netflix will need richer online programming to justify such increases.
Improved content allows tiered pricing
Netflix’s current subscription plans vary according to how many DVDs a customer can rent at a time. The low-priced $8.99 plan has caught on because it gives customers unlimited access to online content, in addition to renting one DVD at a time.
Currently Netflix is focused on bringing older movies and TV shows online. But if the company can license relatively newer content for download, it could justify a tiered pricing structure. In this case, customers would pay a premium to watch newer content. Tiered pricing, in turn, could drive growth in average subscription fee. In the chart below you can modify the Trefis forecast of declining subscription fees to see how rising fees would impact our price estimate for Netflix’s stock.
If studios demand more profits, Netflix may have to pass on cost to customers
In exchange for a 28-day delay in renting new releases, Netflix has been able to license online content cheaply. But as we argued recently, content owners are increasingly demanding higher profits. Over time, Netflix might be forced to spend more on content acquisition than it currently does. In order to protect its margins, the company would likely pass these increased costs on to customers, creating additional upward pressure on subscription fees.
Disclosure: No positions