How Netflix Can Turn Things Around With A Few Tweaks

Nov.24.11 | About: Netflix, Inc. (NFLX)

I think a lot of Netflix (NASDAQ:NFLX) shareholder value is tied to the losing strategy of simple pricing. Pricing strategy is a valuable tool that must be deployed to maximize customer surplus at minimum cost to the company. Every basic microeconomic textbook will tell you that the marginal surplus is very low at the extreme right end of the demand curve. In this article I am not going to beat the numbers to death. Rocco Pendola, LiquidDynamite, Whitney Tilson and others are far more qualified than me to illustrate the stark numbers facing NFLX. I'm going to look at a few strategic things NFLX can do to improve the odds.

A few simple pricing schemes could reduce costs for NFLX, improve customer satisfaction and stop this stream of bad news. The key to NFLX's survival is lowering the fixed cost per subscriber and shifting more of that to a variable (viewing driven cost) cost structure.

  1. NFLX could a bundle of base all you can eat movies + a certain amount of Netflix Premium Dollars per month that a customer could spend on more popular or more recent movies. If a customer ran out of the bundled Netflix Premium Dollars, NFLX could then give them the ability to buy more. Under this approach, a customer could still have access to the latest content, but be limited, forcing the customer to be smart about allocating his marginal Netflix Premium Dollars to maximize his satisfaction. Right now, the NFLX approach is similar to that of a theme park where all the rides are free and so I might go on a ride that I don’t care for. If the theme park gave me exactly X number of tickets, I would go the exact rides I really wanted to go on and get 97% of the satisfaction (possibly more considering the probably shorter lines!).
  1. NFLX could offer an ad-supported package for more price sensitive customers, while offering an ad free tier for customers who would be willing to pay more. In essence NFLX would be forcing its customers to self-select themselves into tiers. The ad revenue would offset some of NFLX costs by shifting them to advertisers. Why is NFLX offering the same deal to customers with differing abilities to pay and differing surplus values on their time?
  1. NFLX could split its pricing into a base package + premium tiers. This could have many possible variations such as tiers based on movie studios, genres of movies (so that a woman for instance who watches primarily romantic comedies would gladly pay for that), recent releases etc. I am sure NFLX has the viewing data to model many different pricing plans to develop some very profitable and targeted ones. Instead of using all the viewing data solely to drive the recommendation engine, why not look at the data as a possible revenue driver via pricing strategy?
  1. To reduce churn, NFLX could have a auto adjusting pricing policy whereby they charge little or nothing in months where customers watch little or nothing. Currently, I suspect, based on my history, a lot of churn is driven by the customer who sees the NFLX charges on the credit card statement, realizes that he hasn't seen a single movie in weeks and cancels out of guilt. If I get charged very little or nothing in the months I don't watch, I would never have signed up and canceled Netflix at least six times in the last eight years. How many people cancel services where they pay nothing? GRPN anyone?

If NFLX management recognizes that you can’t offer lobster in a 7.99 buffet and makes the premium content an add on to the base plan, they can increase revenues without a customer backlash. People are used to the idea of paying more for premium access. Yes, this would be a paradigm shift for Netflix. But at some point if NFLX wants to survive they have to stop looking at the lowest common denominator and start offering more profitable premium products. While all you can eat will always have a certain appeal and ability to attract customers, it has to be balanced by limiting the access and forcing the customer to choose wisely.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.