CASE STUDY:Netflix Price Increase Hurts Membership

Netflix experienced some membership turbulence in 2016 as a price increase was phased in for its US subscribers. In May 2014, Netflix announced that the price of its standard subscription service would increase from $8 to $9. However, established customers were allowed to stay at the $7.99 price for two years. In 2015, Netflix increased the standard price to $9.99. As a result of the pricing plan and the deferred price increase, in May, 2016, the standard pricing plan for long time customers of Netflix increased from $7.99 per month to $9.99 per month. Netflix began notifying customers in April that the price increase would become effective in the second quarter.

Netflix was trying to implement price increases more slowly after a 2011 increase led to negative publicity and a customer backlash. In that case, Netflix separated its streaming and DVD services, and charged separately for both services.

However, regardless of the implementation of the price increase, the higher monthly prices seem to have impacted the growth of membership among US subscribers. In the two quarters before the price increase, Netflix added net membership of 1.6 million and 2.2 million members. By contrast, the number of members added in Q2 was only 160,000, and in Q3 only 400,000. The Q2 growth in US subscribers was the lowest since Netflix began reporting those numbers in 2012.

US Streaming (millions)

Q2 2015

Q3 2015

Q4 2015

Q1 2016

Q2 2016

Q3 2016

Revenue

1026

1064

1106

1161

1208

1304

Contribution Profit

340

344

379

413

414

475

Contribution Margin

33.1%

32.3%

34.3%

35.6%

34.3%

36.4%

Paid Memberships

41.1

42.1

43.4

45.7

46.0

46.5

Total Memberships

42.3

43.2

44.7

47.0

47.1

47.5

Net Additions

0.90

0.88

1.56

2.23

0.16

0.40

Monthly Revenue per Paid Member

$8.33

$8.43

$8.49

$8.47

$8.75

$9.40

Percentage Chg. Rev

3.7%

3.9%

5.0%

4.0%

7.9%

Percentage Chg. Memberships

2.5%

3.2%

5.3%

0.6%

0.9%

Source: Netflix 10Q Q3, 2016

According to a MarketWatch article[1] on the price increase:

Netflix said Monday that customers who learned in April that the price was about to increase had begun canceling their subscriptions, leading to unexpected "churn." Netflix did not flat-out say inits letter to investorsthat the price increase led to higher churn among subscribers, however, instead saying it coincided with "press coverage" of the rate hike and that subscribers misunderstood "the news as an impending new price increase rather than the completion of two years of grandfathering."

The stock market reacted to news of Netflix price increase as well. The stock closed at $102.23 as of March 31, 2016. After the release of second quarter earnings in July, the stock price had fallen to $85.84 per share, a decline of 16%. This decline wiped out almost $7 billion of shareholder value during this period. Most of this decline was immediately following the release of the second quarter numbers.

With competition increasing in for streaming services, especially with the growth of Amazon Prime Video and Hulu, the decline in membership growth could be a troubling sign.

1)How would you calculate the own-price elasticity of demand for Netflix product? (Hint: Paid memberships can be a proxy for quantity demanded).Would you say demand is elastic?

2)Given the answer in (1) above, would you expect revenue to increase or decrease, why?

3)In hindsight, what game theory strategy do you believe Netflix used in this entertainment market? How would you describe their approach in that pricing decision?

4)Comparing the changes in gross revenue trends to changes in paid memberships, what can you quickly infer?

In what market structure would you place Netflix? Why

1)Perfect Competition

2)Imperfect Competition

3)Monopoly

4)Oligopoly

5)Monopolistic Competition

6)Monopsony

7)Oligopsony

5)If you were the CEO at Netflix, facing an almost $7 billion drop in shareholder value, during the price increase period, how would you have justified your strategic move to the investors?