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.

According to a MarketWatch article1 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 in its letter to investors that 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.

Questions: Show the detailed calculations. 1. Calculate the average paid membership growth over the three quarters starting from Q3 2015. 2. Assume that the average growth trend would have continued. Using that projection, Netflix might have expected to add how many million total subscribers in the second and third quarters of 2016? 3. Using the information from question 2, compute the total number of paid subscribers Netflix lost in the second and third quarters of 2016 due to the price increase. 4. Considering the monthly revenue per paid member as the price of the subscription, compute the hypothetical own price elasticity of demand for the last two quarters of 2016. (You will need quantity demand information to solve this question. Please do not do the calculation separately for the last two quarters. Just use the average quantity demand of the last two quarters.) Note: We are interested in hypothetical own price elasticity because the actual demand did not decrease. However, if the growth trend (computed in question 1) continued, Netflix would have more total subscribers in the last two quarters (computed in question 2). Since the trend did not continue due to price increases, the company lost some expected subscribers (computed in question 3), and thats how their expected demand decreased. 5. Based on the answer in question 4, should we expect the revenue to increase, decrease, or remain the same? 6. Given this analysis, why did Netflix stock get hammered after releasing results?

Source: Netflix 10Q Q3, 2016