Context For Netflix’s Price Increase

The price increases Netflix announced this week come around a year after it finished implementing its last set of price increases, a process it spread over several years. Those last price increases occurred at a time when Netflix’s margins were already expanding despite its growing content spending, but this time around, the increase follows pressure on margins from ongoing growth in content spending.

Netflix’s Highly Predictable US Streaming Margins

Netflix is one of the few companies I know of which has set specific long-term margin targets and then made consistent progress towards attaining them. It set a 40% margin target for its US streaming business some time ago, with the intention of hitting that mark in 2020, and for a long time its progress towards that goal was almost linear. Recently, there’s been a little more volatility in that number, but it’s essentially still on track and even ahead of target:

The volatility in the last couple of quarters was due to the timing of new series launches, which were delayed a little this year from the first to the second quarter and therefore moved some costs around a little. But you’ll note from the chart above that the last several quarters have all been within spitting distance of 40%, while Q1 actually exceeded it.

The last set of price increases certainly contributed to that margin progress, hitting in 2014 and 2015 for new customers but in 2016 for existing customers and thereby pushing average revenue per US paid streaming subscriber per month up from $8 to $10, even as cost of revenue per subscriber was falling from $5.30 to $5.00 or so per month. However, since then, cost of revenue per subscriber has actually begun rising, albeit not dramatically, going up around 23 cents per month on an annualized basis over the past year. That, in turn, threatens to slow the progress towards the 40% margin goal and even reverse it, hence the price increases just announced.

Lessons Learned From the Last Increase

As I mentioned above, Netflix chose to stagger the introduction of the last set of price increases, “grandfathering” existing subscribers at the earlier price until prices went up by $2 in 2016, while two single-dollar price increases hit the price for new subscribers in 2014 and 2015. The thinking here was presumably to spread the impact of higher churn from those unhappy about the price increases over a larger number of quarters rather than taking the impact all at once.

In practice, though, the customers that churned did so starting when the price increases for existing customers were announced, earlier in 2016, rather than when most of the increases actually hit later in 2016, as the chart below shows (2016’s numbers are shown in light blue):

As such, Netflix seems to have learned its lesson this time around and has decided to implement the price increases all at once, with the price rising for new customers immediately and for existing customers starting in November. That means it’ll take the whole hit in once quarter – Q4 2017 – rather than over several quarters. Given that Q4 is normally the company’s second strongest for subscriber growth after Q1, that’s probably smart timing, as it’ll likely still manage positive growth overall even with several hundred thousand fewer net adds.

Increasing 4K Impact

One interesting wrinkle in the new price increases is that they affect each of the three tiers of service Netflix offers on the streaming side differently. There’s no price increase for the basic, standard definition, single-stream service; there’s a one dollar price increase for the most popular HD, 2-stream service; and a two-dollar bump in the price for the Ultra HD, 4-stream service. Given that the revenue per US streaming user has historically tracked very closely with the middle tier’s pricing, it’s very likely that this is by far the most popular service, and that the numbers on the UHD and SD plans are small and largely cancel each other out.

However, as more and more people buy not only 4K TVs but also streaming boxes from the major players, all of which have recently been updated with better 4K support, that could start to change. We could therefore see higher uptake of the UHD service at $14 start to push average revenue per user above the $11 we’d see if the past pattern continued. That will make the choice to raise that price by two dollars instead of just one perhaps the most consequential change of all, and one which will likely accelerate the progress towards 40% margins and beyond.

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Jan Dawson

Jan Dawson is Founder and Chief Analyst at Jackdaw Research, a technology research and consulting firm focused on consumer technology. During his sixteen years as a technology analyst, Jan has covered everything from DSL to LTE, and from policy and regulation to smartphones and tablets. As such, he brings a unique perspective to the consumer technology space, pulling together insights on communications and content services, device hardware and software, and online services to provide big-picture market analysis and strategic advice to his clients. Jan has worked with many of the world’s largest operators, device and infrastructure vendors, online service providers and others to shape their strategies and help them understand the market. Prior to founding Jackdaw, Jan worked at Ovum for a number of years, most recently as Chief Telecoms Analyst, responsible for Ovum’s telecoms research agenda globally.

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