April 25, 2015 at 6:46 p.m. PST
Long-time Netflix subscribers are in for a surprise next year. The video streaming service will be raising rates for loyal customers.
I logged in to my Netflix account to manage my video quality settings. The account management screen displayed an ominous message: “Your plan price is guaranteed through at least May 9, 2016”.
Netflix maintains the price increase is necessary to keep up with inflation. As technology matures, however, the cost of hosting, video production and other technologies decrease in price. As Netflix gains more members, they achieve a greater economies of scale effect. This should, at least, keep the price constant for people subscribing to the same service. It makes sense to charge more for Ultra HD or multiple screens.
Technology Costs Less Over Time
Remember when computers were first available to consumers? The first home computers couldn’t do much. They typically had 16 – 64 KB of RAM and programs were loaded using a cassette tape. They were expensive. Computers like the Commodore 64 and Atari 800 cost as much as $1000 when they launched. This was back when you could buy a can of coke (in a vending machine) for 25 cents and a $40,000 annual income was considered upper-middle class. Compare that to today, where for less than $200, you can get a computer with far greater capabilities.
Decreasing costs of technology are not limited to home computers. Servers and high-end audio and video production computers have also become less expensive and more capable over time. Tape Op featured an extensive forecast of audio engineering advancements. As time progresses, the cost to produce audio projects has decreased. Indeed, someone with a personal computer, audio interface and some decent mics can produce music with professional results. The capabilities are beyond what major label studios could produce decades ago, at much higher costs.
Technology is getting cheaper and better. Netflix has diminishing data center costs in the future. Furthermore, the cost to produce movies and TV shows also decreases. Of course, certain types of blockbuster movies seem to spend a tremendous amount of cash. If you look at the results, they accomplish what was once impossible. But your typical movie or TV show can be produced for much less these days. This is why there is a proliferation of TV shows and independent movies. There are more shows than anyone can possibly watch. There is no scarcity. The cost of acquiring content has also decreased considerably. Netflix is not getting the blockbuster Hollywood movie that was in theaters last month and cost $300 million to produce. The majority of their programming is relatively inexpensive.
Netflix does face some increased costs. They must pay higher salaries for employees. The price of commercial real estate is also increasing. Both costs are staggering in the San Francisco Bay Area.
The decreasing cost of technology outweighs increasing costs of facilities and employees. Netflix is not a software company. They don’t even run their own data center. With the infrastructure in place, they can add additional content and subscribers without a linear increase in employees and facilities. At best, this means subscribers’ rates should at least remain constant. However, as Netflix grows their subscriber base, they will realize a greater economies of scale effect.
UPDATE:
It has been confirmed that Netflix will raise the price of its most popular, 2-stream HD plan from $7.99 to $9.99 in May 2016. This puts the price in line with what new subscribers have been paying since October 2015.
Economies of Scale Effect Should Decrease Membership Costs
Do you shop at Costco? If so, do you notice how inexpensive everything is? You can get the same product sold in a supermarket for less than half the price at Costco. Of course, you have to buy twice as much and purchase an annual membership. If the consumer commits to buying a larger quantity, the fixed costs in producing the item are mitigated. In layman’s terms, this is a volume discount. Economists call this the economies of scale effect.
Netflix continually boasts about adding new members at every quarterly conference call. This should benefit existing members. As more members contribute their subscription fee, Netflix has more cash to operate. Greater revenues and increased content purchases also enable better negotiation with studios and networks. They can purchase content for less. The increased data center demand also offers economies of scale benefits. Amazon charges less per GB of data served as the overall data requirements of their clients grow larger. Netflix is benefitting from economies of scale, but soon their subscribers might not.
Netflix Gets Better at Raising Subscriber Rates
Remember the last time Netflix raised their rates? They severed the free streaming service from DVD rentals and charged extra for it. It was a catastrophe. Their stock price plummeted. It took years for their stock to recover. They promised better content, however, the notion that they needed to increase rates spooked investors. It increases suspicion that Netflix sees their growth slowing. A growing business can keep prices constant while increasing profitability.
Netflix isn’t going to let this happen again. They have a new way of raising rates. Current customers are still paying the same subscription price. This is a smart move, because it prevents existing customers from terminating subscriptions. If they do, they must pay a higher rate as a new subscriber. Currently, Netflix charges new customers more. It is truly bizarre and almost unprecedented in this industry. It is a strategy forged from catastrophe.
Increases to existing customers’ subscriptions will be staggered. That’s why everyone has a different guaranteed price date on their account summary. You can check this date by logging in to your Netflix account. It is displayed on the main account page.
I have been with Netflix for over a decade. My price is guaranteed until May 9, 2016. It is very specific, down to the day. This ensures that there will be no commotion about Netflix raising rates. They are doing it piece-meal, to avoid a backlash that can negatively affect the stock value.
Netflix is Facing Greater Competition
In April 2015, HBO launched their HBO NOW service, targeted at cord-cutters. HBO subscribers can now enjoy the service without subscribing to cable. HBO has offered streaming for several years, however, it was a perk of membership. Now anyone can subscribe to the HBO NOW streaming service.
Since subscribing to HBO NOW, I haven’t watched Netflix at all. I used to watch Netflix every day. They seem to be nervous, bombarding me with emails to titillate me into watching. Given that I would lose my current price if I temporarily cancelled Netflix, I am keeping the service. When this changes, I may be more inclined to cancel Netflix and re-subscribe for a few months. Keep in mind, many new Netflix subscribers face no penalty from cancellation.
HBO NOW is just one of the many competitors challenging Netflix. As more competitors enter the fray, Netflix loses the almost-exclusive market they enjoyed. They don’t really compete with Hulu Plus, as the services offer complimentary content. To some degree, this is true of HBO NOW, but the services overlap quite a bit more.
HBO offers original shows that rival Netflix-produced programs. They also offer better movies, although the selection is smaller. The connoisseur viewer may opt for HBO NOW’s high quality programming and cancel Netflix, which may seem inferior. As the collusion between TV providers (cable, satellite), networks and content producers dissolves, more streaming services are entering the market. There is a strong rumor that Apple will launch a complete “cable” channel line-up directly on Apple TV. Many networks are streaming their content, free of charge, to viewers. Netflix isn’t special anymore.
Rate Increases Are Only Acceptable With Better Content
The justification Netflix provides for raising rates is simply ridiculous. The claim that they must raise rates to meet inflation is irrational. The decreasing costs of technology and economies of scale benefits should outweigh inflation’s impact. They should instead promise to increase the quality of their content. They have come a long way in this respect. I used Netflix streaming almost 10 years ago, and the options were paltry and unattractive. The service would go offline in the late evening for maintenance. It was almost as cute as Comedy Central in the early days.
To justify a rate increase, Netflix needs to acquire better content. They need to get the Star Wars movies and other blockbusters. Producing better original content must be a priority. House of Cards is overrated and relies heavily on product placement to increase revenues. The product placement is oppressive and detracts from the narrative. Unfortunately, it is their flagship orignal program. To succeed, they have to get blockbuster movies a few months after they debut in theaters. The need to get popular TV shows the day after they have aired. The problem is that Netflix is not a Hollywood-friendly business. They are a Silicon Valley corporation. They are outsiders trying to assemble their own entertainment vertical. Corporations like Apple and HBO can dance circles around Netflix when it comes to negotiating content deals. HBO offers better original programming.
The only certainty is that Netflix will raise rates for long-time subscribers starting next year. It remains unclear whether the streaming giant will be able to out-negotiate bigger players. Loyal viewers may grow tired of Netflix and move on to greener pastures.
I haven’t watched Netflix in weeks. I don’t cancel because I am hedged into a low rate. When this changes, I can see cancelling Netflix and signing up for just a few months. There are new and exciting options every day. This is the year of the cord-cutter. HBO NOW could very well be a Netflix killer. At the very least, it will maim them. Netflix can only raise prices and keep subscribers if they improve their offering. While this is possible, they face a lot of competition. Larger corporations can forge exclusive deals, leading to a decrease in Netflix subscribers over time.