Aside

Netflix Pricing: What Not To Do

Netflix, a service whose adoption rate has been growing at astounding rate of 3.6M users a quarter, has changed the way we watch shows and movies at home. They are one of the most successful tech firms started in the late 90s. Just think of some of their dot.com competitors: Excite, Kosmo, and Webvan and where are they now? Dead. But not Netflix. They invented a category that in 2008 was still being scrutinized by analysts. But they’ve clearly overcome a lot of obstacles. In fact, Blockbuster’s bankruptcy is largely credited to Netflix. This company has chops.

Yesterday, Netflix boosted its prices by an amazing 60%. Now in net dollars, it wasn’t that much money as the new pricing is still 20ish dollars, and some people will actually go down in fees if they line one type of delivery over the other. But context really matters. This pricing move came in a crappy economy; the US has nearly 10% unemployment and a consistently skittish stock market. The stories of average people holding two jobs to cover health care, and such are consistently dominating our news cycles. Not surprisingly, an outcry started immediately, reaching the maximum of 5000 comments on their blog. Even as I was writing this post, I had a search open for #DearNetflix and 250 new tweets arrived in 10 minutes. (I should point out only 1 of the 250 was positive/neutral; the other 249 were all talking of the Netflix Fail.)

As pricing strategies go, Netflix did 4 things wrong:

The Takeaway. Internet video streaming started at no additional charge with Netflix’s regular subscription service. Which given how it was rolled out, positioned it as effectively “free”. That let consumers deal with the fact that only a portion of Netflix’s content was available via the “Watch Instantly” option. It had a rather bumpy introduction. But what was more important? Customers were not told it was going to cost more, so expectations were not set. Streaming seemed like it was “included” in the base price. In retrospect, Netflix could have done this better. Perhaps they would have write something to their base to say:

Thank you for always being pioneers with us. We’re trying something new and we’d like to share it with you. We’re gifting this to you at no extra charge. Let us know what you think, and how it works. We know one day we’ll have to raise prices cause this is a big increase for our costs, etc. But for now, it’s a gift for our loyal customers, and we hope you like it enough to recommend more Netflix to more of your friends.

Whenever you raise prices, you want to add something to the offer, not take something away. Do a bundle of suites rather than raise each individual price point. Add features. Provide templates. The combination of not setting expectations and then doing this move is key to the flam-o-rama online.

Second, don’t raise prices on a less-than-awesome product. Delivery service is poor, the CD quality is random, and my none-too-statistical polling today would say 1/3 of streaming experiences with the Netflix service is less than awesome. Fix things before you raise prices. You want people to say “yeah, that price increase sucks, but man, I got it bad for Netflix. But instead, there were a ton of tweets like this one.

3rd Mistake: Wrong Pricing Strategy for Stage of Adoption. I’ve done pricing now over 20 years, first at Apple (they had a killer good/better/best play), through Autodesk years, for Adobe and so on. I’ve come to see only 3 relevant pricing strategies. I wont’ dig deeper  into the details but here’s the thing: the one Netflix pulled is what you do after a company has arrived. You can jack prices when you have the category well established and you are – by far – the category leader. It’s what you do when there are few alternatives. It’s what you do after you own 85% marketshare. It’s what you do if everything is built around your standards. But this is not the move to pull at 7% market share of users. No, No, No. You don’t “revenue optimize” as Netflix just did at 7% market share; instead, you price to drive share growth. Netflix should be finding a way to get to every household at one price point or another. At 23 Million subscribers, Netflix still has to beat down the entrenched player of Cable, and make sure other entrants (i.e. redbox and especially iTunes) don’t come in and take disruptive position. If you believe you’re market saturated, then it’s fine to raise prices. Somehow, I don’t think that’s the message Netflix is aiming for.

Lack of Empathy. That’s surely the fourth thing they got wrong. And that‘s really what is behind most of the outrage. It wasn’t just that the price went up, it’s that the tone of the communication was so matter of fact about it. I find this to perfectly understandable. Netflix product managers are probably sitting in their cubicles and thinking customers aren’t going to like what they’re about to say, so they work really hard at just not being defensive. But this is when we businesses can (and dare I say, should?) be human. In fact, this is when it works to your advantage to show your humanness. When you have to make a tough choice, which this clearly is, it’s totally cool to say “this was tough, as we know that we’ve been offering a great value and now we have to change things”.  I would have had Netflix say something like:

To grow what we can offer and make sure we get our library of video content even better, we started paying a lot of content producers, a lot of money. We need to do this price increase because it’ll help us get you the best content, and make your Friday evenings that much more enjoyable. And while we know that no change is easy, we hope one of these options will work for you cause, we love having you as a customer. One thing we’re doing to help with the transition is to leave pricing as is for our existing customers until 2012.

This pricing move is not unexpected. In November, it was released that Netflix is now a “primarily a video-streaming company”. Then, Reed Hastings just as much said he was going to have to do a price rise at the All Things D conference. But they got a few things wrong in the roll-out.

Well, what do you think about their pricing strategy? And what you would recommend they have done differently?

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16 Responses:

  1. David Kay. July 14, 2011 at 12:17 am  |  

    Nilofer -

    This is a very thoughtful and clear analysis. Thanks! Good traps to avoid.

    dbk

    Reply
    • Nilofer Merchant. July 14, 2011 at 12:52 am  |  

      Thanks David. I wondered if the positioning would have been better received if it was sharing that they want people to move to streaming. That’s actually the deal, right? Maybe they should have owned that more?

      Reply
  2. Sumit. July 14, 2011 at 2:53 am  |  

    I think I can vaguely guess Netflix’s thinking behind the abrupt rise. Actually if you remember it’s a two step rise. Few months back they introduced the streaming only plan and increased the minimum plan by a couple of dollars if you wanted your one DVD out plan. At the time I was a 1DVD+Streaming customer. I ignored the price rise and continued with the plan thus paying a couple of bucks more for the rare DVDs we ordered.
    Today I cancelled the DVD option all together.
    I don’t have cable and my son is a Netflix hog (he’s the one who watches TV the most at home). For me not having DVD is no big deal, you always have Redbox for the occasional movie nights, or Amazon Video.

    I don’t really know how much money they will be winning or losing from subscription losses, but I am guessing the pricing has more underlying content deals for the future and all that is going to be towards streaming not DVD.

    But your case here does make an interesting reading for a marketing/pricing noob like me. Thanks,
    Sumit.

    Reply
    • Nilofer Merchant. July 14, 2011 at 2:54 pm  |  

      It may very well create the right shift in usage to move folks off of DVDs. In that case, brilliant pricing move. What I’m more worried about is customer churn. Their filings show that in order for Netflix to get to their 23M households today, they’ve churned through 30M+ other households. That’s a very high churn rate for a company that could be ubiquitous.

      Reply
  3. Tim Lenz. July 14, 2011 at 3:09 am  |  

    Well said, Nilofer. Even though I’m a long-time Netflix customer and know and like several Netflix executives, the first thing I thought when getting their price increase notice was that it’s time to drop the physical media delivery.

    And I think that actually might be at the heart of this move by Netflix – it’s a way to significantly modify their existing customer delivery preference to all streaming. A way for Netflix to move away from physical media.

    But, as you so eloquently said, they could have communicated the message much better.

    Reply
    • Nilofer Merchant. July 14, 2011 at 2:55 pm  |  

      So funny how much the “social” stuff matters, right? They’ll rebound. As you said, great company and strong leaders.

      Reply
  4. dusanmal. July 14, 2011 at 3:39 am  |  

    Probably the best analysis of this problem I have seen.
    One thing that you should have added after “Internet video streaming started at no additional charge with Netflix’s regular subscription service. Which given how it was rolled out, positioned it as effectively “free”” is the quote from Netflix related to the price hike “Given the long life we think DVDs by mail will have, treating DVDs as a $2 add on to our unlimited streaming plan neither makes great financial sense nor satisfies people who just want DVDs.”
    That “redirection” mindset is what is bothering me the most. From customer viewpoint we have signed for DVDs by mail at certain price, got free streaming for a while and when streaming became tolerable (late last year) our price for combined service went up, somewhat reasonably. Never in this process did I, the customer notice a drop in my DVD-by-mail price to 2$…

    I think Netflix is also delusional about the consequences of this decision. Many people think that they want to focus customers to streaming by this move. I don’t think that was the plan. I think that this move exactly mirrors long known Cable TV companies behavior of ratcheting prices up for more or less same service. I believe that Netflix wants customers to adopt both services and pay more in total, by inertia. I also believe that the result will be exactly opposite (looking at many comments on the issue and my own decision): people will split and take only the service they value more (some streaming, some DVDs). Net result, strangely mirroring current politics is less total revenue from the move intended to charge customers more in order to grow revenue. Market economy 101.

    Reply
  5. Steve. July 14, 2011 at 3:55 am  |  

    Great analysis, Nilofer, and it is indeed the lack of empathy that I (and I think most people) found appalling. I’ve read that mail about a dozen times now and still can’t believe they sent it to me as a customer. I don’t have the expertise to comment on the wisdom of the pricing strategy, but I can tell you that it was not the message, but how it was communicated (and I use “communicated” very loosely here given the incompetence of that mail), from the subject line, to the lack of any kind of salutation and introduction. It’s not that they priced customers out of their product, it’s that they alienated them from their brand by not being human, as you well point out.

    Reply
  6. gregorylent. July 14, 2011 at 4:43 am  |  

    stock price is substantially up .. makes the company more valuable .. customer numbers probably showing no decline on volume …

    can’t see the problem ..

    practical business decision handled ok

    the narrative in the second paragraph, the set-up for the article, seems to have a bit too much woe-is-me for truly progressive problem-solving or thinking .. my god, no one would start a businesss, let alone raise prices, burdened with those concepts

    Reply
    • Nilofer Merchant. July 14, 2011 at 2:59 pm  |  

      Gregory:

      I’m sorry it came across that way and appreciate the feedback. I’ve raised prices in good times and in bad and I’ll definitely say that that context matters for what is in the mind of the consumer. That’s why I spent some energy on it.

      Pricing has a great deal to do with behavioral economics, which is also what I studied for my undergrad degree. If you don’t understand context, you often get it wrong cause you assume the pricing move is all about “you” rather than about “the consumer”.

      One thing Netflix could have used was movie ticket pricing as an anchor. Movie tickets are now $10 bucks in my neck of the woods so an evening out for our family costs a lot. They should have positioned (i.e. anchored) their new pricing against that alternative to solve the Friday evening problem for lots of families.

      Down economies are actually great times to start businesses; you can pick up great talent, cost of capital is low, etc.

      Reply
      • gregorylent. July 14, 2011 at 4:44 pm  |  

        felix salmon on why they did it, good insight http://felixsalmon.tumblr.com/post/7616264985/what-netflix-isnt-saying

        Reply
        • Nilofer Merchant. July 14, 2011 at 4:46 pm  |  

          Very good insight. Thanks for sharing it.

          Reply
        • Sumit. July 15, 2011 at 8:04 pm  |  

          I guessed as much, it’s got to do something with content providers’ arm twisting!!!
          The way Felix puts it, I am glad they did it and I would gladly give up my DVD rights to continue having ad free Television viewing experience…

          Reply
  7. Zorro for the Common Good. July 15, 2011 at 8:34 pm  |  

    Personally, I think they should have grandfathered in current subscribers. Presumably Netflix plans to grow its subscriber base many times over. So why not reward their most loyal customers?

    A somewhat analogous situation occurred last year with AT&T Wireless. They knew they needed to start migrating customers (especially iPhone users) off of unlimited bandwidth. So first they stopped offering unlimited plans to new customers. Then they went to their existing customers and told them they could get a price break if they moved to a capped plan, or they could continue using their unlimited plan (but if they switched, they wouldn’t be able to go back). They were very transparent about why they were doing it, and no one came out of the deal feeling like they were getting screwed. I myself hung on to my unlimited plan, figuring bandwidth needs were only going to keep going up, but the way they handled it allowed me to make that decision for myself.

    By not offering existing customers any benefit (other than a two-month grace period), and by then trying to spin it as a positive development, Netflix burned through a lot of goodwill.

    Reply

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