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Internet television and movie streaming giant Netflix (NASDAQ: NFLX) ruffled some feathers when it announced another price hike. Starting in May, longtime Netflix subscribers will pay $9.99 for the high-definition version of the service.
Longtime subscribers, who since October had been grandfathered in and thus spared the Netflix price increase, aren’t likely to be pleased with the news.
From a business perspective though, it makes perfect sense for Netflix to raise prices. In fact, subscribers might as well get used to it, because it probably won’t be too long before the company hikes prices once again. Here’s why.
Focus on US Profitability
Netflix has two separate objectives right now according to its geographic regions. In the international markets, the focus is first and foremost on subscriber growth. Netflix is still relatively new to international markets, and the No. 1 job there is racking up as many subscribers as possible.
Netflix launched in Japan last September, and launched in Spain, Portugal and Italy the following month. In January 2016, the company announced its intention to launch in 130 additional countries – essentially everywhere except China.
The company added 4.04 million international subscribers in the fourth quarter. But Netflix also lost $109 million in its international business last quarter – much wider than the $79 million lost in the fourth quarter of 2014.
Such strong international subscriber growth propelled the company to a record 5.59 million member additions in the fourth quarter of 2015. Netflix can accept losses right now in the international markets as it invests in subscriber growth. But that won’t last forever – just look at the U.S. as an example of what to expect from Netflix going forward.
In the U.S., membership additions actually slowed in the fourth quarter to 1.5 million, down from 1.9 million new subscribers in the fourth quarter of 2014.
Netflix’s growth in U.S. subscribers has declined over the past several quarters. This was inevitable; at this point, most people in the U.S. who want Netflix probably already have it. Sooner or later, the international markets will get to the same point – and when that happens, the task will be increasing profitability there, just as it is here.
Despite the fact that subscriber growth slowed in the U.S. in the fourth quarter, Netflix expanded its profit margin on U.S. customers by more than six percentage points year-over-year.
The first way to increase profitability would be to grow subscribers, but the trajectory of Netflix’s domestic subscriber growth is down. The logical next step is to raise prices to keep expanding margins, and that’s exactly what Netflix plans to do.
Why Is Netflix Raising Prices? Because It Can.
Normally, a company would have to think long and hard about raising monthly prices by 25% for its longstanding customers. But Netflix isn’t a run-of-the-mill company. It’s disrupting the television industry and has attracted a loyal fan base for its vast library of television shows and movies.
Netflix understands that it isn’t likely to lose many subscribers by raising prices by a measly $2 per month. Even if customers are frustrated with the price increase – and many have taken to social media to express their displeasure – the majority aren’t going to leave.
This is called pricing power, and Netflix has a lot of it.
The reason is because even with the price hike, Netflix is still a compelling value proposition in comparison to the available alternatives. Netflix helped spark the cord-cutting phenomenon because it is far cheaper than expensive cable packages.
And Netflix still has fairly little to worry about in terms of competition. Sure, there is rival streaming service Hulu, but Netflix is fending off Hulu effectively – at least for the time being – with original content such as its hit shows “House of Cards” and “Orange Is the New Black.”
Nobody likes paying more for services, but U.S. subscribers shouldn’t feel too badly. Their international counterparts will soon be paying more as well. It’s only a matter of time before Netflix’s international strategy mimics its current domestic strategy.
In the meantime, U.S. subscribers might as well get used to the higher price. In fact, Netflix is likely to pass along another price increase, perhaps to $12 a month in a year or two, in order to keep profits growing as subscriber growth plateaus.
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