Netflix Quietly Perfected Their Pricing. Here’s What You Can Learn.
Editor’s Note: This article was first published on January 25, 2018.
You know the story. Back in 2011, Netflix restructured their pricing in a big way. They unbundled streaming plans from the traditional DVD-by-mail business, increasing the price of the combined offering from $10 a month to $16 a month. And they rebranded their DVD-by-mail business to Qwikster.
The public reaction was staggeringly negative. Netflix lost a whopping 800,000 subscribers in Q3 2011. Their stock price plummeted immediately following their Q3 2011 earnings release. Over the course of four months, Netflix’s stock price dropped by almost 80% compared to July 2011. In the chart below, you can see the painful progression (courtesy of Yahoo! Finance).
When asked about the 2011 price change, Netflix’s CEO Reed Hastings said he wasn’t sure if the company had run customer focus groups before announcing the new plans. And, if they had run focus groups, he wasn’t sure what those focus groups had said. All of this uncertainty didn’t instill much confidence…
Fast forward to present day. In October of 2017, Netflix announced another pricing change. They raised the price of their core Standard plan from $9.99 per month to $10.99 per month. This change crossed a critical threshold in the minds of consumers and create a sizable gap in price between Netflix and Hulu Plus (which rings in at $7.99 a month).
With this new change, Netflix announced that existing customers would be automatically migrated into new plans – a move in stark contrast to a 2014 pricing change that grandfathered in existing customers, allowing them to keep lower prices for two years before being migrated to the newer, more expensive plans.
Given the company’s fraught history with pricing, I could not wait to hear how the 2017 pricing changes are impacting Netflix’s bottom line went. On Monday, January 22, Netflix announced the results in their Q4 2017 earnings.
By all measures, colossal success. Subscriber growth was not hurt by the pricing increase whatsoever. In fact, Netflix added 2 million new streaming subscribers in the US and 6.4 million overseas, 33% more than what Wall Street analysts had forecast. Both new and existing customers happily swallowed the price increase, which lifted Netflix’s revenue by 35% (faster than their 25% growth in average paid streaming memberships).
When asked about the impact of the price increase, CEO Reed Hastings told analysts, “We saw very little effect on sign ups and growth [from the price increase] and thus, the really strong results.” #Humblebrag.
With more subscribers, and with all subscribers now paying 10% more on average, Netflix saw a massive increase in profits. Operating income jumped to $245M, up from $154M the previous year. (Sidenote: Even very small pricing increases can have an outsized impact on a company’s profitability. You can read more about that here.)
You can guess what happened to Netflix’s stock price. It soared.
If it worked once, why not double down?
Netflix could have taken their pricing windfall and called it a day. It would seem prudent to avoid rocking the boat knowing that the competitive landscape was about to get tougher as consumers would now have the choice of new streaming services from Apple, Disney, CBS, YouTube and many others. But if it worked once, why not try again?
The resounding success of their 2017 pricing increase gave Netflix the conviction that they had not yet reached a ceiling on price, the point at which price becomes an impediment to subscriber growth. They still had room to try their luck again. In January 2019 the company announced higher pricing for each of their plans, which represented the largest price increase in the company’s history according to Variety. With these changes, Basic would go up to $8.99 per month (+13%), Standard would jolt to $12.99 (+18%) and Premium would go to $15.99 (+14%). The plans themselves remained exactly the same as they were in 2017 (see below).
This again turned out to be a major win for the streaming giant. The price increase announcement had an immediate positive impact on the stock price (the headline in CNBC was “Netflix raised prices and the stock soared”). In the company’s first quarterly earnings call after the price increase, CFO Spencer Neumann indicated that churn levels were very consistent with the 2017 pricing increase despite the fact that this one was much more significant and even impacted the Basic plan. Furthermore, the company reported that it beat expectations on both domestic and international paid subscriber additions (9.6 million versus a forecast of 8.9 million).
All of this translates to a massive impact on the bottom line. Let’s do some quick math. If we assume the company has 60 million US subscribers who will now pay $1 more per month and that pricing hasn’t impacted churn or subscriber growth, that means a jaw-dropping $720 million increase in annual revenue. All of that extra revenue is pure profit – it doesn’t require new investments in content or hosting or marketing or sales. Given that the company made $1.2 billion in net income in 2018, this 13% increase in revenue per customer actually means a 60% increase in profitability. Not too bad for a dollar meal sized price increase.
What you can learn from Netflix’s pricing strategy
There are a number of lessons SaaS companies should take away from Netflix’s successful 2017 and 2019 pricing changes, as well as from their epic 2011 fail. Here are my top five:
1. Pricing is critically important
How many business decisions can send your stock price spiraling down by 80% one year and then rocketing up another? The Netflix case proves that pricing changes can make or break a business, and therefore it’s important to invest in making the right pricing decisions. It also reinforces that even small changes in pricing can add up to major improvements in a company’s profitability.
2. Don’t let one mistake stop you from touching pricing again
After the Qwikster disaster of 2011, Netflix could have decided that they were never going to touch pricing again. They did, in fact, leave pricing alone until 2014. But over time, Netflix collected evidence that they had an opportunity to revisit pricing in a more thoughtful way. When they were ready to do so in 2014, Netflix took a conservative approach to mitigate the risk of another backlash. The success of their 2014 pricing change gave Netflix the confidence to take a more aggressive approach the next time around and then an even more aggressive approach in 2019.
3. Pricing power comes down to value and customer satisfaction
In their Q4 2017 earnings call, Netflix’s CEO Reed Hastings was asked if he had plans for future price increases. His response perfectly summed up a value-based pricing philosophy. With a value-based approach, pricing power is an output that you can measure based on how much value you deliver to customers relative to alternatives on the market. It’s not a best guess, a snap decision, or an input based on a company’s cost structure.
“I think it’s a tricky thing because it really has to be a reflection of the underlying quality of the experience on a relative basis. So, as long as we’re able to continue to improve our content and our whole experience at a remarkable rate…then asking our customers to help us fund that at higher levels is reasonable. But if we weren’t gaining relative value for the customers, then we wouldn’t be changing prices.”
– Reed Hastings
4. Communicate pricing changes at the right time
One reason why Netflix’s pricing change went over so smoothly was the timing. The 2017 price increase coincided with the launch of amazing new original content, including new seasons of popular series like Stranger Things and The Crown (which I both highly recommend) and the debut of a big budget action film starring Will Smith (Bright). Other companies should similarly launch pricing increases when they can tie those increases back to improvements in customer value, for instance through new product launches, increases in NPS, new partnerships, or better analytics.
5. Present your customers with choices
Finally, customers respond better to pricing increases when they have options. And that’s true even if the options aren’t all that great. In Netflix’s case, while they increased the price of their Standard plan, they kept their entry-level Basic plan at $7.99 per month. A budget-conscious customer could by all means downgrade if they could not afford Netflix’s price increase. Doing so would mean giving up a lot – no more HD streaming and only 1 concurrent device. Still, having a choice makes the customer feel in control, and makes it easier for them to swallow a price increase.
What have you learned from Netflix’s pricing strategy? Let us know in the comments or tweet to @poyark or @OpenViewVenture.