Wednesday, July 13, 2011

Netflix's Recent Pricing Change

I believe Netflix's recent decision to change their pricing structure is actually a move that promotes the streaming feature as a top-tier element in their catalog of products they offer to consumers. Initially, streaming was simply a perk you got if you subscribed to your one disc at a time offering. I am sure this was integral to helping spur customer adoption of the service. Equally beneficial was their AOL like partnership drive to embed a Netflix player in every conceivable consumer electronic device possible - Computers, iPhones, iPads, connected TVs, DVD/Blu Ray players, Wii, PS3, XBox, etc.

Once they had a number of people using the product, they started to hear requests from people who are ONLY interested in the streaming product (I'm one of them). Those customers wanted a cheaper option where they didn't have to pay for the option of getting a disc in the mail. Netflix, being the customer-focused company they are, listened to their customers and made one available. And it was cheaper (by a buck) because Netflix no longer had to send out DVDs.

The big question is WHY are they doing this? Is it because they have to or because they want to? Personally, I think it is because they want to and their ultimate goal is to kill off the desire to get physical DVDs in the mail. Not because they're losing money - but because the margins on streaming only are so much better - like thirty-three times better. Netflix was launched in 1997 and has been profitable since 2003.

Let's follow the money.

After doing a little research back in 2010, it cost Netflix $0.015 per gigabyte to stream a movie. Assuming a typical movie is about 1.8 GB in size, this works out to a cost of about 2.7 cents. Netflix had negotiated a special deal with the United States Postal Service which allowed them to use their specially designed mailers and qualify for the standard 1 ounce postage rate - $0.44 per mailing. So the cost associated with distributing a physical movie to a customer is $0.88.

Netflix ships discs Monday through Friday. This works out to an average of 21 2/3 shipping days per month (52 weeks * 5 days / 12 months). Shipping a disc to you and then back is going to take 2 days. If you assume Netflix sends the next disc in your queue to you on the same day they receive a disc from you, you will only get 7 DVDs per month. If they ship it to you the next day, then you're down to 5 DVDs a month.

For a given month, if a single disc subscriber watches the movie the day/night they get the disc and return it the next day, Netflix will pay $6.16 in postage to deliver (and receive back) 7 DVDs. $4.40 in postage at the 5 DVDs a month rate. Contrast that to 13.5 cents for streaming five movies or 18.9 cents for seven movies. Streaming looks better from a cost perspective, eh? Consider the fact that streaming has absolutely none of the other costs associated with physical DVDs - the mailers, warehousing, receiving and sending out DVDs.

At the end of the day, I think Netflix ultimately wants all of their customers to switch to streaming consumption and one of the best ways to do that is to make it the cheapest option. If you want streaming AND physical DVD distribution, then it is going to cost you twice as much. Some will pony up the extra dough. Many, I predict, will pick one option or the other. I bet streaming will win because theoretically, you can get a lot more value for your money because you don't have to wait for the physical discs.

It is funny to listen to the posturing from Hollywood and industry pundits at how they allude to the possibility that Netflix will lose access to the content it currently serves. According to NPD's VideoWatch Digital tracking service, in January and Feburary of this year 61% of the movies that were downloaded or streamed from Netflix. The next closest competitor was Comcast at 8% followed by a three-way tie for third at 4% between Apple, DirectTV and Time Warner Cable. When the contracts between content providers and Netflix come up for renewal, I would be willing to bet the content providers are going to get some more money for their wares. However, there is no way they'll pull their content because digital distribution is the future and Netflix is the 800lb Gorilla. Does anyone seriously think the content providers will get a better deal from Amazon or Apple? NBC Universal was unhappy with the deal they were getting with iTunes distribution and they pulled their content. Their digital sales flatlined and guess what you can buy/rent now on iTunes? I am an outsider, but in that little scuffle I'd say NBC Universal came back with their tail between their legs - making some money is better than making no money.

Netflix provides a great service to their customers. They offer DVD and HD quality streaming. They realize the DVD is "dead". Blu-Ray still has a little life in it, but let's revisit that after the iTunes juggernaught starts offering 1080p content this fall.

For the above numbers, have a look at the following articles:

"Netflix too big to fail?" entry on the I, Cringely blog

"GameFly to USPS: higher postange than Netflix costs us $730k per month" - ARS Technica

Netflix Fee Calculator