Value of Netflix

Netflix recently announced increases to their monthly membership fees.

Their standard plan lets you check out 3 movies at-a-time. It increased 10% to $21.95. Director
Mitch, who recently joined Netflix, upgraded to the five movies out-at-a-time package. It’s increasing 13% to $33.99 — a very odd number IMO.
After the announcement, Netflix’s stock decreased 17% and some in the press
had suggested that it was related to the price increase. Well, the drop also
had to do with the operating loss, and quite frankly, the stock is overvalued.
When I started writing this, their P/E ratio was at an astronomical 822. They’re even more overpriced than my favorite retail company at 587 P/E.

Netflix’s business is essentially a fulfillment service. You place an order on the web site, a DVD is scanned and put in the mail. When you return it, it’s scanned again and sent off to its next destination. No retail stores. Simplified inventory control. Established distribution channel (USPS). No bleeping tapes to rewind or get “accidentally” recorded over. What’s not to love?

Their pricing is a tiered, flat-fee system, which presents an interesting twist because it’s in Netflix’s best interest if you subscribe, but don’t use their service too much. For example, suppose it costs them $.50 each time you check out a movie. (These costs include: postage both ways, an envelope, and scanning. Not included are cost of the media, handlers for the volume, which should be proportional in some way, or content on the web site.) If the average person checks out 7 movies a month, that’s $3.50 in variable costs. Or, looked at another way, that’s about $2.80 revenue per rental. Last time I went to Blockbuster, they were charging about $4.00 for a rental. (Yes, I know it’s not directly comparable since Blockbuster is a retail store.)
If Netflix has happy customers who rent more often: variable expenses increase and margin decreases.

Because I can’t sleep,
am on my
summer ‘Flix hiatus
, I was interested in quantifying this a little better with me as a use case.
For the six month period from October through March, I rented 72 movies, or 12 movies per month. This works out to about $1.66 plus sales tax per movie:

6 months * $19.95 / month / 72 movies = $1.66

My prior rental period, January – April 2003, was comparable: 46 movies, or $1.73/movie. Factoring in sales tax and the price increase, I’m spending about $2.00 per movie.

Given that I can have three out at a time, I was initially surprised that I rented fewer than three movies per week:

72 movies / 26 weeks = 2.7 movies/week.

Ignoring any implications this has on my winter social patterns, let’s assume a movie available in the Tacoma distribution center. The simplest pattern looks something like this:

  • Day 1: Movie ships from Netflix.
  • Day 2: I receive the movie and watch it that evening.
  • Day 3: Movie put in mail.
  • Day 4: Movie received at Netflix.
  • Day 4 or 5: The movie in my queue goes out.
  • Once I get my queue ramped up, I can theoretically get a new movie every day.

    Day:123456
    Movie
    1L1A1M1
    2L2A2M2
    3L3A3M3
    4L4A4M4
    L = leaves ‘flix, A = arrives my place, M = mailed back

    Except… that Sundays are a postal holiday, meaning my queue gets delayed a full day at least four times a month. No problem, I can still churn through a theoretical 26 movies per month. This is the worst case for Netflix, but it doesn’t happen very often.

    Occasionally, through “natural causes,” the mail isn’t this efficient and a movie takes a day longer. This happens a third of the time at either the checkout or return side of the transaction. Because our pipeline was “full,” the net result of a day’s delay in the mail is one fewer movie per month. So, this gets us down to about 20 movies per month, which is still a lot.

    Now, in the event that USPS is performing too well, Netflix has another option: internally delay the movie a day. I don’t know that they officially do this, but it wouldn’t surprise me in the least that a movie might “need to be fulfilled by the Cut-and-Shoot, TX facility” every once in a while (nudge, nudge) or the “returned movie came in after we shipped movies out for the day” (wink, wink). It really doesn’t matter because if I really wanted to maintain the pace of movies, I’d upgrade to their next plan.

    So now Netflix has some comptetion from WalMart and Blockbuster. WalMart’s obvious claim is cheaper price — they have more clout with vendors and an existing, highly profitable distribution “network” in the stores. DVD rental is commoditized and the teeming masses will buy based on price.
    Meanwhile, Netflix is losing money and compensates by increasing their subscription price. This is a double whammy because it will piss off some existing subscribers and defer some new subcribers to WalMart.

    An interesting theoretical “solution” to this is to have double-secret pricing whereby if a customer threatens to cancel, they suddenly grandfather the subscription for a few more months. The conversation would go like this:

    (Borrowing heavily from Kuro5hin)
    Marketing: Let’s raise our prices!
    Sales: Um, WalMart is undercutting us 25%.
    Marketing: But we’ve got selection. Look at all the foreign flicks Carson rents.
    Sales: Most people aren’t Carson. They just want whatever popular here in the U.S.
    Marketing: Okay, how about this. We’ll rig the web site so if a customer tries to cancel, we’ll offer them a lower price and try to keep them.
    Sales: E-x-x-x-x-x-x-xcellent. Let’s go play a round of golf!
    Marketing: (*cough*) You mean “Go off site to strategize.”

    (later)

    Customer support: Hey, guys, I’m getting calls about this discount. Other people want it, too. Um, anybody there?

    9 thoughts on “Value of Netflix”

    1. Netflix also removed their grandfather policy- I’ve been on a grandfathered plan for 3 years now, it’ll be cancelled with the pricing change.

      That was my incentive to stay at a higher level.

    2. We’ve never used Netflix. We simply subscribe to every cable channel known to man in hopes that most of the movies we’re interested in will make it to our television sooner or later.

    3. > Netflix has another option: internally delay
      > the movie a day

      I think this is happening to me.

      One of the reasons I am on the 5-a-time plan is because I am going through the ST:DS9 series (I rarely saw them on TV). I watch 1-2 episodes a night (they’re 45 minutes without commercials), so with “regular” movies and going through a DS9 disk in 2 days, I am churning through the rentals.

      (OT: I just saw the one with Quark’s Cardasian love interest. What would what THAT love child look like?)

      Just this week I returned two DVDs on the same day in the same outgoing mailbox (mine). One was tagged “in” the next day – the usual. The other was tagged in the FOLLOWING day. Got separated in the mail or delayed in house? You decide.

    4. GAMEZNFLIX.COM offers both Games and Movies. They just merged the Games and Movies sites. They have an annual plan for $222…where you get 6 dvds/games out per month. They even give you 2 extra months…that’s $15.72 per month…WOW! Delivery time for me is 2 days. Check it out.

    5. CEO Reed Hastings has said that he wants to increase customer satisfaction by encouraging members to rent alot of discs, even if that seems to reduce Netflix’s margin, because it also reduces customer acquisition costs. However, there is anecdotal evidence to the contrary. I wonder if they’ve reached the point where their growth is so rapid they can afford higher churn.

    6. Thanks for the comments. There are certainly a couple of ways to look at this.

      In the simplest form, more DVD churn == more cost for Netflix. There are two opportunities for generating ripples in the system that essentially reduce the variable costs.

      First, they can ship something from a different center — there’s no cost differential for them. In fact, this may even be done to balance the distribution network with demand. For example, there’s a facility in Tacoma. On average, it takes one day from mailbox to mailbox, thus a video they say is shipping today will most likely arrive tomorrow (or Monday if a weekend). If the video is shipped, say, from New York, it might take three days. It still goes back to Tacoma, but my theoretically perfect queue has lost a couple of movies.

      The U.S. Postal Service could be the “fall guy.” With 9 digit zip codes and volume, the USPS is very efficient. But every once in a while, a government holiday kicks in, or there’s a burp in the system, or something mysterious disrupts the schedule. We can’t really tell, because there’s no tracking, but we can agree that any delays do not hurt Netflix, and may in fact be beneficial.

      Looked at another way, there is negative value for the perception that one cannot have “unlimited videos” per month. Practically speaking, it’s highly unlikely that Neflix’s average customer churns through 20+ videos a month. I’m guessing it’s probably closer to 8, once the novelty wears off. (As an analogy, think of your garden variety wireless plan. Most people buy “400 minutes,” thinking they’ll actually use it, when in fact they use closer to “200 minutes.” If I’m consistently close to 400 minutes, I may bump up to the next plan because the penalties for going over are severe.)

      Without hands-on knowledge of Netflix, it’s purely speculation.

    7. elvis r. campos

      How did u get the “gmail” account?

      Jim responds: A wonderful woman from Brazil invited me.

    8. Netflix’s customer support, quoted in the New York Times (April 7, 2005): “In determining priority for shipping and inventory allocation, we give priority to those members who receive the fewest DVD’s through our service. As a result, those members who receive the most movies may experience next-day shipping and receive movies lower in their Queue more often than our other members. By prioritizing in this way, we help assure a balanced experience for all our members. Those that rent a lot of movies get a great value, and those with lighter viewing habits are able to count on our service to meet their limited needs.”

    9. I know there is some bagging on Netflix here but I have had a great experience with them. I’m on the 5-at-a-time plan for $30 and rent between 17-20 DVDs per month. I guess this makes me a mid to light user for the 5 DVD plan and maybe that exempts me from ‘throttling’ but I consistently get 1 day turnaround from the TX Nextflix dist. center and very rarely get cracked/scratched DVDs. I guess it helps the distribution center is I know there is some bagging on Netflix here but I have had a great experience with them. I’m on the 5-at-a-time plan for $30 and rent between 17-20 DVDs per month. I guess this makes me a mid to light user for the 5 DVD plan and maybe that exempts me from ‘throttling’ but I consistently get 1 day turnaround from the TX Nextflix dist. center and very rarely get cracked/scratched DVDs. I guess it helps the distribution center is I know there is some bagging on Netflix here but I have had a great experience with them. I’m on the 5-at-a-time plan for $30 and rent between 17-20 DVDs per month. I guess this makes me a mid to light user for the 5 DVD plan and maybe that exempts me from ‘throttling’ but I consistently get 1 day turnaround from the TX Nextflix dist. center and very rarely get cracked/scratched DVDs. I guess it helps the distribution center is I know there is some bagging on Netflix here but I have had a great experience with them. I’m on the 5-at-a-time plan for $30 and rent between 17-20 DVDs per month. I guess this makes me a mid to light user for the 5 DVD plan and maybe that exempts me from ‘throttling’ but I consistently get 1 day turnaround from the TX Nextflix dist. center and very rarely get cracked/scratched DVDs. I guess it helps the distribution center is I know there is some bagging on Netflix here but I have had a great experience with them. I’m on the 5-at-a-time plan for $30 and rent between 17-20 DVDs per month. I guess this makes me a mid to light user for the 5 DVD plan and maybe that exempts me from ‘throttling’ but I consistently get 1 day turnaround from the TX Nextflix dist. center and very rarely get cracked/scratched DVDs. I guess it helps the distribution center is I know there is some bagging on Netflix here but I have had a great experience with them. I’m on the 5-at-a-time plan for $30 and rent between 17-20 DVDs per month. I guess this makes me a mid to light user for the 5 DVD plan and maybe that exempts me from ‘throttling’ but I consistently get 1 day turnaround from the TX Nextflix dist. center and very rarely get cracked/scratched DVDs. I guess it helps the distribution center is I know there is some bagging on Netflix here but I have had a great experience with them. I’m on the 5-at-a-time plan for $30 and rent between 17-20 DVDs per month. I guess this makes me a mid to light user for the 5 DVD plan and maybe that exempts me from ‘throttling’ but I consistently get 1 day turnaround from the TX Nextflix dist. center and very rarely get cracked/scratched DVDs. I guess it helps the distribution center is I know there is some bagging on Netflix here but I have had a great experience with them. I’m on the 5-at-a-time plan for $30 and rent between 17-20 DVDs per month. I guess this makes me a mid to light user for the 5 DVD plan and maybe that exempts me from ‘throttling’ but I consistently get 1 day turnaround from the TX Nextflix dist. center and very rarely get cracked/scratched DVDs. I guess it helps the distribution center is

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