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:
Once I get my queue ramped up, I can theoretically get a new movie every day.
|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.”
Customer support: Hey, guys, I’m getting calls about this discount. Other people want it, too. Um, anybody there?