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Rafi Mohammed: Netflix—One of the Biggest Pricing Blunders in Business History

Netflix
CNBC.com
Netflix

In early July, little did Netflix know, but it was about to make one of the biggest pricing blunders in business history. How does one make such a mistake? Take a service that consumers love to relax with and raise prices by 20% - 60%.

Not surprisingly, consumer backlash has been swift, strong, and action-packed.

Social media erupted with stinging criticisms – the emotions expressed akin to discovering a long-trusted friend is taking advantage of you. Forecasting a subscriber base of 25M by the end of its third quarter, Netflix has since downwardly revised this estimate to 24M. Expect more losses when long-time customers receive their newly inflated bill and opt for rival services such as Blockbuster or Redbox. Wall Street has been more vicious; Netflix’s stock is down 56% since its price increase announcement .

So what should Netflix do now? Offer an apology “with meat.” Sure, Reed Hastings, Netflix’s CEO, apologized but he omitted a key component of a business apology – the giveback. Mr. Hastings needs to learn from Steve Jobs. In 2007, 68 days after the introduction of the iPhone, Apple lowered its price by $200. Facing a barrage of outrage - much like Netflix experienced - Apple handled the situation with grace. Within 24 hours of the price hike, Mr. Jobs apologized and offered a $100 Apple credit giveback to those who bought at the peak. The anger subsided and all was quickly forgiven.

Here’s how Netflix should apologize: rollback prices to pre-meltdown levels and guarantee a six month price freeze for all current customers as well as those who sign up by October 31. Also make clear that prices will increase on November 1. This apology has meat as well as potential upside. First, it creates a public relations opportunity that can transform a fiasco into increased growth. Disgruntled customers will likely accept the mea culpa and return. More importantly, with high awareness of Netflix, new customers will flock to the service before the price hike. Second, it seeds the idea that prices will increase in the future.

While the Netflix’s future may be digital - as opposed to shipping physical DVDs - it’s important to note that these offerings are not good substitutes today. Netflix’s streaming library contains roughly 20,000 mostly older titles compared to its DVD collection of over 100,000 titles. If you want the latest premium content, you have to watch the DVD.

The bigger challenge facing Netflix is its future pricing strategy; will “unlimited” work for a comprehensive streaming library? I don’t think so. First, with the convenience of streaming, people are going to watch more content – which ultimately increases Netflix’s costs due to higher payments to content providers. That said, the real question is will Netflix be able to procure new premium content for an “unlimited” service. The incentive to purchase DVDs – cash cows for studios – will diminish if potential buyers know they can watch their favorite movies and television shows at will with an unlimited Netflix streaming package. I believe new/premium content providers will balk at being included in an unlimited package or alternatively charge high per-view royalty prices.

Given these new costs, it’s inevitable that Netflix will turn to one of three digital pricing strategies:

  • Unlimited catalog content plus pay-per-view for premium content.
  • Unlimited tiers: Good (catalog – low price), Better (catalog plus – higher price), Best (all catalog plus premium content – highest price).
  • Cell phone-like pricing packages. Customers can choose from a range of monthly packages containing a set number of catalog and premium content views.

Netflix’s pricing snafu is a growing pain in its transformation into a digital company. It needs to, and can, make amends with customers today. The key question is will it be dominant in the digital content provider domain? Netflix loses two of its key advantages in this arena:(1) infrastructure and (2) cheap unlimited pricing. For DVD distribution, Netflix’s physical infrastructure provides a hard-to-replicate sustainable advantage. In contrast, barriers to entry are low for digital content delivery – there will be many healthy competitors. Finally, it’s likely that the key pricing strategy consumers love about Netflix’s service – unlimited at a low price –will not be feasible in the digital media world.

Rafi Mohammed is author of "The 1% Windfall: How Successful Companies Use Price to Profit and Grow" and has been working on pricing issues for the last 20 years. He is the founder of Culture of Profit LLC, a Cambridge, Massachusetts-based company that consults with businesses to help develop and improve their pricing strategy. He also holds the title of Batten Fellow at the University of Virginia's Darden Graduate School of Business (in residence, Spring 2001). A frequent commentator on pricing issues to the print media, Rafi has also made prime time appearances on CNBC as an expert pricing commentator.