Netflix price hikes won't hurt subscriber growth

Nicole Sinclair
Markets Correspondent

Netflix (NFLX) confirmed reports on Thursday that it will be raising prices again this fall. And while the company’s past price increase announcements were met with investor skepticism, the stock rose sharply on the latest price hike news.

This reaction suggests the company may have turned a corner on managing expectations and retaining core customers, strengthening its positioning going forward.

In fact, co-founder and CEO Reed Hastings has learned his lesson when it comes to managing customer and investor expectations. The most significant lesson: make changes more gradually, or risk alienating customers and investors.

In July 2011, Netflix announced it would separate DVDs and streaming, costing subscribers $7.99 a month each, or $15.98 for both. This represented a 60% price hike for members who wanted access to both. (At the time, Netflix’s streaming library was less extensive, with still high interest in DVDs). In the end, the significant price hike and the later, then-aborted effort to spin off its DVD unit was not well-received by customers. The stock fell over 75% by the end of the year and the company lost almost 1 million subscribers.

As the company worked its way back, Hastings has managed pricing changes carefully. In fact, the price hikes in May of 2014 and October of 2015 were more muted and allowed for a “grandfathering” period where existing subscribers could pay the original lower rate until 2016.

And, the company also introduced a new “basic” plan in 2014 that has not changed from $7.99 per month to accommodate the most price-sensitive customers.

In other words, the 2011 debacle allowed Hastings to better manage customer demand and price elasticity, according to analysts. That, plus content development, better-positions the company.

Original content—including “Stranger Things,” “The Crown,” “House of Cards,” “Master of None,” “Unbreakable Kimmy Schmidt,” and “Orange is the New Black”—has continued to retain customers and attract new ones. In fact, in the company’s second quarter report, it saw an increase of over 5 million subscribers, bringing the company to 104 million subscribers worldwide.

RBC’s Mark Mahaney said that survey work over the years indicates that content, not price, is the leading churn/churn-back factor among Netflix subscribers.

“We believe that Netflix’s pricing power has increased materially over the past few years as their content slate and technology has improved,” according to Mahaney. “Therefore, we believe that this price increase will likely be a revenue growth catalyst for the company.”

At this point, price increases with a sticky customer base should be a positive for the company and the stock, particularly as it invests more in originals. (The company said it would spend $6 billion on content this year).

Per RBC, the price increases could lead to $650 million increase in domestic revenue in 2018 and increase domestic revenue growth from 15% to 25% for that year, causing overall revenue growth to rise from 22% to 28% in 2018.

“Higher prices = higher revenue growth….THIS is what is causing Netflix’s stock to rise,” Mahaney said.

Nicole Sinclair is markets correspondent at Yahoo Finance

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