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Netflix $2 Rate Increase: The Right Price at the Right Time

Netflix can seemingly do no wrong. But it wasn’t long ago that CEO Reed Hastings made one of the biggest blunders in recent corporate history. Back in 2011, Hastings hiked the price for those who wanted both streaming and DVD rental from $10 to $16, and Netflix lost 200,000 subscribers in six months. It was a disaster, though one from which the company has recovered.

This month, Netflix imposes the first price increase on its existing subscriber base — $2 — since that debacle. This time around, however, the company is doing the right thing for the right reason.

Netflix management proclaimed an ambitious goal last year for its domestic streaming business: hitting 40% margins by 2020. The company’s U.S. streaming contribution margin is one of the most amazingly consistent trend lines in its sector — rising steadily over the last few years — so it seems on track to hit that target on time, or even early.

The key to that climb was raising prices strictly for new subscribers in 2014 and 2015, driving solid increases in average revenue per paying subscriber. These increases have contributed nicely to profits, despite Netflix’s ballooning content costs, which will amount to $5 billion in 2016 alone.

Given the fluctuations in Netflix’s costs from one quarter to another, the impact is best seen on an annual basis. Profit per subscriber has increased from just over $2 in 2012 to more than $3 in 2015, and the first price increase in late 2014 helped expand the margin more significantly for 2015 than for any of the three previous years.

A big part of growing margins has been the economies of scale that come from a rapidly growing subscriber base. From first-quarter 2012 to first-quarter 2016, Netflix doubled its base to 46 million U.S. customers and saw margins grow from 14% to 35%. But as domestic growth cools, the big question is whether the phasing in of the price increase for many subscribers will drive higher churn.

There are several reasons to believe the effect won’t be anything like as dramatic as last time. For one thing, the increase is more modest: 25% versus 60%. Also, the value of a Netflix subscription has increased significantly in recent years. Finally, Netflix plans to phase in the price increase over the rest of the year, rather than introducing it in one swift move, so even if there is a churn effect, it’ll be spread out over three quarters.

The $2 price increase will likely cause the most churn among those with limited incomes. But the overall impact should be modest, perhaps a couple of hundred fewer subscribers per quarter over the rest of the year — something Netflix can easily absorb as it pursues those 40% margins.

Jan Dawson is the founder and chief analyst at Jackdaw Research, an advisory firm which covers the consumer technology market.

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