The Netflix Price Hike

Netflix customers got a nasty surprise this week, as the company announced a very substantial increase in the price of its services.  They used to offer unlimited video streaming for $7.99, plus you got one DVD at a time, by mail, for an extra $2 per month.  This is important, because not every title is available via streaming, and movies become available on disk long before they can be watched online.

Under the new price structure, which goes into effect for existing customers in September, the cost of the DVD by mail is rising to $7.99 per month.  That brings the price of streaming plus a disk to $15.98, instead of $9.99 – a hefty jump.

I used to have a Blockbuster Online account, but recently switched to Netflix.  One of the great virtues of Blockbuster’s service was that you could take your movies received by mail to the local Blockbuster store, and trade them in for free rentals.  You also got a coupon in the mail every month good for a free rental. 

Unfortunately, the brick-and-mortar Blockbuster stores closed down, with the last one in my area giving up the ghost a couple of weeks ago.  With the elimination of this benefit, Netflix and its excellent streaming service became more attractive.  (Among the many wonders of Netflix streaming, you can access it through any of the major videogame consoles, while a lot of new DVD players have wireless modems and Netflix software built in.  That means you can watch the streaming movies right on your TV, instead of your computer monitor.)

With this background in mind, when I got my unwelcome surprise email from Netflix, I wondered if the demise of their competition at Blockbuster might have been part of the reason for the rate hike, along with increased shipping costs to send out those DVDs. 

An interesting article at The Sundries Shack makes the case that a much more important factor is rising licensing costs from movie studios for the streaming video service.  Basically, because Netflix is competing with other companies, notably, for streaming video rights, the movie studios are dramatically increasing their licensing fees. 

How dramatic?  About eleven hundred percent over the course of the next two years.  A CNN report predicts the licensing fees for streaming content on Netflix will go from $180 million in 2010 to $1.98 billion in 2012.  Unsurprisingly, Netflix got sweet deals when it was pretty much the only big streaming video service.  Now that they have serious competition, the prices are going up.

But wait!  It’s the cost of receiving DVDs by mail that is increasing.  The streaming video service is staying at $7.99 per month.  What gives?

Well, Netflix can’t hike its streaming price by much, because it’s still locked in furious competition with Amazon, Hulu, and others.  The streaming video audience is only a mouse click away from switching to another service if displeased.  They appear have calculated they will lose fewer customers by increasing the DVD rental price (and they probably do have some increased shipping costs to contend with.) 

There must be some marketing psychology involved in figuring that happy streaming customers will grumble and pony up another six bucks a month to keep the DVDs coming, but they might switch online services if told they must pay more for streaming video.  The coming months will tell if Netflix has miscalculated.

In the long run, competition is likely to make the popular streaming video services more robust, and keep their prices low relative to each other, while the DVDs by mail will probably dwindle away.  Demands from these competitive companies should also begin pushing those studio licensing fees down, as the size of the streaming video customer base increases, and providers pressure the studios to reduce those licensing fees, so the growing market can be more vigorously exploited.

What if the studios decide to collude and keep cranking those licensing fees up?  The price of the streaming services would increase so much that customers would begin dropping away, and soon the weaker video providers would begin dropping out of the market.  Pressure would grow on individual studios to offer cut rates, and become the new darling of the video providers.

It’s an interesting example of how the market forces driving business decisions might be less than obvious to the consumer… but companies operating in a competitive market have enormous incentives to keep these forces from distorting the consumer experience too much.  It takes a while for market equilibrium to be discovered, especially when the ultimate customers for a service have access to technology that allows them to be incredibly fickle. 

Now imagine what a government-run video streaming service would be like, and how it would have reacted to the forces that drove the Netflix price hike.