What you don't know about Netflix's price increase

Posted by Alex on January 17, 2019

What can we learn from netflix's pricing strategy?

Netflix raised prices $2 yesterday, and as a direct result, their shares added 6.5%. As a CEO, CFO, or controlling shareholder, wouldn't it be nice to do the same thing? Add $2 to prices and add $9.5 billion to your market capitalization? Move over Warren, I get the cover shot on Barron's this month. 

Netflix makes it look easy, but It's not that easy. 

Here's how Netflix did a successful price change–and lessons you can take directly to your business. 

Hard pricing lessons learned

Back in 2011, Netflix cut 75% off its share price and enterprise value with a bungled price change. By the time the dust settled 4 months later, between raising prices in some cases as high as 60% and trying to split streaming and DVD-by-mail into two entirely separate services (remember Quikster?) the stock had gone from a high of $43.54 to  $8.91. Apart from the horrible example Quikster set for the world (the New York Times did a postmortem if you're curious–"hubris" sums it up well), three lessons were learned.

First, one strategic decision at a time–or you won't have the data. Netflix entered uncharted territory with both a huge price increase and the split-up of their services. I'm sure their analysis was sound on paper, and I'm sure the price sensitivities were different across those segments, but doing it all at once meant that subscribers were now thinking about it, and when people think about things they act differently than if they aren't thinking (I'm serious). They had to think about Netflix and Quikster and that made people angry. To show that anger, they quit Netflix–to the tune of 800,000 people, the most significant subscriber loss ever. 

Second, in spite of what I said above–Netflix might not have known price sensitivity very well. A 60% price increase for a recurring consumer subscription violates our innate sense of fairness. It also goes well beyond where data is reliable. Just think about it–usually, you pay $5 for something. Now it costs almost $10. Does that sound different than, say, $5.50?  Bloomberg, famous for its high prices and consistent increases (it has raised prices every year since it began) has never raised prices by more than 10%. Combined with the perception that value was being taken away (separating Quikster) and inconvenience added (two logins, having to make a decision), Netflix set itself up for pain.  Getting the data right is critical, as is keeping price changes within the range where your data is meaningful.

Finally, Netflix marketed it terribly. It came off in the press as something Reid Hastings thought was best for Netflix–not for its customers. Customers, therefore, rebelled. For consumer brands with low friction to quit the service, it's not a winning strategy. 

How Netflix did pricing right in 2019

Fast forward to the present. Netflix learned from its mistakes of the past, and successful price increases since, executing this one brilliantly.

First, it was only a price increase. No funky marketing, no new brands or products, or any other noise to invalidate the data. No major consumer thinking or decisions needed to be made.

Second, Netflix got the data science right and kept the price increases limited. Massive investments in data warehousing, machine learning, and analytics capabilities make doing that science possible. According to LinkedIn and Paysa, Netflix employs 205 Data Scientists who earn an average of $272,087 per year (some, up to $386,615). So they could decide on a $1 increase with confidence. Though that price increase of 18% may sound like a lot, that increase was reserved only for the premium plan, which almost by definition has less price sensitive customers–and was only $3. The cheapest plan only increased by $1–from $8.99 to $9.99–and it had never had a price increase before. Raising the price by "one dollar" sounds reasonable to most consumers. 

Finally, Netflix marketed the price increase in a customer focused way: the price increase would fund more great content for their customers. The reality is cost probably had nothing to do with this decision. Netflix has been spending billions on content for years, without price increases. More likely the new prices seem to be based on consumer willingness to pay. However, increasing costs and an improved service are a great way to justify the price increase. More value for customers is worth paying a little more. After all, Bird Box is getting all that great press now–for another $1? Sure. Why not. 

How you can do what Netflix did

Netflix makes it look easy: increase prices by a dollar or two, and add $9 billion to your enterprise value.  Ok, so it's not that easy, but here are a few ways you can replicate their success in your business:

1. Develop or acquire the data capability.  Netflix spends over 55 million dollars a year on salaries for their data science team, plus likely tens of millions of dollars more on software and tools for them to collect and leverage their data. If that's a little outside of your budget, companies like Perfect Price  can achieve similar results with sophisticated AI and machine learning software, provided it's a fit for your business model. 

2. Understand price sensitivity. If you have only 3 products, like Netflix, this may be more straightforward. If you have over 1 billion prices, like Enterprise, Avis or Hertz, it gets more complicated–but it's still within your reach with new technologies. In fact in complex businesses with millions of prices, there is perhaps more to be gained by a price increase–and less potential for customer blowback.

3. Plan your messaging. In a dynamic industry like retail fuel, airline, trucking or car rental, you might not need to tell your customers. Simply raise prices by different small amounts, based on willingness to pay, and collect the surplus. In less dynamic industries you may need to be more cautious about how you message the change. Even if you do not plan on announcing the change, have your PR team ready to address questions. 

4. Make the change as limited as you can. Nobody wants to lose one million customers overnight–as Netflix did in 2011. Be sure you have the tools in place to understand the sensitivities at the levels necessary to make the change and be confident of what will happen. Do not make multiple changes at once: for example, adding a cut-price product or service while changing the prices of your existing service (as Netflix also did in 2011). 

What to do next

If increasing your enterprise value by $9 billion seems like it's worth pursuing, sit down with your executive team to brainstorm where you have the capabilities and where you need to add capabilities. If you are curious about what kind of an impact a pricing change could have, we'd be happy to discuss our proven backtest method that uses AI to simulate the change, just request more information here. Management consultants like McKinsey and Deloitte are also excellent resources if you don't have the capability in house. 

 

Topics: Consumer Behavior, Price Change Cases, Dynamic Pricing, Artificial Intelligence, Machine Learning, Price Test, Netflix, Price Change, Pricing Strategy, Pricing Best Practices